The Innovations Of Facebook’s Libra Cryptocurrency
and the challenge they present
All cryptocurrencies to date have failed. None of them succeeded in the fundamental purpose of a currency: to be a medium of value exchange in people’s day-to-day consumption, i.e. to serve as ‘money’. The reason for this failure is simple: high volatility. This volatility stems from the lack of intrinsic value, and the only predictor of any cryptocurrency’s value (exchange rate) is people’s speculation. The result is cryptocurrency becoming an investment vehicle, with investors holding onto their cryptocurrencies, hoping to sell them later at a higher price.
Facebook has proposed a solution to high volatility in the introduction of Libra, its own cryptocurrency supported by blockchain technology that is set to launch in 2020. A result of reading all publications by Libra, this article explains the solution and the challenge that this solution brings.
If you are new to blockchain and cryptocurrency, you are advised to read my article: ‘ Using Bitcoin to Explain Blockchain’ as an introduction.
The Libra Reserve
All Libra coins “will be 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” (Libra Association, 2019, p. 7). But what does this look like in practice?
The Libra Association (more on this later) will be the only party that has the power to create (mint) and destroys (burn) Libra coins. Coins can only be minted when authorized resellers purchase them from the Association using government-issued money. This immediately gives Libra coins intrinsic value. The Association then use this money to buy low-volatility assets, and the assets form the Libra Reserve. In other words, the value of Libra coins is strongly linked to the value of the Libra Reserve.
Authorized resellers can sell Libra coins back to the Association in exchange for the underlying assets in the Reserve. This is the only circumstance under which the Association is permitted to burn coins. It also means that holders of Libra coins can be confident that they will be able to sell their Libra coins for government-issued money at a price close to the value of the underlying assets.
It must be emphasized that the Association does not set monetary policy; the creation and destruction of coins are dictated, and constrained, by demand only. There is virtually no risk of inflation.
All this is in stark contrast with other cryptocurrencies, especially bitcoin where coins are created ‘out of thin air’ to reward validator nodes for their work in validating the blockchain. But can you say bitcoin has intrinsic value because it is backed by the operating costs of the nodes? I think that is a stretch.
The Libra Association
To ensure the Libra Reserve is responsibly managed, the control of the Reserve is centralized in approximately the first five years of Libra’s launch (Bano et al., 2019). In fact, the entire Blockchain is permissioned, to begin with, as opposed to being permissionless. The party tasked with managing the Reserve is the Libra Association. But who can join the Association?
To become a member of the Association, one must be a validator node on the Libra Blockchain. But while the Libra Blockchain is permissioned, an organization must meet a comprehensive set of criteria to ensure they are trustworthy and reputable offline, and purchase Libra Investment Tokens to become a validator node. The Tokens are released at the discretion of the Association.
The Libra Investment Tokens are not Libra coins. They simply entitle holders to interests accumulated on the Reserve and voting rights in the Association Council. In a way, the Tokens are the means by which the Association controls who can join them, and thus manage the Reserve. A supermajority vote (two-third of the total vote) is required to pass exceptional changes such as altering the composition of the Reserve basket in response to significant changes in market conditions (e.g. economic crisis).
On The Road To Permissionless
Many of you must be asking: if control is centralized, how can Libra call their system a blockchain? After all, wasn’t the original purpose of blockchain the removal of centralized authorities in the financial system? The Libra Association is very open about this, and they explicitly express a desire to transition from permissioned to permissionless. This means, instead of relying on the stake in Libra Investment Tokens to determine voting rights, the end goal is to rely on the stake in Libra coins to determine voting rights. When the Blockchain is permissionless, any organization who has sufficient Libra coins, the resources to run a validator node, and satisfy some other eligibility criteria (the Association needs time to work these out) can join the Association, and thus maintain and manage the Blockchain and the Reserve.
The Libra Association wants to commence the transition within five years of the public launch of Libra. However, nobody seems to know how a Reserve worth so much money could be effectively managed in an ecosystem where anybody, with the right resources, could participate in its governance. The nice way to put this, by Facebook, is “the association will have to explore ways to further distribute and decentralize the reserve” (Bano et al., 2019, p. 4). The harsh way to say this, again by Facebook, is “as of today we do not believe that there is a proven solution that can deliver the scale, stability, and security needed to support billions of people and transactions across the globe through a permissionless network” (Libra Association, 2019, p. 4). One idea is to create smart contracts on the Libra Blockchain, essentially reducing the governance of Libra into code. But if smart contracts are powerful enough to handle the complexity of even the Libra Reserve alone, that would truly be a revolution.
References
Bano, S., Catalini, C., Danezis, G., Doudchenko, N., Maurer, B., Sonnino, A., & Wernerfelt, N. (2019). Moving toward permissionless consensus. Retrieved from https://libra.org/en-US/permissionless-blockchain/#overview
Libra Association. (2019). An introduction to Libra. Retrieved from https://libra.org/en-US/white-paper/
Originally published at http://hungryandcurious.home.blog on July 14, 2019.
