By Barry Eichengreen, Professor of Economics and Political Science at the University of California, Berkeley; and formerly Senior Policy Advisor at the International Monetary Fund; CEPR Research Fellow. Originally published at VoxEU.
The repercussions and regulatory impact of Facebook’s proposed Libra currency are still unclear. This column, part of the VoxEU debate on the future of digital money, assesses the information as yet made available about Libra, including the implications for its exchangeability, scalability, privacy, and security. It is clear the design of the currency is yet to be finished, and many questions remain about its governance and structure.
Details about Libra, Facebook’s planned global currency, are not easy to decipher. This may be because the currency’s own designers are making up things on the fly. More likely is that they have a reasonably complete plan but are reluctant to reveal it in order to avoid exciting regulators in the US and abroad (see Brunnermeier et al. 2019 for more on the repercussions for the international monetary system of digital currencies). But no one knows for sure.
Nevertheless, more information continues to be unveiled, as regular visitors to Libra’s website are aware. What follows is my assessment of what we know, what we don’t, and what it means for the project.
Libra will function like a currency board. It will be backed by high-quality, liquid financial assets denominated in a collection of stable currencies. This is not unlike the dollar-euro basket-based currency board proposed by Domingo Cavallo during his ill-fated return as Argentine economy minister in 2001.
As in the case of a currency board, the man or woman in the street won’t be able to redeem Libra for the fiat currencies in the Reserve. Only ‘authorised resellers’ will be entitled to move large amounts of fiat and Libra in and out of the Reserve. In the typical currency board, the role of authorised reseller is played by regulated commercial banks. In this case, who they will be, how they will be selected, and how they will be regulated in order to ensure adequate consumer protection is yet to be explained.
The Fiduciary Issue
Whether Libra will be fully backed or almost fully backed is unclear. The document describing the Reserve explains that “the association will pay out incentives in Libra coin to Founding Members to encourage adoption by users, merchants, and developers”. If these payments are in exchange for deposits of fiat currencies by the Founding Members, then this is just an exchange of fiat for Libra like any other – it is not an “incentive” to develop anything. If it is a transfer not made in exchange for fiat, then a portion of the outstanding Libra is not backed.
Some gold-standard and currency-board-type arrangements include a ‘fiduciary issue’ – that is, a certain amount of issuance that is not backed, and then a remainder that is fully backed at the margin. Such systems have generally worked when the amount of the fiduciary issue is strictly limited. How it will be determined here is unclear.
The Reserve will earn interest, or seigniorage. In the case of central banks like the Federal Reserve, seigniorage profits are turned over to the national treasury, which spends them (hopefully) in a manner consistent with the preferences of voters and their elected representatives. In the case of Libra, seigniorage profits “will first go to support the operating expenses of the association – to fund investments in the growth and development of the ecosystem, grants to nonprofit and multilateral organizations, engineering research, etc”.
Should there be an “and then” after the dash in the preceding sentence? And are we talking about engineering research in general or engineering research designed specifically to enhance the operation of Libra-like systems? “Nonprofit and multilateral organizations and social impact partners”, we are told, “will also be able to apply for grants to join the network”. Are we talking about NGOs that enhance access to Libra by giving cell phones and cell phone contracts to poor African farmers, or worthy NGOs with other objectives, like the World Monuments Fund, and multilateral organizations like the World Bank?
In some countries, seigniorage accounts for a nonnegligible share of public resources. A large-scale shift into Libra would therefore transfer their control and allocation into private hands.
Bitcoin’s blockchain-enabled proof-of-work system is slow and costly in computing and energy resources. The minds behind Libra understand that they need a more efficient system. They just don’t know what it is.
Initially, transactions will be processed by “validator nodes” run by the Founding Members of the Libra Association. The initial system “aims to have 1,000 transactions per second for a set of 100 validator nodes”, corresponding presumably to the 100 members for which the Libra Association aims.
There is no reason to doubt that the computers of Visa or Mastercard, two representative Founding Members, or those of Amazon Cloud Services for that matter, can process a thousand transactions a second. But this is not a decentralized, permission-less system. Users will need Visa’s consent in order to use Visa’s node. Nor is it a fundamental technological advance relative to the status quo.
Libra’s documentation describes a desire to move toward a permission-less system, where neither the permission of Visa nor anyone else is needed in order to transact. But that same documentation fails to spell out what alternative to blockchain and a Bitcoin-like proof-of-work system will make this a reality.
Privacy versus Know-Your-Customer Rules
A final issue is the trade-off between privacy and know-your-customer rules. This dilemma is familiar. Banks are required by their regulators to monitor their customer’s accounts for evidence of money laundering, tax evasion, and terrorist finance, and on detecting such behaviour to notify the relevant authorities. But they are also expected to shelter their customers’ accounts and transactions from prying eyes.
Libra’s designers seem to be conflicted about these matters. Consider the following assortment of statements. “The ledger of transactions on the Libra Blockchain will be publicly accessible so that it is possible for third parties to do analysis and to detect and penalize fraud”. But also “Transactions do not contain links to a user’s real-world identity”.
And finally, “because transactions on the Libra Blockchain are pseudonymous, it is possible for third parties to do analysis and detect fraud and illegal activity”. Pseudonymity entails the adoption of an assumed name, as opposed to a legal identity. If transactions are pseudonymous, how can those moving money for illicit purposes be identified and reported to the relevant authorities?
Information about Libra is more abundant today than when the initiative was announced. But important questions remain. How will incentives for development be reconciled with the fully-backed nature of the system? How will seigniorage be allocated? How will the system be scaled? How will the desire for privacy be squared with know-your customer rules? How will authorised resellers be selected and regulated? How will the public sector agencies responsible for systemic stability and consumer protection regulate Libra more generally?
Libra remains a work in progress. Its designers continue to dribble out information about its structure and governance. But their documentation raises as many questions as it answers. Consider this column and invitation to address them.
Brunnermeier, M K, H James, J-P Landau (2019), “Digital currency areas”, VoxEU.org, 3 July.