Project goalImpact on global payments and FX marketRegulatory HeadwindsProject OverviewComparative Analysis of the Libra network with other networksFinancial SustainabilityOur opinion
Friday, 5 July, 2019
The Digital Investor
Enter Project Libra
On 18th June 2019, Facebook released documents describing its blockchain project, Libra. We believe Libra to be the most significant blockchain project initiated by a publicly listed multinational corporation since JP Morgan announced JPM coin. However, unlike JPM coin, which will be limited to a private and centralized ecosystem, Libra coin will be more retail focused and relatively more decentralised. Should the project overcome regulatory hurdles, the network impact of Facebook and other large companies such as Uber, Spotify and Vodafone who are already a part of the Libra ecosystem could result in fast adoption of the network.
In essence, Libra is very different from bitcoin. Libra is first of all a medium of exchange, while bitcoin is a store of value. They are both positioned to potentially become a global unit of account.
In this month’s report, we look into the details of this project. Our key takeaways regarding the Libra project are:
This analysis starts at the macro level and goes down to the details of how the project works. We start by describing the goal of the project, its potential impact on the FX market as well as the global payment system and the regulatory hurdles faced by the project. We then look at the protocol, tokenomics and financial sustainability.
The Libra project intends to offer "a simple global currency" named Libra coin, or Libra in short. Even though the Libra network uses cryptographic techniques and is marketed as blockchain technology, the Libra coin is not a cryptocurrency in its purest form but rather a digital currency backed by an unspecified basket of fiat currencies. The concept itself is not novel (there are several fiat backed tokens in the crypto currency space for example Tether, USD Coin etc), but the scale at which it will be implemented makes it by far the most ambitious project backed by traditional players.
Between 1973 and 1985, the Singaporean dollar (SGD) was a currency backed by an unknown basket of other fiat currencies. The value of the SGD was as good as the constituents of the basket and the approach the Monetary Authority of Singapore (MAS) took to manage it. In the same way, the value of Libra is as good as the constituents of its underlying basket and the way the Libra Association will be able to manage the currencies that back the Libra.
Contrary to bitcoin, which has a pre-defined monetary policy that is firmly embedded within the bitcoin protocol, the monetary policy that supports Libra is flexible in order to adjust to the fluctuations in the value of the underlying currency basket as well as the changes in the demand for Libra. This monetary policy aims to offer a stable currency with low volatility.
By offering a global, digital and “stable” currency, Libra offers the unbanked population the possibility to transfer value (e.g. remittances) instantaneously and at minimal cost. Libra also provides a currency designed to facilitate exchange on multiple platforms, such as those of the founding members (listed in exhibit 2) and several others seeking to integrate with it.
To fully grasp the scope of the Libra project from a business perspective, it is essential to understand its value-add to the existing business of the founding members.
Impact on global payments and FX market
With its global reach, the Libra project is likely to impact both the global payment system and the FX market, two elements of our modern financial system in which central banks play a key role. Given Libra’s stated stance to offer low transaction fees, the most direct and visible consequence of the Libra project is for incumbent credit card companies, payments providers and gateways who may witness a drain in transaction flows towards the Libra network. This seems inevitable because of the sheer combined network effect that Libra is likely to create. A simple strategy for incumbents would be to integrate with the Libra project; however, this approach could potentially result in Libra becoming the price setter for global retail payments.
From a central banking point of view, Libra does not wait for a regulatory framework to exist; it is likely to define a framework going forward. At a high level, the emergence of a private global digital currency such as Libra essentially offers an easily accessible alternative to traditional money, just like bitcoin does within public digital currencies. By doing so, it exerts new disciplinary pressures on central banks. As central bank discipline creates trust, and trust is the reason money is broadly accepted, policy makers have essentially two possibilities: either they accept the situation as it is and thus restrict the use of some policy tools, or, they design regulation to provide them with more room to manoeuvre. As an example, a Negative Interest Rate Policy (NIRP) is a policy tool that exists only as long as there is no alternative. At full scale, Libra could potentially be this alternative threatening the freedom central banks currently enjoy.
Further, when viewed through an economist’s lens, the Libra Association acts similarly to a currency board, i.e. a monetary authority which is required to maintain a fixed exchange rate with a basket of foreign currencies. Libra could become a new type of fiat currency that is virtually accessible at any time and from anywhere. This may have two important effects on the FX market in our view - one on soft currencies and another on hard currencies.
Soft currencies have the reputation of trending lower and losing purchasing power. Often, the reasons behind their chronic devaluations are political uncertainty and economic mismanagement, as seen in the recent extreme case of the Venezuelan bolivar. To manage the depreciation, governments implement capital controls to limit citizens from selling the domestic currency against the hard currency, usually the US dollar. With Libra however, users will access an alternative to their local currency devoid of any capital controls. This could add further pressure on the domestic currency of an economically weak country and may have a destabilising effect on its monetary system and its government as well. The flipside to this is that Libra could provide citizens of such countries with a way out to preserve their wealth.
Hard currencies, on the other hand, are the currencies that have a good reputation for being well managed and liquid (e.g. the euro, the US dollar, the British pound, the Japanese yen and the Swiss franc). They are the most liquid currencies and are also the most likely candidates to populate the underlying currency basket of Libra. As Libra derives its value from multiple currencies, it will be prone to speculative trading in a scenario where a crisis hits one or more of the constituent currencies. Keep in mind that even hard currencies are subject to significant price movements. Within the past decade alone, the euro was materially threatened, the Swiss franc appreciated up to a point that the Swiss National Bank had to intervene, and more recently the British pound depreciated significantly in the wake of the Brexit vote.
The direct consequence of these sharp price movements would be a higher volatility of the Libra, contradicting its original purpose to maintain stable medium of exchange. This can make other stable coins (which are backed by a single fiat currency) and even individual fiat currencies look more attractive. This is because it is much easier to peg one currency to another as opposed to pegging versus a basket.
None of the documents provided by Libra Association have specified how the composition of the underlying assets will be decided and managed, leaving us with many unanswered questions. However, The Libra Reserve paper makes clear that “the association may occasionally change the composition of the basket in response to significant changes in market conditions (e.g., to respond to an economic crisis in one of the represented regions), but the goal will always be value preservation.”
For the sake of argument, imagine that you are a European citizen holding a diversified portfolio of hard currencies in addition to Libra. Further assume that the euro is part of the Libra basket and that a euro crisis resurfaces. What would you in this scenario do to protect your financial wealth? Would you buy Libra? Or would you buy Swiss franc, US dollar, gold or bitcoin? You may speculate that due to the significant changes in market conditions, the euro will see a drop in value and the Libra coin, may also suffer a price correction (since euro is a part of its underlying basket). You may find it easier to buy the Swiss franc, the US dollar or even the Japanese yen – all of which benefit from safe-haven features during crises. To go one step further, you may even find it safer to access non-fiat currencies such as gold and bitcoin. A rational decision in this situation would be to sell your euro and potentially your Libra for other alternatives. The consequence of this action would exacerbate downward pressure on euro and Libra.
The conclusion of this section is that the emergence of Libra could impact the functioning of the FX market and the global payment system. As a result, policy makers will design rules to maintain controls on these markets. As usual, there are risks and opportunities associated with any new financial technology and the question is how policy makers will balance the advantage a global, digital coin offers to end-users versus the macroeconomic risks it poses to the existing financial ecosystem.
Regulators and central banks across the globe, have so far taken a negative stance towards the Libra coin. The vagueness of the whitepaper is clearly worrying regulators. We expect heightened regulatory scrutiny for Facebook and the Libra Association. It will be essential for Libra’s project management team to clearly state the methods through which they will comply with regulation, especially in those countries whose currencies will act as an underlying to the Libra coin. Exhibit 1 shows the key developments in various jurisdictions since the launch of the project.
Exhibit 1: Global govt. debt outstanding with negative yielding
Source – Bloomberg
This section of the Digital Investor focusses on the Libra project setup and target operating model: i.e. the underlying blockchain protocol, a comparative analysis of the Libra network, the tokenomics, and its financial sustainability.
Libra Association published multiple documents explaining the network and its functioning. Below, we list some important takeaways that will help readers to understand the key features of the Libra and make comparisons it with other existing projects.
The network is currently not entirely decentralized as only entities approved by Libra Association (founding members that run a node) can verify transactions and govern the system. This will change over time as the Libra Network moves from a permissioned one to a permission-less one.
A new language called Move has been introduced to develop smart contracts on the Libra Network. While it is expected to be very user friendly, initial reviews do suggest that it loses out on flexibility when compared to Solidity (Ethereum’s development language).
Exhibit 2: Current Founding Members of Libra Association
Source – Libra.org
Comparative Analysis of the Libra network with other networks
For a clearer visualization, we divide projects based on network type, i.e. private or public and organisation type, i.e. corporate or crypto. JPM Coin is an example of a traditional corporate organisation that operates in a private network as the participation in the network is fully controlled by JP Morgan. Whereas, Bitcoin and Ethereum are two examples of crypto based projects that operate in a permission-less public environment. Meanwhile, Libra Network takes a new approach for creating its ecosystem by starting as a permissioned public network with an intention to evolve into a permission-less public network. Exhibit 3 showcases the main differences between Libra and other major networks.
Exhibit 3: Libra Coin Vs. Other Networks
Source - SEBA Research
Libra Network certainly shares similarities with Ethereum, as it intends to offer its users the ability to develop applications on its platform. Looking at the current status we see Ethereum as the dominant Distributed Application (Dapp) platform with more than 2500 Dapps. In other words, Ethereum has a significant head start over Libra which is yet to launch. Nevertheless, the vast network of users that Libra brings can provide enough incentives for Dapps to move to this new network. We believe that over a longer timeframe Libra has the potential to compete with Ethereum.
The financially viability of the Libra project stands on solid ground. A consortium of 28 entities has already joined the network as validator nodes to govern and increase adoption of Libra coins as a medium of exchange via their platforms.
Each member of the Libra Association contributes USD 10 mn to be a founding member and the number of founding members are expected to increase from 28 to 100, representing a USD 1 bn corpus. This reserve could grow substantially over time as more revenue is driven through the network. Over the medium term we expect the reserve to provide a stream of cash flows that could potentially cover the cost of running and sustaining the project. Taking the average policy rate of the five largest central banks as a simple proxy to estimate a conservative return on reserves (assuming an equal-weighted basket) results in an expected return of approx. 50 bps for the Libra Reserve (Exhibit 4). This figure is comparable to the expense ratio of very large exchange traded funds focussed on traditional asset classes.
Exhibit 4: Policy Rate of Major Economies
Source – Bloomberg
Any organic growth, which in our view will be an important component of total revenue generated by the network and also does not consider and any interest proceeds from a larger Libra Reserve. Exhibit 5 shows the 10 largest listed founding members by annual revenue, with a clear dominance of Facebook and Vodafone, that count for more than half of the total revenue (estimated at USD 200 bn).
Exhibit 5: Top 10 Libra Listed Founding Members by Annual Revenue
Source – Bloomberg
Based on available information, the Libra project demonstrates several positives and negatives. It has received much pushback from the crypto community for being centralised and the central banks of the world as they see it as a threat to their existing position. Public sentiment, as evidenced by news reports in general, also remains somewhat muted as concerns around data privacy in the aftermath of the recent Facebook scandal are yet to be fully addressed.
No one can deny that the project offers the ability to connect world finance in a more inclusive manner and at a scale never experienced before, but at this stage, many questions are unanswered. However, we believe that the Libra project will help popularize the use of blockchain based currencies. It is, in our view, a catalyst for mass adoption.
We do not see Libra as a competitor to bitcoin as we believe both the currencies are fundamentally different on multiple aspects. The Libra coin is designed as a medium of exchange to facilitate economic activity on the internet, while bitcoin showcases protocol design (similar to gold) that will make it a good store of value in the future. We believe both bitcoin and Libra will be working towards becoming a global unit of account.
The macroeconomic implications of this project are several. To facilitate the transfer of values globally, at virtually no cost, and with low volatility are some of Libra’s attractive features that will benefit people across the world. By providing such a new technology, incumbent financial infrastructure will be challenged – this includes existing global payment networks as well as the FX market. There is no doubt that a regulatory framework has to be put in place in order for the Libra project to mitigate the risk of creating economic and political instability at the global level.
1The Libra Association is an independent, not-for-profit membership organization, headquartered in Geneva, Switzerland. There are 28 founding members in Libra Association (Exhibit 2) ↵
2 Libra Network refers to the “blockchain” layer that Libra Association is currently building ↵
3Libra Investment Token are given to the founding members. These will earn them dividends from the interest earned by the Libra Reserve and allow them to vote. ↵
4Nodes refers to the 100 founding members who will be responsible for validating the transactions on the network. ↵
Subscribe to the research newsletter and get weekly updates about the latest articles of SEBAresearch
Subscribe to newsletter↓
This document has been prepared by SEBA Bank AG (“SEBA”) in Switzerland. SEBA is a Swiss bank and securities dealer with its head office and legal domicile in Switzerland. It is authorized and regulated by the Swiss Financial Market Supervisory Authority (FINMA). This document is published solely for information purposes; it is not an advertisement nor is it a solicitation or an offer to buy or sell any financial investment or to participate in any particular investment strategy. This document is for distribution only under such circumstances as may be permitted by applicable law. It is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation or would subject SEBA to any registration or licensing requirement within such jurisdiction.
No representation or warranty, either express or implied, is provided in relation to the accuracy, completeness or reliability of the information contained in this document, except with respect to information concerning SEBA. The information is not intended to be a complete statement or summary of the financial investments, markets or developments referred to in the document. SEBA does not undertake to update or keep current the information. Any statements contained in this document attributed to a third party represent SEBA's interpretation of the data, information and/or opinions provided by that third party either publicly or through a subscription service, and such use and interpretation have not been reviewed by the third party.
Any prices stated in this document are for information purposes only and do not represent valuations for individual investments. There is no representation that any transaction can or could have been effected at those prices, and any prices do not necessarily reflect SEBA’s internal books and records or theoretical model-based valuations and may be based on certain assumptions. Different assumptions by SEBA or any other source may yield substantially different results.
Nothing in this document constitutes a representation that any investment strategy or investment is suitable or appropriate to an investor’s individual circumstances or otherwise constitutes a personal recommendation. Investments involve risks, and investors should exercise prudence and their own judgment in making their investment decisions. Financial investments described in the document may not be eligible for sale in all jurisdictions or to certain categories of investors. Certain services and products are subject to legal restrictions and cannot be offered on an unrestricted basis to certain investors. Recipients are therefore asked to consult the restrictions relating to investments, products or services for further information. Furthermore, recipients may consult their legal/tax advisors should they require any clarifications. SEBA and any of its directors or employees may be entitled at any time to hold long or short positions in investments, carry out transactions involving relevant investments in the capacity of principal or agent, or provide any other services or have officers, who serve as directors, either to/for the issuer, the investment itself or to/for any company commercially or financially affiliated to such investment.
At any time, investment decisions (including whether to buy, sell or hold investments) made by SEBA and its employees may differ from or be contrary to the opinions expressed in SEBA research publications.
Some investments may not be readily realizable since the market is illiquid and therefore valuing the investment and identifying the risk to which you are exposed may be difficult to quantify. Investing in digital assets including cryptocurrencies as well as in futures and options is not suitable for every investor as there is a substantial risk of loss, and losses in excess of an initial investment may under certain circumstances occur. The value of any investment or income may go down as well as up, and investors may not get back the full amount invested. Past performance of an investment is no guarantee for its future performance. Additional information will be made available upon request. Some investments may be subject to sudden and large falls in value and on realization you may receive back less than you invested or may be required to pay more. Changes in foreign exchange rates may have an adverse effect on the price, value or income of an investment. Tax treatment depends on the individual circumstances and may be subject to change in the future.
SEBA does not provide legal or tax advice and makes no representations as to the tax treatment of assets or the investment returns thereon both in general or with reference to specific investor’s circumstances and needs. We are of necessity unable to take into account the particular investment objectives, financial situation and needs of individual investors and we would recommend that you take financial and/or tax advice as to the implications (including tax) prior to investing. Neither SEBA nor any of its directors, employees or agents accepts any liability for any loss (including investment loss) or damage arising out of the use of all or any of the Information provided in the document.
This document may not be reproduced or copies circulated without prior authority of SEBA. Unless otherwise agreed in writing SEBA expressly prohibits the distribution and transfer of this document to third parties for any reason. SEBA accepts no liability whatsoever for any claims or lawsuits from any third parties arising from the use or distribution of this document.
Research will initiate, update and cease coverage solely at the discretion of SEBA. The information contained in this document is based on numerous assumptions. Different assumptions could result in materially different results. SEBA may use research input provided by analysts employed by its affiliate B&B Analytics Private Limited, Mumbai. The analyst(s) responsible for the preparation of this document may interact with trading desk personnel, sales personnel and other parties for the purpose of gathering, applying and interpreting market information The compensation of the analyst who prepared this document is determined exclusively by SEBA.
Austria: SEBA is not licensed to conduct banking and financial activities in Austria nor is SEBA supervised by the Austrian Financial Market Authority (Finanzmarktaufsicht), to which this document has not been submitted for approval. France: SEBA is not licensed to conduct banking and financial activities in France nor is SEBA supervised by French banking and financial authorities. Italy: SEBA is not licensed to conduct banking and financial activities in Italy nor is SEBA supervised by the Bank of Italy (Banca d’Italia) and the Italian Financial Markets Supervisory Authority (CONSOB - Commissione Nazionale per le Società e la Borsa), to which this document has not been submitted for approval. Germany: SEBA is not licensed to conduct banking and financial activities in Germany nor is SEBA supervised by the German Federal Financial Services Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht), to which this document has not been submitted for approval. Hong-Kong: SEBA is not licensed to conduct banking and financial activities in Hong-Kong nor is SEBA supervised by banking and financial authorities in Hong-Kong, to which this document has not been submitted for approval. This document is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in Hong-Kong where such distribution, publication, availability or use would be contrary to law or regulation or would subject SEBA to any registration or licensing requirement within such jurisdiction. This document is under no circumstances directed to, or intended for distribution, publication to or use by, persons who are not “professional investors” within the meaning of the Securities and Futures Ordinance (Chapter 571 of the Laws of Hong Kong) and any rules made thereunder (the “SFO”). Netherlands: This publication has been produced by SEBA, which is not authorised to provide regulated services in the Netherlands. Portugal: SEBA is not licensed to conduct banking and financial activities in Portugal nor is SEBA supervised by the Portuguese regulators Bank of Portugal “Banco de Portugal” and Portuguese Securities Exchange Commission “Comissao do Mercado de Valores Mobiliarios”. Singapore: SEBA is not licensed to conduct banking and financial activities in SIngapore nor is SEBA supervised by banking and financial authorities in Singapore, to which this document has not been submitted for approval. This document was provided to you as a result of a request received by SEBA from you and/or persons entitled to make the request on your behalf. Should you have received the document erroneously, SEBA asks that you kindly destroy/delete it and inform SEBA immediately. This document is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in Singapore where such distribution, publication, availability or use would be contrary to law or regulation or would subject SEBA to any registration or licensing requirement within such jurisdiction. This document is under no circumstances directed to, or intended for distribution, publication to or use by, persons who are not accredited investors, expert investors or institutional investors as defined in section 4A of the Securities and Futures Act (Cap. 289 of Singapore) (“SFA”). UK: This document has been prepared by SEBA Bank AG (“SEBA”) in Switzerland. SEBA is a Swiss bank and securities dealer with its head office and legal domicile in Switzerland. It is authorized and regulated by the Swiss Financial Market Supervisory Authority (FINMA). This document is for your information only and is not intended as an offer, or a solicitation of an offer, to buy or sell any investment or other specific product.
SEBA is not an authorised person for purposes of the Financial Services and Markets Act (FSMA), and accordingly, any information if deemed a financial promotion is provided only to persons in the UK reasonably believed to be of a kind to whom promotions may be communicated by an unauthorised person pursuant to an exemption under the FSMA (Financial Promotion) Order 2005 (the “FPO”). Such persons include: (a) persons having professional experience in matters relating to investments (“Investment Professionals”) and (b) high net worth bodies corporate, partnerships, unincorporated associations, trusts, etc. falling within Article 49 of the FPO (“High Net Worth Businesses”). High Net Worth Businesses include: (i) a corporation which has called-up share capital or net assets of at least £5 million or is a member of a group in which includes a company with called-up share capital or net assets of at least £5 million (but where the corporation has more than 20 shareholders or it is a subsidiary of a company with more than 20 shareholders, the £5 million share capital / net assets requirement is reduced to £500,000); (ii) a partnership or unincorporated association with net assets of at least £5 million and (iii) a trustee of a trust which has had gross assets (i.e. total assets held before deduction of any liabilities) of at least £10 million at any time within the year preceding the promotion. Any financial promotion information is available only to such persons, and persons of any other description in the UK may not rely on the information in it. Most of the protections provided by the UK regulatory system, and compensation under the UK Financial Services Compensation Scheme, will not be available.
© SEBA / Kolinplatz 15, 6300 Zug, Switzerland