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Facebook’s Digital Currency Libra and Its Implications
2019 Jul/17
Facebook’s Digital Currency Libra and Its Implications Jul. 16, 2019 PDF
Summary
Facebook announced plans to launch its new digital currency, Libra, in the first half of 2020 and create the Libra Association with 27 institutes. Facebook’s Libra project can be summed up in three points. First, Libra blockchain will be switched from a permissioned to permissionless one within five years. Although it is uncertain what the ultimate platform will look like, whether the Libra project is successful will be the key to Libra’s long-term differentiation strategy. Second, Libra is different from existing stablecoins in that Libra’s value is tied to major currencies, more specifically the US dollar, British pound, euro, Swiss franc, and Japanese yen. Third, Facebook will support smart contracts using its own programming language called Move. These characteristics suggest that Facebook presents a new blueprint for building a financial platform which enables a number of users to easily enjoy the benefits of existing digital currencies. Moreover, the Libra launch will reduce psychological hurdles to overall digital currencies, and catalyze the launch of new digital currencies developed by other corporations. This will provoke a much livelier debate about whether it would be desirable for private-sector companies to issue their own currencies and compete with central banks. Meantime, central banks are expected to discuss the adoption of central bank digital currency (CBDC) to replace cash.

On June 18, Facebook announced a plan to launch its new digital currency called Libra in the first half of 2020. On top of that, Facebook has formed a new subsidiary, Calibra, for Libra, which will be a founding member of the Libra Association with 27 organizations across the globe.1)

The big tech platform’s entry into financial services might be welcome news for those with little access to traditional banking services. However, grave concerns are being voiced over Facebook having easy access to consumer financial data because Facebook has been blamed for huge data leaks exposing the personal data of its users over the past few years. Shortly after Facebook’s announcement, governments and the Bank for International Settlements (BIS) expressed their stance that Facebook’s move into finance needs close regulatory scrutiny. The US Senate is expected to host a hearing on Facebook’s Libra on July 16. 

Whether Libra will be successful is anyone’s guess because it will take considerable time to address regulatory uncertainty. But it is clear that digital currencies will attract more attention from regulators and consumers than before. This article explores the characteristics of Libra in comparison with Bitcoin and other digital currencies. We also briefly discuss central banks’ concerns about and future responses to the growth and proliferation of digital currencies.  

 

Three characteristics of Libra

 

Facebook’s Libra project can be summed up in three points: i) a permissioned blockchain, which will be switched to a permissionless one; ii) a stablecoin tied to several major fiat currencies; iii) a financial platform relying on smart contracts.
 
First, Libra is a permissioned blockchain. Blockchain is a system in which digital ledger recording online transactions is simultaneously distributed across and managed by all the nodes in the network on a consensus basis. Unlike Bitcoin, a permissionless blockchain where anyone can participate without obtaining any prior permission or consent, Libra is a permissioned blockchain where only a selected group of members can join the network.2) In other words, a decision on whether to issue or (if needed) burn Libra will be made only by the members of the Libra Association. In addition, a vote on any change to the system will be given only to the members.

As permissionless blockchain allows an unspecified number of users to access or join the network as a miner, decentralization is the most attractive characteristic of Bitcoin. However, it intrinsically has caused concerns and fears about system stability, security and scalability. A centralized system appears to be an unavoidable choice for Facebook to maintain the stability of its own payments system. It is no coincidence that there is no permissionless one among blockchain projects being conducted by banks and fintech firms in major countries. Hence, there is no big difference between the Libra blockchain and other blockchain-based payments systems as many critics have pointed out. It is noteworthy that Facebook plans to transition the Libra blockchain to a permissionless system within five years. It remains unclear as to what permissionless Libra platform will look like and whether the transition will be possible in a short period of time.3) However, it is highly likely that the success of the transition will be the key to Libra’s long-term differentiation strategy.  
Second, Libra is a stablecoin. Because of high price volatility, Bitcoin has been practically denied the status of a means of payment. On other hand, a stablecoin, also called “price-fixed cryptocurrency,” is pegged 1:1 to the US dollar. In many cases, a stablecoin maintains its value by depositing fiat currency as collateral in a certain institute. Recently, algorithmic stablecoins are also getting attention.4)  

Over several years, global banks have put efforts into developing their own digital currencies, and most of them under development are stablecoins. JPMorgan plans to issue JPM Coin built on its own blockchain network, Quorum. JPM Coin is pegged to the US dollar in a 1:1 ratio. As it targets corporate clients, the new coin is expected to be used in offshore money transfers or bond transactions between companies. Many other global banks are reportedly considering or carrying out a blockchain project, only for corporate clients. An exceptional case is Japan where the government has encouraged large banks to issue stablecoins as part of its efforts to reduce the ratio of cash payments. Mitsubishi UFJ Financial Group (MUFG) is set to put its own digital currency, MUFG Coin, into practical use for bank customers.5) Bank deposits can be converted into MUFG Coins at a 1:1 ratio with smartphone apps. The stablecoin will be used in retail money transfers and payments. Meantime, Mizuho Bank, together with Japan Post Bank and other financial institutions, is preparing to launch J-Coin that employs QR codes in time for the Tokyo 2020 Olympic Games. There has been almost no launch of digital currency for retail payments system in any countries other than Japan. Given that, Facebook’s Libra launch is timely in that Facebook can gain a foothold in the market for online retail payments ahead of others. 

Unlike existing stablecoins, Libra’s value is tied to major currencies such as the US dollar, British pound, euro, Swiss franc, and Japanese yen.6) It is important to build market trust in Facebook’s commitment and capacity to redeem Libra for national currencies at any point in order to keep its price volatility low. In general, banks only hold a fraction of total deposits as cash on hand under a fractional reserve banking system. In contrast, Facebook will hold 100% cash reserves to back Libra, which is seen as an attempt to stabilize the value of the stablecoin in the early stage of circulation.  

Third, Facebook will support smart contracts using its new programing language called Move. In smart contracts, the terms of the agreement between parties are written into lines of code and stored on the system. As the agreement is automatically verified and enforced on the network, users are able to save transaction costs by reducing reliance on intermediaries and to execute the contract in a secure manner at the same time. Smart contracts, running on the Ethereum blockchain, are already being used in various fields of real estate, insurance, distribution, and so on. Move, a programming language for Libra, will likely be different in format from Solidity, a programing language for Ethereum. Obviously, with Libra, Facebook envisages moving beyond a payments system and building a financial platform. It still remains to be seen which type of smart contracts will become popular as the development of Move is not fully completed. 

Thus, Facebook’s intention is to establish a financial platform that enables users to easily enjoy the benefits of existing virtual currencies. This is a long-term vision that cannot be found among large global banks or other platform providers. Facebook’s announcement of the Libra project is worth noting in the sense that it presents a new blueprint for putting digital currencies into practical use.  

 

New challenges facing central banks 

 

Can Facebook’s Libra reach the status of national fiat currencies as some predict? In the short run, Libra could end up becoming just a (cross-border) fund transfer or payments system similar to Venmo.7) What Facebook differs from fintech firms or global banks, however, is the number of actual users worldwide reaching 2.4 billion. This means that mainstream consumers will finally have the opportunities to get familiar with the concept of digital currency through Libra. Hence, Facebook’s Libra launch will lower psychological huddles to overall digital currencies regardless of whether Libra materializes the true spirit of digital currency as Bitcoin supporters criticizes. Moreover, the Libra launch will likely prompt global banks or large tech companies to be more active in developing their own digital currencies for worldwide users. 

Imagine that commercial banks and companies in the private sector issue their own digital currencies, and those currencies compete with fiat currencies. This picture reminds us of a “free banking system,” supported by economist Friedrich Hayek. Hayek argued that it would be more efficient if a central bank has no exclusive right to issue currency and all banks are left to issue their own currencies. Although it is very questionable whether a free banking system is necessary despite the risk of undermining the central bank’s stability, the debate will be livelier than ever before. Accordingly, new challenges will surely arise for central banks and international bodies, such as the BIS and Financial Stability Board (FSB). 

For the last several years, central banks have considered whether to issue their own digital currencies, a.k.a Central Bank Digital Currency (CBDC), amid a gradual decline in the use of cash.8) But most of these central banks studied only the potential impact of CBDC on monetary policy, ignoring the possibility of competing with private digital currencies such as Libra. Now that this is being taken seriously, discussions about the adoption of CBDC are likely to begin in earnest in the near future.    
 


1) The Libra Association is an independent, not-for-profit organization headquartered in Geneva, Switzerland. The founding members of the Libra Association include payment companies (Visa, MasterCard, PayPal, etc.), internet-based companies (eBay, Uber, Lyft, etc.), telecommunications companies (Vodafone, lliad, etc.), blockchain companies (Coinbase, Anchorage, etc.), venture capital firms (Andreessen Horowitz, etc.), and non-government organizations (CDL, Kiva, etc.). Facebook aims to have 100 members in the Libra Association before the official launch of Libra.
2) For more information on blockchain and its recent developments, see Blockchain in Capital Markets: A Brief Review (Cho, Sung Hoon, 2016), and 4th Industrial Revolution and Capital Markets-Artificial Intelligence and Blockchain (Kwon, Min Kyeong, Cho, Sung Hoon, 2018).
3) The Libra white paper published by Facebook states that the Libra platform will move to a permissionless system based on proof-of-stake (PoS), suggesting that they do not consider proof-of-work (PoW) protocols used by Bitcoin. The current Libra blockchain uses a Byzantine Fault-Tolerant (BFT) consensus protocol, called Libra BFT. 
4) Terra is a prime example of uncollateralized algorithmic stablecoin. See Blockchain Trends 2020 (Connecting Lab, 2019) for information on how to classify stablecoins by type. The Terra Alliance joined by Tmon and The People of Delivery, just to name a few, was set to launch Terra-based payments system in June but decided to postpone it due to the lack of relevant legal and institutional arrangements in South Korea.
5) The launch of MUFG Coin is slated for the second half of 2019. From 2017, the new coin has been tested by nearly 1,500 MUFG employees.
6) In other words, if existing stablecoins are likened to an exchange rate regime pegged to the US dollar, Libra can be described as simila to an exchange rate regime pegged to a basket of currencies. A case in point is the International Monetary Fund (IMF)?셲 Special Drawing Right (SDR). SDR supplements the existing foreign exchange reserves of member countries in the event of a credit crunch or financial crisis. It is made up of the following five currencies: USD 41.73%, EUR 30.93%, RMB 10.92%, JPY 8.33%, and GBP 8.09%. 
7) Venmo is a provider of mobile payment service, owned by PayPal. There is also Transferwise, a fintech firm specialized in international money transfers.
8) See Country Stances on the Issuance of Digital Currency (Kim, Bo Young, 2019) for information about studies on digital currencies by central banks around the world including South Korea.