Lessons From Libra: The Future Of Digital Currency

Costanza Picchioni

The project of launching a new cryptocurrency, Libra, was announced by Facebook on June 18th last year and explained with an official document, a White Paper available online.  However, in the subsequent months the project met strong opposition from regulators and state authorities, culminating with a very hostile hearing on 23rd October 2019, in which Mark Zuckerberg had to face strong criticism from the US House of Representatives Financial Services Committee. As a result of the persistent hostility from the part of Western governments and regulators many partner firms got cold feet and have since backed out. Thus the project is now in question and it may never see the light, at least not in its original form. Yet it is important to understand the controversy surrounding Libra, as it will give us good insight into possible future developments within the fast moving world of digital currencies – as well as within the international monetary system- in the process of moving away from dollar dominance.

First of all it is best to recall the basic features of the new currency as outlined in the White Paper.

Libra is meant to be a cryptocurrency based on blockchain technology, enabling instant payments (most notably by mobile phone), across many countries. The stated objective is to give easy and low cost access to financial services to vast numbers of people now cut off (or paying excessively) in poor countries as well as to improve payment facilities in advanced countries.

Unlike other cryptocurrencies, whose value can fluctuate wildly, Libra is designed to be a stable currency. The paper states that Libra will be fully backed by a collection of low-volatility assets, such as bank deposits and short term government securities ‘in currencies from stable and reputable central banks’ (White Paper, p 7). Libra will be acquired by users by exchanging such assets (bank deposits and government securities), which will then be held in the Libra Reserve. The full reserve guarantees that the exchange rate of Libra will remain within the fluctuations of its underlying currencies.

The new global currency will be managed by the Libra Association. The White Paper indicates all the companies participating in it. Not surprisingly, they are very large investment funds, financial institutions, and transnational corporations, and they have paid a minimum of $10 million each to join. In addition, Facebook has created a subsidiary, Calibra, to provide accessory services, such as digital wallets for users to store and exchange the new cryptocurrency.

Perhaps at this point it is worthwhile to clarify the difference between existing mobile phone payment arrangements and those that Libra would enable: while with current arrangements the payment app taps into the bank account of the user, with Libra the payment app would be tapping into the user’s Calibra digital wallet, bypassing banks and state currencies. 

The Libra Association is headquartered in Geneva, Switzerland, and the currency is officially registered in this country.  As Switzerland has a long tradition of allowing considerable privacy to financial transactions, the suspicion arises that Libra may be aimed at attracting illicit trade, suspicion further reinforced by the secrecy inherent in the blockchain technology. However, it has to be said that, as Libra will be pegged to the US dollar, and as all dollar clearings must go through US-regulated entities, US authorities would be able to access information concerning the relative transactions, if they wanted to. This leads us into the thorny subject of why Libra has encountered so much opposition. So what are the main issues that the authorities have raised?

The first one, as mentioned, is the secrecy of its transactions, and therefore the possibility that it may facilitate crime and tax evasion. The next, and far bigger problem, is the fact that if this currency is successful in attracting a very wide user base, perhaps of a magnitude comparable to facebook’s 2.4 billion followers, it will build up huge reserves, more than sufficient to destabilise any currency (in this regard, the speculations conducted by Geroge Soros in 1992 come to mind). In other words, the problem is that this currency has the potential to bypass state authorities, destabilise and displace state currencies and finally, most important of all, to undermine the position of the dollar as the main international exchange and reserve currency. Hence the opposition of the authorities, especially American ones. Does this mean that Facebook’s purpose is to destabilise entire economies and states, as well as the current international monetary system? Not quite, but in order to understand what its main aim may be we need to proceed gradually and by exclusion.

First of all, Libra is not meant to compete against Bitcoin (or other similar cryptocurrencies) because, although they share the same blockchain technology, they are very different animals.  Bitcoin is an independent currency (i.e. not pegged and not backed by any reserve) whereas Libra is pegged, and therefore it is a proxy currency. It is a proxy of the basket of currencies that will be chosen for its reserve fund, mainly the dollar. Perhaps at this point it is worthwhile to clarify the difference between a proxy and an independent – or complementary – currency (Charles Eisenstein. Sacred Economics, 2011. Chapter 15).

Normally a complementary currency is created by a local community (or a trading community, such as a supply chain) in order to boost the local economy by replacing goods produced far away with locally sourced goods.  This currency, like most state currencies, is un-pegged and can be created at will, obviously within the limits of the additional production that it is able to bring into existence. Therefore the main difference between a complementary and a proxy currency is that whereas the former is backed by a ‘local’ economy and its exchange rate (if it is exchanged at all) is subject to volatility, the latter draws its value not from its connection to an underlying economy, but from its connection to another currency (or basket of currencies) into which it can be exchanged at any time, at a fixed rate. Like complementary currencies, Bitcoin is un-pegged and can be created at will.  However, not within the limits of an underlying economy (which does not exist) but within the limits imposed by its algorithms. (Incidentally, the problem with Bitcoin and other similar cryptocurrencies lies precisely in the fact that they don’t have an economy underpinning them).

Getting back to Libra, we have established that it is a proxy currency, therefore its connection to the real economy is only indirect and its real domain is the financial economy.  This can be seen clearly from its two stated aims: a) to connect to the existing financial infrastructure the vast number of people in third world countries that don’t have a bank account (an estimated 1.7 billion, according to the White Paper); and b) to improve the payment systems of advanced countries which, however, are not particularly in need of it, as fast and low-cost payment systems supported by mobile phones are already widely available in these countries. In this latter case we can easily conclude that the aim of Libra is to capture users who are already well connected and therefore to divert already existing connections. For the moment let’s concentrate our attention on the 1.7 billion ‘unbanked’ people directly referred to in the White Paper. It is estimated that 1.1 billion of them have a mobile phone. In sub-Saharan Africa mobile money accounts (which enable the transfer of money by SMS) are widely used and growing rapidly

Here another important factor enters the scene: China’s competition for this market. Two social media companies in China, Tencent and Alibaba, have launched mobile phone payments that run very quickly and have begun to displace banks from this market. These payment methods are becoming very popular in China and now this country is moving fast to capture the international market for mobile phone payments by creating a new digital currency, which is simply a digital version of the renminbi. The intention to launch a new digital currency was announced in August 2019, just two months after Facebook’s announcement, and it is expected to take place in 2020. Both China’s central bank as well as its private banks will be legitimate issuers of the digital renminbi.

We can easily see that China, having become an economic giant, is now seeking to obtain a slice of the gain and, most importantly, of the hegemonic position deriving from inserting its currency in the international monetary system as a major player, in a position to compete with the dollar. China is leveraging the possibilities offered by blockchain and smart phone technology in order to pursue this aim; however, the technological aspect is only a small part of what China has been doing in the pursuit of its very long term objectives. The renminbi is backed by massive economic, strategic and technological power, and China is building up its own internet infrastructure to support its new international payments system. On the other hand, the Libra Association is not a state: Libra is a proxy of western currencies and is bound to use the already existing (American-controlled) international financial and technological infrastructure. Therefore Libra is in the ambiguous position of competing against China over the international mobile phone payment market – this way indirectly helping to preserve the position of the dollar and other western currencies – while at the same time it is also vying to disrupt these same western currencies and bypass the authorities of the relative states.  

The next piece of information that we need to add in order to solve this riddle is the fact that Western finance on the whole is bankrupt. Too many toxic assets have been created, which, short of very fast economic growth, will have to be written off in one way or the other. One relatively painless way would be monetary inflation, or QE. This avenue is already being pursued in part but, if embarked upon in the scale necessary to clear the backlog of toxic assets polluting our financial system, would inevitably destroy the credibility of Western currencies vis-a-vis the renminbi. Within this general state of near-bankruptcy, not all Western countries are in the same situation. In absolute terms (size of foreign debt) the main problem is in the US, a country posting huge trade deficits year after year. On the other hand, Germany is a country with huge trade surpluses, although it also has a bankrupt banking system (most notably Deutsche Bank and Commerzbank) that will probably need to be bailed out at some point, for the joy of German (or maybe European?) taxpayers.  Within this context, Libra could serve to bring the monetary resources of the western countries all under a unified management in an underhanded way, in order to be better able to plug the holes in the system without interference of individual governments and their ever more restless populations. But there is more to it, as the total resources of the Western countries are not sufficient for the task. Therefore it is necessary to tap into other resources by building up a huge reserve fund obtained by attracting directly potential users worldwide, and bypassing their governments.

We have now enough information to start putting together the pieces of the puzzle. We have established that Libra is trying to capture the 1.7 billion ‘unbanked’ people living in third world countries, possibly a slice of the world illicit trade, western consumers (as well as other consumers from non-western rich countries – for example, oil exporters), and in general all those Facebook users worldwide that might be attracted to the new currency. We have also established that Libra is designed to be a proxy currency, pegged to a basket of currencies similar (if we exclude the Chinese Yuan) to the basket that makes up the IMF reserve system.  In this sense Libra is very reminiscent of the currency issued by the IMF, the Special Drawing Right, or SDR [1]

What is an SDR? This is a brief explanation taken from the book “The New Case For Gold’ by James Rickards (portfolio Penguin) p. 49-50 :

“The IMF issues notes, they are not denominated in dollars but in special drawing rights (SDRs), worth about $1.38 each [value which fluctuates in the market].  What is an SDR? Well, it’s world’s money. But not the kind you carry around in your pocket. […] Still, SDRs are money, and they play an increasingly important role in global finance as the dollar’s power declines. There’s actually a trading desk inside the IMF that can swap SDR’s for other hard currencies.  [….]. The IMF doesn’t issue SDRs except in liquidity crises.”

If we read the following passage from the same book (p. 50 -52), we will perhaps obtain enough information to complete the puzzle.

The next time there is a global liquidity crisis, it will be bigger than the capacity of the Federal Reserve and other central banks to contain.  The Fed has used up its balance sheet dealing with the last crisis. It has not been able to unwind the balance sheet, and it’s unlikely it will for a decade.  The same is true of the other central banks. They have no further capacity to print money without destroying confidence, […] they are at the limit of what they can credibly do.”

Then Rickards goes on to say that in the next liquidity crisis the only solution will be to turn to the IMF, which will bail out the system by issuing a massive amount of new SDRs. This is essentially no different than creating massive amounts of dollars and other western currencies, and therefore it has the potential to destroy the value of assets denominated in those currencies.  Still, there’s a chance it might work. According to Rickards:

“If it works at all it will be for two reasons. One, almost no one understands it, and two, we won’t have SDR’s in our pockets.  SDR will be used by, for and between countries, not individuals.  SDRs won’t be transparent.  They will be highly inflationary if printed in sufficient quantities, still, no one will actually see them [….].  If SDRs work it will be in part because few people understand them. Still, if people do understand them, they are likely to lose confidence.”

It may be pure speculation, but it seems to me that Libra could be a clever way to overcome this problem and bail out the system in a pre-emptive manner (avoiding another collapse by plugging holes as and when necessary) in an underhanded way (bypassing official procedures and state involvement implied by an IMF intervention) and by means of attracting more reserves than the western system currently has at its disposal.

Aside from this very suggestive scenario, the fact remains that the Western system is starting to have a major rival.  Therefore, even if Facebook’s project is abandoned, we are likely to see other Libra-style operations in the near future, resurfacing under different guises (perhaps promoted by other Silicon Valley giants such as Amazon, Google etc.). In addition, we are likely to see many states trying to contain the renminbi’s expansion in world markets by issuing digital versions of their own currencies. We will have to wait and see, but trying to understand the true role of Libra has provided a frame of reference useful to analyse future developments.

 

About The Author

Costanza Picchioni has a degree in Business and Economics from the University ‘La Sapienza’ of Rome, Italy. For the past few years, she has been a core member of the Positive Money community group in Hammersmith, studying the reasons for the 2008 financial collapse (as well as our monetary system, and the wider context of the last 200 years of economic history). This research has culminated in a series of articles, available on her blog Paradigm Change.

 

Notes

The current proportions of the currencies composing the SDR are as follows:

US dollar 41.73
Euro 30.93
Japanese Yen 8.33
Pound sterling 8.09
(total western currencies 89.08)
Chinese Yuan (included only recently, in 2016) 10.92

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