Facebook’s proposed cryptocurrency, called Libra, is generating some spirited discussion, to say the least.
To some, Libra could replace those crumpled green bills in your pocket and help Average Joes seamlessly send money from one continent to the next, even without a bank account. In terms of disruptive potential, it could impact consumer spending habits the way Netflix has changed consumer viewing habits.
To others, namely policymakers and technologists, Libra’s risks may be too high for myriad reasons. Plus, given Facebook’s record with user privacy, it could result in consumers having their personal data monetized for the benefit of Facebook and other tech firms. (For perspective, Libra hasn’t even launched yet, and scams involving it are popping up all over the internet.)
But one thing seems clear: Libra’s poised to shake things up. But what the heck is Libra, and how does it compare to the most well-known cryptocurrency system, Bitcoin?
THEY USE THE BLOCKCHAIN DIFFERENTLY
Libra and Bitcoin are built on a backbone known as the blockchain. Basically, this means both Bitcoin and Libra store transactions in a giant, ever-growing digital ledger that’s distributed across a network of users. When you spend or receive either currency, that transaction must first be validated by those across the blockchain. After a transaction is approved, all the pertinent information about that transaction is encrypted in a block that is added to the chain linking every other transaction that came before it (hence the name).
Once information is on the blockchain it becomes permanently and publicly available to anyone connected to the network, meaning no single entity (like a bank) controls access to the data. How Bitcoin and Libra validate their transactions, however, is different.
Bitcoin: To verify a bitcoin transaction, participants on a network race with each other to solve a complex mathematical puzzle that requires massive computing power. The first person to crack it and prove their math is correct earns a little bitcoin as a fee, and that transaction is added to the blockchain — success! Any person, so long as they have the right equipment, can validate bitcoin transactions. Bitcoin mining operations can range in size from a single computer in a college dorm room to massive warehouses filled with thousands of computers running 24/7.
Libra: Solving all those puzzles consumes a ton of computing power and energy. By one estimate, the Bitcoin network consumes as much energy annually as the Czech Republic.
Libra would make the process more efficient by granting validation permissions to a 100-member (there are 27 right now) non-profit organization based in Switzerland, known as the Libra Association. The founding members include large, well-known companies such as PayPal, Visa, eBay, Uber, Spotify and, of course, Facebook. Together, these companies would pitch in at least $10 million each to buy bonds and currencies that would back Libra (more in the next section). They’d use technology to host virtual libra wallets and validate transactions. When libra needs to be created, these founding members would create more libra. When libra needs to be taken out of the system, they’d destroy it. This network of validators, in turn, gets to keep the interest that’s generated from assets that back libra’s value.
Libra, therefore, would be similar to traditional payment processers like Visa or Mastercard: When merchants who pay to access a credit card network accept payments from a customer, that payment goes to the business owner’s bank. The bank sends that info to Visa or Mastercard, which then validates the transaction and charges a small fee for each transaction settled on their network.
THEY BASE THEIR VALUE ON DIFFERENT THINGS
Bitcoin: Bitcoin is entirely removed from global currencies or hard assets and is simply a peer-to-peer network that doesn’t require policing by policymakers or banks — that’s its appeal. Therefore, Bitcoin’s underlying value is simply based on its trading activity on cryptocurrency exchanges. That’s partly why Bitcoin is such a volatile asset: A single bitcoin reached $19,000 in 2017 and dropped to roughly $3,200 a year later. Because it’s so volatile, it isn’t very easy to purchase stuff with it. How much bitcoin do you charge for a sweater if the price of bitcoin relative to the dollar can fluctuate 10, 20 or 30 percent in a single day?
Libra: Volatility is what Libra aims to solve for. A libra’s value would be pegged to a basket of low-volatility bonds and currencies from all over the world, which would stabilize its underlying value — hence why it’s known as “stablecoin.” Therefore, the value of libra would rise and fall with the value of the bonds and currencies that back it. Since those assets tend to be more stable, you wouldn’t expect to see huge swings in libra’s value from one day to the next.
ONE WOULD LIKELY BE REGULATED, THE OTHER ISN’T
Bitcoin: It’s sort of the Wild West out there. If a hacker steals thousands of people’s bitcoins, there’s really no recourse. There’s no FDIC insurance for your bitcoin virtual wallet. There’s no bank or government entity verifying transactions or preventing fraud. That’s part of Bitcoin’s appeal for some, but also why some believe the system is too risky. If there’s any regulatory aspect to Bitcoin, it’s that you still need to pay capital gains taxes if you sell bitcoin for a profit in the U.S. (yes, the IRS is keeping tabs.)
Libra: This is where some of the fears about Libra creep in. Being backed by global currencies and bonds could have ramifications for global markets and national economies. That’s partly what’s driving global policymakers’ concerns about Libra, which means there’s a good chance this cryptocurrency would be highly regulated (in fact, Facebook is asking to regulate Libra). That means using libra to pay for things may get complicated.
Here’s one example: Since your libra would be pegged to a basket of bonds and currencies, the amount of libra you own may grow in value if your local currency, for example, depreciates. If you then buy something with libra, you may be triggering a capital gains tax event (on top of other sales taxes, etc.). Will you need to track capital gains every time you spend libra? The answer isn’t clear, but this gives you an idea of what regulators are grappling with.
Even more established cryptocurrencies like bitcoin, ethereum and ripple are highly speculative and volatile. And Libra is still a concept that may never even come to fruition. Still, every new development in the world of cryptocurrency provides a hint of how our paradigm for money could continue to shift in the future.