Tag Archives: Libra Association

Libra Leverage

How Corporate Money Grabs all the Dividends

Libra was announced by Facebook and an Association of companies just a month ago. There has been tremendous interest as well as significant government pushback.

The Libra token and its Calibra wallet will not go live until some time in the year 2020.

The Association is impressive, including Visa, MasterCard, and PayPal along with 25 other companies and non-profits. Facebook’s reach is tremendous, with around 2.5 billion users around the globe. And Visa and MasterCard have relationships with all major banks on the planet.

Is it a shadow bank?

Libra is Corporate money, as distinct from Government money (fiat), or Private money (Bitcoin or gold). 

This is not a bank, at least not as yet. President Trump, in a tweet that was probably written by his Treasury Secretary, said they should go get a ‘banking charter’. The French foreign minster is of a mind to deny them any operations in France. In the UK, the Bank of England chair has expressed a willingness to have the BOE hold Association reserves.

In Asia, they have announced that they have no plans to enter India for now, a country which is not friendly toward cryptocurrency at present. China is looking at its own token; Facebook has little presence in the country due to censorship restrictions. Some countries in Southeast Asia have open attitudes; the Thai central bank plans to meet with Facebook soon.

The on-ramps to exchange various national fiat currencies for Libra are uncertain. It seems as if they want to use cryptocurrency exchanges and perhaps purchases through the credit card providers as methods for buying Libra tokens. But these don’t really address the advertised purpose of bring finance to the unbanked.

Although not a bank, the Association can be thought of as a kind of shadow bank, or perhaps a sort of money market fund.

The Libra currency is tied to a basket of leading fiat currencies. While the exact composition of the basket is unknown, it is reasonable to assume that the US Dollar, the Euro, and likely the Japanese Yen and British Pound will be in the basket. Perhaps there will be Swiss Francs as well, since the Association is registered in Switzerland.

Two classes of Libra tokens

Each corporate member of the Association must stake $10 million, and this gives them the right to validate transactions on the network and offer other services to users.

Now it is important to understand that there are actually two types of tokens, the regular Libra token for users, and a special Libra Investment token issued only for members of the Association. The latter is a proof of stake token, the former is a stable coin. This is a key to initial profits generation for the Association.

This whole scheme is somewhat reminiscent of the two classes of shareholdings of Facebook. Mark Zuckerberg controls 60% of the votes by holding class B stock that has 10 times the voting power of Class A shares.

As a stable coin there is no prospect for appreciation. Rather the Libra will lose value in line with the inflation rate of the constituent currencies in the basket.

Dividends will accrue only to the Libra Investment token, and not to the regular Libra token holders.

Now what does this mean in practice? It means the users get fiat-like non-interest bearing depreciating currency, i.e. a ‘stable coin’, and the Association receives all the dividends that, in a more generous model, a sharing model, would accrue in some part to users.

The Association has said they want to grow to 100 members. Let’s imagine that two years from now they have 50 members. That means an aggregate stake for operations of $500 million.

But let’s suppose they also have 500 million users two years from now, which is not a stretch, and that those users maintain an average balance of only $20. One could imagine that it ends up being significantly higher since a percentage of users could end up holding hundreds of dollars’ worth of Libra or more.

Libra tokens are backed by a fiat reserve basket invested in short-term securities that pay dividends only to the Association

Leverage applied

But 500 million users at just $20 average is $10 billion worth of ‘float’. This, the Libra Association has said, will be invested in short-term government and (possibly) commercial notes.

In the US yields at 3 and 6 months for government T-bills are just over 2% (2.13% and 2.07% today). In the UK the short term bank rate is 0.75%. There is a challenge for the Association in Europe where most short term rates are negative or near zero. The same is true in Japan.

For simplicity let’s assume current 3-month interbank rates in London for the $, Euro, Pound, and Yen; these rates between banks are currently 2.4%, -0.33%, 0.77% and -0.08% respectively. And for further simplicity let us take a basket that has 50% Dollars, 30% Euro, 10% Pounds and 10% Yen. The overall basket would earn about 1.17%. (It would also require recycling of dollars towards the Euro and Yen to stay balanced).

Now on $10 billion of deposits, 1.17% is $117 million. This is not shabby at all, given the stake of the Association is $500 million. Effectively they are making out like bandits, earning 23.4% on their collective stake. While $117 million divided 50 ways is not very much for the corporate members, in aggregate, this is very good business.

And it provides a platform and income stream that can be used to develop add-on services and applications. There can be little doubt that Visa, Mastercard, and PayPal are interested in value-add service provision to the user base.

That is a gross amount, from this the Association will need to fund operations which include systems and personnel for maintaining all the user accounts, the wallet and other software development, and for the maintenance of relationships with banks and cryptocurrency exchanges. And, not insignificantly, they will need funds allocated to their lobbying efforts with governments to promote favorable regulation in each country in which they operate.

Still, let’s imagine they spend $37 million on operations two years down the road, this still leaves them with $80 million profit on $500 million, a return on equity of 16%. This is a very nice business earning nearly double stock market returns, with a simple business model. And it is all leveraged on the deposits of the users. This assumes full backing of all deposits as Facebook has indicated; there is no fractional reserve assumption here.

This is all money made on the deposits of their users, who place local currency into Libra, and earn nothing. It is the price to them, presumably, of convenience, and perhaps the benefit of an account in a lower inflation currency than their local one. 

It could be a lot of trouble for the Association to also pay out interest of only 1% or so on hundreds of millions of accounts with small balances and distribute that. But one can imagine that down the road there would be pressure to pay some interest at least on balances above a minimum amount.

Note also that countries with less strong currencies could find their foreign reserve positions and banking systems threatened if large amounts of local currency are exchanged for Libra. They could well end up restricting usage of Libra, if not banning it outright. And if they care about their citizens, they may demand that Libra share the wealth.

Advertisements

Libra: Corporate Money in furtherance of surveillance capitalism

This blog is the first of a two-part series capturing my thoughts on Libra, Facebook’s cryptocurrency announced in mid-June. My thanks to Shahin Khan for his comments and suggestions.

Libra is a clever name. It implies harmony, peace and balance. Librae was also an ancient Roman unit of weight and was used in Middle English to refer to a pound. As we know the English monetary pound started out as a pound of silver. It’s symbol continues to be a special form of the letter L. So there is a deep historical monetary reference.

Libra aims to be the coin that takes cryptocurrency mainstream. Starting in 2020.

Government Money, Private Money, Corporate Money

The idea of a fully digital or electricity-based money goes back several decades. The introduction of Bitcoin in 2008/09 was both a result of technological advancements that provided the foundation for a secure cryptocurrency and a reaction to the failures of the banking system and fiat currency that produced the Great Recession.

Bitcoin fits in the category of Private Money. No government issues it; no corporation is behind it. It is created on ‘mining’ computers in accordance with the Nakamoto consensus and its monetary policy, with a Proof of Work cryptographic algorithm; anyone can mine it. It as if you dug up gold and refined it and fashioned into a bar and stamped the weight and fineness. In this case the Nakamoto consensus inserts the new money into the decentralized open ledger for Bitcoin at the public address of the miner and under the control of the private key of the miner. The miner can sell (transfer to another public address) the Bitcoin for fiat on an exchange and use that fiat to pay the electricity bill and other costs.

Libra, introduced by Facebook and 27 Association partners in mid-June 2019 is, make no mistake, Corporate Money. It is created by an association of corporations in a partnership expected to grow to perhaps 100 members over time. Each member of the association has to stake $10 million to join and must fulfill other requirements related to size and reputation. (Certain non-profits can join under less stringent guidelines).

Is it a blockchain? 

These Association members are then able to act as validators of transactions into the open quasi-decentralized ledger of Libra. This is a permissioned ledger maintained by the Association members who take turns serving as the lead validator, each with the larger of 1 vote or 1% of votes.

A key part of the security of Bitcoin is based in chaining of transaction blocks. The chain is created by hashing the previous block and inserting that hash into the current block, and doing this repetitively.

In the Libra model, the block and the chain are virtual. Libra blocks are batches of transactions as proposed by the lead validator. A 2/3 quorum among validators is required to approve the block of transactions. Establishing that quorum relies on a chain, but there is no direct relationship between the ‘block’ and the ‘chain’ for these.

Referring to it as the Libra Blockchain, as the white papers do, is a marketing stretch at best. Each new transaction creates a new ledger state that is stored as a Merkle tree and validated. There are no blocks in the ledger, much less a blockchain. Facebook wants to use the term to help ease the regulatory burden perhaps, and because of general market awareness.

The consensus used by validators is a voting mechanism that requires a 2/3 majority and is a type of Byzantine Fault Tolerance. The consensus can be thought of as a hybrid with Proof of Stake since Association members must put up considerable capital. And in fact, the Libra white paper states the intent is to move to a Proof of Stake algorithm over time. This remains a tricky problem; Ethereum has been delaying a move to Proof of Stake for years.

Smart Libra

My Mom was a Libra, she was smart. This Libra also intends to be smart, and to support a range of applications. Libra has its own language, called Move, for smart contracts, including the core token creation, accounting, and payments functions. This is a stack-based language with restricted functionality and with a source level compiler, intermediate representation and a run-time environment in a virtual machine to execute bytecode. Initially the intermediate representation, bytecode specification, and VM are available as open source; the compiler is under development.

Move is designed to be safer than say, Solidity, the default smart contract language for Ethereum, which has suffered a number of hacks. Being better than Solidity is not a high bar.

Less flexibility and not being Turing-complete can prevent ambiguity and are thus desirable attributes for smart contracts moving money around. Initially only a predefined set of essential contracts are available, but the intent is to open things up to the developer community over time.

Move will be the development environment for smart contracts implementing a wide range of e-commerce offerings accessed from the Facebook portfolio. The Libra Association will proceed carefully to maintain security. 

Composition of the SDR before the Chinese Yuan was added

SDR-Lite

But enough of the gory technical details. What is Libra in currency terms and what is it good for? In currency terms it is a basket of strong currencies such as the US dollar ($) and the Euro (€), created with 100% reserve backing in the form of short-term securities (bills) and cash deposited in bank or brokerage accounts. It appears that the initial currencies in the basket will also include the UK £ and the Japanese ¥.

The Libra money supply is dynamic. Libra will be created or destroyed (burned) in response to demand. Thus, unlike Bitcoin, its monetary policy is derived from the mix of currencies in the basket.

So it is a stable coin, but unlike other stable coins, it is tied to a currency basket. It looks rather like the Special Drawing Rights (SDR) administered by the International Monetary Fund, but without the Chinese Yuan. Facebook is not allowed to operate in China for censorship reasons, so the Yuan, which is also subject to strict capital controls, is left out of the basket.

Think of it like a money market fund, but the dividends from holding short-term government paper do not go to holders of Libra. They accrue to a separate currency called the Libra Investment Token that is only held by Association members who have staked the $10 million entry fee.

As Corporate money, it is important that it be audited to ensure full reserves are held as backing, otherwise the value could drop below the nominal currency basket value. It may trade at a slight discount or premium in any case.

There are risks with pegging to a basket of fiat money and accepting fiat money that is not in the basket. For example, suppose a banking liquidity crisis, or a crisis of confidence arises, in Italy (as an example), and fears arise that Italy might withdraw from the Euro.  If the Libra Association is holding Euro in Italian banks, seeking higher yields than in Germany, then in this instance they could lose the peg, slip below the nominal value, due to concerns of bank insolvency.

What Could Have Been

The promise of cryptocurrencies includes decentralization, trustless security, immutability, open source access, permission-less participation, autonomous smart contracts, pseudonymity, a tamper-proof monetary policy, and an easy-to-use development environment. 

Achieving such a mix of attributes is difficult. When it has been approached, it has resulted in slow transaction rates and volatility, making the currency unsuitable for high volume transactions or for every-day use.  To address this, the industry has responded by (a) compromising on the ideals of cryptocurrency, accepting less-rigorous variations of the above attributes in order to achieve higher transaction rates, and (b) creating stablecoins tied to fiat currency to address volatility. 

Facebook’s commanding global digital presence can drive adoption and take the cryptocurrency concept to the mainstream. However, Libra compromises on too many attributes of the ideal cryptocurrency to be categorized as anything but a walled-garden Corporate money, and barely a “crypto” currency at that.

Imagine if instead of creating this Corporate money Facebook had:

  1. Created a currency (call it Solar) that association members could mine on supercomputers via Proof of Work, but also any Facebook user could mine on their laptop or phone, and
  2. Established a system that would pay license fees in Solar for data placed into the Facebook platforms, and
  3. Implemented a true blockchain that would secure the ownership of the data for the originators.
  4. The name ‘Solar’ indicates that the currency would be beyond global and eventually be used in colonies on the Moon, Mars and Callisto.

But that wouldn’t be Corporate money, that would be People’s money. That wouldn’t be in furtherance of surveillance capitalism.