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Libra: How Facebook and others plan to ‘meet the daily financial needs of billions of people’

21 Jun 2019, 00:00, ,

The whitepaper for the Facebook-backed Libra cryptocurrency dropped on June 18th and is being viewed by some market observers as a watershed moment for the space. The project's undeniable reach, significant backing and novel technical design has some excited, however, there are questions surrounding whether regulators will accept the Libra business model and its management of user funds.

“Libra’s mission is to enable a simple global currency and financial infrastructure that empowers billions of people.”

This week’s announcement of the Facebook-backed Libra project has sparked global mainstream media coverage and heated debate within the blockchain industry.

It is easy to understand why the project has piqued such intense market discussion. The release of Libra is seen by many as a turning point for the blockchain ecosystem because of the implications it has for digital currency adoption. Facebook’s massive existing user base, Libra’s impressive list of founding members, and a well-structured whitepaper point to the significance of the project.

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Google trends data for ‘Libracoin’

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_Google trends data for ‘Facebook crypto’ _

Facebook’s publicly traded stock rose 4% on Monday. Equity traders appear bullish on its prospects in the short term following the Libra documentation release.

"We view Facebook’s introduction of the Libra currency as a potential watershed moment for the company and global adoption of crypto," RBC Capital Markets analyst Mark Mahaney wrote in a note to clients. "The mission for Libra is a simple global currency and financial infrastructure that empowers billions of people." Mahaney gave Facebook stock a ‘Buy’ rating and set a price target of $250, well above its current price of ~$188.

The price of crypto market benchmark Bitcoin has risen ~2% in the last week. This price reaction may be considered muted given the wider implications of Libra’s launch. However, it is understandable, given that it is unclear how Libra will integrate with the rest of the digital asset ecosystem. It is unknown whether Libra will be tradable with BTC.

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This is not the first time Facebook has entered the ‘virtual currency’ space. The mega corporation previously launched Facebook Credits to much fanfare and media coverage in 2010. However, the transaction costs and margins involved with managing individual numerous daily microtransactions proved to be too expensive and the project was scrapped. Libra has similarities in that it is also designed to be an in-app medium of exchange for peer-to-peer payments across the Facebook ecosystem.

What is Libra? Mapping core monetary aspects of the ecosystem

Libra will be the cryptocurrency issued and minted by the Libra network, a blockchain developed by a foundation based out of Geneva, Switzerland and backed by a consortium of corporations, called the Libra Association, led by Facebook. The Libra Association‘s role is to coordinate the network nodes, develop and secure the network, and promote a wider vision of financial inclusion.

The Libra cryptocurrency will be backed by a reserve basket of financial assets (Libra Reserve) provided by node operators. For its initial release scheduled for 2020, Libra will be backed by a basket of four fiat currencies: USD, EUR, JPY, and GBP.

The Libra Reserve will comprise of a basket of held low-volatility assets structured to keep its value relatively stable. Libra is not a traditional stablecoin, which are typically valued by the price of a single low-risk asset or fiat currency. A better definition for the token may be that it is a ‘low volatility digital currency’, although it is likely to be called a stablecoin as the market understands this concept.

The reserve will always be fully backed by a basket of custodian held low volatility assets. This makes monetary policy straightforward, with no inflation and new tokens minted based on user demand and network resellers sending reserve assets to Libra. The reference price of Libra upon launch should only change based on price movements within FX markets, and not due to supply/demand imbalances within the reserve.

The initial list of fiat assets to be held by the reserve includes currencies from a wide range of stable governments in order to reduce the impact of individual inflation or default. The assets themselves will be reinvested into low volatile bank deposits and government securities. Short-dated securities issued by governments are actively traded and will allow Libra to maintain a funnel for good liquidity. Returns from these investments will help fund the operational costs of the underlying Libra Association that manages the network.

This decision to use user funds to invest in low-interest bonds, then using this interest to pay for operational costs, may create issues with financial regulators. Additionally, there are questions surrounding custody. Libra will need to manage bank deposits to robustly handle user funds. It is not clear at this stage who Libra’s banking partners will be, or whether users will accept that their assets are essentially being frozen by a custodian and they have forgone any rights to interest earned on those assets.

Network decision makers and who runs the Libra network

The Libra blockchain, as well as the low volatility token designed as a medium of exchange, Libra, also utilizes a native governance token, Libra Investment Token or LIT. The model is comparable to the MakerDAO ecosystem, which utilizes the DAI token as a low volatility medium of exchange and MKR as the token that allocates governance rights.

Initially, the network will function as a closed network with a fixed set of permissioned nodes.

The Libra investment token will act as a staking token for these nodes, with larger amounts of LIT reflecting a higher level of commitment to the Libra network and equating more governance power within the Libra Association. Validator nodes have decision making power over the network. The most important network decisions require a greater than two-thirds supermajority from validator nodes. The LIT token gives holders the right to a share of future interest accumulated by the Libra reserve.

In order to become a validator node and become a network decision maker, an entity needs to make an investment of at least $10 million in the network through purchasing Libra Investment Tokens. Network decision making for validator nodes in the council will include:

  • Electing and removing members of the Libra Association Board.
  • Approving the budget of the association annually.
  • Approval of changes to Libra’s guiding principles including the current reserve management policy.

Eventually, the network will expand to a point of wider efficiency and the LIT token will be phased out of the ecosystem, and it will be easier to become a validator node. At some point in the future, Libra proposes that it will become a public, permissionless payment network and a true Decentralized Autonomous Organization (DAO).

The money in the reserve will come from two sources: investors in the separate Investment Token, and users of Libra. The association will pay out incentives in Libra coin to founding members to encourage adoption by users, merchants, and developers.

To support higher efficiency, there will be authorized resellers who will be the only entities authorized by the association to transact large amounts of fiat and Libra in and out of the reserve. These authorized resellers will integrate with exchanges and other institutions that buy and sell cryptocurrencies to users.

The whitepaper states, “The association will encourage the listing of Libra on multiple regulated electronic exchanges throughout the world. These exchanges offer both web portals and mobile apps for users to buy and sell Libra.” This leaves open the possibility that Libra will be liquid and potentially tradeable with crypto assets such as BTC or ETH. Depending on the Libra Association’s attitude towards the KYC requirement for potential partner electronic exchanges, Libra may have the potential to develop into a distributed, semi-permissionless cryptocurrency with multiple popular apps to integrate with.

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The Libra association’s 28 founding members each paid a minimum of $10 million to join and become validator node operators. Notable brands who have already joined the association include PayPal and Mastercard from the payment services space, Lyft and Uber from ridesharing, eBay from e-commerce and Coinbase from crypto. It is hoped that the association will comprise 100 members by the network’s full launch date in 2020.

The Libra blockchain

Every Libra payment is permanently written into the Libra blockchain — a cryptographically authenticated database that acts as a public online ledger designed to handle 1,000 transactions per second.

It will eventually run with a stake based consensus blockchain with a 2-token system. This new financial infrastructure will rely on the Byzantine Fault Tolerant consensus algorithm and will support smart-contracts after it completes its transition from a permissioned to a permissionless environment (apparently 5 years after launch).

When a transaction is submitted to the Libra blockchain, each node runs a calculation based on the existing ledger of all transactions. It uses the implemented Byzantine Fault Tolerance system, and two-thirds of the validator nodes must come to consensus that the transaction is legitimate for it to be executed and written to the blockchain. Libra is a permissioned blockchain and uses a consensus model comparable to cryptographic payment networks such as Ripple and Stellar.

Transactions are not entirely free on Libra. They each incur a tiny fractional cost of transaction value to pay for Ethereum-style “gas” that covers the cost of processing the transfer of funds.

Permissioned blockchains have advantages such as better transaction speeds, greater capacity, and more straightforward network governance.

However, they sacrifice censorship resistance and often lead to power imbalances where the closed network of nodes exert individual preferences for network directions over the entire stakeholder base.

The Libra blockchain will be open source with an Apache 2.0 license, and any developer can build apps designed to work with it using the newly created Move coding language. The blockchain’s prototype launches its testnet today. The blockchain is essentially in a beta, development stage for at least the next few months. Eventually, depending on the stability of Move, developers should be able to create smart contracts for programmatic interactions with the Libra blockchain.

Calibra: What end users interact with

Facebook will operate Calibra, a consumer-facing wallet and regulated subsidiary, which will provide a link between social and financial operations, and build and manage an interface for users to interact with the Libra Network. Facebook plans to integrate its ecosystem (which includes Messenger, Whatsapp, and Facebook.com) into the Libra payment network via Calibra over the next 18 months. This is a possible user base of 2.4 billion and has the potential to significantly expand the adoption of digital currency and blockchain payment solutions.

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What Calibra will look like

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What a Calibra transaction might look like within Messenger

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Like some other cryptocurrencies, Libra has the potential to act as a hedge against macroeconomic uncertainty. In economies with unstable local currencies, Libra may have tremendous potential as a tool for financial inclusion. The level of inclusion is dependant on the nature of Libra’s KYC/AML procedures and local ecosystem use.

The process for the network to become permissionless will take at least 5 years. It may also be challenging to find local banking partners and develop an agnostic regulation strategy that appeases regulators across multiple jurisdictions. This is especially nuanced given that Libra is designed to disrupt the utility of traditional fiat payment systems and has complex custodian requirements.

Regulatory considerations

Also worth considering is Facebook’s chequered past of mishandling private user data, failing to protect users against malicious actors, and attempting to cover up these occurrences when they are detected internally.

Maxine Waters, chairwoman of the House Committee for financial services, said on Tuesday that Facebook should halt the development of the project until Congress and regulators conduct a full review of the payment network.

“Facebook is continuing its unchecked expansion and extending its reach into the lives of its users,” said Walters. Her view is that cryptocurrency markets are unregulated and Libra customers may be exposed to undue risk when interacting with the new digital currency.

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Extended version of Maxine Waters initial statements on the Libra launch

Other US senators have voiced similar concerns.

Regulators in Europe also joined their US counterparts in voicing concerns surrounding the launch of the project. French Finance Minister Bruno Le Maire in a recent radio interview called for more regulation of tech companies.

“This instrument for transactions will allow Facebook to collect millions and millions of data, which strengthens my conviction that there is a need to regulate the digital giants,” he said in an interview on Europe 1 radio.

On June 19th, the United States announced that it will host a hearing, entitled Examining Facebook’s Proposed Digital Currency and Data Privacy Considerations, set for July 16th. The committee has yet to nail down who will testify at the hearing. Lawmakers in the Senate are likely to present sharp and aggressive questioning during the hearing.

Governor of the Bank of England Mark Carney said on Tuesday that he will be keeping an open mind on the proposed cryptocurrency, but has warned it is likely to face tough regulation if it becomes widely used.


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