NEGATIVE ECONOMIC IMPACT OF LAUNCH OF LIBRA
This article was co-authored by Yanan Niu
Facebook’s Libra project has been fighting for survival since its inception, owing to a mauling from compliance officers, politicians, and regulators who, while may like the idea of having a global digital currency, don’t trust a social media company like Facebook, to operate it [1].
This has attracted a lot of attention, both from people and regulators. Though Libra is marketed as an international stablecoin to improve the efficiency of the payment systems and reduce the cost by use of a decentralized blockchain with no central authority [2], its architecture suggests that it will be governed by the Association as the de facto central authority [3]. Libra is designed as a private permissioned system where transactions will be governed by heavyweight validator-firms (nodes), each being a member of the Association [2], [3]. The marketing of Libra has primarily been around its focus towards accelerating the development of economic and financial globalization. But the prime question here is HOW?
a. If the vision is to achieve this by having fast payment systems, it could have been done by the use of existing payment systems like Paypal and Swift on Facebook’s applications.
b. If the vision is to help the unbanked by providing financial inclusion and access, the problem would be acquiring Libra coins in the first place. If Libra needs to be bought using fiat money, which is an assumption since no clarity is yet available on the process of acquiring Libra, then how would the unbanked population get the same, given that sovereign currency to Libra conversion requires a bank account denominated in fiat currency.
c. If the idea is to provide a safe asset for people in unstable countries with high inflation, like Zimbabwe and Venezuela, it can be achieved by using money market ETFs offered in a digital (or dematerialized) format [4].
1. Regulatory resistance
WITHDRAWAL OF PARTNERS
Democratic Senators have remarked that “Facebook appears to want the benefits of engaging in financial activities without the responsibility of being regulated as a financial services company,” [5]. This has been a major reason for the departure of some of the financial companies from the Libra Association as they expect scrutiny from regulators, not only on activities associated with Libra but all payment processes. Though Facebook hasn’t commented much on the withdrawal of these companies, it did mention that the exits will not deter Facebook from their plans [6].
REPUTATION
Facebook’s repeated controversies related to handling data of users is also a major concern in regions like Europe.
DISPARITY WITH TRADITIONAL FINANCE
Regulators have also pointed out Libra’s shortcomings as an actual currency as it lacks the last resort lender and deposit guarantee system of any form, which might seem like an architecture created to dodge responsibilities if things go south [5]. The limited liability of Libra members is in contrast to the backing of central banks when it comes to fiat currency. Thus, regulators are recommending that a global stablecoin should be issued provided all regulatory concerns have been addressed [5].
During the financial crisis, central banks globally “print money” and lower the interest rates to add money supply and allow businesses to continue running. This act of increasing or decreasing the money supply in moments of contraction or expansion, allows central banks to maintain economic balance. However, Libra could disable the central banks from operating interbank overnight money market which in turn could affect the economic activity and inflation [7].
Additionally, the use of technology in the origination, servicing, and disbursement of loans [8] could reduce the importance of banks as lenders of money. Thus, it would affect their role in the interbank markets [9] because the central bank’s balance sheet could become smaller, which in turn will weaken its ability to influence the interest rates offered by financial institutions. But, if Libra becomes a dominant means to exchange value, central banks could lose this [10], which is making the regulators concerned about its competition with sovereign currency [11].
AML AND KYC CONCERNS
Lack of anti-money-laundering standards, which was pointed out by a democrat [12] has also been a major concern in regards to Libra. The standard policies within the monetary system like anti-money laundering and KYC also need to be checked in case of Libra, to ensure that basic pre-requisites are met. Moreover, there is no clear view concerning how Libra aims to prevent consumer isolation and ensure the liquidity of Libra coins.
Blockchain provides anonymity making identities of its users pseudonymous. On the other hand, a permissionless blockchain will not guarantee complete privacy since all transactions and their history in chronological order are visible to all nodes [13]. Further, once created, a user cannot be deleted, having all the correspondent transactions visible to other parties. After a bilateral analysis between GDPR policy and Libra coin, a few discrepancies have been noticed and are advised to be properly catered before Libra’s official launch [14]:
· Identification of the identity and obligations of data controllers and data processors.
· Identification of the processing that is necessary for the performance of the service (article 6.1 of the GDPR).
· Difficulty in rectifying or removing personal data from the network (right to erasure).
Libra validators are part of the governance and, thus, more limitations with regards to clients’ data exposure should be adopted. Each network participant should agree to certain terms and conditions relative to GDPR directives before being granted access to the network. The highest concern risen to Libra is how could they turn personal data into anonymous data while maintaining the system’s security and preventing black market activities.
Thus, Libra Association (and its resellers) will have to operate under appropriate licenses and comply with regulatory scrutiny [15].
2. A spur to central banks
Besides the drastic reaction of some governments over the Libra project, somehow it also spurs the governments around the world to move forward with their digital currencies [16]. Central banks do have several benefits to issuing digital currencies.
a. The first benefit is that it will be easier for the central bank to implement monetary policies. For example, some central banks tend to implement negative interest rates policy as a long-term policy instead of short-term stimulus, primarily because the global real interest rates have been falling for the past 35 years [17]. If there is cash, people are more inclined to hold cash than bank deposits under such circumstances [18].
b. Some innovative instruments of monetary policies can be executed easier with the help of digital currency, such as “Helicopter money” proposed by the Bank of England [17]. Digital currency can simplify the payment process to varying degrees since new money is created and equally distributed to every citizen to simulate the market economy, and a digital money system can help to provide such a distribution channel.
c. It can help central banks to recapture a portion of Seigniorage, referring to the profits generated by being able to issue money [17]. Besides, it can provide a digital bank account to “unbanked” people, a group that cannot be ignored [19].
d. Facebook has also described its validation methodology where once the number of validators reaches 100 each validator including Facebook will have a share of 1% of voting rights. This could be seen as an improvement over the Board of Governors of the Federal Reserve System, not all of the twelve Federal Reserve Banks have voting rights; besides the Fed Chairman and president of the Bank of New York (Vice-Chairman), four of the remaining eleven Reserve Bank presidents serve one-year terms on a rotating basis [3].
e. Digital currency could enable people to transfer money to individuals or businesses anywhere in the world and purchase desired products and services online within seconds without going through the unnecessary hassle (i.e. limited or no access) and financial burden of high transactional costs [3].
As a result, it is highly likely that major central banks would be willing to issue their own digital money.
3. An incentive for the Libra Coin and the Libra Association
Mainly due to its high volatility, Bitcoin has repeatedly caused doubts regarding its efficiency in terms of assuring a secure and safe environment on a larger scale. Until now, what has mainly influenced the global perspective is the Bitcoin’s underline blockchain technology. Aiming to push the limits farther, Facebook decided to apply the blockchain principles for Libra Coin.
Libra Association has a large amount of control over the Libra asset and its usage. When Libra Association members join and pay their $10 million minimum, they receive Libra Investment Tokens. Their share of the total tokens translates into the proportion of the dividend they earn off of interest on assets in the reserve. Those dividends are only paid out after Libra Association uses the interest to pay for operating expenses, investments in the ecosystem, engineering research, and grants to nonprofits and other organizations [20]. This interest is part of what attracted the Libra Association’s members. If many people carry a large balance of Libra coins, the value of the reserve will grow and the Libra Association members will earn significant interest. However, this approach contradicts the main distributed idea behind blockchain technology, which is seen as a hybrid between a distributed and centralized world.
Each time someone cashes in a dollar or their respective local currency, that money goes into the Libra Reserve and an equivalent value of Libra is generated for that person. Equivalently, if someone cashes out from the Libra Association, the number of Libra coins is converted to the local currency and is given to the customer. The number of Libra coins that have been converted back to fiat currency is destroyed [21]. This idea is meant to balance the inflation rate of the Libra Coin. However, it relies a lot on the fair-play among validators. If a consistent 100% value of Libra coins, backed with real-world assets in the Libra Reserve, is kept in circulation, the protocol works. On the other hand, once Libra Coin becomes popular enough and a lot of money is managed through this coin, badly oriented validators might be interested in over generating Libra coins for their use. This would result in an individual’s gain that would eventually lead to Libra’s crash due to inflation.
Catering to Bitcoin’s main issues — transaction time and volatility, Libra Coin has the power of becoming the global coin. This way, Facebook could reach its possible goal of allowing everybody with a phone connected to the internet to transfer funds quickly, securely and with a low-fee [22]. Moreover, replacing Bitcoin’s proof of work concept, Libra could be seen as a low-cost, more nature-friendly currency.
4. Conclusion
Monetary and technological evolution have been paired since millennia. Being regarded as a medium of exchange, it has evolved from actual consumable products or valuable natural metals to fiat currencies, transitioning towards digital and blockchain-based currencies. Libra has created a great contribution to the innovative exploration of the new currency landscape. Facebook’s coin sets up the beginning of a new era, where the proof of work idea becomes outdated and a more cost-efficient approach is regarded. This could have a major impact on the world economy.
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