Since it was announced on June 18th, Facebook’s Libra coin has attracted a lot of attention. I haven’t read many of the comments about it, and decided to first read the white paper myself, in order to get a somewhat unbiased idea about it. I say ‘somewhat unbiased’ because I have been working in the field of monetary systems for too long now to avoid all biases. The big question is: “What value does the Libra bring to its myriad of stakeholders?”
What is Libra?
For those who have missed all the hype, Libra is a new cryptocurrency, as announced by Facebook. Indeed, Facebook will not govern it all by themselves, but is setting up a non-profit organisation, the ‘Libra Association’, together with representatives from organisations such as PayPal, Visa, Mastercard and others, which are all listed in the white paper.
Libra coins can be obtained by buying them from authorised resellers, which I shall refer to as ‘resellers’ for the rest of this article. These resellers have to buy the coins from the Libra Association. The act of buying the Libra coins from the Libra Association results in the creation (minting) of the Libra coins. Exchanging Libra coins back into regular currencies also goes through these resellers. The resellers on their part can sell coins back to the Libra Association if they wish, thereby destroying (burning) them.
Once the coins are brought into circulation through the resellers, they can be used for trade with organisations and businesses who are willing to accept the Libra as currency. They might also be used for speculation, which is what mainly happened with Bitcoin.
Setting trust issues with a company like Facebook aside, a first impression of the white paper comes across as fairly positive. The claim that it would save a lot of people from loan sharks by giving them easy access to a sort of bank account is very likely to be achievable. However, that depends on how eager Libra resellers are to extend cheap loans to poor people in developing countries. There is no guarantee whatsoever that the classical loan sharks would not be replaced by Libra loan sharks. However, because competition on those markets would cross borders, that problem might get solved by itself.
The fact that the technology underpinning the Libra coin is made open source is very good news. That way, the open source community can learn from the advances made by the Libra blockchain technology and can either build on it or apply it to other projects. It is bound to attract a lot of attention from developers, which can only be interpreted as good news for the crypto world at large. Of course, any contributions to the Libra framework by the open source community will also benefit the core founders of the Libra coin.
Value stability – a partially unachievable promise
Things become more complicated when it comes to the acclaimed “value stability” of the Libra coin. The white paper claims that the exchange rate of the coin will remain stable thanks to the backing of low risk financial assets. These financial assets include bank deposits and government securities in currencies from stable and reputable central banks, amongst others. From my perspective, this “value stability” claim cannot be upheld, at least not for everyone.
“Because the reserve will not be actively managed, any appreciation or depreciation in the value of the Libra will come solely as a result of FX market movements.”
The above is a literal quote from the Libra reserve paper. Add to that the fact that the Libra is not pegged to any currency in its basket and you get the situation where its trade value is fully dependant on market forces which, as we all know, can be very unpredictable.
The paper on the Libra reserve is full of good intentions to protect consumers from currency volatility. However, no concrete regulations are mentioned. Pegging the Libra to the average or median of the currencies in the basket would be, for example, a concrete protection, but it is literally stated that the Libra Association does not determine monetary policy, thereby leaving everything to the resellers.
These resellers are partially protected against losses because they will always get a minimum price for their Libra from the Libra Association. However, this is not the case for the users of the Libra since for them the exchange rate is set by the market. Furthermore, that exchange rate can either be a lot higher or a lot lower than the exchange rate the resellers obtain for it, depending on demand and the profit structures of the resellers.
The claim that a ‘bank run’, a situation where everyone wants to get rid of their Libra as fast as possible to minimise losses, can never happen is therefore only technically true. The resellers are guaranteed that every Libra they hold is backed by the Libra Association, which plays the role of the Libra Central Bank.
However, the resellers sell their Libra at market value, which will probably be higher than what they pay for it themselves, and can buy them back in at a lower rate than what they sell them for. If the price were to plummet, resellers have the liberty to protect themselves from losses by paying far less for a Libra than what they can get from the Libra Association. This could trigger a ‘bank run’ on the resellers.
This means that the claim of full backing by the reserve only counts for the resellers, and not for the users. The only way to protect against that would be to set maximum and minimum exchange rates for resellers close to the value of the reserve divided by the amount of Libra coins in circulation. However, that would mean the value of the Libra needs to be pegged to the value of the reserve and that’s setting a monetary policy from which the Libra association explicitly refrains.
Libra and currency regulations
Regular currency exchange is supervised under the Forex market regulations. It isn’t mentioned anywhere that the Libra currency exchange falls under these same regulations, thereby limiting regulations to what the Libra Association and the authorised resellers manage to agree on. This could be problematic. The Libra Association is set up as non-profit, but I would be very surprised if the authorised resellers would not be for-profit organisations, which will most likely try to keep regulation as far away from maximising profits as possible.
The Libra Investment Token
Let me introduce you to the Libra Investment Token. It is only mentioned once in the document about the reserve and the Libra Association document elaborates on it in more detail.
This is a token, and, in essence, a second coin. Investors can acquire these tokens by investing a minimum of ten million dollars. In the initial phase, up until the Libra is officially launched, this makes them a founding member.
Investment tokens will also be sold at a later time when additional funding is needed. This token then entitles the holder to receive dividends from the reserve fund. These dividends are gained from the interest that is generated by investing the money in the reserve fund. The interest is first used to pay for the costs of running the association, the Libra currency system and to invest in further development. The rest is partially paid out as dividends to those holding investment tokens.
At first sight, one might think that these dividends will be small because the investments are low risk and are thus likely to have low yields. However, you have to keep in mind that the goal is to turn the Libra into a world currency, which means that scale starts to play a significant role should they succeed.
The supply of these tokens is limited. Initially they are only handed out to the initial investors and will only be issued afterwards if additional funding is required.
If the Libra successfully turns into an accepted world currency, then the holders of these investment tokens stand to gain huge profits due to the size of the reserve. This would mean that the non-profit character of the Libra Association is just a nice facade for a money making machine that mainly benefits the for-profit organisations that started it.
Power structure of the Libra Association
The Libra Association consists of two power entities (the council and the association board), an executive entity (the association executive entity) and an advisory entity (the social impact advisory board).
The council holds most of the power, including overruling decisions taken by the association board. The members of the council coordinate the technical roadmap of the system, in collaboration with the open source community; they manage the reserve, allocate funds and elect and remove members of the association board. The association board plays the role of an oversight body. More details on the roles can be found in the document of the Libra Association.
The members of the council initially include only the founding members. They have each pledged a minimum of ten million dollars to the reserve in exchange for investment tokens.
These founding members are also the only members who validate transactions on the blockchain when the Libra is brought to market. Entities that validate transactions are called validator nodes. Initially only founding members act as validator nodes but a transition path is described in which other entities can also serve as validator nodes at a later stage. The key is the financial stake. The financial stake in the Libra is initially only determined by the amount of investment tokens one holds. At a later date, holding a sufficient amount of Libra will also count towards this financial stake.
Voting power is also determined by the financial stake one holds in the Libra. Every investment of ten million dollars gains you one vote.
The number of votes is capped in order to limit power concentration. For founding members, i.e., those holding sufficient investment tokens, this cap is set to one percent of the votes or one vote, whichever is greater. If a founding member were to hold more votes than the cap allows, the excess voting power has to be given to the Libra Association board, which may delegate the votes to other entities under conditions listed in the Libra Association document. These votes can be given to entities which do not meet the ten million dollars investment requirement.
It is not quite clear from the document whether investors who hold a sufficient amount of investment tokens, but do not act as a validator node, also hold voting power. Reading between the lines, I assume that one needs to be a validator node in order to have voting power, although I’m not totally sure of this.
For those not holding investment tokens, voting power can only be acquired by acting as a validator node, and either holding an adequate financial stake with the custody of Libras, once these start counting towards the financial stake, or by being lucky enough to acquire excess votes through delegation by the Libra Association board.
The number of active validator nodes is limited, and thereby the size of the council is limited too. It is the council itself which decides on this limit, and if the number of active validator nodes should exceed this limit, the member with the least number of votes is removed. In case of a tie, the member with the shortest continuous membership is removed.
Voting is carried out by either a regular majority or a super majority, consisting of at least two thirds of the votes. A super majority is required for:
- changes in the reserve management policy;
- removing a founding member which does not comply with the eligibility criteria;
- making changes to the Libra guiding principles.
It takes some time to get your head around the text presented in the Libra Association document, but the power structure that has been setup gives a lot of leeway for power games, mainly played by the more affluent players.
Voting power for social impact organisations which cannot cough up the required ten million dollars’ entry fee is dependent on the goodwill of the association board to be handed surplus voting power.
This board is elected by those holding the lion’s share of power. The limit on active validator nodes, along with the procedure for removal of surplus validator nodes, ensures that those who have invested the most, and have been there the longest, will hold on to their seats of power. In essence, the message is, “Trust us; we’re the good guys,” although there is nothing that can be done if that promise proves to be false.
The Libra Coin users
What about the users of the Libra coin? They are crucial for the success of the currency and they will be the main source of funding for the reserve, and thus also for the profits made from that reserve by those that hold investment tokens. However, users hold no power unless they are able to invest sufficiently in Libra.
The Libra is a non-interest bearing currency which means that users forfeit all interest they could have gained on their normal currency. This is unless, of course, someone would be willing to pay an interest on Libra coin accounts, yet if someone would be willing to do that, you can bet that they will be making a far larger profit than they are paying out.
Current interest rates are virtually non-existent, except for those sitting on a lot of money. However, you have to keep in mind that the non-interest bearing Libra is backed by interest bearing financial assets.
Indeed, that interest, which is more than the average Joe can receive on a savings account, is not going into the pockets of the users. It is stated literally in the document of the reserve that users do not receive a return from the reserve.
If Libra truly wants to help people to stabilise their finances then they could have distributed half of the dividends amongst its users, even in Libra, and thus implement a basic income, yet they categorically chose not to do that. This turns users into assets for the investors of the Libra and they bear the brunt of the risk.
Political power impacted
There is also the question of what would happen when the Libra becomes the most used currency in a country where there are currency problems, such as Turkey, for example. The exchange rate of the Turkish Lira has been on a downwards slope for years, leading to high inflation. What if the Turks dumped their Lira in exchange for Libra en masse? This could crash the value of the Lira even further and could have potentially disastrous effects on the banking system of the country. How would that affect the political independence of that country? What would it do to the local economy? One of the goals, as stated in the white paper, is the following:
“We believe that global, open, instant, and low-cost movement of money will create immense economic opportunity and more commerce across the world.”
This implies more international consumption, which could mean a boon for the investor’s international trade balances, but it could be disastrous for local trade. Unless local merchants also switch to the Libra, further damaging the value of the national currency. In that event, what about taxes? Would the Turkish government be forced to accept taxes in Libra or would the Turkish Lira mainly be used for taxes and will the Libra be used for all other purposes? I’m not going to delve into this further, but I thought that it at least needed to be mentioned in a critical article on the Libra.
Although there are a lot of great promises that are advertised by Facebook and the other founding members of the Libra, I’m personally very sceptical about it. Other than the promises, I see nothing that truly guarantees protection of Libra coin users against exploitation, except maybe the fact that exploiting the users is bad for business for the members of the Libra Association. This is because they stand to make a lot of profit from this initiative should they succeed in their goal of making the Libra into an accepted world currency.
I do see a lot of safeguards for the early investors and the resellers though. In the end, should the initiative fail, the losses are minimal. The investors would have access to the developed technology on which they can build other projects. They would have gained a tremendous insight into monetary policy and legislation which can also be used for future projects. The cost of setting up the non-profit organisation is very little and there is virtually no investment in hardware because the initial investors already have the infrastructure needed to set this up. The money that is not used is held in a secure fund which is managed by all the players that put their money into it. Therefore, it is not so hard to imagine that, in the case of utter failure, this fund will be redistributed according to the amount of investment tokens each investor holds.
Should it fail, those who stand to lose the most are the users. There is no guarantee that the resellers will still be willing to buy Libra if their profit margins for doing so fall below certain thresholds. The coins in circulation will then only be useful if the validator nodes, which are run by the initial investors for the foreseeable future, are still up and running. However, there are no guarantees for that and when the risk of validator node shutdown looms it becomes very unlikely that people will still be willing to accept Libra for their goods and services. The open source community could possibly help out there if they set up a parallel structure and offered to exchange Libra to ‘new Libra’. I think it would be a good idea to have that in place from the beginning.
Furthermore, all the Libra which die together with the last validator node would mean extra profits for the founding members because they won’t have to buy them back.
I realise that I’m painting a worst case scenario here and I don’t know how things will evolve. Only time will tell though, and I believe that painting a worst case scenario is necessary because it opens up pathways to improve on what is there and to mitigate the known risks.
Hey Facebook, join the Happonomy
At Happonomy, part of our mission is to help organisations design money so it aligns with those things we find truly valuable in a better way.
So here’s our feedback to the Libra founders: if you are truly interested in creating value for those who have no access to bank accounts and cheap loans, we suggest doing the following:
- Add a dividend of your own design, in Libra, for the users. Pledge to invest at least half of the surplus interest, after subtracting operational costs and structural investments, gained from the reserve to this, thereby implementing a basic income in Libra.
- Put a cap on the dividends which holders of investment tokens can gain and maybe have a look at our Slingshot model for value-driven organisations.
- Change the power structure of the Libra council so that there is a constant rotation with new members, which is also part of our Slingshot design.
- Peg the value of the Libra to the median of the value of the reserve in order to create true value stability for users and not only for resellers.
- Use a method to determine value contribution and build in accountability in order to uphold those values. We have our value canvas which could help you out in determining value.
- For more inspiration, you can also have a look at our own currency design, the Sustainable Money System.
To end on a positive note, maybe the critique published by myself and others could help to shape the final version of the Libra. If not, the developed technology could be useful for the open source community and might one day become the foundation for something that truly has value creation for everyone at its core.