GUEST BLOG: The Great Pretender by Aegis Frumento Esq

June 27, 2019

The Great Pretender

by Aegis J. Frumento, Partner, Stern Tannenbaum & Bell

The Zodiac sign Libra is represented by Themis holding scales. Themis is the Greek goddess of balance, obsessed with harmony, symmetry and equilibrium. Her modern personification is Lady Justice (still holding those scales).

Libra comes to mind because Facebook chose that name for its new cryptocurrency. One horoscope site says of those born under Libra:

[E]verything about you attracts attention and admiration from other people who wish they could be just like you. . . . [Y]our intentions are pure and ultimately all you want is for everyone to be equal.

That sounds like Facebook's wish list in this summer of its discontent. Even cryptocurrency maven Kevin Werbach opined that Libra is Facebook's long-game attempt to win back the trust it lost to data hackers and Russian election bots. On the other hand, Facebook co-founder Chris Hughes sees in Libra another front in Facebook's long march to world domination. And then there are competing arguments as to whether Libra will make or break bitcoin and other cryptocurrencies.

My first reaction is that the thing hasn't even launched yet, so maybe we should just wait before pontificating about it. Given the regulatory scrutiny that Libra has already invited, when or whether ever it will launch is perhaps the better question to ask now.

My second reaction is to remember Occam's Razor: the simplest explanation is the best. This exchange between Leslie Stahl and a user of the mobile payment app M-PESA in sub-Saharan Africa, as broadcast on 60 Minutes three-and-a-half years ago, suggests that simplest explanation. Banks are hard to come by in that part of the world. There are few branches or ATM machines. Necessity being what it is, mobile payments have filled the breach. They are ubiquitous, and easily effected through cheap $40 mobile phones using M-PESA. Upon seeing a demonstration, Stahl asks, "You're texting money?" Yes, is the reply. "You are effectively texting money."

So, who in the world might want to text money over a Facebook infrastructure? Might you guess a population that embraces Facebook but is behind in adopting mobile money transfers? Facebook user statistics are readily available,, and a recent McKinsey study tells us where mobile money transfers are under-adopted Putting those two together suggests Latin America and Asia, and in particular India, Indonesia and Brazil, as targets of Facebook opportunity. Consider India. Facebook has more users in India than in the US, and mobile money transfers have not caught on there like they have in Africa. If I had to bet on Facebook's short-term goals for Libra, it would be for it to become the M-PESA of the Asian subcontinent. Pretty simple, actually.

But Facebook's potential passage to India really is the least interesting thing about Libra. More interesting is how Libra achieves its three principle design goals. According to the Libra Whitepaper, those are (1) to be highly scalable, (2) to verify Libra transactions both securely and quickly, and (3) to ensure the Libra has low volatility.

Those goals address the fundamental drawbacks of conventional cryptocurrencies like bitcoin. Bitcoin transactions are secure, sure, but only so long as there are enough miners to ensure that no one can control 51% of the validation nodes. With the consolidation of bitcoin mining operations, that may be in doubt. See Also, the blockchain data structure, in which new blocks are added about every 10 minutes and build on each other ad infinitum, results in relatively slow transaction times and limit scalability. As a result, bitcoin works best for bulk transfers, but it's a clumsy way to buy a latte. And because bitcoin is untethered to any stable asset, its "value" fluctuates wildly. When Libra was announced, Bitcoin spiked by over $2,000. Why? Do you think I know?

So, to make Libra scalable, fast and stable, its designers freed it from blocks and chains, miners and free-for-all valuations. That tells you all you really need to know to divine the future of cryptocurrencies.

If you think a blockchain that doesn't have blocks or chains is not a blockchain you can have confidence in, you're right. Libra doesn't use a blockchain data structure. Instead, it uses a Merkel Tree that tracks Libra transactions sequentially, without mixing one person's transactions with another's, as the block of a blockchain does. As a result, transactions are validated almost instantaneously, without having to wait for other transactions to be consolidated into a block and validated through mining operations. One consequence of this structure is that older transactions in the same Libras, further back in the Merkel Tree's roots, are not needed to validate more recent transactions. They can be discarded, much like your 1990 bank statements. We are told that this results in a large volume capacity, fast processing speeds, and an ability to scale up rapidly.

Also, Libra doesn't use the brute-force "proof-of-work" algorithms that define bitcoin mining. Libra transactions are validated using "Byzantine Fault Tolerant" algorithms. BFT is a theoretical solution to something called the Byzantine generals problem. How can a group of medieval generals attacking a castle with imperfect communications between them coordinate their attack, when some of them are known to be traitors feeding misinformation to the group?

The math guys tell us that when 2/3 of them agree, reliable information can be assured through cryptography. However, if more than 1/3 of the generals go rogue, we can't trust the information any more. That's why the Libra Whitepaper only claims reliability when no more than 1/3 of the validators provide false validations. Because of that defect, Kevin Werbach wrote in his Blockchain and the New Architecture of Trust that "academic interest [in BFT] had waned, and there were few commercial applications."

But that was way back in 2018.

Libra solves the problem of rogue generals by putting miners out of work and only letting a trusted few validate transactions. The 27 members of the Libra Association, headquartered in Switzerland -- because where else? -- are the Platonic Guardians of the Libraverse. Those founders include (in addition to Facebook, of course) the likes of MasterCard and PayPal, Ebay and Uber, a few venture capital firms and non-profits, but (surprise!) not a single bank. They ponied up $10 million each, and that stash is the Libra reserve fund. That's right. Unlike bitcoin and every other cryptocurrency out there, Libra is backed by real money; its value will rise and fall as does the legal tender behind it.

So, you see, Libra is as far removed from bitcoin as one can get. It is the anti-bitcoin. Libra is based on a cryptographically secure ledger that anyone can access but only Libra founders can validate. Unlike bitcoin "miners" moved by mere greed, Libra's founders have skin in the game. And their stake, Libra's reserve fund, pegs Libra's value to real money and not the madness of the crowd. In effect, Libra's designers are telling us that you can't build a currency on the crypto-anarchy that is bitcoin.

I think they're right. Bitcoin can surely survive as a cryptoasset, so long as anyone is interested in owning it. Even if it only measures the desires of its holders, bitcoin can take a place next to rare bottles of scotch, inverted Jennys, and most securities. A fully decentralized blockchain may have revolutionary uses, too. But, Libra tells us, it won't spawn currency. To buy lattes every morning you need to trust more than the integrity of the transfer. You need to trust that your "money" will hold its value from day to day, so your latte doesn't cost $5 today and $10 tomorrow. Bitcoin, fluctuating wildly from hour to hour, fails that test. Libra explains why, and argues that to work as currency, a crypto-thing needs to be centrally controlled and backed by real value. By that measure, bitcoin is not the future of money. It is only the great pretender.


Aegis J. Frumento
Stern Tannenbaum & Bell
Co-Head, Financial Markets Practice

380 Lexington Avenue
New York, NY 10168

Aegis Frumento is a partner of Stern Tannenbaum & Bell, and co-heads the firm's Financial Markets Practice. Mr. Frumento represents persons and businesses in all aspects of commercial, corporate and securities matters and dispute resolution (including trials and arbitrations); SEC and FINRA regulated firms and persons on regulatory compliance issues and in SEC and FINRA enforcement investigations and proceedings; and senior executives of public corporations personal securities law and corporate governance matters.  Mr. Frumento also represents clients in forming and registering broker-dealers and registered investment advisers, in developing compliance policies, procedures and controls, and in adopting proper disclosure documents. Those now include industry professionals looking to adapt blockchain technologies to finance and financial market enterprises.

Prior to joining the firm, Mr. Frumento was a managing director of Citigroup and Morgan Stanley, a partner and the head of the financial markets group of Duane Morris LLP, and the managing partner of Singer Frumento LLP.

He graduated from Harvard College in 1976 and New York University School of Law in 1979. Mr. Frumento is a frequent author and speaker on securities law issues, and is often quoted in the media on current securities law developments.

NOTE: The views expressed in this Guest Blog are those of the author and do not necessarily reflect those of Blog.

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