Libra Coin: A New Era of Denationalization of Money?By Jun 20, 2019 7 Min Read
It’s finally here! Facebook has launched the long-awaited whitepaper and its cryptocurrency “Libra coin” is expected to launch in 1H 2020. There are 3 key components of Libra:
Key Components of Libra
1. It is built on a secure, scalable, and reliable blockchain; (Libra blockchain)
2. It is backed by a reserve of assets designed to give it intrinsic value;
3. It is governed by the independent Libra Association tasked with evolving the ecosystem.
This article will take a deeper dive in the second component, Libra coin and its potential impact on dollarization and denationalization of money.
The currency used on the Libra blockchain, Libra, is designed as a stablecoin and will be fully backed by a reserve of real assets dubbed the “Libra Reserve”. The trading of Libra is supported by a competitive network of exchanges such as Coinbase.
Libra has a high degree of assurance that it can be converted into local fiat currency based on the exchange rate. It is backed by a basket of low-volatility assets, such as short term government securities and bank deposits in currencies from reputable central banks. This is also the major difference between Libra and existing cryptocurrencies which most of them do not have underlying assets. It is also different from the existing stablecoins which are typically backed by one underlying asset.
It is worth noting that Libra is not a “peg” to a single currency. As the value of underlying asset changes, the value of one Libra in any local currency may fluctuate as well.
The Libra reserve is the key to achieve value preservation of Libra. This whitepaper addressed 7 key questions to provide a comprehensive overview of Libra reserve.
1) Source of money in the reserve
The money in Libra reserve come from investors in the separate investment token and users of Libra. For investors, they use separate investment tokens to take part in a private placement and get Libra coin as return. The amount of these investment tokens will go to the Libra reserve. For users, when they purchase Libra for fiat, an equivalent amount of Libra coin will be created. The amount of fiat currency will be transferred to the reserve as well
2) How will the reserve be invested?
The reserve will be invested in low-risk assets that will yield interest over time. The interest revenue will first go to support the operations of Libra Association, such as grants to nonprofit and multilateral organizations, investment funding on ecosystem development, engineering research etc. The remaining revenue will be served as dividends to early investors of Libra coin.
3) Holding of Libra reserve
To mitigate counterparty risk, the Libra reserve will be held by a geographically distributed network of custodians with investment-grade credit rating. There are 3 criteria in custodian selection: providing high auditability and transparency, avoiding the risks of a centralized reserve and achieving operational efficiency.
4) Value of Libra Coin
Libra coin will be backed a basket of low volatility assets such as bank deposits and short term government securities in central banks. To preserve the capital value of Libra Coin, Libra Association will only invest in multiple government debts with low default probability. To enhance the liquidity of Libra coin, Libra association plans to use short-dated government securities that are traded in liquid markets with a daily volume in hundreds of billions. This allows the adjustment of the reserve size as the number of Libra in circulation expands or contracts.
5) How entities interact with the reserve?
Only resellers authorized by the Libra association can transact large amounts of fiat and Libra in and out of the reserve. These authorized resellers will integrate with crypto exchanges and institutions that buy/sell cryptocurrencies, and provide these entities with liquidity for users trading cash and Libra.
There is no monetary policy set for Libra reserve. Libra association mints and burns coins in response to demand from authorized resellers. Through interaction with authorized resellers, Libra association automatically mint new coins when demand increases and destroy them when demand drops. Any appreciation and depreciation of Libra will be a result of FX market movements.
6) How to protect consumers using Libra coin?
During the early development stage of Libra network, the Founding members are committed to shape the regulatory environment that encourages technological innovation while maintain high standards of consumer protection.
To mitigate behavior of bad actors, the main endpoints (e.g. exchanges, wallets) of Libra network need to comply with applicable laws and regulations and collaborate with law enforcement. The ledger of transactions on Libra blockchain will be visible to public which enables 3rd parties to audit, detect and penalize fraud.
7) How will the reserve change over time?
When there is a competitive market of exchanges, any Libra coin held by users can be sold for fiat currency at a narrow spread above/below the value of the underlying reserve. If there is significant economic crisis in certain regions, Libra association may change the composition of the underlying assets. Such a change would require exceptional circumstances and a supermajority vote by the association’s council.
Libra Coin paves the way for dollarization?
Countries suffering high inflation rate like Iran (52.1% in May 2019), are on their way of de-dollarization as a means to circumvent economic sanction and Iran has banned sale of foreign currencies including USD at exchange bureaus. Libra coin can be an alternative for countries suffering high inflation/ hyperinflation with its utility of capital preservation.
Compared to cryptocurrencies like Bitcoin that are not backed by any assets, Libra coin can be a more popular choice for citizens in high inflation countries due to its backing from a basket of low-volatility assets. Moreover, Libra coin has a wider range of applications in services provided by traditional giants such as Mastercard, Paypal, ebay and Visa. These partnerships enable citizens to make payments and transfer money using Libra coin, across countries that supports these mainstream payment methods.
While Libra coin is backed by the USD, the impact of de-dollarization may be limited when Libra coin gains mass adoption in future. Taking one step ahead, the emergence of Libra coin may reshape the existing landscape of fiat currencies. It is because when citizens in high inflation countries use Libra coin, their dollar value of spending will be based on the underlying asset of Libra coin – USD. This will pave the way for dollarization, and the value of Libra coin can be largely driven by the monetary policies of U.S. Federal Reserve.
Denationalisation of money: A reality?
Nobel prize winning economist Friedrich Hayek wrote his book “The Denationalization of Money” in 1976, advocating people would be better off if they use privately issued currencies instead of government-issued money. Hayek assumed that people prefer currencies with stable purchasing power as they immune from “inflation tax” (negative return of money due to a decrease in purchasing power). Besides, privately issued currencies will gain mass adoption in countries suffering hyperinflation like Venezuela.
Libra coin can be a real contender to achieve the denationalization of money. With the partnership of traditional giants, Libra coin can result in mass adoption in 2 areas:
Partnership with payment giants can make Libra coin a “global” coin. In the future, Libra coin users may access to the Visa market of 11 trillion total volume; join the network of Paypal with more than 179 mn active buyers; and join the transaction network of Mastercard with purchases of 90.2 bn in 2018. When Libra coin can be used in these payment networks, it can truly become a global currency.
Facebook may integrate Libra coin into Whatsapp to leverage the huge potential of remittance market. As first reported by Bloomberg, Facebook is launching its own cryptocurrency targeting Indian remittance market. According to World Bank , India is the top remittance recipients with $79 bn in 2018. Its remittance growth exceeded 14% last year, due to the financial help migrants sent to families following the flooding disaster in India. It is also noteworthy that 191 mn of Indians were unbanked in 2017, only second to China of 224 mn (See exhibit 1).
Exhibit 1: No. of Adults Without a Bank Account in 2017 By Country
Source: Global Findex Report, World Bank
There are 480 mn internet users and over 200 mn Whatsapp users in India. Given the hostile relationship between Facebook and China, it makes sense that Facebook will use Libra coin to tap into the second largest unbanked population in the world.
While Libra coin of Facebook is expected to launch in 1H 2020, we believe this is just the beginning! When Telegram, LINE and Kakao etc have launched their blockchain and own cryptocurrency, the era of denationalization of money starts now!
Matthew Lam 📧