Note: This article was originally published on RGA EMEA Quarterly in September 2019. Following my Zonotho article, I was asked to present to the company on Libra and write an article explaining it. Since this article was written, Libra’s design has fundamentally changed.
On the 18th of June, Facebook announced the launch of Libra, a new digital currency. Not even two weeks went by before the U.S. Congress called for Facebook to halt all further development of Libra and summoned the company to a hearing. Since then, there have been discussions, press releases, and talk of a new bill that prevents tech companies from launching their own digital currencies.
So, why all the drama? And what does it mean for those of us in insurance?
What is Libra?
Ten years ago, Bitcoin became the first successful digital currency, and with its launch it became possible to send money over the internet without the need for banks or governments. Since then there have been many copycats using Bitcoin’s underlying technology, but Libra is the first of these to be created and backed by a major corporation.
Facebook plans to integrate Libra into WhatsApp and Messenger so that you can send money over their platforms as you would a photo, video, or text message. This graphic from their website shows how Libra would function in practice:
Libra will thus be a new kind of money that you can send to people or use to pay for goods and services. What makes it different to Bitcoin, and also to the U.S. dollar, is that it will not be issued through digital currency mining, or a reserve bank, but through the Libra Association.
What is the Libra Association?
The Libra Association is intended to be a non-profit organization based in Switzerland, however the majority of the founding members are private companies in the United States. At the head you have Facebook and Calibra (a separate legal entity Facebook has set up for its work on Libra). Included also are tech companies such as Uber, Spotify, Mastercard, VISA, and Booking.com*.
The Libra Association will play many roles in the system. The most important of these is maintaining the value of the Libra currency. In that sense, they serve a similar function to that of a central bank.
What is a Libra worth?
What is any currency worth? With Bitcoin, the price depends on demand and supply so the price fluctuates based on the market. With the U.S. dollar, however, demand and supply play a role, but you also have the U.S. government requiring the dollar for payment of taxes and the Federal Reserve managing the supply through money printing and reserves. Ultimately, the value of a dollar, and of other fiat currencies, depends on the trust people have in the central bank to protect the currency.
Libra has tried to sidestep the issues of supply and demand entirely. They plan to hold bank deposits of stable currencies (and similar assets) and use these as reserves to back the value of Libra. In theory, they will only create Libra when money is added to these deposits, and they will destroy Libra when money is taken out of them. In that sense, a Libra operates somewhat like a Unit Trust or a promissory note for the assets sitting in these reserves.
Libra should thus have a stable price close to the value of the assets backing each coin. However, the price will ultimately depend on the trust people have in the Libra organization itself. There is also the matter of the interest on these reserves. For now, the Libra Association plans to keep the interest for itself to fund development of the ecosystem and pay dividends to founding members.
What role does the Libra Association play?
The Libra Association will have a lot of power in this system, something the U.S. Congress brought up frequently in its hearing. Aside from printing Libra and collecting interest on every Libra in existence, it will play a number of other roles as well. These include:
Setting Monetary and Reserve Policy: For now, the Libra Association states that every Libra will be fully backed by a reserve. However, as they have the sole ability to create, destroy, and hold reserves for Libra, they also have the ability to alter this policy.
Governance: There are 20 founding members of the Libra Association and the whitepaper outlines its plan to increase this number to more than one hundred. However, it is the existing membership of the Libra Association that decides who are eligible to become members.
Software Development: While the Libra software is open-source, the direction of its development is in the hands of the Association. Thus, the Libra Association is able to change the functioning of Libra as well as reverse or block transactions if such actions fall outside of its policy. There are also plans to introduce digital identity into Libra, something that has raised serious privacy concerns in the hearings.
Distribution: When new Libra are created they will not be sold to the public. Instead, they will be sold to authorized resellers who will then, in turn, sell them to the public. The Libra Association members will decide who these authorized resellers are.
If Libra is successful, the Libra Association will be at the head of a new global financial system, one that falls completely outside of the current banking and government framework. We are going to see a lot of heated discussion about how this should function and be regulated in the next few years.
The clearest application of this is for informal economies. Close to two billion people in the world are without bank accounts, but most of these people own smartphones. Libra would provide banking services to people who are not served by the current financial sector. It would allow these people to make payments at a fraction of the cost, opening new markets that have not yet been serviced.
The current financial system is also restricted to national boundaries. People around the world mostly bank, insure, and invest with a company in their country. But technology companies such as Facebook, Google and Uber, serve billions of people from a small stretch of land in California.
With a digital currency, the same could become true of financial services. There are already companies that accept Bitcoin and provide services to customers anywhere on the planet. However Bitcoin’s current volatility and complexity have made it inaccessible to the general public, much like how only techies used the internet for the first decade or two of its existence.
If Libra can address the regulatory concerns and launch, it will introduce two billion Facebook and WhatsApp users to the idea of digital currency; i.e., money that can be sent as quickly and cheaply as a text message. Whether or not a digital currency controlled by a group of corporations is the best advancement in this area is debatable. But nobody can deny that Libra will have an impact.
For a high-level view of the Libra Ecosystem: see here
* Since this article was first published, Mastercard, Visa, and Booking.com have formally withdrawn from the Libra Association