Libra (A macro focused take)

Libra is a big deal. I would argue that it is among the top 3 biggest things that have happened in money together with Bitcoin itself and Ethereum over the past century. I believe this to be the case both in terms of changing society and also in terms of an investment return for Libra Investment Token holders.

If you are not familiar with the basics of Libra, please read here before you continue.

Libra as a currency board

• The Libra reserve will be like a central bank under a currency board. In that sense it is very smart that they are starting with ecosystem founding partners who will have a vested interest in pushing business into the common pool so that everyone profits.
• In a currency board, the pegged currency country can only expand its monetary base (in Libra’s case — the reserve) if it attracts outside capital via 1) foreign direct investment, 2) positive net exports (selling more goods abroad than it imports), 3) positive capital account (its foreign investments yield financial returns or 4) issuing debt internationally.
• When foreign currency enters the country, it is kept at the central bank as reserves and the local monetary base can be expanded. When the opposite flows are at play, the process is reversed and the monetary based shrinks.
• Libra’s system meets all three academic criteria (as per Hanke and Schuler 2002) for a currency board: 1) maintain a fixed exchange rate with its anchor currencies, 2) allow holders of the currency to move into or out of the anchor currencies without restriction and 3) the monetary liabilities must be fully backed in hard — that is, foreign currency — assets.
• There are other criteria, which can make for an interesting discussion later in time when we see how Libra develops. For example, a currency board should not participate in activities such as purchasing its own government securities (the Libra Association can’t issue debt), regulate commercial banks (in Libra’s case these will be wallets, exchange providers etc.), or act as a lender of last resort (to its own system members like wallets, exchanges, etc.). All of these present an exciting area for further research especially if (or when) other currencies emerge around Amazon, Google, Tencent, Alibaba, etc.
• In currency boards, interest rates differentials between the pegged and the anchor currency matter. The structure of the economies, the business cycle, current account and fiscal deficit/surplus etc all matter. Depending on the relative economic development, various stresses are built up or relieved, which leads to an accumulation of foreign currency reserves or their drain (use to defend the peg). The pegged country’s goal is to attract foreign capital via things like low taxes, low wage costs, political stability, growing economy, undervalued assets etc. It’s complex.
• In Libra’s case, there is one use case so far — payments/clearing so most of the above does not apply at this stage. The goal is to attract businesses and people to send Libra coins to each other and keep a coin balance in a wallet. You do that by offering payments with lower cost, higher speed, monetary stability, global access and reach, security and ease of use.
• The Libra token does not carry an interest rate. There are no Libra coin denominated productive assets — the only asset there is are the balances people/businesses would keep in their wallets, similar to money people keep in their bank accounts. A whole ecosystem (including credit) will be developed around it.

The economics of the Libra Investment Token (LIT)

• Libra’s initial economy will be heavily dependent on the business that the founders/validators bring in to kick-start it. They all invest 10mn usd upfront and will receive LIT.
• A LIT holder will make money twofold: as a validator (similar to miners) getting paid with transaction fees (the gas concept familiar from Ethereum) and from dividends which are generated by investing the reserve assets and after paying the budget of the Association, grants etc. Both of these income streams can be absolutely massive.
• The LIT holders have an interest that people not only transact, but keep balances in Libra Coin so that the reserve grows and earns interest. The LIT holders are also the entities who will govern the system.
• The long-term transition to decentralization described in the whitepaper envisages that the number of validators increase initially to 100 and later up to 1,000 and more. At some point in the future you won’t need LIT in order to govern and profit from Libra, instead any Libra token holder can have an interest in the blockchain (voting, fees, reserve economics, I presume). However, until then (and it’s really not clear when that might happen), the network scale will have increased considerably, much more than the increase in number of validators and LIT owners. Hence, the leverage effect for LIT holders should be absolutely huge.

The Libra coin, monetary policy and the reserve

• The Libra Coin is assumed to be stable relative to the underlying FX reserves, so as global central banks debase their currencies by printing money, the Libra is effectively also being debased vs. things like Gold or Bitcoin.
• At some point people who decide to hold Libra for transaction and liquidity purposes will be faced with the same question as to how to preserve the value of their money and will possibly hedge Libra with Gold/Bitcoin thus cementing their perceived store of value use case.
• Later, if and when assets like Gold and Bitcoin enter the Libra reserve, the dynamics might start to change, but then the endgame for Bitcoin will start to play out.
• An interesting question is how Libra will manage the reserve in the face of negative interest rates given its aspiration to invest in the short end of the curve — after all, the 2-year government bond yields in Japan and Europe are negative (and these are considered “reputable and stable” so would meet Libra’s investment criteria).
• When the reserve gets very large, interesting times sill arise — it can become a buyer of last resort for developed world debt. At the same time, constantly buying up risk-free assets will keep interest rates lower, but can open up all sorts of issues for the availability of risk-free collateral in the traditional financial system. At full scale, the Libra reserve could hold at least 1 trillion usd/eur, easily going to 2–3 trillion. If this sounds too much, consider that you need 2bn users to hold an average balance of 1000–3000 Libra coins (i.e. 1000–3000 usd equivalent). Even though it sounds like a lot and most individual users will probably hold less than that, you have to include businesses where the working capital cash can be thousands or tens of thousands. So on average, you can achieve the above numbers easily. In comparison, China and Japan together own slightly over 2 trillion usd in US treasuries. Remember that Gordon Gecko quote from Wallstreet 2: “…you tell the Treasury department for me that I’m willing to stand on the other side of their auction.”.
• At scale, Libra might control so much developed world capital that it becomes a big political and monetary issue.
• I’m wondering what would happen if the reserve generates an investment loss one (or more years)?
• It will be an interesting experiment in governance as Libra starts looking more and more like a company with shareholders, revenues and profits. Will they have to deal with principal / agent problems? How will the management be incentivized? There will be nothing to prevent validators with votes to partner up and sway decisions one way or the other, similar to any public company.

Libra vs. Bitcoin/Ether

• Libra vs. Bitcoin: if Libra scales, it could be the de facto global consumer payment method, which Bitcoin never got to (so far and this includes Lightning). I understand the point about Libra being permissioned, not decentralized, not censorship resistant etc., but in reality, most people don’t care about that for everyday money transfers. Bitcoin will keep its store of value use case — I don’t see Libra as a competitor. Bitcoin’s payment use case will probably be limited to privacy focused people.
• Libra vs. Ether: Libra will compete with Ethereum and the other smart contract chains when it launches support for smart contracts as indicated in the white paper. Libra can do this with many more users in comparison to Ethereum and can be quite successful for many dapps. The flip side being: no censorship resistance, limited decentralization etc., things which happen to be quite important for some developers. I can see a version of this where the two worlds coexist with their specific pros and cons.
• Libra will surely not be the last of the “tech-giant-coins”, although its first mover advantage is a big plus. We will always have the self-sovereign and privacy aspect divide between the corporate coins and the Bitcoin/Ethereums of the world. We will most likely end up with a massive privacy/usability trade off in society. We will have a private/less scalable and a scaled, but centralized version of money and apps with potentially different pricing structures.

Crypto/Libra vs. traditional finance

• Why should banks, card and payment companies be afraid of Libra? Because so far, all of the financial innovation has happened on top of the existing financial system. In the end, you always used the same end layer. With blockchain and crypto, for the first time in decades, there is a completely new financial settlement layer, available for use today, with constant technical improvements and innovation. The cryptocurrency is the money, wallets are the new banks, miners/validators are the network supporters and money can flow without touching the Visa or Mastercard networks, SWIFT, online banking or any other system we use today.
• It won’t take long before other banking verticals are built in around the payments layer— lending, online banking, corporate products, investments etc — banks have nowhere to hide anymore.
• Let me repeat — all of this exists today at some scale and will only get better. Libra is contributing by bypassing the whole financial system, but also in a way which can scale beyond what most of the current institutions would believe, even if it remains relatively centralized and closed-end.
• Who should be afraid: banks (payment business will go down), TransferWise and the likes, companies like MoneyGram (partnering with Ripple to build an alternative before Libra gets there — otherwise they are both screwed), Western Union (boy, the Libra announcement must have hurt). So far, these companies were not under that much pressure as their crypto competitors had a hard time with bank on/off-ramps. WU and MG will need to become Libra members if they want to stay in business, just look at their long-term stock charts — it is an agony.
• I completely understand Visa, MC and PayPal. They will potentially lose a lot of business to something like Libra so they absolutely need to be in, to disrupt themselves before someone else does it to them. If Amazon and Google announced similar projects tomorrow, the payment firms will join these as well — they have to.
• Ripple and other payment coins should be scared.
• The other stable coins should be scared, especially if they are more centralized (Tether et al). Most of these would likely die off.

Conclusions

• The era of the supranational currencies has arrived
• Libra has a huge potential to reshape the current financial system
• The initial scale and first mover advantage will be nearly impossible to match
• The LIT can achieve similar investment return trajectory as Bitcoin or Ether
• Central banks and governments are already very scared of it even before it has started — some are hiding behind a dismissive tone and others say it outright
• I am certain the people behind the founding members are also not entirely sure how all this will play out and will need to figure a lot of things along the way
• I fully expect it to be banned in some countries, which may temporarily slow adoption there
• Libra, coupled with Facebook’s existing data sounds like a nightmare. On top of everything they know about their users, add real names, address, ID, utility bills, bank account data and payment history.
• I fully expect the privacy problems/concerns to become a very big issue which will be a tailwind for privacy focused cryptocurrencies
• What Bitcoin is doing to Gold as store of value, Libra can do to central banks and financial institutions as payments and transaction money
• Libra will make it harder for Bitcoin to scale as a payment layer and probably for Ethereum to scale as a smart contract layer, at least for users who less concerned about privacy and more about UX and usability and scale
• All in all, if done right, Libra should be very positive news for Facebook’s stock price