Will Libra Tip the Scales for Facebook or Financial Services?
We don't see the cryptocurrency having much effect at this point.
Facebook (FB) announced this week that it, along with various investors, will launch a new cryptocurrency, Libra, in 2020. It will make its own digital wallet, Calibra, available next year as well. While these may strengthen the company’s network effect moat source because Facebook’s 2.4 billion users, as well as its apps like WhatsApp and Messenger, could be more effectively monetized, neither the cryptocurrency nor the digital wallet will meaningfully drive the overall top or bottom lines during the next few years, in our view. We are maintaining our $200 fair value estimate and recommend waiting for a wider margin of safety before investing in this wide-moat and high-uncertainty brand.
Facebook and other members of the Libra Association (which will monitor the development of Libra and technically align and maintain nodes and open-source platforms) plan to launch Libra early in 2020. According to the white paper published by the association, the currency is likely to be less volatile than other cryptocurrencies such as Bitcoin, because Libra will be backed by bank deposits and short-term government securities held in the Libra Reserve, managed by the association. While the association currently has 28 founding members, this is likely to rise to 100 by early 2020. Investments made by the 28 founding members include at least $10 million each; some may become node operators for the currency’s blockchain. Each member is limited to one vote or 1% of total votes. Current members include Mastercard (MA), Visa (V), Uber (UBER), Lyft (LYFT), Spotify (SPOT), Andreessen Horowitz, Coinbase, Booking Holdings (BKNG), and Women’s World Banking. Facebook hopes its digital wallet, Calibra, will be able to be used anywhere and also by non-Facebook users.
While the costs of Libra’s development and its blockchain are probably minimal for Facebook, we think the creation of Libra will not result in a significant improvement in the company’s user monetization during the next few years. First, we do not expect that the revenue generated directly from the currency or Calibra will be material, because we think the nonfee services, such as peer-to-peer payments, are likely to attract users to the currency and the wallet. The Libra Association and Facebook are initially targeting consumers without bank accounts, which the association’s white paper says is about 1.7 billion adults worldwide.
Second, according to Facebook, data related to transactions using Libra will not be used to attract more targeted advertising dollars to the company’s Facebook or Instagram platforms. Again, Libra will be monitored by the association. While Facebook has not explicitly said this, we think it may be able to use transaction data from its digital wallet, Calibra. However, it may face significant regulatory restrictions.
Third, Libra is an open-source platform, which means other apps that compete with Calibra are likely to be developed. Plus, the currency can be used to make purchases or transfer funds by Facebook users as well as non-Facebook users. Even if Libra is adopted widely, it is not likely to bring everyone onto Facebook’s platform or digital wallet.
In the long run, however, we think Facebook’s network effect may benefit from the possible extensive adoption of Libra. In our view, with its 2.4 billion users, Facebook can attract many merchants or retailers to Calibra and therefore accept payments with Libra. Because a wider range of products and services may become available on Facebook’s Marketplace, which already attracts nearly 1 billion users a month, it may attract even more users. The same can apply to Instagram and its Checkout feature. In addition, the ease of use that Calibra may offer could help WhatsApp and Messenger users embrace e-commerce and possibly even other tasks and services, similar to Tencent’s (TCEHY) WeChat.
On the advertising side, while user growth will continue to decelerate, we think the time spent on Facebook may increase as more transactions may be conducted on the company’s platforms. In our view, this alone could attract more advertising dollars.
In addition, if Libra is widely adopted, Facebook (along with other association members) will receive interest on the Libra Reserve. According to the white paper, after using some of the interest on those bank deposits and short-term government securities to cover Libra Association costs, the remaining interest will be paid to members.
While potential long-term benefits from the launch of Libra and Calibra may be attractive, the regulatory risks that Facebook is currently confronting could prevent the company from fully realizing the benefits. In the United States, we think news of the Federal Trade Commission possibly investigating Facebook over alleged antitrust issues may affect the commission’s decision about the data privacy settlement, which according to Facebook may require a payment of $3 billion-$5 billion by the company. While possibly unintentional, the FTC’s move on alleged antitrust issues, combined with the Libra news, may reduce any influence that Facebook might have had regarding a finalized data privacy settlement amount. We could also see further negative reaction from Europe. According to Bloomberg, Markus Ferber, a German member of the European Parliament, said he was concerned that Facebook may become a shadow bank. Last, while users continue to access Facebook, Instagram, WhatsApp, and Messenger, they may not have enough trust in those platforms to immediately embrace Libra and Calibra.
We’re Not Worried About Financial Services’ Moats Just Yet
The Libra announcement makes Facebook the first major company to attempt to bring cryptocurrency into the retail mainstream. Overall, we are not yet worried about a negative impact on economic moats in financial services.
Libra will be run by a consortium, with Facebook as the lead until the end of 2019, at which point all members will have equal power. It will start out as a “permissioned blockchain” with the ambition to move toward “permissionless” over time. Libra will be backed by a reserve, in contrast to a cryptocurrency like Bitcoin, where there is no fiat currency backing, which leads to wild price swings. Facebook believes this will keep Libra relatively stable in value, although not 100% stable. The initial goal is to target the unbanked market. The project also has a focus on cross-border payments, an area that has historically been more difficult to handle from a processing standpoint.
Any prognostications concerning Libra are quite speculative at this point. It is very hard to tell exactly how this will evolve over the next 5-10 years; a lot will depend on how popular it becomes, what the initial uptake is, and if it can reach a critical mass of users and transactions. The initial stages of trying to develop a network effect are inherently uncertain, although Facebook’s existing network effect in its social media platform may help.
In trying to disrupt the financial services industry, Libra will face a number of hurdles. We will focus first on the banks. Facebook’s initial strategy is to go after users without a bank account or access to the existing banking system, so this is not a direct attack on financial services at this point. However, once the platform gets a critical mass of users and volume, it is not hard to imagine that it will begin to affect users with bank accounts. The first hurdle we see is that governments will probably not want large amounts of transactions going through unregulated, unmonitored platforms. Facebook said, “The Libra blockchain is pseudonymous and allows users to hold one or more addresses that are not linked to their real-world identity.” If the platform becomes big enough, we’re not sure governments would like this.
We also have a hard time seeing how this would not create problems for the banks, as they could run into issues around anti-money-laundering and know-your-customer rules. The white paper does say, “While the network is open and accessible to everyone with Internet access, the network’s main endpoints, in the form of exchanges and wallets, will need to follow applicable laws and regulations and collaborate with law enforcement,” but it is not clear to us what following applicable laws and regulations actually entails, and if it would solve these potential issues. It was mentioned that Facebook had conversations with the Federal Reserve before announcing Libra’s launch, but again, details are sparse around the actual content of these conversations.
The second major hurdle is potential political and regulatory pushback against the power of the largest tech companies, which we are already seeing. We don’t necessarily see politicians and regulators going along with Facebook being involved in and monetizing more aspects of the economy. Libra will be governed by a group of companies, but our understanding is that Facebook will still control Calibra, which will “build and operate services on its behalf on top of the Libra network.” We are already seeing pushback here, with comments from Rep. Maxine Waters, chair of the U.S. House Committee on Financial Services, surfacing almost immediately after Facebook’s announcement.
We also wonder if users are going to trust Facebook with their financial transactions, given the trust and data issues that have cropped up recently. Further, we don’t envision that clients who are already heavy users of the current regulated banking system will want to use Facebook for a significant amount of their transaction activity. Unless Facebook becomes something closer to a full-fledged bank, with a more complete product offering, it seems more likely that a bank will still be the center of most people’s financial life. Finally, the banks are already working on developing improved cross-border and real-time payment capabilities, and this has even crossed over into the cryptocurrency landscape with offerings such as JPM Coin (although this is not available to the retail market). We expect banks will provide offerings to meet market demand.
We don’t see Libra having a discernible impact on most of the payment processors we cover anytime soon. Notably, Visa and Mastercard are partners in the effort, which suggests the management teams at these companies don’t see Libra as a major threat. These networks benefit from their immense volume ($17 trillion annually combined), and Libra is extremely unlikely to approach anywhere near their scale over a foreseeable time frame. In the longer run, we think displacing the card networks and the other players in their ecosystem would depend on developing a payment system that is equally ubiquitous and either materially cheaper or more secure. For all their potential, cryptocurrency and blockchain have not yet established that they can present superior options on either front.
When we look at other niches of the payment space, we do see some spots where Libra could have a more material impact. Recent years have seen a proliferation of person-to-person payment platforms, with Zelle (backed by the banks) and Square’s (SQ) Cash App now competing with Venmo. Libra could add another option to that mix, and the support of Facebook could provide the critical mass necessary in what we think is a space with a winner-take-all dynamic over time. Still, we don’t think Venmo is large enough to move the needle for PayPal (PYPL) (which is also a member of the Libra Association), and our view of the prospects of Square’s Cash App is already tempered. The most at-risk company in our payments coverage might be Western Union (WU), as Libra could prove to be an effective vehicle for international money transfers, and the money transfer market is small enough that Libra could build an effective level of scale in a reasonable time frame with Facebook’s backing. We recognize the potential for Western Union to face new types of competition over time. That consideration is the primary driver behind our negative moat trend rating for the company, and we have already baked this type of risk into our long-term assumptions.
We see a lot of uncertainty surrounding the ultimate trajectory of Libra and also a lot of hurdles that will need to be overcome for this cryptocurrency to have any major impact on the incumbents in the financial sector.
Ali Mogharabi does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.