Weekend Reading #23
This is the twenty-third weekly edition of our newsletter, Weekend Reading, sent out on Saturday 29th June 2019. To receive a copy each week directly into your inbox, sign up here.
Is Libra the West’s response to China's payments empire?
The recent announcement of the Libra consortium, distributed ledger and currency initiated by Facebook has led to much discussion and debate.
Some view it as an extension of the surveillance capitalism model of Facebook. Others view it as a pipe dream that can’t possibly work. Having dug into the technical details and the wider global changes with which this intersects, we believe there is potential for Libra to change the world – in ways most don’t expect.
A coin and a chain.
To start out, it is worth noting that there are 3 major elements to the proposal with very similar names.
1. The first of this is the Libra coin, which represents a basket of sovereign bonds and similar instruments.
2. The second is the Libra infrastructure, which is a distributed ledger secured by the various participants in the Libra ecosystem (known as validators).
3. Finally there is Calibra, a theoretically walled-of subsidiary of Facebook that’s building an interface for Facebook users to be able to use Libra.
The Libra coin has attracted much of the attention, as that is the popular understanding of what a “cryptocurrency” is. This is also what has alarmed regulators as it appears that, if successful, this might take monetary sovereignty away from countries as an alternative currency becomes available, not subject to central bank policy.
This fits with much of the language around the launch – that of banking the 1.7 billion unbanked and bringing a stable alternative to them. This has been pitched in a similar vein to classical crypto, not fitting within existing regulations per se, but looking to create a driving force to mold and change them as we have seen with the popularity of Bitcoin and other crypto-assets.
Of course, regulatory arbitrage is nothing new for tech giants, especially those that “move fast and break things”, but there is a question mark over what Facebook actually intends to do, as it appears that the regulatory hammer may be falling upon them due to nefarious use of their existing network. This is where the composition of the Libra consortium and the infrastructure they will be building becomes interesting.
While distributed ledgers come in all shapes and sizes that can befuddle even the most technically-adept individual, the best way to think of these is as a shared, virtual, computer run by lots of other computers (nodes). There is an application layer where the virtual computer does certain things, from something as simple as addition, to running entire applications, a networking layer to communicate changes in the virtual computer to other nodes and a consensus layer to make sure they’re all on the same page.
Libra is similar to Bitcoin, Ethereum and others in this regard, but does some things quite differently. Rather than burning energy in “Proof of Work” to ensure every node is on the same page and there are no nefarious actors, it uses a mechanism that requires two thirds of a set of validators, the consortia members, to be honest in order for transactions to be settled and finalised.
The specific implementation of this is an adaptation of a well known mechanism known as Tendermint and the test network and initial code that we have point to a network that has been designed specifically to transmit tokenised value and steadily gain more and more validators to decentralise further.
This is what’s behind Facebook’s comments that it will be only one of a hundred voters in how this develops, making it not a “Facebook” chain, but shared infrastructure. This is also why we see a range of participants already, from the likes of Visa and PayPal (who would seem to be threatened by this), to eBay and Uber.
But why decentralise?
To understand why Facebook has set things up in this manner, we need to look at how their business model has evolved and the growing threats to it.
Facebook looked to map your real world social network, extend it and monetise through serving you appropriate ads inserted into the news feed that captured your attention. As the population moved to mobile, Facebook also tilted, with 92% of its advertising revenue from mobile in 2018 versus 11% in 2012.
As Facebook looks forward, there are moves to break up its monopoly on our eyes, as the network has been used in deeply political ways and there are concerns over the centralisation of data that they have.
It is also topping out on growth as its growth markets are in areas such as India, where average revenue per user is a tenth or less of that of a Western consumer, and advertisers have much smaller revenues. Libra is a direct response to this, as it extends the strategy of native payments that we have seen emerge on Instagram.
A Libra infrastructure with on-ramps across the world would allow Facebook, via its Calibra subsidiary, to start monetising its users in ways that don’t necessarily involve advertising and in ways that do not actually compromise user privacy. This is because the actual number of data points needed to target an individual is quite low, with Facebook’s treasure trove of historical data allowing it to know you better than you know yourself with just a few indications.
This repository of big data analytics and understanding of human psychology can be used to connect users of Calibra and the associated infrastructure to valuable products and services without necessarily connecting them to their Facebook profiles and/or mining that user specific data.
Indeed, with regulations like GDPR coming into force, Facebook has realised that user data is increasingly being pushed out of silos and under the purview of the user themselves. Facebook is looking to take advantage of this with its new strategy, escaping the impending regulatory hammer as responsibility is devolved down to the individual and local partners, away from Facebook for managing user data. The Calibra infrastructure will be the easiest to use, lowest friction on ramp to the emergent ecosystem and it is looking to aggregate demand for financial products and value in this manner to increase its addressable market and revenue per user.
Going under the hood.
To see how it can do this, we can dig further into the technology and understand that Libra has been set up by taking the best bits of many existing distributed ledgers to create an optimal system for distributing value.
The Libra coin is the first asset to be issued on the ledger, which has a programming language that is more expressive than Script (Bitcoin), but not as open-ended and potentially insecure as Solidity (Ethereum).
This sets the basis for programmable money, something we alluded to in our Future of Asset Management piece, where, using the latest in privacy technology, transfers of value of arbitrary assets can occur with only the minimal amount of information needed being exchanged. This sets the basis for a dramatic expansion in capital fluidity, as more forms of collateral become available.
While faster than Bitcoin and Ethereum at 10 transactions per second, the initial 1,000 transactions per second of Libra also sounds low versus Visa in the thousands and Alipay in the hundreds of thousands. However, the nature of the infrastructure means that each of the validators could potentially run their own sub networks using the same consensus algorithm that are compatible with the main network. This means that Calibra or Visa could theoretically run their own, faster or customised instance and an asset on Calibra could migrate via the main Libra chain to Visa with an assurance that it is a unique Libra coin, tokenised equity or other asset.
This is important as the interoperability and adaptability are what could make this consortium work, mirroring in some ways the evolution of Visa in the early days.
As the data structures are defined and have been made relatively open, we can expect a repeat of the expansion of an ecosystem we saw with other Facebook open source software such as React, a framework that enabled thousands of app developers to easily develop for Android and iOS at the same time.
In particular, we expect local providers and infrastructure to develop in each country where Facebook and its consortia partners operates, accelerated by the potential of accessing billions of customers and Facebook’s 7 million advertising clients.
Enter the competition.
But why is this important and why bother with a distributed ledger? Centralised systems such as Swift will always be faster than decentralised systems due to the overhead inherent in replicating activity across multiple parties.
The advantages in general are the ability to minimise the need to trust counterparties, censorship-resistance in the case of Bitcoin and a few others and a level of standardisation of data types for most consortia-type distributed ledgers, making everyone’s life easier.
In the case of Libra there is a more pressing concern and that is the technological excellence of the associations Chinese counterparts.
Alipay and WeChat Pay now transact larger dollar volume than Visa and Mastercard combined at hundreds of thousands of transactions per second. Each of the digital RMB that are bouncing back and forth is backed by a real RMB at the Central Bank of China, as of last year. These groups have aggressive expansion and distributed ledger plans that will effectively export the Chinese payments ecosystem out of China, where saturation points are being met in many areas. This is the digital analogue (pardon the oxymoron) of One Belt One Road, augmented by Chinese advances in mobile technology and AI.
The target market here is the same market that Facebook and its allies are targeting as their main source of growth from here.
The appeal of the Chinese ecosystem is clear for low and even middle income nations. It is battle-tested, works and could mean that your country is the recipient of Chinese state largesse or even a portion of the huge levels of Chinese citizen savings looking for returns. Against this, in developed markets the only real alternative is to take advantage of the culture of innovation to build a constantly evolving open ecosystem, as we saw with iOS, Windows or Android for example.
This also allows us to look at the discussions around monetary sovereignty in a different light. The reserve backing of Libra coin is to be determined, but the nature of the network means that it could be made so that as fiat, such Indian rupees, are exchanged for Libra, the Libra network turns around and buys that same amount of Indian government bonds, issued on Libra (new or tokenising existing bonds), which could even come at a discount to the market rate today. Any Libra user could suddenly buy those bonds too, as all of the friction has been removed, increasing the government’s ability to spend. The amount of tokenised bonds held on Libra could be dynamically adjusted to the total float of Libra within that country, meaning there is minimal monetary impact.
This type of approach shows how Libra could be a balancing infrastructure against Chinese tech expansion, but also embed the association in a regulatory-compliant umbrella that allows them to outcompete legacy players. This is why we see Visa, Vodafone (owners of m-Pesa) and others in the consortium, as it is better to be inside than out.
Change is coming.
We‘ve been saying for some time that the crypto space is about moving towards a common standard, echoing the evolution of the early internet with the rise of HTTP. Could Libra be the roots of such a standard protocol, one that's a compelling alternative to the Chinese payment behemoths?
Libra is still in its infancy and there are several changes that will likely occur before it goes live next year, if indeed it does go live in its current format. Some of the criticisms of the current iteration are valid, but there are some very interesting elements that could lead to a profound change in the status quo and some solid technological underpinnings behind it.
Here at Three Body Capital we look forward to tracking this and other potential structural shifts. If Facebook can pull off its grand vision, we look forward to building on Libra as it will make our lives, and those of many others, much easier.
What we're doing.
Last week it was Poland. This week it’s Indonesia. We’ve been in Jakarta meeting potential partners and clients. As ever, it’s been a hectic trip with back-to-back meetings – now there’s a first world problem! It’s great to be back in South-East Asia, where the energy, optimism and good humour of the people is contagious, especially when you compare it to the downbeat atmosphere back in the UK. We’re currently enjoying a brief stopover in Singapore for further meetings (and family time) before heading back to Camden HQ next week. Thankfully, the weather forecast for London is looking a little less hot and humid than Jakarta... but not much!
What we're watching.
On the flight over we watched a wild documentary on Netflix called “Bob Lazar: Area 51 and Flying Saucers”. The documentary features a scientist named Bob Lazar who famously came forward in 1989 to do a TV interview in which he claimed to work on reverse engineering a captured alien spacecraft. The documentary is great fun. There are plenty who believe that he’s not a credible source, but there are definitely some mind-blowing aspects of what comes to light from this documentary. As kids (and even now), we were filled with an intoxicating sense of mystery anytime the possibility of alien life seemed even marginally more possible, and this is 40 minutes of pure incremental possibility. Life’s big philosophical questions – what is life, what does it mean and how did we get here? – are all triggered by this seemingly speculative (initially) piece of filmmaking. Maybe we’ll write about that another time!
What we're reading.
It was a spectacular week for bitcoin, with the price breaching $13,500 and then dramatically falling back to $10,500., only to swoop back up over $11,500 at the time of writing. There are plenty of skeptics on what bitcoin has to offer the world, but we believe that the speed and extent of this rebound is particularly instructive after what most had written off (and still do) as the latest incarnation of boom and bust in asset speculation. While bitcoin’s volatility can be frightening and distracting to traditional investors, we urge investors to rather focus on the long term performance. We reiterate our belief that readers should educate themselves about bitcoin and be open to the possibility that it could be a small piece of an investment portfolio. Given the uncertainty now surrounding the reach and policies of global central banks and its implications for currencies, bitcoin can possibly be presented as an escape valve from the existing financial system. We have lots of reading we can recommend but this week we urge readers to have a look at this piece written by Travis Kling, CIO of Ikigai Asset Management.
What we're listening to.
Another week, another podcast. This time it’s The Spectator’s Freddy Gray interviewing the indomitable Michael Wolff, author of Fire and Fury, the now infamous study of Donald Trump’s early presidency. This is just one in a series of in-depth discussions on American politics with the best pundits stateside, offering a broad mix of guests and perspectives. This particular exchange is SUPER interesting. The pair meet a London hotel to talk about the Mueller Report, the influence of Steve Bannon on Trump, and how Trump and Boris Johnson aren't the same political character. Wolff also shares some thoughts on the USA’s changing attitude towards China, which plays into our core investment them, “The Great Game”. As China’s economic and political influence continues to expand globally, America will be forced to change its approach to this great power – with implications for countries everywhere.