July 03, 2019

Libra, probably not a threat

Facebook has been leaking details of its new payments system Libra for a while now. On Tuesday 18 June Facebook finally released the full whitepaper. It has become an unwritten market standard in the cryptocurrency space for any project to release a whitepaper explaining the why and the how.1

The whitepaper tells us that Libra is the token built on the “Libra blockchain”. To the end user this can be thought of as similar enough to how bitcoin or other tokens operate. A blockchain can be thought of (in a non-technical sense) as a list or database. Cryptocurency blockchains in particular are very similar to an accounting ledger – they say “x address sent 0.4564 tokens to y address”. Some agents hold copies of the list and come to agreement on what is on the list at any time by some mechanism. And by this agreement we can be assured that the exchanges took place.

In some sense, we create reality by agreement. This also happens, for example, in financial accounts where if everyone follows the accounting standards then you get some sort agreement on reality and it is “agreed into being”.2  Generally, the differences between cryptocurrencies boils down to how they achieve this consensus. It’s all an issue of trust. There are two ends of the spectrum: you can trust no one except mathematics, as it is with bitcoin, or you can put trust in contracts, the law, and the reputations of companies or people.

Libra does not fit the “ethos” of cryptocurrencies because it is permissioned and trusted.

In Libra’s case this is achieved by agreements between established companies (with their reputations to protect) under established laws. It is a permissioned (only certain people can add to it) and trusted (trust is established “off chain” using legal contracts and reputation) blockchain.3

The advantage of this set up is that it means consensus can be achieved VERY quickly which makes the transfer (from the end user’s perspective) fast. Similar to how merchant payments are fast (in New Zealand) using eftpos because of the layers of trust banks have built between each other and Paymark.

Overall the Libra Association and the Libra Reserve appear to be a form of banking type institution. It issues what economists call a “money substitute” which is a promise that can be redeemed into money (fiat money anyway). The initial supply of assets to this “bank” comes from the initial investment of the Libra Association. And new Libra is only created when new fiat money is exchanged.

This looks familiar to how we saw banks operate in the era of free banking. Except Libra have added a perfunctory and unnecessary layer of “decentralisation”. This is probably in an attempt to piggyback off the cryptocurrency “ethos”. This really creates only more questions.

Libra offers some benefits to people who send remittances – such as migrant seasonal workers.

The main benefit of Libra (as of right now) for New Zealanders will be for those of us who send or receive remittances. This is not a trivial portion of the population, every year we welcome thousands of seasonal workers who will benefit from having access to a fast and cheap way to send value to their families. In 2018 the total number of places for seasonal workers was 12,850. This is only part of the remittances market.

Remittances can be very expensive to send so any solution that can achieve lower fees and allow workers to send more money to their families is welcome.

We don’t yet know the details around buying Libra, we know there will be “authorised resellers” who are the only ones allowed to transact large amounts of Libra to and from the reserve. Which implies that we will be able to interact with some agent and send them flat money in exchange for Libra. What is and is not a “large” amount will be decided by the Libra Association is another question mark – what if we wanted to transact say 500,000 Libra to purchase a house?4

We know that it will use a “wallet” app on your phone or other devices. This app, if it is following the general trend of “wallet” apps, will allow the user to scan a QR code which will generate a transaction for the agreed upon number of Libra and send the transaction to the Libra blockchain. Where it will then be confirmed by the trusted members.

Additionally, the Libra Association includes businesses like Uber and Lyft. So it will be a benefit to those of us who travel and wish to use an Uber in a country where we do not have a bank account. Paypal also solves this problem but there is no harm in having alternatives in a market. Basically, anyone who wants another alternative payment system (with presumably lower fees) will want to use Libra.

A final selling point of Libra is that its price (in terms of US dollars) is held stable through its being “backed” with assets. The specific form of these assets is unknown but the whitepaper tells us that they are low volatility assets like cash and bonds. The whitepaper also tells us that the assets will be owned by the Libra Reserve.

The Libra Association will authorise certain entities to interact with this reserve of assets. This opens a Pandora’s Box of regulatory issues and we don’t have all the details available as yet. The reserve is under passive management and Libra has stated that “any appreciation or depreciation in the value of the Libra will come solely as a result of [foreign exchange] market movements.”

Libra may be a welcome innovation.

At first appearance it seems the Libra Reserve cannot go bankrupt as it has no liabilities and the amount of Libra issued will always be equal to the reserves. But it looks like token holders will be left with increasingly worthless tokens if the value of the assets in the reserve falls too low. This is a risk to users.

There are other risks involved with Libra. We don’t know how it will fit into the existing Anti Money Laundering legislation. If they get it right then, in combination with its stable price, Libra could be used as an easy way for New Zealanders to buy other cryptocurrencies or tokenised assets safe in the knowledge that they are not falling foul of any legislation. 

Overall Libra may be a welcome innovation to the cryptocurrency market. Despite not conforming to the general “ethos” of cryptocurrencies it may be more of a boon than a bane. Probably critical in this regard is how the regulatory authorities approach this Pandora’s Box.

1 Any project without one, or with a poor one, is derided as a “pump and dump”. It’s an emergent solution to an information asymmetry problem. Same goes for any project whose code is not open source.

2 It happens in regular bank transactions as well. The banks agree that we transfer money from one to another.

3 Whereas bitcoin is permission less and trust less.

4 The general idea of Libra is probably for small every day transactions.