LIBRA, THE FACEBOOK’S NEW CRYPTOCURRENCY: STILL SO MANY QUESTIONS BUT SO FEW ANSWERS.

In the present article, we will face certain issues not entirely clear, including the role and the nature of Libra and its impact on the current monetary and financial policy.  

Facebook announced the creation of Libra, a virtual currency, built on the blockchain system. It will be managed by the Libra Association, a not-for-profit membership organization headquartered in Geneva, which, at the present time, has 28 members, consisting in companies, nonprofit and multilateral organizations and academic institutions, from all over the world.

The white paper, released by Libra Association’s members on 18 June last, launches the project, explaining its goals and its main operating rules. The mission for Libra appears to be the creation of “global currency” (and its financial infrastructure) to allow anyone, who owned a smartphone, to execute payments and to transfer money, even in the absence of a bank account.

Libra, like other cryptocurrencies, will operate through the blockchain, which is a technology common to all other the virtual currency. In summary, this means that transactions will be managed in a distributed and decentralized way. Nevertheless, unlike the other cryptocurrencies, the blockchain will be “permissioned” instead of “permissionless” and it means that the transactions will be validated by pre-selected node rather than (potentially) all the nodes of the blockchain.  A further important difference compared to other cryptocurrencies is that Libra will be fully backed by a reserve of real and low-volatility assets, such as bank deposits and government securities, issued by central banks. According to the white paper, interests on the reserve assets will be used to cover the costs of the system and to ensure low transaction fees, if any. According to the intentions of its creators, Libra should be a global, digital, stable currency.

On that basis, we wonder if any relationships between a monetary system based on digital and global currency, and the current system, based on currencies issued by central Authorities under the control of the States can be identified?

“Money”, with its main functions and characteristics, is a social convention which permits to attribute value, generally accepted, in order to carry out exchanges of goods and services.

The currency, in order to serve the abovementioned purpose, must be:

• a means of exchange;
• a unit of account;
• a reserve of value.

“Means of exchange” means how much the buyer is willing to pay at the moment of the purchase of a good or service. “Unit of account”, instead, means the parameter which allows measurements and comparisons of economic values. Finally, the “reserve of value” allows anyone, who has the possibility, to transfer over time the purchasing power.

Set out the abovementioned main characteristics of the currency, it is clear that all the steps in its evolution, from its first forms to new digital currencies, have been characterized by the prevalence of two key factors: the stability of the value and the use by as many people as possible.

Indeed, the reserve of value, as a characteristic of the currency, is the condition for the other two, since the currency is not able to be neither a unit of account nor a means of exchange, in the absence of the reserve of value.

The most recent economic theories show that the achievement of the stability of the value is ensured by the adoption of specific strategies which affect the supply and the demand of money, in order to avoid high inflation (loss of value) or deflation (fast growth of value). Until now only legal tenders have been able to ensure the stability of its value over time, through the adoption of monetary regulations policies entrusted to central banks, such as measures on money supply and on interest rates[1].

Therefore this system, based on discretionary policies aiming to ensure the stability of the value of the legal tender over time, assures the domination of the legal tender over other currencies.

However, the cryptocurrencies, issued by private entities, don’t have all the abovementioned characteristics. They are characterized by decentralized management. Furthermore, their value is secured by users’ confidence in its performance. Their value is not controlled in a discretionary manner, through ad hoc policies, but it is regulated by automatic protocols.

The absence of specific interventions by third parties caused excessive volatility of cryptocurrencies’ values. For example, in the Bitcoin case, the quantity of digital currency released to the market is fixed (established in advance within the limit of 21 million). In that way the supply of Bitcoin does not always correspond the demand, determining a strong volatility and preventing this particular kind of currency from working as a proper reserve of value. This reduced the number of users over time and jeopardized the Bitcoin function as means of exchange and unit of account.

This is why the founder of Facebook had the idea to create a cryptocurrency with different characteristics, as already mentioned.

The value of Libra is not determined by users’ confidence in automatic supply protocols (which, as mentioned, are not able to establish in a discretionary manner the correct quantity of currency to inject into the economy on the basis of the demand), but it is determined by a basket of real assets, which ensures a stable value over time.

In addition, in accordance with the documents set up by Libra Association, it seems that the system will issue as many Libras as units of legal tender deposited and, conversely, it will “remove” as many Libras as the amount of the withdrawn funds. This should contrast the volatility of the currency.

But, if it is so, it is legitimate to ask: what is the nature of Libra? Is it comparable to a true currency or it consists of an instrument representing a sum already paid, as if it were a voucher or, as enlightened by some experts, a traditional prepaid card?

Very little is known today about Libra to develop the reflection further, and there are other crucial questions, such as: what are the authorities which will be able to monitor the new cryptocurrency? How will Libra be compliant with anti-money laundering legislation and data protection regulations? (it should be remembered that Facebook was involved in a thorny dispute regarding infringements of the legislation on data processing, known as Cambridge Analytica)? What kind of reserves and guarantees should Libra provide to build the necessary confidence? How will the exchange and the transfer of Libras between private individuals take place?

We will have the opportunity to return to this topic soon.

[1] That system was facilitated by the introduction of specific legal provisions, such as the obligatory acceptance of legal tender at the face value if used to make payments and/or discharge a debt (see Art. 1227 of Italian Civil Code) or the obligation to pay taxes in the same currency.