Cryptocurrencies Part 4 — Cue Libra!

Source: TechCrunch

It’s a bitcoin…No, it’s fiat…Wait, it’s a stablecoin…Libra!

In my previous pieces, I detailed cryptocurrencies, how they operate in tandem with the blockchain, and their relevance as asset classes and as media of exchange. However, there’s a new kid on the cryptocurrency block…Libra.

No, I’m not talking about the astrological sign here. Facebook announced its ambitious cryptocurrency project last April, and it’s quite different from the standard cryptocurrency framework. Titled the Libra Project, the initiative is set to roll out in 2020.

Let’s take it from the top. What exactly is the Libra project?

As per the Libra White Paper, ‘The Libra mission is to enable a simple global payment system and financial infrastructure that empowers billions of people.’ People would be able to use fiat currency to buy Libra and transact using the digital currency via apps and wallets like Facebook’s Calibra and other third-party services. They can cash out at any point in time as well.

The Libra Project comprises the following main aspects:

1. The Libra Blockchain

This is a new blockchain built via the Move programming language. According to the Libra White Paper, ‘Move takes insights from security incidents that have happened with smart contracts to date and creates a language that makes it inherently easier to write code that fulfils the author’s intent, thereby lessening the risk of unintended bugs or security incidents.’

The design ensures security and protection from double-spend attacks. The LibraBFT consensus algorithm used for transaction verification also proves to be more energy-efficient than the Proof of Work model employed in Bitcoins. There are some key differences between the Libra model and those of other cryptocurrencies.

In the case of Bitcoins, while transactions are verified and added to the ledger by a decentralised network of nodes, Libra transactions are verified by a central consortium known as the Libra Association. In essence, by possessing a permissionless system, anyone with the mining capability can join the Bitcoin blockchain as a node. However, Libra’s blockchain incorporates a permissioned model, restricting the number of nodes to those within a particular Association or group. While the original plan was to transition to a permissionless model, the organisation backtracked on the idea due to regulatory backlash. It currently holds the stand that those wishing to join as nodes must secure certain approvals, though the plan hasn’t fully taken shape yet.

The transaction capability is also higher for Libra, with around 1000 transactions per second in comparison to Bitcoin’s 7 and Ethereum’s 15 transactions per second capacity.

2. Libra Coins

Libra Coins belong to a category known as stablecoins. Bitcoins and altcoins are not backed by any assets. Neither are fiat currencies, but they do possess the backing of the sovereign. A stablecoin, on the other hand, is backed by a stable asset or basket of assets and, as a result, it experiences much less volatility than traditional cryptocurrencies. Single-currency Libra Coins like ≋USD, EUR, GBP and the multi-currency Libra Coin ≋LBR (a smart contract weighted average of single-currency Libra Coins) are up for grabs in the proposed model.

Each single-currency Libra Coin is backed by the Libra Reserve 1:1 by cash and liquid assets. These assets are denominated in the respective currency and issued by the home country. As ≋LBR is essentially a basket of single-currency stable coins, it also gets backed by the Reserve.

Payments received using single and multi-currency Libra Coins can then be converted into the local currency easily as their underlying value is directly based on fiat backing.

3. The Libra Association

The Libra Association refers to a network of institutions — financial institutions, non-profit organizations, venture capital firms, telecom players and others, who are responsible for the oversight, operation and management of Libra Networks, the Reserve and the payment system. They also serve as validator nodes for transactions. The Association Council comprises one member each of the entities present in the Association and each such representative has one vote. Facebook will also get only one vote as part of the Association. Each member had to invest at least $10 million and meet certain threshold criteria to get on board and they would receive a portion of the transaction fees once the network goes live. They would also earn interest on the assets held in the Reserve.

Facebook, Uber, Spotify, Temasek, Lyft and Kiva are some of the members of the Association currently and Libra is looking to expand the number to 100. However, some issues crop up about privacy on the network. One of the biggest deliverables of Bitcoins and similar altcoins is the pseudo-anonymity and decentralization. However, in addition to having the Association responsible for transaction verification, the presence of players like Facebook does make privacy concerns so much more real. A ‘Friend Finder’ feature on the network and the potential harnessing of transaction data do pose some questions. Facebook, however, has been allaying fears by assuring separation of this data from social media information.

4. The Libra Reserve

The Libra Reserve comprises of high-quality liquid assets that would fully back the Libra Coins. While traditional banks hold a fractional reserve of liquid assets to meet deposit liabilities, the Libra Reserve operates in a manner such that for every Libra Coin there is a corresponding real and liquid asset. These assets are located across custodian banks. Hence, with the introduction of Libra Coin, there’s no new creation of money, but just a repackaging of the existing money supply. While this backing serves to instil confidence among users that they will be able to convert their Libra Coins to fiat at will, there are some other provisions like redemption stays and haircuts to hedge against possible runs on the Reserve. The Reserve is also responsible for minting and burning new coins per supply and demand forces. This is in contrast to Bitcoins where the number is capped at 21 million.

According to Charles Hayter, co-founder and CEO of CryptoCompare, ‘Bitcoin is permissionless, fully decentralized, deflationary and volatile. Libra is permissioned, more centralized, governed by supply and demand and pegged to fiat currencies.’

5. Market Makers and Service Providers

There are coins which will be transacted, there’s a network on which transactions can happen and there’s a Reserve backing these coins. However, a key ingredient would be the market makers who would buy from and sell these coins to exchanges and OTC dealers. These designated dealers would be the ones offering liquidity within the confines of tight spreads and the Libra Network would interact with them in the minting and burning of coins. Virtual Asset Service Providers (VASPs) are customer-facing entities and facilitate user transactions. Regulated, certified and unhosted VASPs are all allowed to operate on the network after clearing varying qualifying criteria.

Facebook is building its wallet offering titled Novi (previously called Calibra), which is set to roll out on WhatsApp, Messenger and as a standalone app. The service provider proposes to refund lost coins whenever possible in the event of any scam or hack. One cannot lose access to the wallet as the platform manages various keys. Novi also promises no hidden fees for cross-border transactions and easier payments. These features would make handling Libra easier than working with Bitcoins. However, Novi isn’t a method to send coins anonymously, as one would have to upload an image of Government-issued ID proof.

Threats and Competitors

The departure of major members like PayPal, Visa, Mastercard, Stripe and eBay last October dented the credibility of Libra. While it might not have caused a long-term negative impact, regulatory hindrances are causing delays, threatening to derail the project. The luxury of time is indeed non-existent in the world of technological innovation. And Libra isn’t the only one in this race.

The Celo Foundation’s Alliance for Prosperity is similar in aim to Libra and its Association, seeking to bank the unbanked and facilitate financial inclusion via digital currencies. Celo is an algorithmic-based stablecoin platform, with its Reserve comprising other cryptocurrencies to back the Celo Gold and Celo Dollar. With a shared ancestry combining elements of Libra and Ethereum, the Alliance already has 75 members, some of whom are Libra members as well.

Celo claims to have a reach of 400 million people, and though this is dwarfed by Facebook’s reach of 2 billion people who can potentially use Libra, multiple aspects are playing in Celo’s favour. Celo might be cut less slack from regulators than Libra because of its dissociation from Facebook and the absence of fiat backing. However, AML and illicit activity financing issues will be pain points. Its decentralization, by being an open-source project could be a plus, a model where there’s no minimum investment requirement. Libra’s model is more centralized, where certain invited members alone can validate transactions. But the bottom line is that both players need to overcome significant regulatory hurdles.

Aside from other stablecoin providers, central banks around the world are getting their skin in the game. The US Fed recently announced FedNow, its instant payments system set to launch in two to three years. Many are experimenting with their own Central Bank Digital Coins (CBDCs) including the central banks of China, Thailand, Canada and Switzerland. JP Morgan had issued its JPM Coin a few years back as well.

Way Forward

Libra’s rollout is currently planned between November-mid and year-end. Before that, the Libra Association is looking to reach 100 members. It’s also awaiting a FINMA (the Swiss Financial Market Supervisory Authority) license to be deemed as a formal payment system. Plans to register with the US Treasury’s FinCEN (Financial Crimes Enforcement Network) as a money service business are also on the cards. It remains to be seen whether the project can navigate the regulatory barriers and concerns and launch by the end of the year. As to its potential impact, it does seem like a lot of big players will be watching its performance with bated breath to discern the same.

A finance and public policy enthusiast, passionate orator, keyboard player and reader who loves dreaming big, working hard and trying out new things.