Congressional Libra Hearings Show It’s Tough to Innovate on Compliance
Facebook made waves with its recent announcement that it plans to launch a digital currency system called Libra. The proposed payment system combines features of centralized service providers and federated blockchain-like value transfer to bring more people into the digital financial fold (and hopefully keep them on Facebook in the process).
The social media giant has teamed up with dozens of founding “Libra Association” partners, including Visa, Uber, and Andreessen Horowitz, to build the Libra network, which is slated to launch in 2020.
While the system is as yet merely an idea, the regulatory interest it has generated is real and substantial. Libra project lead David Marcus faced two tough days of congressional scrutiny where he was grilled on topics like privacy, anti-money laundering rules, securities law, monetary policy, and even the programming language Rust.
The hearings were uneven, with some lawmakers taking the opportunity to ask thoughtful questions on the regulatory contours of this proposed technology while others unfortunately adopted a reflexively hostile posture to any new development on the Libra project.
Here are a few of the standout takeaways from this week’s testimony marathon.
Is It Better to Ask Forgiveness than Permission?
Let’s start with the bad news. Entrepreneurs watching these proceedings may come away with the message that when it comes to launching disruptive technologies, it is better to ask for forgiveness than permission.
Working with Congress does not appear to generate much goodwill. From the start, Facebook has touted its intentions to work with lawmakers so that the Libra network will pass regulatory muster. In fact, its general white paper boasts that Libra will not only be compliant, it will “[innovate] on the compliance and regulatory fronts to improve the effectiveness of anti-money laundering” and other existing rules—it wants to be super-compliant.
Perhaps this submissive posture is necessary for a large company like Facebook, which is no stranger to data and content controversies. Regardless, the general tone of this week’s congressional hearings suggests that such attempted good deeds will not go unpunished.
Rather than reserving their time to ask questions to better understand Libra’s design and intentions, many lawmakers demanded that the project be paused or shut down.
House Financial Services Committee Chairwoman Maxine Waters pressed Facebook to “agree to a moratorium on any movement going forward on developing a cryptocurrency” until Congress is appeased.
The day before, Senate Banking Committee ranking member Sherrod Brown opened his statement asserting that “Facebook is dangerous” before later emphasizing that Congress would “be crazy to give them a chance to experiment with people’s bank accounts” or to let them “use powerful tools they don’t understand.”
But Rep. Brad Sherman perhaps took the cake on congressional threat inflation with his assertion that Libra could end up doing “more to endanger America” than 9/11.
For his part, Marcus reiterated to his inquisitors that Libra would not launch until all concerns are addressed. Is this wise? It may be impossible to “address all concerns” in a way that would please lawmakers, especially given many of their bombastic and often off-the-wall statements about the project. (Of course, committing to “address concerns” is not the same as committing to resolve them.)
Such aggressive congressional posturing may ultimately encourage other innovators to simply deploy first and worry about the fallout later.
Many Lawmakers Understand the Distinction between Permissioned and Permissionless Systems
As mentioned, much of this antagonism comes from the mere fact that it is Facebook that is launching Libra. Would, say, Google have invoked such a response if they took up the same project? I think yes, and the reason is Libra’s planned structure.
As mentioned earlier, Libra is not a “blockchain-based cryptocurrency” in the traditional sense, although it is planned to employ concepts from those technologies like cryptographic proof and shared consensus.
Rather, Libra is planned to be a “permissioned system,” which means that only a select few entities—called the Libra Association—will be allowed to run the network and approve transfers. If it was called the “Google Pay Association,” it would create the same trusted third party (and therefore regulation) problem.
This is in contrast to a “permissionless system” like Bitcoin, where anyone in the world can connect their computer to run the network and validate transactions. Permissionless systems are thus robust in terms of security and “censorship resistance,” since no one or group of parties can successfully target or block transactions.
Libra says its initial permissioned structure is necessary to achieve the scale they want. But they seem to recognize its downsides, and hope to transition to a fully permissionless structure in the future.
That may or may not happen. But for now, designing Libra to be permissioned means that regulators can target a discrete group of validators. Permissionless systems provide no such regulatory targets.
Many in the cryptocurrency community were worried that policymakers may group all cryptocurrencies together with Libra and target policies towards them that don’t make sense.
Fortunately, this does not seem to be a threat. Bitcoin rarely came up during the hearings at all, and when it did, it was often to distinguish the technologies. Many policymakers seem to understand that Libra validators will have discretion in a way that, say, the Bitcoin network does not.
Rep. Ted Budd in particular seemed to have done his homework, calling upon his colleagues to “differentiate Libra and [other cryptocurrencies] like Bitcoin” when considering new rules. (Later testimony by cryptocurrency expert Meltem Demirors provided an excellent primer for those still in the dark.)
Libra’s Structure Raises Unique Regulatory Questions
It makes sense that Libra’s permissioned design invites regulatory scrutiny that competitors like Bitcoin do not. Because permissioned validators have more discretion over which transactions to validate, they can act in ways that affect users that Bitcoin validators cannot.
Take, for example, anti-money laundering (AML) regulations. Libra believes that AML rules, which require financial entities to maintain certain customer data, will only apply to the “on-ramps and off-ramps” of the network—meaning things like wallet providers, one of which is Facebook’s own “Calibra” offering.
This is how it works with permissioned systems; wallets and exchanges undertake AML compliance. But the Bitcoin network can’t discriminate against transactions, it is a neutral network. A permissioned system like Libra has more discretion, so policymakers may expect the Libra association, and not merely wallet providers, to exercise it.
A related, but opposite, line of inquiry concerns privacy. Many lawmakers fear that Facebook will use Libra to hoover up more user data for ad monetization. Facebook formed the separate Calibra entity for this reason. It hopes Calibra will establish a firewall of sorts between Facebook advertising and its wallet service.
If Facebook’s description of Libra is accurate, then it does not seem that monetizing user transaction data like critics fear will be a big problem—Facebook account data should not comingle with Calibra wallets. But if the Libra Association is compelled to maintain AML data on the network level, that creates another privacy risk in the form of potential breaches.
Then there are the financial questions. Libra differs from Bitcoin in another important way. Bitcoin’s value is not “backed” by government currencies or securities, its value is determined by market activity given the age and security of the network.
Libra, on the other hand, is a “stablecoin,” which means that it is managed so that the value hopefully remains stable and backed by a basket of currencies and assets. These assets will be kept in a bank and managed by a group called the Libra Reserve, although Libra coin holders will not be able to trade in their currency for the assets that back it.
Facebook maintains that Libra will not engage in monetary policy since Libra coin units will simply be created when a user purchases them and destroyed when a user sells them. Marcus also stated that Libra does not consider itself a security or an ETF, although it looks a lot like those things, but rather a pure payment system.
Regulators will probably disagree. Already, the Federal Reserve and US Financial Stability Oversight Council is examining whether Libra will be financially stable. The Securities Exchange Council, which has taken a famously conservative approach towards cryptocurrencies, is weighing whether Libra fails the “Howey test” that determines which assets are subject to securities law. Former Commodities Future Trading Commission chairman (and hearing witness) Gary Gensler testified that Libra “looks like an investment vehicle and that Libra may even resemble some banking structures.”
Again, these regulatory questions only arise because Facebook made the decision to design Libra as a centrally-managed reserve system, federated and monetarily-neutral though it may be. “Unbacked” cryptocurrencies like Bitcoin raise no such regulatory questions.
“Innovation Not Welcome Here” Is an Unhelpful Posture
It is understandable that the Libra project has received so much scrutiny. The fact that Facebook is behind it, plus its unusual permissioned structure, creates many questions about the project’s design, privacy policies, and intentions. Some lines of questioning shed a bit more light on a quite muddy concept.
Perhaps Libra’s structure will indeed run afoul of established regulations, and changes will need to be made. This is a predictable outcome of Libra’s decision to retain centralized authority over transaction validation and reserve management within a hand-picked consortium. Fortunately, it seems that many lawmakers understand that permissionless systems like Bitcoin are not subject to these rules because of their designs.
But regardless of the merits of any outstanding regulatory questions, the hostile posture that many lawmakers adopt towards new innovation is unfortunate. Even when companies show openness to work towards compliance, some lawmakers will succumb to the temptation of obstruction. With “partners” like these, who needs competitors like WeChat Pay?
The subtext here is that American lawmakers risk losing doubly. First, a hostile posture to innovation may scare entrepreneurship from taking root in US soil. What’s worse, the innovations that do spring forth elsewhere may not harbor the values and norms of the US. Lawmakers are chasing away possible allies at their own peril.
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