Social Media – I/O Fund

Facebook has been clobbered by privacy issues for nearly 16 months now. A pivot into cryptocurrency could help save the social media giants market cap while making good use of the platform’s 2.3 billion users. The main issue for investors is the short-term risks with privacy and data may not outweigh the long-term opportunities with crypto this year.

Background on Facebook’s Cryptocurrency:

News has been circulating for some time about Facebook’s cryptocurrency venture with news officially breaking on Friday that Facebook has signed a consortium of firms known as the Libra Association to govern Facebook’s cryptocurrency. The list of names joining is impressive, as reported by the Wall Street Journal to include Paypal, Stripe, Visa and Mastercard. Rumor has it that more names will be revealed today, including venture firms Andreessen Horowitz, Union Square Ventures, cryptocurrency exchange Coinbase, and a few non-profits such as MercyCorp.

Here is the full list set to be announced on June 18th:

source: The Block

According to an introductory blog post that will be published this week, Libra will be built on the Libra Blockchain, which is a “secure, stable, and reliable blockchain” and backed by Libra Reserve, “a reserve of real assets” that will provide the cryptocurrency with “stability, low inflation, global acceptance and fungibility.”

The coin will be traded on Messenger and Whatsapp, which helps solve the mystery of how Facebook plans to monetize the app that was acquired for $19 billion many years ago. To compete with payment applications, the cryptocurrency transfers will have zero fees and Facebook is currently working with merchants to accept the token. According to The Information, Facebook has plans to roll-out ATMs to exchange traditional assets for cryptocurrency.

To avoid Big Tech anti-trust issues, which is becoming a buzz-phrase this year, Facebook created the independent foundation to oversee the cryptocurrency. Each company paid $10 million to operate a node that validates the transactions, which will help decentralize the global currency.

Facebook Cryptocurrency: More Questions Than Answers

Facebook and Google frequently attempt to pivot from advertising with more failure than success. Google calls these “Other Bets” with “bet” being an appropriate word as user adoption for massive tech companies is always challenging to predict. Psychologically, these companies do not hold as much power as investors may think as acquisitions have always been the better path rather than launching products (Facebook: Instagram and Whatsapp vs. dating, for instance, or Android and YouTube for Google vs. Google Glass, for instance).

While it may seem the names of the Libra Association are partners, they are more likely to be paying $10 million to remain diversified and to have a stake if Facebook pulls off crypto. As in most things tech related, it will ultimately be up to the user adoption rate of the technology.

Despite the bump in price the stock has seen this past week, there will likely be a lull mid-year for the stock as privacy wears on and crypto is too nascent to have a serious impact on the financials.

Here are some Long-Term Risks to Facebook’s Cryptocurrency:

Bank accounts are not tied to Messenger or Whatsapp, therefore there will be friction in the transfers and setting up crypto wallets.
Messaging apps like Venmo transfer money without fees already and is linked to bank accounts. In other words, payment applications may be a better fit for crypto transfers.
Many thought leaders in tech and those inclined to support disruption are adamantly against the Facebook platform and began the #deleteFacebook campaign. This group uses Signal for messages. Are power Facebook users and Whatsapp users disruptive enough to drive crypto adoption?
Amazon already accepts payments while Apple is moving into financial services. Facebook’s direct leap into crypto could have psychological barriers for users who have not used Facebook for a payment of any kind. Notably, Jack Dorsey of Square is also hiring a crypto team.
Cryptocurrency is heavily regulated by foreign governments, and in some cases is illegal. With Facebook showing signs of saturation domestically in the United States, the company will have to rely on foreign governments legalizing the coin and allowing Facebook to be a crypto player in their country. I see this as a major headwind as currency brings up more regulatory issues than what tech has dealt with previously.
Facebook is known for being used for election tampering and there is bipartisan support to regulate the social network. Globally, Facebook has been used by terrorist groups. Therefore, the platform could be especially prone to fraud and laundering compared to Amazon, Apple or a pure-play crypto option.
Facebook would need to be regulated closely like a financial institution which would change how the company collects and uses data. Gramm-Leach-Bliley Act is a good example of a regulation that tightens the use of data for companies that are involved in financial transactions.

This month, I will be attending the Bitcoin 2019 Conference in San Francisco. Follow me for updates.

Background on Facebook’s User Growth Trajectory

Facebook’s rampant growth from 2004-2017 was due to a viral coefficient formula which is also known as the k-factor. The k-factor equation was taken from epidemiology, in which a virus that has a k-factor greater than 1 indicates exponential growth. The equation for virality for websites and applications describes the growth rate:

k = i * c

i = number of invites
C = conversion rate

When K is equal to one or greater, you have viral growth.

Facebook’s growth rate trajectory was exponential because people found the network more rewarding when more people they knew joined the network. The same will be true for Facebook’s deceleration, as well. As people start to spend less time on the social network, there will be viral deceleration.

To illustrate, a loss of 1 million users in the United States to Facebook is not a 1:1 loss, like it would be for Netflix or Google, where users are isolated from each other in a “silo.”

If I stop using Google, your search results are not affected.

If I stop using Netflix, your programming choices are not affected.

Even Twitter can withstand user loss as the platform is not based on a reciprocal following structure. This is why a celebrity can have 60 million followers, yet only follow 135 people in return.

If 1 million users close their Facebook accounts in the United States, however, it will be subject to a negative k-factor. These 1 million people who delete their accounts weaken the content on the platform for the 50 million-500 million people who were connected to them (assuming each user has at least 100 friends and some are inter-connected).

Now, if 2 million of the subsequent 50-500 million start to use Facebook less due to the impact the original 1 million had, then another 500 million to 1 billion will have a less enjoyable experience, which will reduce time on site. If 5 million from those 500 million find the platform less interesting because their favorite people have left the platform, the affects will continue to spiral.

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This is why Snap has been a popular short. Snapchat continues to lose daily active users on a quarter-over-quarter basis in North America and Europe. Only last May, Snap began to report a sinking growth rate of 2.13 percent – which was its slowest ever at the time compared to 5 percent in Q4 2017. See below for how Facebook’s user growth rate compares.

It should be noted that this was once Facebook’s strength and Twitter’s weakness. New users on Facebook had a low barrier to entry because total friend count grew relative to how much you reciprocate and follow back. Twitter, on the other hand, has had a tough time attracting new users because there is no reciprocation.

Facebook Reported Slowest-ever User Growth Rate in Q2 2018

The viral-coefficient-in-the-reverse explains why the most important metric for investors to pay attention to in Facebook’s earnings report is the user growth rate. Last quarter, Facebook’s monthly user count grew 1.54 percent compared to 3.14 last quarter. Daily active users grew even slower at 1.44 percent, compared to 3.42 percent last quarter. Previously, the slowest daily active user growth rate was 2.18 percent in Q4 2017. If this number becomes stagnant, the social media platform can decelerate very quickly. This is also why it’s possible for Facebook to report strong earnings and there still be a sell-off. If and when this number goes into the red, Facebook will have reached its peak as a social media platform –and profits will soon follow this trailing decline.

Disclosure: I shorted this stock in April of 2018 and have a put option on this stock as of October 2018 as I expect the user growth rates to continue to decline in the near future. Readers should also note these declines are more likely to occur in high average revenue per user markets (ARPU) such as the United States, Canada, and in Europe.

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