Many know Libra as an ancient Roman unit of weight/currency, an astrological sign depicting the scales of justice and/or the French word for “free” (libre). Most recently, Libra has been gaining notoriety as a cryptocurrency proposed by Facebook that would amalgamate all three meanings – money, justice and freedom.
In a whitepaper* published earlier this summer, the Libra Association focused on using blockchain technology to improve financial inclusion among the more than 1.7 billion unbanked adults globally and to reduce excessive cross-border remittance costs (which average greater than 7%). The longer-term aspirations of Libra are much larger, as the paper notes: “The world truly needs a reliable digital currency and infrastructure that together can deliver on the promise of ‘the internet of money.’” The impact of developing a new global currency and financial infrastructure extends well beyond the unbanked.
Libra, like other cryptocurrencies, would be a digital asset built on the foundation of blockchain technology with the goal of facilitating transactions. But Libra has characteristics that collectively would make it unique among cryptocurrencies. Libra can be more easily understood if we break it down into three parts – the blockchain, the currency/reserve and the Libra Association.
Blockchain. In simplest terms, Facebook’s stated goal is to build a secure, scalable, reliable and flexible blockchain that can serve as a solid foundation for financial services. Thus far, Facebook seems to have largely leveraged the best practices of other blockchain projects (i.e., Byzantine Fault Tolerant consensus protocol, Merkle trees, etc.). Two characteristics of Libra currently worth highlighting are the permissioned network and new programming language (Move). The eventual goal is for the blockchain to be permissionless, but access will initially need to be granted to run a validator node to ensure the network maintains sufficient scale/security. Scale is dependent on speed, and Libra is initially targeting 1,000 transactions per second versus Bitcoin at less than seven transactions per second. Move is designed to make it easier to write secure/verifiable code for execution on the blockchain and thus is expected to support an open-source environment where smart contracts can be developed that extend beyond payments to other financial services (i.e., loans, insurance, etc.).
Currency/Reserve. In an effort to minimize the volatility associated with most cryptocurrencies and increase its chances of becoming a more trusted medium of exchange, Libra would be backed by a reserve of real assets that provide an underlying intrinsic value. Details regarding the reserve mix have not been disclosed, but the Libra Association has noted that the reserves would be invested in stable/liquid assets such as bank deposits and short-term government securities denominated in fiat currencies trusted to preserve value over time (i.e., store of value).
Libra Association. A Switzerland-based not-for-profit organization that would govern Libra. Facebook plans to maintain a leadership role during Libra’s development stage but by launch would have the same commitments, privileges and financial obligations as any other founding member. The association is currently targeting 100 founding members, which must satisfy minimum technology/business criteria and be willing to commit to a $10 million initial investment. The collective responsibilities of the association will be the development and promotion of the network, operation of the validator nodes and reserve management.
Facebook has targeted the first half of 2020 for Libra’s launch, but we would not be surprised to see the launch delayed. There is still a lot to do from a governance and technical perspective and Facebook has publicly stated that Libra would not launch officially until it has fully addressed a growing list of regulatory concerns and received the appropriate approvals.
Being a founding Libra Association member provides some commercial interests, but none appear significant enough to justify such a large undertaking in the near term. The motivating factor behind Facebook’s strategic attempt to launch a cryptocurrency is the further monetization of its network/platform, which it plans to achieve through the development of a Libra wallet (Calibra).
Libra Association. As a founding association member, Facebook would be entitled to its share of any remaining income generated from the interest on the reserves after all operating/investment costs were covered, but this is unlikely to have a meaningful earnings impact given the low rate environment and high operating/investment costs. As the operator of a validator node, Facebook could potentially earn the fees/commissions from the transactions it verifies, although this was not explicitly stated in the whitepaper and any transaction fees/commissions are expected to be very low. That said, if Libra ever truly evolved into a fiat currency (i.e. no longer backed by reserves), the members of the Libra Association would arguably possess an enormous competitive advantage that is difficult to fully quantify. As the de facto central bank of a globally accepted fiat currency, this group of private entities would essentially be able to create the currency used to cover their operating/investment costs.
Calibra. In conjunction with the Libra announcement, Facebook announced a new fully owned subsidiary called Calibra, which is developing a digital wallet that would provide access to the Libra network. Facebook is positioned to quickly become the largest Libra wallet, given its first-mover advantage and nearly 3 billion monthly active users (approximately 35% global population) across all its platforms. Initially, the wallet would be integrated into WhatsApp and Messenger, as well as made available as a stand-alone app. Clearly, the ultimate goal is to become the default platform for peer-to-peer payments and ecommerce. The integration of messaging and payments into one platform should drive higher user engagement, which could be monetized via transaction fees as well as higher advertising spending. As the largest wallet, Calibra would also be well positioned to cross sell additional financial products and services like loans, insurance and wealth management.
The global financial/payment system is essentially comprised of numerous gatekeepers. These gatekeepers maintain centralized ledgers of financial data and facilitate transactions by acting as trusted go-betweens in exchange for a commission or fee. Blockchain technology, in its purest form, seeks to eliminate the need for gatekeepers and thus has the potential to hugely disrupt the global financial payments industry. Libra’s initial permissioned approach wouldn’t eliminate go-betweens, but it would be disruptive because it establishes a new set of potential gatekeepers (the Libra Association).
Based on the current list of association members, Libra’s gatekeepers appear to be a mix of institutions that are well positioned to help develop the necessary technical capabilities and/or drive adoption. Currently, established payment network processors are well represented, but arguably face longer-term disintermediation risks if the association successfully develops a truly permissionless, decentralized blockchain that can achieve the speed and scale required to fully replace current payment networks.
The association membership currently doesn’t include any of Facebook’s FAANG peers or commercial banks. While Facebook insists that the association is open to any institution that satisfies the membership criteria, the banking system understandably has long-term disintermediation concerns and the FAANG peers thus far appear committed to their own digital payment strategies, which often partner with or leverage the current banking/monetary system. The biggest long-term winners should arguably be the network/platform companies, asset owners and consumers.
Governments and regulators around the world have unanimously expressed concerns regarding Libra as well as cryptocurrencies more broadly. In the U.S., a group of more than 30 organizations sent a letter to Congress and regulators requesting a moratorium on Libra due to profound concerns regarding national sovereignty, corporate power, consumer protection, competition policy, monetary policy, privacy and more.
Libra is arguably more exposed to global regulatory regimes than other cryptocurrencies given the more centralized nature of the network. The Association must figure out how to satisfy the growing list of concerns and still maintain significant competitive advantages over current conventional payment networks. Even if the Association addresses all the regulatory concerns it faces, there is still the risk that Libra is simply banned by governments seeking to protect their vested interests in the current global financial system. After all, governments are big beneficiaries of central bank seigniorage profits and the broader banking system is one of the largest buyers of local-currency debt. Emerging market governments would arguably be most negatively impacted as EM assets are less likely to be included in the Libra reserves. Thus, the EM policy response is likely to be the most pronounced, complicating the initial plan to target the unbanked citizens of these countries.
It’s early days and there are still many unknowns surrounding Libra, so we are not expecting a significant near-term impact.
Over the medium-to-longer term, we are closely monitoring the risk of disruption to the current payments ecosystem. If Libra truly achieves the scale and security to process transactions in a permissionless network where anyone can be a validator, this could largely disintermediate the current gatekeepers of the global payment system. But even if the individual members’ significance as a validator node is diminished, the Libra Association would arguably still be a gatekeeper as it is collectively tasked with managing the reserves. As the Libra network grows in size and scale, the management of these reserves could conceivably disrupt the nature of money creation in a modern economy and along with it, sovereign fiat currencies. Governments have a strong vested interest in retaining a monopoly on money creation, particularly for global reserve currencies, and are unlikely to let this slip away easily. It seems unlikely any of us will ever be able to pay our taxes in Libra.
On balance, we have difficulty envisioning Libra getting far off the ground. Even so, as with all innovations, we are following Libra with great interest as it has the potential to creatively destroy some of what many believe are the most defensible business models around today.
*”An Introduction to Libra,” Libra Association Members.
Opinions, estimates, forecasts, and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. The views and strategies described may not be suitable for all investors. References to specific companies, securities, asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to buy or sell. The above commentary for informational and educational purposes only and shouldn’t be considered investment advice. Many Calamos Funds hold positions in Facebook as of the date of publication.
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