Source: The Libra Association

Facebook announced the other day that it would be issuing its own cryptocurrency called Libra, to a flurry of hype and media attention. On the surface it just looks like another drop into the already saturated cryptocurrency market, but this time from a larger more established player. I would like to talk a bit about how this is more than just Facebucks as some people have called it, and how there will be nothing to fear in the short term as Libra will not so much face technological hurdles as much as it will face credibility issues that are as old as money itself.

It is worth noting that the mainstream media focused on privacy issues with the currency, mostly because of the headlines recently surrounding Facebook and Zuckerberg basing dragged in front of the US Congress. If you read the white paper on Libra though, it is mainly focused on the unbanked population in emerging market countries and reducing transactions delays and costs. This population is estimated to be about 1.7 billion people worldwide and represents a huge opportunity if they can even touch a fraction of that population.

What is Libra and How Will it Work?

It’s not just Facebook but rather a consortium of 27 different partners that will be working together on the Libra initiative, including names like MasterCard and Uber. The goal is wildly ambitious: to create a new global currency and an alternative financial network for instant payments. From the initial 27 partners, Facebook hopes to grow the consortium to 100 partners by next year. Each partner is dedicating some resources for design and implementation as well as at least $10 million each.

Source: Libra Association

The Libra name was chosen to make reference to the Roman measurement for a pound once used to mint coins. The project is to be run by a non-profit based in Geneva Switzerland called the Libra Association. The association is to be overseen by the partners in the consortium through a board of directors which will have voting power over the design and release of Libra.

The Libra Association will be headquartered in Geneva Switzerland Source: okr.ch

The actual digital token can be acquired through a Facebook subsidiary called Calibra, which we know will require buyers to show a valid government identification. The currency is going to be backed by a basket of real world currencies and liquid assets from “reputable central banks” which include US Dollar, Euro and Yen assets. It will still be based on the same blockchain technology that is used for other crypto currencies like Bitcoin and Ethereum but will be underpinned by a new programming language called Move.

So unlike Bitcoin or other cryptocurrencies, this one will be backed by a reserve of real world assets held in custodian banks which will have investment grade ratings and be geographically dispersed. The initial reserve fund will constipar of the contribution of each of the members of the consortium. The reserve will then grow 2 ways: either new partners come into the consortium and put money in or users exchange their fiat money for the tokens. The fiat money would then be contributed to the reserve. Designated Libra resellers would distribute new coins or buy circulating ones via regulated cryptocurrency exchanges.

It is being built so that any software developer in the world will be able to build a digital wallet or offer “other services” on top of it.

If the service catches on, Calibra would soon be looking to offer financial services to customers such as lending and investing.

A Refresher on the Basics

Now that we have the broad overview of how it will work, it is worth revisiting the basics of what constitutes money:

• Store of Value – Money needs to be a store of value. If I earn $25 today and can save it and then buy goods next week because it keeps its relative value.

• Unit of Account – This means you are able to assess the value of goods and services in terms of the currency.

• Medium of exchange – This means it is widely accepted to trade for other goods and services.

The problem with other cryptocurrencies is they have an issue with the first two. No one knows exactly how to value Bitcoin versus the dollar or other currencies so it swings wildly based on speculation. There is some theory that it should be based on the cost of the electricity used to produce it but that is tenuous so far.

Libra tried to solve this by backing the currency with a reserve of real world assets. In this way the value will not swing as wildly and people will be able to start to make plans with it for the future and

There Are Immense Challenges

There are some key challenges that will face Libra which have not been answered yet, mainly:

• Privacy – This is the most immediate concern. How would a subsidiary (Calibra) of a company known for privacy issues be able to ensure the security of user’s information?

• Adoption – Just like any currency, there is a critical mass of adoption that will need to take place. This will be spurred initially by the consortium, who will accept the token for their services.

• Credibility – This setup is essentially what’s called a currency board, very similar to what Argentina had in the 90’s although that reserve was in US dollars. The long term credibility and adoption will also depend on how credible people believe the Libra Association is in maintaining the ratio of digital coins to the reserve. Would the association act in an interest detrimental to one of its members to maintain credibility of the currency? For example if one of them faced bankruptcy?

• Speed – The curren limitation of currencies like Bitcoin is their inability to perform many transactions quickly, currently the cap for Bitcoin is 27 per second. This remains an open question for a system that envisions billions of users and does not provide a tested solution of how it would do so.

• Reserve Transparency – Transparency of the reserve would be key for traders and institutional adopters. There as been no information given as of yet how, or if, the size and composition of the reserves will be shared.

• Regulators – The US Senate Banking Committee has announced hearings on July 16th to discuss their concerns over the currency. If push comes to shove and Libra was cut off from the US dollar, would it be able to survive?

• Self Regulation – The idea is to encourage an open system where any user or developer can build a digital wallet. This leaves open the possibility of future digital banks with Libra deposits and assets, who would regulate such a bank and how would they do it given the potential to be able to run it anywhere in the world?

The Primary Ingredient to Start

Trust. The usage of Libra will be subject not just to marketing and even widespread usage but trust. The more a track record of credibility is built and adhered to, the wider and deeper will be the adoption of the new currency. Facebook has over a decade of credibility, the US government has hundreds of years and a history of performance underpinning the global financial system which will not easily or quickly be replaced.

This trust is really what is at the heart of the privacy concern, those about regulation, speed and transparency. Despite the fact that the Libra Association is a non profit run by a consortium, the primary challenge will be disassociating the currency from Facebook for those who may see it as another tool to exploit the masses for corporate fat cats. This is not easily or quickly done and take time to take hold, of it ever does. It seems that thought has been put into this which is why a non profit entity, a board structure and a consortium of partners was formed as opposed to Facebook going it alone.

There’s Also a Problem if it’s Successful

Let’s assume Libra overcomes all the technical issues, is really successful and hundreds of millions of people all over the world use it. As pointed out in this post by Tamas Blummer, the reserve backing the currency will face trading and custody issues due to its size.

Let’s take a short numerical example. Let’s say that a portion of the unbanked 1.7 billion and a few hundred million in the developed world use Libra regularly and keep balances. Let’s assume for this example that number of people worldwide is 800 million. If the average balance across all these accounts is $500, and there was a 1 coin to 1 dollar ratio, that means the reserve would be $400 billion in size.

That may sound huge but it still would not come near something like the Japanese government pension fund, the largest in the world, which has $1.4 trillion in assets but it would make the reserve a huge global player. It would still be able to influence bond auctions of the Chinese or US governments. It also would have to find a place to hold those assets. Since banks can fail, the only foolproof way would be to hold them at central banks which would require getting a banking license in those countries.

The other solutions to this problem which Tamas pinta out are to hold some of its own assets in Libra (reserve banking, just like your traditional bank does now) or to float Libra with no backing, which at that point would make it no different than Bitcoin.

Conclusion

The challenges are impressive and as I have pointed out, will not stop at adoption. There will have to be continuous work, commitment to the project and no big stumbles in terms of credibility to make the currency work but it does have a chance, especially starting off with this much corporate involvement and attention. In the coming months we will see if it is even allowed to get off the ground by governments and regulators. It should be, it’s ambitious plan to push the envelope of progress and bring on the next age of finance and banking. I hope they are successful because it could mean a new era of self determination for hundreds of millions of people.

A Note About This Post

If you’ve made it this far, I thank you as you are reading the 50th post published this year. This is a notable milestone for me as it represents the longest streak of consistent content I have put out since I started the site. This site was restarted on December 31, 2018, in the spirit of enjoying the process of refining my writing skills, sharing knowledge and pushing myself to be more disciplined and knowledgeable in my field. My following is still small, only about 100 people visit the site a month but I have faith that consistent output, delivering value through strong content , sharing my personal challenges and above all, gratitude, will attract readers in the long run. Thank you for reading and feel free to leave your comments on anything I write below.

The information provided by www.cashchronicles.com is for informational purposes only. It should not be considered legal or financial advice. You should consult with an attorney or other professional to determine what may be best for your individual needs. www.cashchronicles.com does not make any guarantee or other promise as to any results that may be obtained from using our content. No one should make any tax or investment decision without first consulting his or her own financial advisor or accountant and conducting his or her own research and due diligence. To the maximum extent permitted by law, www.cashchronicles.com disclaims any and all liability in the event any information, commentary, analysis, opinions, advice and/or recommendations prove to be inaccurate, incomplete or unreliable, or result in any investment or other losses. Content contained on or made available through the website is not intended to and does not constitute legal advice or investment advice and no attorney-client relationship is formed. Your use of the information on the website or materials linked from the Web is at your own risk.