Know-How - 20.06.2019

Facebook Coin: A Crypto Currency Relevant for Hundreds of Millions of People in Developing and Emerging Countries

On June 18, 2019, the white paper of Facebook’s cryptocurrency project “Libra/Calibra” has been released. First information with respect to the vision, the goal and the implementation of the project have been published.


This article first appeared on medium.com on 19th June 2019.

Key Insights

  • The goal is to provide a stable token backed by real assets as bank deposits and government bonds (see specific details below).
  • Libra will therefore not be pegged to the USD or another traditional currency; it will therefore be “money”, but not a “currency”.
  • Libra will not target the enterprise payment sector such that Libra would be used as means of payments between companies. For Libra, this would require the status of a currency. Please note that companies are required to do their accounting in EUR, USD etc.; they will not switch their accounting systems to adopt Libra.
  • Facebook targets hundreds of millions users in developing/emerging countries.
  • The current approx. 30 Libra partners altogether have access to >1 billion users including direct access to the “last mile” which is already installed apps on smartphones.
  • Adoption will be achieved very quickly, within months after starting in Q1 2020.
  • Libra will therefore revolutionize the remittance market.
  • There will be two tokens: one payment token (for payment) and one utility token (for discounts and other benefits to provide incentives).
  • Governance of the Libra Association will not be done by Facebook alone but by a group of larger corporations, mostly US-based.
  • In the short term, there is hardly any impact visible on competition with European banks and other financial organizations since they mostly do not tackle the remittance market for individuals.
  • In the mid term, hundreds of millions of users will hold Libra tokens and potentially can exchange them at crypto exchanges. This could drive adoption of crypto assets such as Bitcoin rather than hamper adoption.

Main objective of Libra

The main objective of Libra/Calibra is to provide an infrastructure to conduct worldwide payments in a quick, easy and cheap manner. It is based on an own crypto currency called “Libra”, which operates on a distributed ledger technology (DLT) called “Libra blockchain” and is mainly accessible via mobile phones. “Calibra” apparently will be a service provider engaging in IT development e.g. for developing wallets used in Facebook’s apps (e.g. Whatsapp). It appears that Facebook intends to offer further financial services on top of that blockchain. The project has the potential to decrease transaction costs remarkably and to increase financial inclusion of hundreds of millions of people worldwide.This perspective is especially promising in developing countries without a solid financial market infrastructure.

However, Libra/Calibra also raises questions with respect to centralization, data security and regulation. The severity of these issues mainly depends on the exact implementation of Calibra and cannot be deeply analysed at this point of time.

Main benefits of Libra

In case Libra coin is deployed to Whatsapp and Instagram with its hundreds of millions of users adoption would be there overnight. A new medium of payment would be created with minimal operational effort and hundreds of millions of users could be reached through already existing and well-established forms of digital social interaction. These users would mostly sit in developing or emerging countries. The biggest advantage of this concept is that it can be integrated into many already established and well-known existing networks (such as the Facebook Messenger). This allows a maximum roll-out speed and the product is integrated in such a way that the user does not have to worry about complex interrelations and a lot of code, nor does he have to put in a lot of extra effort to use Libra. The key point here is the companies partnering in the Libra consortium already have access to the “last mile”, that is a huge installed base of apps where some updates could provide this new functionality.

Libra has the potential to decrease transaction fees to a large extent. This is mentioned as one of the main objectives of the project. Fees can mainly be saved in cross-border transactions. Imagine a foreign worker earning money in another country and sending remittances to his family back home in his country of origin, typically with a different currency, every month. Today, intermediaries take about 10% of the transaction volume as fees (financial costs can sometimes even be up to 30%). This means that from a EUR 500 remittance only EUR 450 can technically reach the family. Even more extreme, short-term credits do often charge an interest rate of up to 400%. Facebook can provide an extraordinary benefit by taking down cross-border transaction fees for hundreds of millions of people in developing and emerging countries. This would heavily favor financial inclusion in the respective countries. According to the white paper, 1.7 billion adults worldwide are currently excluded from the financial system (31% of global population) and do not have access to a bank account at all. However, two thirds of them possess mobile phones with internet access. Hence, Libra coin could provide the infrastructure to conduct payments via the phone without having access to conventional banking services. All in all, it has the potential to support financial inclusion of 1 billion people on the planet.

Libra will not solely be a payment network. It will also allow programming simple smart contracts. This way, loans or other financial services could easily be developed with Libra, and offered to the users.

Governance and centralization: a key issue of the project?

According to the white paper, decentralization is one of the most important features and the main philosophy of the project. Therefore, Facebook decided to give up power in order to be at eye level with all other partners in the whole consortium. Facebook has founded a subsidy company “Calibra”, the initiator of the project, and has so far gained a lot of extraordinary partners. It reads like the “who-is-who” of the payment and tech world, e.g. Visa, Mastercard, Paypal, Uber, Spotify, and furthermore other well known blockchain and venture capital companies. Calibra intends to build a consortium with different big players — also from different fields of operations. However, Facebook is up to now the only big involved player from the GAFA (Google, Apple, Facebook, and Amazon) companies. Most of the partner companies are US-domiciled — hardly any European or Asian companies are included right now. However, this can change since the Libra Association opened up a partner form on the website. It is aimed for around 100 partner companies when starting the network in the first half of 2020.

Calibra and the other partner companies form the Libra Association, domiciled in Geneva, Switzerland. A Swiss location has been chosen since Switzerland has traditionally been a neutral country and has proven to be open-minded with respect to blockchain technology. The Libra Association will operate as an independent non-profit organization and is responsible for the development of the ecosystem. The tasks of the association are to support developments with respect to the Libra Blockchain, to coordinate the consensus between the stakeholders, to foster, develop and expand the network and to manage the Libra Reserve. The association will be governed by a council where each member might have voice.

According to a person familiar with the situation, Facebook has charged each partner USD 10 million to manage their own node within the network. This permits all members to access and view the network. Facebook could collect USD 1 billion from the intended 100 project partners. The funding from the consortium members will be used to back the coin.

During 2019, Facebook will keep the leading position of the consortium in operational terms. However, Facebook will share the same rights, privileges and financial obligations as the other partners of the association as soon as the Libra network has been started. This avoids any issues in terms of Facebook’s influence and ensures a balanced stakeholder power in the critical first phases.

The exact degree of decentralization cannot be fully determined based on the whitepaper and the current information. Even if Facebook/Calibra is only one member of the consortium, most of the other partners are companies with a remarkable amount of market power.

A centralized framework would pose the risk of having the whole system controlled by a few centralized parties, who could misuse their position. Therefore, the roll-out and the first weeks of system operation must be analyzed to make any forecast more precise.

At the beginning, the Libra Blockchain will be operated as a permissioned blockchain. However, the type of blockchain is planned to change in the future to provide an open network and will be permissionless. In the white paper, it is furthermore argued that currently a tested solution for a permissioned system does not exist in a form which provides enough stability and safety. It will be one task for the association to analyze the implications of a change of the permissioned to a permissionless network and to increase the degree of decentralization over time. The switch will be conducted within the first five years after the introduction of the Libra Blockchain. This step will be essential to increase the degree of decentralization within the project.

Other key issues

Insufficient data security is another issue. Within the consortium, partners are granted the right to access and view the network. Hence, the system could be designed in such a way, that transaction data is accessible for partner companies.

The distribution of the token via third parties brings up regulatory questions. In the Libra system, will it be possible to buy Libra tokens via third parties even without following proper Know-Your-Consumer (KYC) procedures? This raises issues with respect to money laundering and terrorist financing not different to classical crypto currencies like Bitcoin. However, the project might offer the opportunity to better understand the nature of its users’ financial behaviour as well as the possibility to trace back suspicious financial activities.

Effects on existing companies

The effects of the project on existing companies can be expected to be rather marginal. Although Libra is asset-backed, it still classifies as a crypto currency; to be more precise as a “payment token.” Companies have to do their accounting in Euro or in US-dollar. Libra will be money but not a currency. Therefore, effects on enterprises should be limited — especially in the short term. Please recall that Libra’s core targets is the remittance market which can be said to be retail banking in developing and emerging countries.

Currently, new anti-money laundering (AML) rules are discussed in Europe. In particular the German Ministry of Finance intends to introduce new AML rules. These rules are made in such a way that they also will apply to crypto assets. Libra tokens would most probably fall under these new rules such that a company holding Libra tokens or operating with them must — in Germany as of January 1, 2020 — have a license of BaFin (Germany’s financial market authority). Right now, there is not one single company in Germany which would have both the technological knowledge to experiment with Libra token and which would probably also use its license to do so. Of course, there are companies with the technological knowledge and there are other financial organizations with the adequate licenses. But, as outlined above, there is at this point of time not one company being able to handle both at the same time: technology plus license. We have to wait, to clearly scrutinize whether this is a chance or a risk.

Architecture of Libra

The Libra Reserve
The Libra coin is designed as a (more or less) stable coin and is backed by reserves of real assets, the Libra Reserve. This is one difference to most of the classical crypto currencies such as Bitcoin, which are not backed by real assets. The high volatility and the insufficient scalability is one of the main reasons why crypto currencies are not heavily used today. The main goal of the design as a stable coin is to decrease the volatility, which can foster trust and acceptance on a larger scale.

The Libra Reserve will be traded on stock exchanges. Hence, the coin can be converted into fiat currencies according to a flexible exchange rate. Therefore, the value of the coin is expected to be more or less stable. Libra Reserve will be backed by a collection of assets with low volatility, namely bank deposits and short-term government bonds issued by stable economies. However, the coin will not be perfectly fixed and will fluctuate. Hence, the value of the Libra Reserve changes with the value of the underlying assets. The assets will be stored at geographically separated locations. The income from management of the underlying assets (that is, the interest rate) will be used to pay operating costs, to keep the transaction fees low and to pay dividends to early investors. The latter point is legitimate as those companies joining the consortium early have to invest USD 10 million.

The Libra Blockchain
The Libra coin is based on the Libra Blockchain which is developed to ensure high scalability, high security and flexibility with a remarkable transaction speed of up to 1,000 transactions within a second. A new programming language called “move” has been developed for the implementation of the individual transaction logic and the respective smart contracts. According to the white paper, security aspects have the highest priority. In the future, it is intended to provide access to the blockchain for developers to create smart contracts by themselves and to support the further development of move.

Another interesting point is the process of finding a consensus in the Libra DLT ecosystem. The consensus will be in the form of a Byzantine-Fault-Tolerance (BFT) mechanism with the consensus protocol LibraBFT. In the white paper, this choice is justified by the high operational resistance of the system. The consensus is expected to work correctly even when some validator notes are not working properly — ⅔ of the nodes have to confirm transactions. Besides, the consensus mechanism is supposed to provide low latency and is energy-efficient as compared to Proof-of-Work. As always with DLT systems, in the Libra Blockchain, data will be secured by hashes, which makes it possible to detect changes within the existing data. Pseudonyms are possible which makes it easy for clients to use one or more addresses, which are not connected to their offline identity. At this point, a Libra testnet exists and is available open source. In the future, every client, developer and company can use the open source Libra network to develop products based on the Libra Blockchain to e.g. include it into the daily payment services.

Conclusion

Libra has the potential to yield impressive benefits in the framework of a worldwide, decentralized financial ecosystem such as lowering the costs of financial transactions (like remittances) and driving an increase in financial inclusion in developing and emerging countries. According to the released white paper, decentralization and data security will be a major focus of the project. Facebook promises that it does not collect data from Libra transactions to target ads at consumers and not to put oneself in the foreground with regard to voting and decision rights in the development and operations process through the spin-off in Calibra in association with the Libra Association. However, progress with respect to the technical architecture and the handling of privacy has to be monitored closely to see how decentralization and data security is actually included. This factors will heavily impact the success of the project.

The Libra coin does not make fiat currency-backed stable coins reluctant. The project mainly aims to decrease transaction costs and to increase financial inclusion for individuals with a special focus on the unbanked in developing countries and elsewhere. On the opposite, fiat currencies, as EUR or USD, on the blockchain (“Cash on ledger”) can exploit their full potential in advanced economies and enterprises. Hence, there are two different business models underlying the respective tokens.

Authors

Prof. Dr. Philipp Sandner is head of the Frankfurt School Blockchain Center (FSBC) at the Frankfurt School of Finance & Management. In 2018, he was ranked as one of the “Top 30” economists by the Frankfurter Allgemeine Zeitung (FAZ), a major newspaper in Germany. Further, he belongs to the “Top 40 under 40” — a ranking by the German business magazine Capital. The expertise of Prof. Sandner, in particular, includes blockchain technology, crypto assets, distributed ledger technology (DLT), Euro-on-Ledger, initial coin offerings (ICOs), security tokens (STOs), digital transformation and entrepreneurship. You can contact him via mail (email@philipp-sandner.de), via LinkedIn (https://www.linkedin.com/in/philippsandner/) or follow him on Twitter (@philippsandner).

Jonas Groß is a project manager and research assistant of the Frankfurt School Blockchain Center (FSBC). His fields of interests are primarily crypto currencies. Besides, in the context of his PhD he analyzes the impact of blockchain technology on monetary policy of worldwide central banks. He mainly studies innovations as central bank digital currencies (CBDC) and central bank crypto currencies (CBCC). You can contact him via mail (jonas.gross@fs-blockchain.de), LinkedIn (https://www.linkedin.com/in/jonasgross94/) and via Xing (https://www.xing.com/profile/Jonas_Gross4).

Felix Bekemeier is a project manager and research assistant of the Frankfurt School Blockchain Center (FSBC). His interests include the microeconomic analysis of agent behaviour in DLT networks as well as the use case development, monetary theory and policy as well as regulatory strategy. You can contact him via mail (felix.bekemeier@fs-blockchain.de) or on LinkedIn (https://www.linkedin.com/in/felix-bekemeier)

More about the Frankfurt School Blockchain Center
The Frankfurt School Blockchain Center is a think tank and research center which investigates implications of the blockchain technology, crypto assets and distributed ledger technology (DLT) for companies and their business models. Besides the development of prototypes, it serves as a platform for managers, startups, technology and industry experts to share knowledge and best practices. The Blockchain Center also provides new research impulses and develops training for students and executives. It focuses on banking, finance, mobility and “Industrie 4.0”.



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