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Can stablecoin Libra become the new crypto on the block?

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There’s a new cryptocurrency in town, but the long-rumoured stablecoin Libra will have to overcome some major obstacles to become an investible asset.

Facebook’s proposed launch of a new cryptocurrency, Libra, has certainly stirred up some interest. Not to mention controversy.

The initiative is backed by a 27-strong consortium, the Libra Association, based in Switzerland. Facebook subsidiary Calibra has a leading role, and other key participants that have been announced include Visa, MasterCard, Lyft, Uber, Vodafone Group and many others across blockchain, telecommunications, payments and venture capital firms, as well as non-profit organisations.

Libra’s declared mission to create a simple global currency and financial infrastructure and its initial remit is to serve the underbanked in developing countries. The idea is to give anyone with a mobile phone and internet access the ability to transfer funds across the globe instantly, securely and at a low cost. The cryptocurrency can also be translated into an actual currency on receipt.

To coincide with Libras planned 2020 launch, Facebook also acquired an Israeli start-up, Servicefriend, to support the rollout of the currency by building AI-driven chatbots which will be used to interact with customers.

Urs Bolt, partner at BIG Blockchain Innovation Group, says: “Libra is certainly a controversial topic of conversation and many people are sceptical about whether it will succeed or not. But it is interesting, as it is a strong consortium of businesses and therefore should have the means, the reach and the power to be something successful.”

Libra will run on a blockchain network secured at launch by 100 distributed computer servers, or nodes. Each blockchain algorithm will be put to work as a command-line program suitable for interactive use or scripting, with consistent options and file formats throughout the toolkit. It will also be Byzantine fault-tolerant, meaning faulty behaviour by some of the actors in the network will not compromise the security of the broader network. In fact, the Libra blockchain makes it very hard for any attacker, as they would need to compromise 33 separately run nodes when launching an attack against the system.

Each of the association partners will operate an independent network node (a server) that will support transaction validation and share the transactions throughout the network. It also has a consensus-based algorithm – once two-thirds of the partners have approved a transaction, it will take place and be recorded.

Daniele Mensi, chief marketing sales officer at NextHash, says: “The consensus algorithm means that the two-thirds approval, when reached, will make for automatic updating of the distributed ledger. It is also built on a programming language which is much more scalable and can process 1,000 payments per second. This is unlike Bitcoin, which currently only has capacity for two per second.”

That being said, Bitcoin does have a solution for this in so far as it has a ‘lightning network’ that can sit on top and aggregate payments before they are validated. This creates vast efficiency and also makes it scalable. All is not lost.

However, the backing of software giants with cash-heavy balance sheets within the Libra association does mean that scale, intrinsic usability and further refinements are likely.

‘Libra will have a reserve, much like central banks, and will be able to create or destroy units of value but it is not a single national currency and so will fluctuate differently to a single currency.’

Daniele Mensi, NextHash

Aside from user uptake, the biggest issue that Libra has lies with national regulators. A number of major jurisdictions (US, EU) have expressed concerns about the various strengths of cryptocurrencies, with authorities in France and Germany pledging to block Libra from operating in Europe, while China and India have outright banned it. Countering this, Libra is aimed to be regulator-friendly by design and so, in theory, should be able to meet know-your-customer and anti-money-laundering requirements of any regulator without undue concern.

However, there are other issues. Libra will be fully collateralised by a basket of currencies and short-term debt obligations. This makes it a ‘stablecoin’. While this means that Libra’s value may fluctuate as foreign currency rates change, by design it is intended to be fairly stable to enable payments and remittances.

A run on Libra would be serious, as there would not be a central bank to stop it. And at the same time, if take-up is good, the Libra Reserve is likely to grow to such a size that it will become ‘too big to fail’ – giving rise to a systemic risk issue.

Anton Ruddenklau, head of digital innovation at KPMG, explains: “Having stability in its underlying reserves is important to regulators and central banks, as a coin that was not stable, but widely used, could have massive ramifications on monetary policy.”

Mensi adds: “From a government viewpoint, there is clearly a concern about the impact on national currency and monetary policy. Libra will have a reserve, much like central banks, and will be able to create or destroy units of value, but it is not a single national currency and so will fluctuate differently to a single currency. It will be more like an index in terms of volatility and it will depend on how the underlying assets are weighted too.”

A paper by the Association of German Banks summarises the issue well: “The Libra Reserve resembles a currency board, like that operated in Hong Kong. Full backing by stable currencies can only be maintained if Libra is used only for the purpose of making payments. If loans were granted in the Libra universe, which is highly likely since it is supposed to be an open system, then money would be created. This newly created credit money would no longer have backing. This would make Libra, like any currency board, vulnerable to a bank run,” it says.

Fees and tax revenues are also an issue. Cryptocurrencies have little to no transaction costs when money is transferred across borders. The advent of a new cryptocurrency, with a potentially very large user base, has governments and traditional banks concerned. This is because Libra could herald a shift away from traditional government taxes and banking fees to a new international monetary system controlled by corporate entities like Facebook and Uber.

Finance

Investing in crypto

Cryptocurrencies have had their main use as an investible asset until now. According to Statista forecasts, they will grow to US$11.65bn (£9.6bn) by 2022. Compared to 2018, this would mean an increase of 468 per cent.

Daniele Mensi of NextHash says that crypto and blockchain investments should be seen as a hedge – something to invest in to protect against a fall in more mainstream investments.

“The way that crypto and blockchain investments react to broader market conditions is different to how mainstream investments work so they have been popular as a hedge,” he says.

Whether Libra will prove to be a popular investment remains to be seen. Currently, it is not an investible asset in its own right. Its launch does, however, come at a time when Bitcoin is faltering in terms of market capitalisation: since 2015, Bitcoin’s market share has gone down by 38 per cent to only 53 per cent, which may be related to the fact that, since 2014, an increasing number of cryptocurrencies have entered the market.

In addition, a trading platform specifically for cryptocurrencies has recently been launched. SmartBotCoin is intended to serve both beginners and expert traders alike. It has a real-time stream for market and portfolio updates, as well as advanced security. It is also able to process both manual and automated trading.

Half of all financial intermediation globally now happens outside the banking system, according to the Financial Stability Board. The assets of non-bank financial institutions have grown by over 50 per cent since 2008. That’s a concern on both the oversight and the revenue fronts.

Libra itself accepts that a collaborative approach is needed. Facebook’s head of Calibra, David Marcus, told the US Senate Committee on Banking, Housing and Urban Affairs in July that Libra is not planning to offer banking services, but he acknowledged that banking regulation would be in order if it were.

However, when asked if he would commit to refraining from moving forward with Libra until policymakers put appropriate regulations in place, Marcus replied: “I committed to waiting for us to have all the appropriate regulatory approvals and have addressed all concerns before moving forward.”

He was also asked to commit to a pilot programme to launch Libra to one million users with regulatory oversight. Marcus said that Facebook came out with this plan and a white paper prior to Libra’s full release in order to go through regulators.

Bolt, however, says that the white papers that Libra has produced don’t really answer many of the questions that the industry and the regulators have. Thus more collaboration is needed.

“The reaction of regulators differs. The US is trying to ban it, the Swiss are much more relaxed and innovative, and the UK is somewhere in between,” Bolt explains. “Libra needs to work with the various regulators to work out how to best integrate into existing systems and regulatory frameworks without introducing systemic risk.”

Regulators, however, are not the only ones having doubts in the proposed system – even a couple of partners in the association itself are having second thoughts. According to a recent Wall Street Journal report, Mastercard and Visa were named as companies reconsidering their position before a meeting on 14 October with representatives from the companies involved. Furthermore, payments firm PayPal became the first member to exit Libra Association in order to focus on its own core businesses.

The Bank of England’s Future of Finance report states that private-sector ‘new finance’ will need “the right conditions to innovate and thrive. This means creating appropriate hard infrastructure and the right soft infrastructure, including a well-respected legal and judicial system, rules, regulations and standards to empower competition and ensure safety and soundness.”

The report goes on to advocate a National Payments Strategy Council to create an appropriate roadmap.

What is certain, however, is that Libra’s digital nature is likely to act as a catalyst to innovation globally within the payments arena. Obviously, banks will react to defend against disruption and new entrants will seek to find solutions to plug gaps in the current marketplace.

Bolt summarises: “This goes further than just the Libra initiative... it is obvious that something of this kind is needed within the market and that it would get the volume and the scale needed if a number of other elements, like the regulation and the stability of the coin, are resolved.”

Applications

Where’s the market for Libra?

Libra’s initial use case will be to bring mobile payments to the unbanked. Focus markets are yet to be announced but are likely to be in the developing world. The idea is that digital currencies like Libra could provide new pathways out of cash-dependence and accelerate the journey of the estimated 1.7 billion unbanked consumers into the formal financial system.

On the face of it, this seems like a good idea. According to the University of Sydney Business School, emerging economies will grow 75 per cent faster than developed ones and these emerging economies will be double the size of the G7 economies by 2040. If Libra can penetrate these markets, then it looks to have a sound business model of organic growth that is dependent only on its users having mobile phones.

But there is always a ‘but’.

Anton Ruddenklau, head of digital innovation at KPMG explains: “Firstly, there are already good mechanisms in place with things like M-Pesa. Is there actually a need for something else? Local governments have also objected to something that is pegged to G10 currencies – it is a sovereign issue and some have likened it to a colonial approach. Thirdly, those that don’t already have mobiles and access to remittance schemes like M-Pesa are not likely to suddenly get access.

“As of yet, Libra has yet to do any social-impact analysis of the cost of equipping such people and whether it would be something best led by central government – thus Libra is a solution for a problem but is it the best or only solution?” he asks.

Other use cases already in action include the J-coin: an initiative by Mizuho Bank. This is a QR-code-based smartphone payment service app, J-Coin Pay, which was introduced to its bank account holders in March 2019. Customers can also link accounts from 57 financial institutions via the J-Coin Pay app.

There is also an initiative by a 13-strong group of the world’s biggest banks, who are looking to launch digital versions of major global currencies in 2020. This follows years of research that has convinced banks that the technology underpinning cryptocurrencies could be used to make trading more secure and cheaper by deploying distributed ledger technology (DLT).

DLT uses blockchain networks and enables participants to instantly share information on an open-access ledger, which can never be altered or erased. Theoretically, the technology could replace reams of paperwork and processing.

This UBS-led research on a ‘utility settlement coin’ (USC) has been in the ether since 2015.

Other comparable examples include the JP Morgan Coin, used to settle inter-firm transfers, or Singapore Airlines’ KrisPay, which involves loyalty points used as payment mechanism with other merchants or other loyalty points providers.

Other potential use cases lie in cross-border payments that are currently expensive. This would be useful for small businesses where banks can’t, or won’t, cater for their needs. It would also reduce foreign exchange risk.

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