Now that the dust has settled on Facebook’s Libra announcement, it is time to take stock. The Menlo Park-based company’s move into blockchain has received an enthusiastic welcome from the crypto community. , which has lurched from one scandal to another in recent times.
That is understandable. Much to the chagrin of its proponents, the crypto ecosystem and blockchain have become a subject of derision and criticism in mainstream press. The entry of a tech powerhouse provides the field with validation and a legitimacy of sorts.
For Facebook, cryptocurrencies could help stabilize a swaying ship. Blockchain’s decentralized and trustless structure might make the public trust it again.
There’s also the monetary consideration. The social media network’s growth in North America and Europe has plateaued. A crypto-enabled payment services platform in emerging markets could help transform its business and commence another period of phenomenal growth for the company.
That, anyway, is the goal. But the pathway to that goal is fraught with problems. Here are four of them.
Facebook’s Blockchain is Neither Decentralized Nor Permissionless
The typical blockchain is a decentralized system consisting of a series of databases connected to each other and containing blocks of transaction data. But Facebook’s whitepaper describes its system as a “single data structure that records the history of transactions and states over time.”
It does not conform to the decentralized ethos of standard cryptos in which anyone can download software and fire up a node to mine a coin. Transactions on the Libra blockchain will be recorded and approved by a series of validator nodes run by members of the Libra Association, the Switzerland-based nonprofit that governs the cryptocurrency.
The association, which is a diverse mix of payment processors, e-commerce companies, and non-profits involved in bringing banking services to the poor, has stringent criteria for membership.
For example, businesses aspiring to become members must have $1 billion in market cap or $500 million in customer balances on their platform. For MasterCard and Visa, both of whom are members, the amount is chump change. But it is an expensive investment for small- and mid-size businesses interested in having a governance say in Facebook’s cryptocurrency.
The entryway for nonprofit groups to the association is similarly narrow. Those interested in working with the association (and helping Facebook’s purported mission of providing financial services to the unbanked masses) must have an annual operating budget of greater than $50 million. That requirement rules out a significant chunk of nonprofits with small budgets.
In effect, the Libra Association is a centralized collection of established behemoths and nonprofits interested in the benefits of marrying Facebook’s network data with payment services. During a conference call with online publication The Information, Jerry Brito, Executive Director of Coin Center, also questioned incentives for existing association members to move from a permissioned system, in which they earn interest from Libra’s reserves of government securities and bonds, to a permissionless system of declining returns due to a dilution in stake because of widespread distribution in Libra tokens.
Facebook’s Proof of Stake Algorithm Could Cause Problems
Facebook’s whitepaper estimates a timeline of approximately five years to make its blockchain permissionless and allow anyone to run a node on its system. But it is not clear if running a node might turn out to be a wise and cost-effective decision.
The governing consensus mechanism for Facebook’s blockchain is Proof of Stake. In this type of consensus, invotes for critical decision-making among nodes are decided based on the number of tokens staked by a given validator node. For example, if business A has a greater number of tokens staked as compared to business B, then A will get more votes than B in decisions. Big businesses, which have the resources and capital to accumulate tokens, are naturally at an advantage over small businesses and individuals.
The economic incentives of running a node on Facebook’s blockchain are also not clear. The technical requirements document states that self-hosted validator nodes (or nodes that are run in a data center by association members) must have a full-time site reliability engineer to maintain software and an assortment of security defenses to guard against hacks. All of these amount to a tidy amount of money.
Nathan McCauley, co-founder and CEO of digital asset custody provider and Libra Association member Anchorage, said those costs will “likely” be low in the future, in line with the current costs to run an Ethereum node. Available anecdotal evidence, however, points to a different story.
As numerous articles have already documented, mining Ethereum, which currently uses Proof of Work algorithm, consumes massive amounts of energy and requires specialized mining machines. likely then that the Libra token will be profitable only when it is produced at scale in data centers assigned to the task.
The Facebook Privacy Problem Still Exists
Privacy has been Facebook’s nemesis for most of its existence. The social media behemoth has landed itself in hot water time and again for playing fast and loose with user data. Blockchain promises transparency and accountability.
Within the Facebook ecosystem, however, those buzzwords may not amount to much. While the Libra blockchain is open-source, the Calibra wallet is a closed system. Put simply, developers will not be able to see its code or ascertain the provenance and destination of transaction data associated with the Libra token in the wallet.
In past conversations with journalists, Facebook has pointed to other Libra activities – the nonprofit foundation and its commitment to an open source blockchain – as proof that it is serious about transparency and privacy. But the company has a record of reneging on its promise.
The other problem with Calibra is that its wallet is custodial, meaning that Facebook will be responsible for custody of Libra tokens. Facebook will hold the private keys used to unlock access to the cryptocurrency and, consequently, will own the tokens.
In Facebook’s defense, several popular exchanges, including Coinbase, are custodial. Custodial wallets are risky because they transfer ownership of the tokens from an individual to an exchange. The owner essentially outsources security of their coins to the exchange. As numerous hacks and scandals within the cryptocurrency ecosystem have shown over the years, that is not always a safe option.
Facebook has promised to refund investors if there are hacks. But that is small consolation for investors who may have staked (or held the crypto for a long period of time) their coins.
Global Regulatory Challenges
The scale of Facebook’s operations means that regulatory problems will continue to multiply for the social network. The company has already had conversations with regulators in the US and UK about its token. But the application of existing security laws to cryptocurrencies and blockchain is unclear. This means that Facebook could face even more challenges from authorities down the road. Some, like France and Germany, have already struck warning notes. Democratic Rep. Maxine Waters from California has asked for a moratorium on Facebook’s plans to develop a cryptocurrency “until Congress and regulators have the opportunity to examine these issues and take action.”
Coin Center’s Brito also points to other challenges. For example, will investors in Facebook’s “low-volatility” cryptocurrency token have to pay a capital gains tax when its price appreciates? Facebook has already marketed another token – Libra Investment Token – as a security to private investors. Whether Libra, the cryptocurrency, is deemed a security remains to be seen.