Libra 2.0: Multiple Stablecoins in a Smart Basket
By: Stephen Perrenod
Tags: Libra, Finance, Cryptocurrency, Bitcoin, Central Banks

Libra 2.0: Multiple Stablecoins in a Smart Basket

By Stephen Perrenod on The Capital

Since Libra’s introduction in 2019, I have written five articles here on Medium about Libra (1.0), and how it compares to Bitcoin and CBDCs:

https://link.medium.com/8vlOVpvEP5 — Libra: Corporate Money in furtherance of surveillance capitalism

https://link.medium.com/YjjVPuyEP5 — Libra, Facebook’s Corporate Money

https://link.medium.com/shyvpMAEP5 — Libra Leverage

https://link.medium.com/z69uvkbIP5 — Bitcoin Crosses the Chasm: Libra pushes it over

https://link.medium.com/QZHIzciIP5 — Currency Wars: Libra accelerates the Battle of the Central Banks

Now the Libra Association led by Facebook, has rolled out its second version of its white paper. https://libra.org/en-US/white-paper/#an-open-and-competitive-network

Statue of Justice, Old Bailey, CC BY 2.0 Charles D. P. Miller

Corporate Stablecoin

Libra is corporate money, just as fiat is government money, and Bitcoin is private money, and it is in the stablecoin category. The stated focus for the Libra Association and Libra cryptocurrency is on making efficient payments available widely, at low cost, including to the billions of people who are unbanked and underbanked.

The Association has shrunk a bit. Originally there were 28 prospective members. Some of the big names dropped out, including Visa, MasterCard, and PayPal. They now have 22 members. But they have incorporated as of last October, and they have constituted a board of directors and a technical advisory committee. Association members each have one vote.

The Association creates and burns Libra tokens as necessary, and these tokens will be 100% backed by government securities, mostly with less than 3 months’ duration to ensure high liquidity. When it comes to validating transactions, a Byzantine fault tolerant protocol requiring a 2/3 majority is used.

Distribution

“Libra Networks will not directly interface with consumers, but will instead partner with a select number of Designated Dealers to extend liquidity to consumer-facing products, such as wallets and exchanges. These Designated Dealers will commit to making markets within tight spreads and will be able to accommodate high volumes of trading.” — Libra white paper

Designated dealers might be cryptocurrency exchanges operating in a particular country, or they might be other financial services providers who wish to enter the stablecoin market. The Libra Association will look for those exchanges or fintech companies or banks that can handle substantial volumes.

The SDR Twist

Libra was introduced as a stablecoin, with a twist. The twist was to propose a basket of fiat currencies, in concept similar to the Special Drawing Rights of the International Monetary Fund. In fact, they nearly reproduced the SDR mix, although they substituted the Singapore dollar in the basket for the Chinese Yuan introduced into the SDR a few years ago. This avoidance of the Yuan (also known as renminbi) was obviously due to strict capital controls in place for the Yuan, as well as the difficult prospects of working with the Chinese banking authorities, who are focused on their own digital Yuan, the DCEP. Not to mention the Facebook app being banned in China.

However, the stablecoin basket ran into pushback from central banking and monetary authorities and legislatures across the West. Firstly, because of Facebook’s reach to billions of customers, there are concerns over adherence to financial regulations (KYC, AML) and the potential for the disruption of monetary policy, especially in developing countries.

Additionally, the SDR-like aspect seems to have really stepped on the toes of the IMF, BIS, and major central banks. SDRs themselves are issued only by consensus of the IMF and are certainly not intended for retail use. They are a sort of backstop to the global dollar-based monetary reserve system, with new tranches issued under special circumstances.

Compromising with Government Money

The Libra Association has engaged in extensive discussions with relevant authorities. According to their white paper they have had discussions with the G7 stablecoin working group in particular, and “constructive dialogue with international stakeholders such as the Financial Stability Board, World Bank Group, International Monetary Fund, Bank for International Settlements, Inter- American Development Bank, World Economic Forum, and central banks and financial system authorities in jurisdictions around the world.”

The Statue of Justice on the roof of the Old Bailey has a sword, as well as scales. Unlike governments, the Association has no sword, just scales to balance supply and demand for Libra. So they have demurred.

Based on these discussions, the Libra Association has backed away from the SDR-like basket as their primary offering, and recast what was originally a clear plan, into a ‘proposal’. But they are not eliminating the idea entirely.

Instead of a basket of currencies in the form of a stablecoin, they will produce multiple stablecoins for various jurisdictions, initially including the US dollar, Euro, and British pound. Over time they will want to introduce stablecoins in all major currencies where the volumes of transactions would support such a stablecoin, directly tied to that nation’s fiat currency, and where national authorities give them the go-ahead.

CBDCs

Furthermore, the Libra Association anticipates the move toward central bank digital currencies (CBDCs). They hope to be able to link their stablecoins in a given country directly to that nation’s CBDC, essentially becoming a distribution channel for the CBDC (as an example, it is expected that AliPay is a channel for China’s DCEP, and the DCEP may be live as soon as May for some user trials).

What they hope, but do not say outright, is to be a preferred provider of CBDC wallets in various jurisdictions. This is sort of like the primary dealer analogy for banks dealing in Treasury securities with the Federal Reserve.

Not a Basket, but …

The Libra team is keeping the SDR-like basket idea alive, in the form of a smart contract. The basket above the base Libra Network would be implemented as a layer, as a smart contract on top of the underlying stablecoins. And in fact they are already proposing initial weights of 50%/18%/11% for the top three components, the $, €, and £.

The smart contract approach affords maximal flexibility. One could imagine Libra developing multiple baskets. These could be of use to corporations engaged in international trade, for example. A basket could be constructed reflecting the degree to which a country or corporation realizes trade revenue in a particular currency.

The Move programming language for smart contracts, as I wrote last year, is one of the most appealing parts of the Libra proposal. Move is a stack-based language with restricted functionality. It has special structures for assets, so that a move of an asset is a unique event. Not being Turing complete is a good thing when it comes to cryptocurrencies; security is enhanced by having fewer attack points.

Stablecoins, CBDCs, and the Greater Recession

The new Libra comes at an interesting time, as the global economic environment, and as a consequence the currency regime, enters a period of unprecedented strain due to the COVID-19 pandemic on top of existing trade frictions as well as supply chain challenges from both of these causes.

A Libra-like design could foreshadow a replacement of the dollar-based foreign exchange and central bank reserve regime with a basket of CBDCs, defined and updated by the IMF and central banking authorities. With a smart contract it would be easier to include more major trading nations in such a basket, rather than limiting to five as is the case with the SDR. The Libra Association is asking central banking and government authorities for guidance along these lines.

The dollar-based global system and the Eurozone both will be severely stressed in the next few years. Developing nations will have greater problems as they seek to repay dollar-based debts. There are many financial market observers who are suggesting that CBDCs could be a vehicle for helicopter money or universal basic income (UBI) schemes, allowing for more efficient and broader distribution of financial support to citizens.

Tipping the Scales

Libra 2.0 tips the scales more toward government money (1) by ensuring integration into the regulatory system internationally (KYC, AML, Travel Rule) and with each national financial regulatory authorities where it will operate, and (2) by tying Libra to individual national fiats, and in the future, possibly to CBDCs.

A future Libra 3.0 at some point will have to tip the scales back toward a more balanced position that incorporates the needs and desires not just of corporations and governments but of humans. A future position will need to reflects the desires of a large user community if they wish to be successful. As the Association rolls out the product later this year (only after they receive their financial operating license in Switzerland) and into next year they will begin to face the true user requirements of perhaps a billion people or more. What will they discover that users most want?

How will Libra truly differentiate from existing solutions? Privacy, security, convenience are all attributes of fiat cash and of a number of existing mobile cash apps. What else can Libra offer to compete with these existing solutions? Mobile cash apps are already widespread, coronavirus-free, and quite convenient.

Now that they have mollified the banking authorities perhaps, the Libra Association needs to come up with some differentiators for users. At present, their first two use cases look to be (1) as an alternative to Tether as an on-ramp to cryptocurrency exchanges, and (2) as a means to transfer value across national boundaries.

Foreign Exchange Flows

But if instances of Libra are tied to various national fiat-denominated stablecoins how will they handle the foreign exchange side of things? They will be reliant on the existing banking system. To the extent that Libra allows for more transfers of foreign currency into or out of an economy, it becomes an issue for the central bank of that country.

A Libra user working in the United States sends a Libra dollar-based amount to their family in the Philippines. That then has to go through the foreign exchange process just as if it were a Western Union transfer, for conversion to pesos. Fees should be lower, so that is a net positive for the users.

The central bank has to manage the overall dollar flows into and out of the Philippine economy.

The central banks and the banking system of the nations in question have to be involved. Capital flows in might be welcome, but if they are too great, or reverse to outflows due to a weakening domestic currency or global economic crisis, it becomes a problem for the central bank to manage.

There could be a run on the banks if people wish to convert pesos to dollar-based Libras all at once. And with mobile Libra wallets, it’s presumably 24 hour banking, 7 days a week. It will be tempting for authorities to place limits or capital controls on the amounts of Libra transferable per day.

All this means Libra could fall short of the Association’s goals for a widely available and efficient global payment system.

At a minimum we expect that Libra will greatly broaden cryptocurrency usage at the most basic level, that of stablecoins. As CBDC solutions roll out, Libra should be able to share in the success of those in many jurisdictions, if they execute effectively. However, their new positioning will cause central banking authorities to slow walk their licenses while the central banks themselves are preparing to roll out their CBDCs and as they consider how they will manage the very likely increase in foreign exchange flows.