Libra 2.0: A Preliminary Analysis (Part I)
A Quick Take on Libra Coins
Note: the analysis below is based on public information available on or before April 18, 2020. This is part of a planned series of (relatively brief) posts on the new Libra proposal. I do not pretend to provide a comprehensive overview nor a thorough analysis; instead, this series should rather be considered a casual commentary.
Background
In June 2019, Facebook took the world by surprise [1] when it announced the development of Libra, an ambitious project involving a global, privately-issued currency running on a new, digital payments infrastructure.
The regulatory backlash was immediate: in less than 24 hours, concerned MPs, outraged ministers, and indignant lawmakers rushed to express their vehement opposition. Facebook’s David Marcus and Marc Zuckerberg were grilled by angry US legislators at their respective hearings in what must not have been a very pleasant experience – at least for them.
Then Libra went quiet, leading some to believe that the project had been put on ice. Far from it, however: on 16 April 2020, the world was again taken by surprise when Libra published an updated version of its white paper (v2), which proposes numerous modifications to the initial vision in response to severe regulatory pressure.
So, what has changed?
Quite a few things, actually. As my intention is not to bore you with a long, meticulous list of changes, I will limit the focus to a few adjustments that I believe are key to better understand Libra’s market positioning.
The overarching theme guiding these revisions is, in Libra’s own words, the attempt “to marry blockchain technology with accepted regulatory frameworks.”
This change in focus is well reflected by the updated white paper: first, in terms of size (increasing from 12 to 29 pages, with a brand-new 7-page section titled Compliance and the Prevention of Illicit Activity); and second in terms of the use of more prudent language.
For instance, the term cryptocurrency has been removed from the document (never mind that Libra was never a cryptocurrency to begin with), and the word decentralised has been quietly replaced with distributed. Similarly, the language has shifted from somewhat vague assertions (e.g. responsible financial services innovation) to more concrete, regulatory-friendly propositions (e.g. safe and compliant financial applications).
Apart from changes to the wording, tangible modifications to the platform’s scope, operations and governance have been proposed. I will analyse some of the implications in the coming posts, starting with Libra Coins today.
From Libra (Coin) to Libra Coins
The probably most notable change concerns the introduction of so-called single-currency stablecoins, which are effectively digital representations of national fiat currencies. What started as an opportunistic move to alleviate the concerns of central banks may eventually turn out to be a major adoption catalyst as it greatly increases the platform’s attractiveness and utility to end users.
A complex network of dealers and service providers are supposed to provide markets for stablecoins, whose supply will be adjusted in response to market demand through an unspecified process involving multiple intermediaries that I fail to properly grasp. As a result, I don’t think the proposed single-currency stablecoins can be considered merely another form of e-money; though I can’t either quite fathom right now what exactly they should qualify as instead (I would be more than happy to update this paragraph if someone could enlighten me on this subject). For the lack of a satisfying response, I am currently not in a position to publicly judge the updated Reserve arrangement, though I have my reservations as to whether the protections will be sufficient to prevent a run on the reserve.
It is not surprising to see that Libra is eying central bank-issued digital currency (CBDC) as a potential replacement for private stablecoins, which would greatly simplify the design and significantly reduce counterparty, liquidity, and settlement risks – among others. It remains to be seen whether central banks will succumb to the admittedly enticing prospect of leveraging the Libra infrastructure as a trusted operating system for issuing CBDC (“OS-CBDC”) – much will depend on the final governance arrangements underlying the system (more on that in a future post).
And this finally brings me to Libra Coin (≋LBR), a synthetic composite asset similar to the IMF’s Special Drawing Rights (SDRs), which will be composed of *fixed* nominal weights of a basked of yet-to-be-defined stablecoins. Oh, and did I mention that all of this will be automatically managed by a smart contract on the blockchain? I mean, what could go wrong? The exact issuance and redemption processes remain a mystery to me [2], as does the currency’s value proposition. I can only imagine that it was just too tempting for the Libra Association to hold on to the vision of a global, new type of private money.
I find the white paper’s arguments (cross-border settlement medium and a low-volatility store of value) to be rather unconvincing: after all, why would anyone want to use an alien new type of currency with no price anchorage in the real world when instead you could have access to a digital version of the world’s indisputable reserve currency that underpins the majority of global trade? I’m of course referring to the US dollar; or, to be more precise, its Libra instance (≋USD).
End users whose national currencies are not supported by the platform will need to be onboarded via third-party service providers that provide an off-chain bridge (“last mile”) to a Libra Coin. I find it hard to believe that this Libra Coin would be ≋LBR rather than ≋USD (or, for that matter, another supported currency that is a popular substitute in the given country; e.g. ≋EUR in Eastern European countries). Unless end users demand access to ≋LBR as a vehicle currency or alternative store of value, there is little incentive for local service providers to create liquid (off-chain) markets for ≋LBR.
And I am fairly certain that it will take a long time – if at all – before ≋LBR will have a chance of even being considered a safe and trustworthy option. Settlement media and trusted stores of value are not made in a single day – quite the opposite!
Conclusion
The introduction of single-currency stablecoins significantly increases Libra’s attractiveness and utility as an alternative payment infrastructure for end users (consumers and businesses), but also reduces the potential for the synthetic ≋LBR currency to become a meaningful settlement medium and global unit of account. In the future, Libra may position itself as an attractive digital infrastructure for central banks to issue CBDC, which would eventually replace single-currency private stablecoins and turn the platform into the operating system for CBDC.
In its current form, the updated white paper offers little insight into the mechanics of the issuance, management, and redemption of Libra assets, which is a key requirement for a more detailed analysis of the economics of the proposed Libra Coins. The release of further information and clarifications by the Association on this matter would thus be welcomed.
[1] Well, kind of. Many cryptocurrency and payments aficionados were aware of internal efforts to tinker with some ‘blockchainy’ payments system, but were definitely surprised by its ambitious scope.
[2] For each new ≋LBR to be minted, does a specific amount of single-currency stablecoins (e.g. ≋EUR, ≋USD) corresponding to the fixed nominal weight of the composite index need to be burned? Or will they be temporarily/permanently locked? Or something else entirely? How can they be redeemed? So many questions…