Libra and Cryptocurrency Regulation – reuben
Nobody has ever accused Mark Zuckerberg of lacking ambition. On the surface, Facebook’s Libra is just another Bitcoin spinoff, or maybe an attempt to build a better PayPal by incorporating just enough blockchain technology to throw around buzzwords like “permissionless” or “stablecoin”. But the reality is not so simple, and the implications are enormous. Libra is truly living up to its historical scale imagery, as a great deal hangs in the balance over the next couple of months. If successful, this project could reshape the global financial landscape. If it fails, blockchain as a whole could suffer. And either way, domestic and international regulation will never be the same.
The (current) crux of this issue seems to revolve around what Libra can potentially do. This isn’t a PayPal or a Venmo where some level of KYC (often proxied via a bank account or debit card) is functionally required to participate in the payment platform. Rather, if Libra follows in the footsteps of other cryptocurrencies, wallets (accounts) will be easy to generate, and throwaway/burner wallets will be common. Historically, this will lead to an environment where a user will be able to transfer value from one online wallet (account) to another without much in the way of KYC. If their full vision is realized, individuals will be able to exchange fiat currency for Libra either online or at brick-and-mortar establishments, and then the individual tokens will flow unchecked around the Libra ecosystem. Depending on how Libra is implemented, particularly around the fiat gateways, this can cause some major headaches for lawmakers. Just a highlight of some of the open questions and regulatory concerns include:
1) What will the entryway into Libra look like?
Cryptocurrencies in general are a strange beast. Bitcoin, inarguably the prototype, is designed to be as open as possible, to the point of including the ability to generate an offline wallet so even those without reliable internet access can interact with the network. The end result of this was a landscape dotted with wallets of unknown ownership. More recently, a combination modern forensics and increased regulation has managed to make considerable headway in pulling back the curtain.
A key realization here was that regulating the gateways does a lot to regulate the underlying cryptocurrency.
Despite the popularity of crypto as an investment and/or a store of value, the world has seen very little in the way or real use cases. Functionally, this means that most individuals will, at some point, want to turn their tokens back into their native fiat currency. Many governments, including the US, have taken an approach that (very broadly speaking) allows for most cryptocurrency-to-cryptocurrency transactions to fly around freely (that is, from untracked wallet to untracked wallet), choosing instead to require KYC only at the exchange points. This gives a fairly complete record of when and how much value is being liquidated for some functional use, which is a (possibly the) fundamental concern. The question, then, is whether Libra will choose to follow this example. While Facebook has stated that they plan to comply with AML/KYC regulations in all jurisdictions, open questions remain.
What happens, for instance, if the majority of Libra initially flows through a small number of gateways, but then diffuses into the larger market? If anonymous wallets are allowed to exist, regulating the exchange points may not be enough. If I go through KYC and buy Libra with my credit card, and then send it to an anonymous wallet, which then sends it to another anonymous wallet, regulators have no way of knowing whether either of these wallets are owned by me, or by someone else. If those anonymous wallets send Libra to a terrorist organization, it’s unclear whether that was outside of my control, or at my direction. One extreme method for rectifying this would be to require KYC to even get a wallet. This would put a serious damper on adoption, but would also offer the most transparency (although likely not full transparency) into which hands this currency is passing through. We don’t have enough details at this point to know what these gateways will look like, but how they are set up—and what regulations are attached—will have a tremendous effect not only on how Libra is used, but on how digital currencies will be regulated moving forward.
2) How can regulators limit the illicit activities enabled by a virtual currency?
Throughout human history, many illegal activities have been facilitated by currency of some kind, from back alley cash deals to huge money laundering operations. Virtual currency, however, poses new threats in the form of anonymity, immediacy, and secrecy. For the first time, humanity is seeing a financial ecosystem that can be housed entirely under the control of a private actor. This actor can build their coins to be entirely anonymous if so desired, and the use of these coins can (in theory) be kept completely secret from the state.
If I create a digital coin and convince enough key people in my life to accept this coin as payment, such a proto-money system can thrive without anyone outside of my network ever knowing.
If I were more ambitious, I could theoretically expand this network overseas, and finance less-desirable activities or purchases. This is the principle behind many black markets that run on Bitcoin — the Bitcoin doesn’t ever need to be cashed out once it’s in the system. Even without an exchange, a seller will accept Bitcoin as payment so long as they can (or believe that they will be able to) then use their Bitcoin for other purchases and transact with other sellers who hold the same expectation of being able to later ‘spend’ it. This is how fiat currency works: there is rarely an inherent value, the system is kept afloat entirely by the trust of the participants. And just as most fiat currencies are capable of thriving in a closed system (i.e. a country), digital currencies can do this, as well.
Regulators have a healthy fear of such sub-networks forming and thriving, and the more widely-adopted a pseudonymous currency is, the greater the chance of this happening. In a lot of ways, the worry seems to be more about Libra’s ability to bolster wider adoption than anything else. Compared to other cryptocurrencies, Libra is incredibly centralized, with surprisingly strong levels of planned KYC (according to their testimony to Congress, the accuracy of which remains to be seen). When what we know about Libra’s technology and protocols are pitted against those of, for example, Bitcoin or Ethereum (or any other decentralized project), it’s clearly a subpar choice for the sophisticated criminal. But the tech and protocol are only half the story, and what Libra has going for it is everything that comes along with adoption. There’s an inherent UI hurdle present with most decentralized tokens, and this has done a lot to chill mainstream use and functionally restrict some types of criminal behavior. But adoption brings trust; the same trust that we have in fiat currency. This trust could allow Libra to carve out black markets of its own, while simultaneously opening the doors to new bad actors who are led to the more troubling Bitcoin (or other) black markets.
3) More importantly — which regulators will even have jurisdiction over Libra?
One of the most fascinating aspects of cryptocurrencies is their ability to fall outside of most, if not all, jurisdictional bounds. Much of this is due to their decentralized nature — without any single entity to hold accountable, decentralized currencies exist both everywhere and nowhere at once. Libra is slightly different in that Facebook, a US corporation, is the clear origin of Libra, and they’ve chosen to house The Libra Association (the ‘governing’ member body) in Geneva, Switzerland. This may offer both legal persons for assigning liability (The Libra Association and Facebook, Inc.) and jurisdictions (Switzerland and the US) for rectifying injury (if appropriate). What is unclear, however, is who can actually regulate these known entities. A privately-issued currency is not something that the world has had a lot of practice dealing with, so regulators are scrambling to find their footing. Calibra isn’t really a bank; nor are they an investment firm or a true money transmitter. If anything, they may end up doing something closer to selling their private currency as wholesalers. Who regulates this activity? Facebook says that they will be regulated by Switzerland, but is this enough to make other lawmakers back off?
Things get even more complicated when the global nature of Libra is considered. By offering a wallet as a sub-feature of other popular Facebook products (whatsapp, messenger, etc.) as well as in standalone app form, Facebook is inviting worldwide adoption. Unfortunately, many jurisdictions are unprepared for the mass adoption of a digital currency. Some don’t have any plan whatsoever, and a surprising number of countries — the US included — are still lacking comprehensive laws that give unambiguous guidance. Additionally, many US states have enacted laws that are likely to be challenged by the federal government, further slowing down what is already looking like a long and convoluted process. Before it’s too late, the US will have to decide whether to attempt to regulate the currency at the company level (an option with a ticking clock) or at the consumer level (which leaves much out of their control), or whether they should take a different approach altogether. Meanwhile, every other country is going through similar calculations. The only common ground is that nobody knows the best path forward.
Ultimately, the answers to a lot of these questions depend heavily on how well-received Libra is by the general public. Outcomes could range from a brand-new financial paradigm to just another rarely-used Facebook product that has invisibly implemented blockchain to verify user payments. However, regardless of the success of Libra in particular, these issues are going to be coming up sooner rather than later. We need clear and fair regulatory guidance, and the only way to achieve this is through neutral, open discussions between lawmakers, academics, and technologists. To facilitate these critical conversations, RegTrax, a new initiative from the CodeX Stanford Blockchain Group, hosts an unbiased forum with the hope of bridging these gaps. As Libra blazes the trail, we will be following along with any new developments concerning the larger blockchain space, and offering our own insights as we learn more. Check back often for more news, updates, and discussions, or learn more about Libra via their white paper.
Published at Mon, 22 Jul 2019 16:06:01 +0000
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