Created by a consortium led by Facebook, Libra’s proclaimed mission has been to enhance financial inclusion across the globe.
Following its release in June 2019, the Libra project seems to be evolving from a network centered around one unique multi-currency stablecoin (“libra” or “≋LBR”) into a new global payment system and financial infrastructure.
In the following analysis, the respective changes of Libra’s core features are discussed. These are contrasted with the original features from the first whitepaper (June 2019) and complemented with an in-depth analysis of the potential rationale behind some of the design changes.
Finally, we shine some light on questions surrounding (i) whether this proposal would impact global monetary stability, (ii) regulations and the stablecoin ecosystem, (iii) financial inclusion, and (iv) the pegging mechanism with the Libra Reserve.
Libra’s mission is to “enable a simple global payment system and financial infrastructure that empowers billions of people”.
To achieve its goal of improving global financial inclusion, this project relies on three pillars:
The Libra Blockchain is a programmable distributed ledger, with an open-source infrastructure, that focuses on scalability to serve its mission of powering transactions “for billions of people”.
To achieve this goal, this backbone of the payment system must allow for (i) settlement finality (ii) high-transaction throughput, (iii) low latency, and an (iv) efficient high-capacity storage system. It further needs to be (v) interoperable and (vi) upgradeable.
The Libra Blockchain relies on the following six characteristics:
For some of the technical details about its dedicated programming language Move (and smart contracts), please refer to our previous report. The testnet is available here.
Diverging from its original design, the Libra Network now strives to also offer single-currency stablecoins (e.g., ≋USD, ≋EUR, ≋GBP, etc.) and incrementally increase the number of supported currencies.
Each of these stablecoins will be fully backed by collateral held in the Libra Reserve, an off-chain reserve composed of two types of high-quality liquid assets (HQLA):
Various risks such as currency risk from fluctuating foreign exchange rates, as well as spillover, interest, and credit risks, might be mitigated by requiring every issued single-currency stablecoin to be fully collateralized with dedicated assets. The Libra Network thus appears to be primarily collateralized on an individual and not an aggregate level.
The Libra Network will manage the associated reserves and already stated a strong interest to directly incorporate CBDCs (Central Bank Digital Currencies2) as a single-currency stablecoin within the Libra blockchain, whenever possible.
While the single currencies on the Libra platform would be thus also available as products on their own, some of them would be pooled together into a currency-basket, Libra Coin or “≋LBR”. This was already envisioned in the initial layout of Libra.
The multi-currency Libra Coin would be similar to the Special Drawing Rights (SDR) of the International Money Fund (IMF) and thus have fixed nominal weights.
While it is thus not yet known which currencies will be included and what their respective weight will be, Libra made an example of composing LBR out of “≋USD 0.50, ≋EUR 0.18, ≋GBP 0.11, etc.”. The Association further stressed the intent to work together with regulators, central banks, and international organizations (e.g., IMF) under the FINMA “college” to define a commonly acceptable basket composition.
From a technological point of view, the ≋LBR is expected to work as follows:
Graph 1, below, conceptualizes the interaction and distinction between reserve assets, single-currency stablecoins, and ≋LBR.
Finally, it is intended that ≋LBR could be used for two distinct purposes:
The Association is an independent membership organization headquartered in Geneva, Switzerland. It is governed by the Libra Association Council with one representative per Association Member.
The Association’s declared purposes are:
In addition, according to the whitepaper, major policy decisions require the consent of two-thirds of the Council representatives (i.e., the same supermajority of the network). It is also required in the Libra Byzantine Fault Tolerance (LibraBFT) consensus protocol.
Members of the organization consist of “businesses and nonprofit organizations” from around the world. As of writing, 8 of the 28 original founding members have already left the Libra association. One of the leaving members, Visa, explicitly stated regulatory concerns as a motivation to leave. Graph 2, below, shows the original composition of the Libra association and which members already left.
However, three new members (Tagomi, Shopify, and Heifer) have joined since its inception. The process of how new members might join the Association is clearly specified and envisions a “market competition” that supposedly replaces the initial ambition of Libra to - over time - become a permissionless network. The competition would center around the following capabilities:
According to the whitepaper and other working documents, multiple parties would be involved in the network operations:
|Network participant||Description & Function||Conditions||Relationship to Association||Regulation|
|Members of the Association||- Operate nodes |
- Participate in governance
|Network operation:n/a |
Join network: Pay to join
|- Constitute association |
- Voting rights for governance decisions (1m1v)
- Payment system license under “FINMA college”
|Designated Dealers||- Purchase stablecoins from association |
- Sell stablecoins to VASPs/ Association
- Make markets & provide liquidity to VASPs
|No transaction- & account balance limits||Contractual relationship||Extrinsic: |
|Regulated VASPs||- Offer consumer-facing products (e.g., exchanges, OTC dealers) |
- On-board users
|No transaction- & account balance limits||Meet internal off-chain requirements||Extrinsic: |
|Certified VASPs||- Offer consumer-facing products (e.g., exchanges, OTC dealers) |
- On-board users
|Transaction- & account balance limits||Meet internal off-chain requirements||Intrinsic|
|Unhosted Wallets||- On-board users||Transaction- & account balance limits||No direct relationship||Intrinsic|
|Users||- Access transaction accounts & stable currency |
|Transaction- & account balance limits||No direct relationship||Implicit only|
The below graph illustrates a conceptual structure that displays how these various players are interacting. The respective tiers indicate differences in terms of (i) conditions of participation (unlimited to limited), (ii) relationship to the Libra Association (defined to undefined), and (iii) regulatory burden (decreasing).
|Libra v1||Libra v2|
|Mission (whitepaper)||“Libra’s mission is to enable a simple global currency and financial infrastructure that empowers billions of people.”||“The Libra Association’s mission is to enable a simple global payment system and financial infrastructure that empowers billions of people.”|
|Currencies||A single cryptocurrency backed by multiple real-world assets (e.g., GBP, USD, JPY, and EUR).||Multiple single-asset stablecoins (e.g., LibraUSD, LibraGBP) and a smart-contract based “Libra coin” (≋LBR) backed by fixed weights on multiple single-asset stablecoins running on the Libra Network.|
|Reserve Management||Libra Networks, a subsidiary of the Libra Association.||Libra Networks, a subsidiary of the Libra Association.|
|Peg system for multi-currency libra||Decided solely by the Libra Association.||Defined by the Libra Association upon consultation with regulators, central banks, and international organizations (e.g., IMF) under the guidance of the Association’s main supervisory authority, FINMA.|
|Consensus||LibraBFT: a Byzantine Fault Tolerance algorithm that is a variation of HotStuff.||LibraBFT: a Byzantine Fault Tolerance algorithm that is a variation of HotStuff.|
|Programmability||Move language.Smart contracts must be approved by the Association.||Move language. Smart contracts must be approved by the Association. No plan for permissionless smart contracts but plan for a working framework to allow third-parties to evaluate them.|
|Consensus Mechanism||Permissioned. Plan to pivot to a permissionless network (Proof of Stake with a 2-token model).||Permissioned. Plan to move toward a “market-driven” network for validators (Proof of Authority).|
|Compliance and regulatory features||Not defined5.||Defined through a comprehensive framework for financial compliance and network-wide risk management. It includes: |
- Anti-Money Laundering (AML)
- Combating the Financing of Terrorism (CFT)
- Sanctions compliance
- The prevention of illicit activities
- The establishment of a Financial Intelligence Function (FIU-function) uphold operating standards for network participants.
While Libra was careful to highlight their intent to comply with concerns raised by global regulators, it is unclear whether some of the implemented changes would mark a radical difference with the previous proposal.
The initial whitepaper was very careful to stress the fact that Libra was a “cryptocurrency” and seemed to be particularly retail-oriented in the terminology6. One potential interpretation is that Libra deliberately tried to label itself as a cryptocurrency to mark itself as one out of several solutions dedicated to everyone’s daily use. Even though this notion has fully disappeared, with the new whitepaper wording being more transparent and technical, it still remains fairly similar in design: Libra Coins are stablecoins, i.e., cryptocurrencies running on a permissioned blockchain.
Libra does state, for example, their desire to cater towards feedback presented by the G20-composed Financial Stability Board (FSB). More explicitly, the FSB’s most recent consultation paper on stablecoins mentions that Libra might substitute sovereign currencies and therefore impose risks on the monetary stability of various countries. Libra itself pointed out that the Association would “work with the relevant central bank and regulators” to make a dedicated stablecoin available and thus mitigate the risk of currency substitution.
This hinges on the premise that Libra is narrowly overcollateralized. However, the reserves of Libra constitute out of two different elements, short-term government debt securities and fiat currencies. Additionally, Libra made it clear that only short-term government debt with a rating of at least A+ (i.e., Standard & Poor’s) would be acceptable.
As of now, only 37 countries have such a rating. Displayed below in Table 3, the predominant number of countries have a lower rating. Most notably, most of the countries with ratings below A+ are also at higher risk of having their currency “substituted”. As such, there seems to be an inherent conflict between collaborating with central banks to ensure their monetary stability and maintaining a high quality of collateral.
If all stablecoins were to be partially reflected in the Libra composition, there might be a spillover risk from poor collateral of a single stablecoin onto the basket-currency ≋LBR that acts as the network-wide settlement asset.
Nonetheless, this risk is likely addressed by merely restricting the number of stablecoins that compose “≋LBR” to the ones with the best-rated collateral.
|Rating (S&P)||Countries||GDP[of global]||Population[of global]|
|A and below||156||28%||70%|
Source: Binance Research. Data from Worldbank, Standard & Poor’s.
Generally, Libra uses a three-tiered design to stay compliant with applicable regulations. Regulation occurs at the (i) level of the Libra Association, (ii) protocol-level, and the (iii) VASP level. The first two are internal, whereas the last - and arguably most demanding - level is externalized to the VASPs.
The Libra Association applied to the Swiss regulator, FINMA, for a Payment System license. In order to process the application, the FINMA has initiated a “College” where they involve “more than 20 supervisory authorities and central banks from around the world”. As such, a payment system may very likely qualify as being “systemically important”7 and would have to comply with even more stringent criteria laid out by the BIS. It is important to note that there are very few payment systems, and most of them are operated by a central bank and of only regional scope. Libra could thus do to payment systems, what SpaceX did to the space industry.
Additional regulation at the Association level is internally imposed and governs (i) due diligence for all parties in the Libraverse (including association members), (ii) the creation of a risk-based compliance program with a supervisory body, the Financial Intelligence Function (“FIU”) and (iii) risk-based conditions of participation.
The protocol level is implemented as an automatic regulation that governs all on-chain activity. It imposes limits on transactions and balances of select addresses and prevents sanctioned addresses from sending or receiving currency. Furthermore, wallet addresses located in select jurisdictions (e.g., North Korea and Iran are on the FATF’s blacklist) may be identified by their IP address and subsequently blocked from participating in the Libra network.
The protocol level also addresses Unhosted Wallet users and their higher risk profile. Unhosted Wallet users do not undergo the same onboarding process as other users and thus pose a higher threat from an AML/CTF perspective. While the intention is to manage this risk with particularly stringent oversight and lower transaction/ balance thresholds, users could conduct some sort of "Sybil attack” on the Libra Blockchain and simply create multiple wallets. Such behavior would be identified and prevented on the protocol level.
The last relevant piece of Libra’s effort to stay compliant involves the VASPs. VASPs will be forced to comply with the so-called “travel rule”. The travel rule is applicable to cryptoassets since January 2020 and requires the regulated entities to pass on information about the asset owner. The association will provide an “off-chain protocol to facilitate compliance with Travel Rule and record-keeping requirements”. Most interestingly, Libra Networks may force Unhosted Wallet Users to also provide equivalent information whenever requested.
Libra highlighted that it intends to move to its mainnet “within the next months”. Simultaneously, the previously mentioned recommendation from the FSB urged regulators to roll out local, respective regulation before Libra was to launch. As this regulation would not only be applicable to the stablecoins of Libra, but more generally to all stablecoins, existing projects would also likely need to comply with such regulation.
Yet, pressure on existing stablecoins is not only originating from stablecoins moving into the spotlight of regulators, but also from increased competition on non-trading functions of stablecoins (e.g., remittance, payment).
The existing stablecoin market is currently dominated by Tether and several additional, smaller players, such as Paxos, Centre, and Trust Token. The use-cases of such stablecoins rely primarily on the existing crypto-industry and facilitate trading on exchanges, arbitrage across multiple trading venues (e.g., BTC/USDT trading pairs), and a more broadly usage in various centralized- and decentralized applications (e.g., DeFi).
On the contrary, Libra’s use-case is very different as it would focus on use-cases that are not related to trading. As stated before, Libra’s focus is on financial inclusion and establishing a retail and corporate financial infrastructure for payment applications across its global ecosystem, composed by its network of partners. One particular noteworthy use-case relates to the benefits of improving the technical functionality of currency, i.e., making it programmable. Features like Hashed time-locked contracts (HTLCs) could bring great efficiency improvements to the current payments landscape. As discussed in a previous report on HTLCs, there are many conceivable benefits from atomic delivery-vs-payment (DvP) and payment-vs-payment (PvP).
While, as discussed in section 1.3, several of the most prominent partners have opted out (e.g., Paypal, Mastercard, Visa8) since June 2019, we expect multiple new partners to join (back into) the Association once the new roadmap and regulatory environment provide increased clarity on what to expect from Libra.
If ≋LBR were to become widely used with products directly quoted in ≋LBR, we could imagine new stablecoins, both fiat-backed (e.g., collateralized stablecoin) and crypto-backed (e.g., Maker), replicating its peg on multiple permissionless networks like Ethereum. This optimistic long-term vision could also entail a future where Libra Coins would be added onto multiple crypto exchanges once the networks further matured and became even more commonly adopted. If so, Libra could act as an alternative to existing stablecoins, hence increasing the competition on existing market participants. However, in this scenario, benefits could be massive to the rest of the crypto-industry, pushing the adoption to the masses.
In short, Libra Coins (LibraUSD, LibraEUR) would compete with existing cryptocurrencies on non-trading use-cases such as remittances, programmable currency, and other applications. Yet, the permissioned component of the Libra network, with smart contracts requiring a pre-approval from validators to be deployed, would prevent its adoption in emerging sectors like decentralized finance (DeFi) where anyone can deploy a new protocol and applications with full network composability. Subsequently, Libra Coins and stablecoins are unlikely to be direct competitors.
As indicated earlier in Chapter 3.1, the stated eligibility criteria for collateral would de facto exclude most of the countries from having their currency added to Libra. If these rules were to be enforced, more than 70% of the global population would be excluded from having a dedicated stablecoin. While this could thus be perceived as negative for users, the opposite is true. The alternative of having a dedicated single-currency stablecoin is for Libra to provide its multi-currency asset, ≋LBR, to these (relatively) low-rated countries.
Conversely, this could - theoretically - allow roughly 70% of the global population to get exposure to a stable currency. Before, however, being able to use Libra, users must set up a wallet, which is theoretically possible via three different wallet providers: (1) Unhosted Wallets, (2) certified VASPs, and (3) regulated VASPs.
However, Libra already pointed out that Unhosted Wallets and certified VASPs might only become available in the future, leaving regulated VASPs as the only gatekeeper to the Libra universe.
Notably, all regulated Virtual Asset Service Provider entities must be registered or licensed in 1 of the 38 FATF member jurisdictions, effectively excluding local organizations from poorer, less developed countries. To further understand this dimension, it is necessary to point out that the current financial institutions (e.g., JP Morgan) are the candidates most likely to participate as a VASP. Since these VASPs would continue to carry most of the regulatory burden - as discussed earlier in chapter 3.3 - profits from the user’s activity must exceed the costly on-boarding and compliance process. In addition, some of these financial institutions are already working on proprietary distributed ledger technologies (e.g., JP Morgan on its “JPM Coin” and the Quorum blockchain), which may potentially make them not eager to collaborate.
Even though a risk-based AML approach allows VASPs to exercise some flexibility, the most straightforward question to ask is why the existing global financial institutions would go through the costly process of onboarding customers to Libra, but not to their own platform. From a financial perspective, this would only make sense if transaction fees and other user-generated revenue are higher in Libra than within the current banking system.
Naturally, this is a simplistic take, as the boundaries between financial inclusion and access to a stable currency have been blurred. Out of the ~5.5 bn people living in countries with an S&P rating below “A+”, “only” ~1.7bn people do not have access to financial accounts. Furthermore, barriers to financial inclusion exist not only in the form of on-boarding costs, but must be complemented with, for example, insights from the latest WorldBank & BIS report on “Payment Aspects of Financial Inclusion”. This report identified the following elements as the main drivers for financial inclusion:
“Fintech offers opportunities [to improve financial inclusion via]: (i) transaction account and payment product design; (ii) access points; (iii) awareness and financial literacy; and (iv) large-volume recurrent payment streams.
Source: Bank of International Settlements, World Bank.
Arguably, this payment system, with its strong ties to Facebook, is well-suited to create an intuitive product design that is highly user-friendly. For example, Calibra, the wallet developed by Facebook, would be directly integrated into popular services like Whatsapp and Facebook Messenger. As such, the Libra project could immediately address two out of the four main drivers of financial inclusion.
In the long-term, network effects and the addition of Unhosted Wallets would greatly improve “access points”. Once these access points are there it is likely that Libra is also going to be used for remittances or “large-volume recurrent payment streams”. Consequently, Libra could not only completely reshape the global payment system but vastly increase the levels of financial inclusion. (If they find a way to minimize the Unhosted Wallet User’s burden to comply with regulation such as the travel rule, which seems challenging with their currently pursued approach).
For instance, a store in Manila could sell its goods to a party located in Argentina with greater facility, transacting in a single stable currency for both of them. The transaction types without Unhosted Wallets are conceptualized in the below graph.
Contrary to Unhosted Wallets with balance and transfer restrictions, crypto-collateralized stablecoins (e.g., Dai on Ethereum) represent an alternative already available that can be used by anyone on the planet, without any restriction, and transferable without any limit in a fairly short amount of time at a low transaction cost.
Libra’s edge is, of course, the promise to scale this payment network far beyond the scope of what projects like MakerDAO could achieve in the foreseeable future. Such a global payment network would have implications in bilateral trades across countries and could ultimately lead to capital efficiency gains worldwide9.
Unlike most stablecoins, the Libra Reserve would mostly own non-cash assets. Instead, it would rely on short-term securities (80%) and other money market instruments (20%).
As stated, there are two primary risks relating to the redemption process of the Reserve:
To prevent these scenarios, the two suggested solutions are:
However, emergency operations would occur if the system were to become temporarily undercollateralized. These operations would occur under the guidance of relevant regulatory authorities. According to the multiple whitepapers, it would include:
The team behind Libra stated its intention not to become a monetary issuer, with the rationale being that each Libra Coin would always be fully backed by collateral. To that end, Libra properly addresses the function of banks being subject to reserve requirements and fractional money (i.e., banks print money based on the requirement).
However, Libra would still “print money” based on assets that are not cash. Regardless of their maturities, zero-coupon bonds are typically issued at a discount, as they carry a risk higher than cash. Instead, the system treats short-term money instruments as a commitment to receive cash at maturity, with a similar risk profile. The system relies on positively-yielded instruments to reward validators and other parties in the system, hence implicitly admitting the reward model being dependent on the instruments added to the platform. In general, the higher yield, the higher the risk profile of a financial security. As a result, a basic discounted cash flow analysis would price Libra Coins below face value.
In addition, the system would likely rely on multiple portfolio managers in charge of managing the Reserve, which might raise additional concerns on whether these Libra Coins are indeed fully collateralized stablecoins as they would be subject to human decisions.
Finally, with at least 80% of the assets being backed by short-term government securities, it is possible that the Libra Reserve would become a major buyer of short-term government debt securities if the project were to be widely adopted, hence with possible adverse effects on the traditional fixed-income industry (i.e., an increase on the demand side would lead to lower yields).
Mostly addressing previous concerns, the team indicated its intention to work with central banks to directly incorporate central bank digital currencies (CBDCs) in the network. While this would mitigate risks relating to interest & credit risk and monetary creation, such a scenario requires central banks to view Libra as a monetary platform that is compatible with their own visions and goals for CBDC.
Libra matured in its narrative and general conception - instead of simply rolling out a new “cryptocurrency” to its vast user-base, Libra seemingly reacted to the (mostly) negative response from public officials and opted for a much more cooperative approach that centers around building a global, blockchain-based payment system.
However, its core mission remains intact with multi-currency libra being set to co-exist with traditional stablecoins (e.g., LibraUSD, LibraGBP). In that regard, the project has not only re-stated its desire to launch but broadened its product offering towards enabling a global audience access programmable currencies, including a “SDR” currency.
This is already remarkable on its own, as most payment systems are domestic, have not seen real innovation and seemingly lack ambition - an optimistic comparison would be to say that Libra aims to do to the payment system what SpaceX did to the space industry: shaking the foundation of a well-established system with high entry barriers.
While Libra’s approach to release without pre-regulatory approval was criticized, it has forced global regulatory bodies to work on a general framework to work with Libra, hence fast-tracking the public discussion about digital currencies in modern society. Unintended side-effects were the increased development speed of China’s CBDC and the Libra Association losing some of its founding partners due to the strong regulatory pushback.
Nonetheless, one of the core elements for Libra to really become a global settlement system are Unhosted Wallets. Unhosted Wallets would greatly improve the availability of Libra, hence making them the key drivers of financial inclusion. With the intent to quickly go to market, Libra somewhat sacrificed these elements - for now. The team behind Libra has made it very clear that they still see Unhosted Wallets as a core element that is crucial to their mission and will find a way to balance regulatory compliance and intuitive product design.
Despite critical concerns about monetary stability and the associated pegging mechanism, Libra has incorporated various suggestions from public bodies like central banks and other institutional entities and seemingly continues to reaffirm its commitment to its broad mission for financial inclusion.
Overall, Libra still lives to its initial ambition. Despite most commentators considering Libra to have scaled down, in our view, this updated whitepaper reaffirms the ambition of the Libra organization to massively impact and reshape the global payment industry, disregarding the time it might take.