Category Archives: In Depth

Bond inflows hit record, but the rally is not over yet

It seems that nothing can break the bond rally — or deflate the bond bubble, as critics would say. Inflows into bond funds have hit a record this year, in tandem with record high bond prices, but how long can the euphoria last?

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Facebook faces big questions for the Libra currency

Facebook’s announced “currency”, Libra, has understandably created a splash. The social network’s track record does not inspire a lot of confidence. Its unwitting facilitation of Russia’s threats to democracy in the West is the biggest and the best known example of its weakness. Allowing Facebook to issue currency seems like a really bad idea. So let’s look at some of the things that could go wrong.

Clearly, Facebook’s ambitions cannot be stopped. After all, more than two billion users trust the social network with their digital lives, most probably not realising how far Facebook reaches into their offline lives. The social network’s influence seems hard to counteract — so if enough people adopt it, its “currency” has a high chance of success.

Possibly this is why Mark Carney, the Bank of England governor, did not reject Facebook’s incursion into the world of finance outright. The “entity” would be “so important” that the Bank of England, the Federal Reserve, the European Central Bank and other major central banks of the world would have “direct regulatory oversight” over it.

“This would be a global public good, so it would have to not be owned by Facebook or tech companies,” he said. “We don’t want criminals and terrorist to be using this.”

Carney also said that regulators want people’s data to be protected, but it really is not at all clear how they would ensure this. Already, people give away too much personal information on Facebook, not realising or perhaps not caring how the company uses that information.

And if there is only so much speculation that can be carried out on the back of cute videos of dogs or babies, the possibilities of exploiting financial transaction data if it falls into the wrong hands are unlimited. Presumably, Facebook knows this, and “welcomes” regulation. But judging by its track record on protecting users’ data, that doesn’t mean much.

So how could this “currency”, or more correctly put, payments transfer system, be exploited by people with bad intentions?

Facebook currency Libra has its own programming language

Facebook’s currency, Libra, comes with its own programming language. Source: Facebook

Libra, which is planned to launch next year, will take customer deposits, which it will then invest in government bonds. It will also hold “normal” currencies as reserves, and will offer transfer and payment services around the world to its users.

Facebook, aware of its chequered reputation, was careful to surround itself with allies so that it does not look like it is doing this by itself, but really it is in the driving seat.

The appeal of this new currency is obvious: it will “democratise” payments because it will be available to anyone, it will lower the cost of banking for the poorest segments of society, and it will give access to finance to millions of people for whom cash was the only option because of lack of banks nearby and lack of funds to pay banking fees.

However, the devil is in the details, and some of these details are in the white paper accompanying the announcement of the currency’s launch. Here are some of the worrying points:

Access to anyone

Initially, the blockchain technology underpinning Libra will be a “permissioned blockchain” — that is, access will be granted to run so-called “validator” nodes. These are volunteer-based nodes in the blockchain that facilitate its decentralisation and speed, but are of no real use for the person running the node, because they do not allow that person to create or change any aspect of the currency.

Facebook says: “to ensure that Libra is truly open and always operates in the best interest of its users, our ambition is for the Libra network to become permissionless.” Currently, there is no “proven solution” to “deliver the scale, stability, and security needed to support billions of people and transactions across the globe through a permissionless network,” the white paper says.

But, it adds, the aim of the company and its support network is to research and implement a transition to a permissionless network within five years of the public launch of the Libra system. A permissionless blockchain allows anyone to join.

Its own programming language

The Libra blockhain was built using its own programming language, called “Move.” It can issue cryptocurrencies, tokens and other digital assets, handle transactions on the blockchain and manage validators (nodes).

The launch of Move has been obscured by the launch of Libra, but it can end up being a much bigger deal. In fact, for some developers it already is a much bigger deal. They enthuse about Move’s ability to lessen security incidents and prevent the cloning of assets. The language also facilitates automatic verification that payment transactions only change the account balances of the payer and receiver.

However, the inventor of the language usually controls it. It is not clear how much of its future development will the Libra system be able to control, and to what purposes. The white paper is quite vague on this, saying things like: “We anticipate that the ability for developers to create contracts will be opened up over time in order to support the evolution and validation of Move.”

Backed by other assets

Unlike other cryptocurrencies, which are not backed by anything, Libra will be “fully backed by a reserve of real assts”, called the Libra Reserve. This will help build confidence in the currency and would encourage users to adopt it faster.

The Facebook currency will be backed by “a collection of low-volatility assets, such as bank deposits and short-term government securities in currencies from stable and reputable central banks,” according to the white paper. As the value of the underlying assets will change, the value of one Libra will fluctuate with it, even though the company promises to choose the reserves to minimise volatility.

In practice, this means that Libra users will have no way of knowing how much their so-called currency is actually worth. In that respect, Libra will act more like a mutual fund than an actual currency, except there will be no single fund manager.

Facebook says the assets in the Libra Reserve will be held by a “geographically distributed network of custodians” who will have “investment-grade credit rating”. This will be done to provide both security and decentralisation of these assets.

While all this sounds wonderful on paper, the above three points are enough to raise question marks, such as: what if fraudsters manage to infiltrate the permissionless blockchain? Who will compensate Libra users for losses because of it, if that happens?

What if Move, the programming language, is modified (by humans or AI) so that the whole system is hijacked by a few people? (Or, even worse, what if it has been designed that way?) What happens if one or more of the backing assets turns sour despite its investment grade? Remember that this happened before. How would Libra cope with a fire sale of its backup reserve assets in such an event?

The above are just a few of the questions that Facebook must answer before it is allowed to launch its so-called “currency”. But perhaps the two most important questions are, who will ask them, and how. Facebook has a habit of simply not answering inconvenient questions, given a choice.

What’s behind the Fed’s ‘whatever it takes’ moment

January was an extraordinarily positive month in the markets for virtually all assets, after a horrible 2018 — and it’s all due to the Fed. The US central bank executed a massive U-turn in its monetary policy and, while many observers like to point to low inflation as the reason for the Fed’s aborted effort to normalise monetary policy, something more sinister is behind it.

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Turkey is just the canary in the coalmine

The headline may be a bad pun, but the warning is serious. Many people believe that the trouble with Turkey’s currency is confined to that country, but that is far from the case. Turkey is just the first country that implemented populist policies when the going was good to now pay for these policies. The markets are about to teach populists a lesson, and Turkey is the first instalment.

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Europe’s year of change depends on its voters

Beyond the depressing, backward-looking policies that the Brexit vote and the election of Donald Trump as US president seem to have brought, there is a ray of hope.

People elsewhere in Europe, seeing the first ugly consequences of populism, might find enough motivation to go to the polls in elections just to try to keep populists out of government. I am talking about the decent people who are tired of politicians but aren’t seduced by the populists’ siren calls.

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What religion can teach us about business management

— This article was originally posted in Youth Ki Awaaz, India

By Sourajit Aiyer

One advantage of being an Indian is that one gets to see multiple faiths and religions in close proximity. But the world of our religions often looks very distant from the world of our business.

Many perceive business to be pragmatic and religions to be emotional and that the two do not really intersect. But the texts of various religions actually have a lot of pragmatism, which has a lot to teach modern business management. Here are some of these teachings:

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Banking on a rate cut in India after demonetization

By Sourajit Aiyer

The Indian central bank’s upcoming policy review this week, a month after demonetization, holds ample suspense for a possible interest rate cut.

The demonetization of Rs 500/1,000 currency notes since November 8 has led to a rapid inflow of deposits in banks. Brought in to fight black market money and counterfeits, the amount in circulation in these notes was estimated at around Rs 14 trillion, i.e.  about 86% of the total.

Citizens were asked to deposit them in their banks, leading to the deposit surge. The Hindu, a leading daily, said ~Rs 8.5 trillion had been deposited by end November and estimated it to reach  between Rs 10-11 trillion by early-December.

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Interest rate cuts not enough to boost Indian companies

By Sourajit Aiyer

Last week, in an article, I looked at the reasons behind the slow growth of wages in India. They have a lot to do with the slowdown of profit growth. One way to boost profits is to invest, but for this you need to raise capital; so let’s take a look at the background and prospects for capital raising by Indian companies.

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In Corporate India wages grow slowly, tracking profits

By Sourajit Aiyer

Demand slowdown has hit top line growth for Corporate India for a while; companies are maintaining profitability by operational measures. And when one digs deep into long-term data, interesting findings come to light.

From an employee’s perspective, the impact of low profitability varies among sectors. If you are working in the right one, you are lucky!

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The Eastern European scapegoat proves the EU is working

I was reading the other day on the blog of excellent Bucharest-based economist Radu Craciun his latest article: “Is Eastern Europe the EU’s scapegoat?” When I read the headline, I thought the article was about Brexit; but in fact, Radu writes about how some experts in the EU claim that the single currency was created as a way to maintain the unity of the Union after it expanded “too rapidly” to the East.

Well, that’s new. I didn’t realise that, besides causing English people to behave irrationally against their own interests and vote to leave the world’s biggest trading bloc, Eastern Europeans are also guilty of inspiring what could turn out to be the world’s least successful currency union.

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