Most Interesting ETF Filing Ever: Libra

June 25, 2019

My interest in cryptocurrency and bitcoin has been tangential. It’s this thing happening on the edge of my experience, but not something I interact with much daily.

As a tech nerd, however, I’ve been drawn to the technology underneath it, and as a finance nerd, I’ve been intrigued by the whole Sartre-esque “what is money anyway?” dialogue it’s created.

I initially dismissed the filing by Facebook et al. around Libra. I skimmed some press coverage and moved on with my day.

But this weekend I dug deeper, and ran across this passage from the Libra white paper:

“Users will not directly interface with the reserve. Rather, to support higher efficiency, there will be authorized resellers who will be the only entities authorized by the association to transact large amounts of fiat and Libra in and out of the reserve. These authorized resellers will integrate with exchanges and other institutions that buy and sell cryptocurrencies to users, and will provide these entities with liquidity for users who wish to convert from cash to Libra and back again.”

Accidental ETF

“Huh,” I thought. “That sounds a lot like creation and redemption in an ETF!”

Reading further, it became clearer and clearer that that’s actually what Libra is: an actively managed ETF that will invest in a basket of currencies based on a set of investment objectives. In this sense, it’s exactly like the WisdomTree Emerging Currency Strategy Fund (CEW).

CEW does, quite literally, the exact same thing Libra is planning on doing, with a few exceptions:

  • CEW charges a 0.55% expense ratio. Libra does not have a fee embedded in its valuation peg to its basket.
  • CEW invests in short-term instruments in each currency, and holders of CEW gain that interest. Libra invests in short-term instruments in each currency, but the foundation keeps all the interest to fund operations.
  • CEW is a 1940 Act-regulated ETF, that trades on regulated exchanges, which customers access through regulated broker-dealers, and whose assets are stored with regulated custodians. Nobody has any idea what Libra is, how its exchange for goods and services (or dollars) will be regulated, how customer access points will be regulated, or how custodians will be regulated.

Knowing that I’m rarely the first one to the party on ideas like this, I started reading everything I could find. There’s a lot out there, including the obligatory Financial Times vitriol, but after some digging, I stumbled across this post from David Weisberger on Medium, in which he also got the ETF connection:

“In fact, it is so much like an ETF, I would be stunned if the SEC does not at least contemplate asserting that it has jurisdiction over the market for Libra tokens.”

Regulatory Octopus

Here, Weisberger is getting right to the heart of the matter, and it’s so blatant and obvious that I have to imagine this is intended. Facebook, PayPal and Visa are not slouches when it comes to managing regulators. I’d argue they’re consummate pros: Super Bowl contenders. They know what they’re doing.

One possibility is that Facebook et al., have already figured out the regulatory angle by which they think they will be able to dance through the securities registration minefield.

For instance, you can avoid becoming a registered investment company if you stay underneath a specific threshold of owning securities; if Libra aggressively limits its exposure to bonds and other assets, and mostly holds currencies, it could avoid (at least) the ’40 Act (although it would limit the income earned for the foundation).

Big Hill To Climb, But Here’s A Path

Even then, though, questions related to the 1933 Act, potential classification as demand notes, and considerations related to CFTC regulation of the token as a swap still exist. One way or another, it won’t be easy.

And as it stands now, the baseline interpretation of what’s actually written in the filing (I mean “white paper”) is simply: “Libra is just CEW in sheep’s clothing.”

So what does that mean?

For starters, I don’t think that means it’s dead. I actually think it’s much more interesting. If Libra is, at core, just an ETF, it’s a relatively easy cleanup to file it as such, formally.

The ’40 Act bits aren’t hard; the hard part is trading. By definition, Libra is intended to be exchanged 1-to-1. The whole point is that I’ll be able to use Libra the same way I use cash. In that sense, having a wallet with 100 Libra in it is supposed to be very much like having a wallet with a $100 PayPal balance (or if you’re transacting in Chinese renminbi, Alipay).

Libra’s Exciting Element

Libra envisions making these transactions seamless and registered on the blockchain. So for example, right now, I don’t have a way to hand Amazon a share of the SPDR S&P 500 ETF Trust (SPY) in exchange for a bunch of books and sunscreen and groceries. Libra envisions a world where I can directly do just that.

This is why it’s so exciting. Not because I want to use a lot of Libra in my day-to-day life, but because it opens up a regulatory discussion about a radically improved way of moving a security from pocket A to pocket B.

Whatever regulatory solution the Libra consortium comes up with (and there’s going to be a lot of money pushing for a solution), it strikes me that it could have far-reaching implications well beyond digital currencies. Any solution that works for Libra nearly has to work for CEW, or SPY or any other ETF.

After all, ETFs are just baskets of things that we value. And the only reason we have to trade through brokers and exchanges, and settle overnight through the National Securities Clearing Corp. is because the system evolved that way from the Great Depression, one deprecated slip of paper at a time.

Other Tilts At This Windmill

Discussions abound of all the other ways folks are trying to crack this nut—to become “the new dollar” in consumers’ or corporations’ lives. Special drawing rights (SDRs) get brought up in almost every conversation.

SDRs are issued by the International Monetary Fund, and are, like Libra, an actively managed basket of securities. But that’s where the similarity ends: They’re nontransactional, and it’s the transactional piece of this that’s where all the interesting bits are.

What else do we know about Libra and its place in the crypto firmament?

Well, it’s not “its own currency” in the way bitcoin (and its countless variants and copycats) are. Bitcoin is a nonfiat currency; a kind of digital gold whose primary value (to me) seems to be its disconnection from central banking and other governmental oversight.

That’s fine for what it is, but the inherent value fluctuations and basis risk that come with standing apart from fiat backing will always be a huge barrier to entry to bitcoin gaining traction as a primary means of exchange.

No ‘Stablecoin’

Libra is also not a “stablecoin,” the portmanteau used to cover things like Tether. If nothing else, Tether showed the dangers of one firm just deciding how things work, without any regulatory oversight or transparency.

Tether promised to have its cryptocoin backed by dollars held in reserve, but, well, not so much. I gather Tether is still a going concern, but I lost track of the countless court proceedings that have resulted from that flawed claim.

It’s also not a debt instrument—there’s no “promise to pay” here. There’s a “promise to exchange” from a held basket. The rights of unit holders and the mechanisms for dispute resolution and so on are all still very vague, but ultimately, it’s inconceivable to me these don’t end up being … you guessed it … just a fund. An everyday, plain old fund.

The closest example to something like this has been the success of M-Pesa, a global payment system originally started in Kenya that has spread geographically throughout the region. Unlike Libra, however, M-Pesa is actually, really, just a mobile banking system, which has special licenses from regulators to act as a banking system. In other words, the need for a digital transaction solution forced the regulators to make room for the future, which sounds, well, promising.

Predictions? We Got ’Em

This may make Libra seems like a far-fetched, not-gonna-happen idea, but I don’t think so. I really think it’s just a matter of timing, not feasibility.

There’s nothing technically all that tricky about what Libra is proposing. Essentially all of the hurdles are either adoption related (which, having already grabbed Facebook and Visa as backers, seems pretty well in hand) or regulatory in nature.

It’s certainly possible that U.S. regulators just pooh-pooh the whole thing; in which case, Libra can simply restrict access by geography and say, “Sorry, this ain’t a U.S. thing; never mind.” That would be super unfortunate, ceding more ground to international players (which is already happening; you can use Alipay at Walgreens!).

To me, it’s far more likely this is the beginning of a much-needed and really interesting conversation about the role of money in the modern world. That’s the right discussion to be having in Washington, and Libra is a big enough initiative to put it on the agenda.

For that reason, as much as I’m wary of Facebook, in this case, I for one welcome our new crypto overlords.

Contact Dave Nadig at [email protected]

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