Libra is a digital currency that was developed by Facebook in an effort to empower people all over the world. To achieve this objective, the social media giant aimed to create a global digital currency and infrastructure that would help provide financial inclusion to billions.
In turn, the Libra Association, a Switzerland-based nonprofit, was created to help govern the network that underlies the Libra currency and help it realise its goal. Facebook will serve as a founding member of this association, along with other prominent organisations such as Visa and Uber.
The Libra Token
The Libra Token is designed to be a digital currency that people and businesses can use on a global scale. The token is the native asset of the Libra Blockchain, whose code is open-source so anyone can develop on it.
As for what problem this innovation will address, the Libra's white paper cited World Bank statistics estimating that 1.7 billion people are "unbanked," meaning they lack an account through either a financial organisation or a mobile service provider. When explaining why they choose to remain this way, these individuals cited issues like high fees for sending remittances and ATM transactions. In other words, the current financial services industry is prohibitively expensive for them.
Individuals are not the only ones potentially missing out. It has been estimated that roughly 70% of the small businesses in developing nations don't have credit available to them.
If Libra gains strong enough adoption, it could potentially be used to provide the "unbanked" with access to financial services. Libra is providing a smart contract platform, which together with Libra Blockchain, could be used for this innovation.
More specifically, developers building on this platform could potentially offer insurance or blockchain-based lending to interested parties. Such developments could open up these basic financial services to large groups that cannot otherwise access them.
This digital token was created for use on several platforms, including Facebook, Facebook Messenger and WhatsApp. Facebook's most recent reported figures put its user base at more than 2 billion, so that massive base could help bolster adoption.
Facebook's announcement that it plans to release Libra, along with its issuance of educational materials like white papers, generated widespread media coverage. Peter Colin, a legal technologist at Thomson Reuters, noted that Libra could lower transaction fees and bolster efficiency.
The Libra token is pegged to a basket of relatively safe assets, a move that was made to ensure that this digital currency would maintain a stable value relative to fiat currencies.( "A collection of low-volatility assets, including bank deposits and government securities in currencies from stable and reputable central banks," will back every unit of Libra.
The Libra Reserve
The Libra Reserve, designed to help support the value of this new digital currency, will hold the aforementioned assets. It should be noted that while the Libra currency was designed to maintain stability, the underlying assets backing it will effectively be fiat currencies. As a result, it is expected that this cryptocurrency will experience some fluctuations relative to different kinds of fiat currency.
However, the Libra Reserve was set up to help minimise the price fluctuations of the digital currency. To meet this objective, the reserve plans to prioritise liquidity and capital preservation, only investing in short-term debt of governments that have little chance of defaulting on their obligations.
Further, several custodians in different locations will safeguard the assets of the Libra Reserve in order to ensure that these assets are decentralised and secure. To help manage the risk of one of these financial institutions failing, the Libra Association indicated that it plans to work with custodians that have investment-grade credit ratings.
The digital currency was designed to be bought and sold by a network of exchanges as a way to ensure that Libra maintains high liquidity, which means that interested parties can easily convert their units of Libra into units of fiat currency based upon a certain exchange rate. Facebook has likened this approach to the historical strategy of introducing currencies that could be exchanged for real assets (like gold) in order to foster trust.
Investors should know that they cannot work directly with the Libra Reserve to buy or sell Libra. Instead, the reserve will transact with authorised resellers, who will have exclusive right to buy significant amounts of Libra and also sell the digital currency back to the reserve.
These resellers will work with exchanges and other financial institutions that work directly with users, providing them with liquidity so that any end-users of Libra can easily buy the digital currency and sell out of it.
Investors should also be aware that Libra's money supply will fluctuate based on supply and demand. More specifically, the only way to create new units of Libra is to purchase them from the reserve with fiat currency.
The Libra token is designed to maintain a relatively stable value relative to different fiat currencies, so investors can potentially incorporate it into a portfolio with riskier assets in order to help reduce volatility.
As an example, an investor has a simple portfolio of digital currencies that consisted of 20% Bitcoin, 20% Ether, 20% XRP, 20% Litecoin and 20% Bitcoin Cash, which are all highly volatile digital currencies. They could potentially lower their overall price fluctuations by incorporating Libra, which is designed to be a stablecoin.
Investors who are interested in Libra should know that the Libra Association has indicated it plans to encourage regulated exchanges to list the new digital currency. The Libra Association indicated in its document "The Libra Reserve" that it was in discussions with banks and institutions that trade cryptocurrency to be authorised resellers. The intention is to lower barriers in order to maximise liquidity for users.
Investors should also keep in mind that because Libra was designed to be a stablecoin, it doesn't hold the same potential for high returns as other digital currencies like Bitcoin and Ether. Some traders have generated very substantial returns, but also major losses, using these cryptocurrencies.
As long as Libra works as intended and maintains a relatively stable value, it won't have the downside risk of other digital currencies. As a result, it is not in danger of losing more than 80% of its value in a matter of months, like the broader digital currency market did in 2018.
Libra transactions will be recorded on the Libra Blockchain, which the Libra website describes as "a decentralized, programmable database" designed to enable people around the world to use Libra as a medium of exchange. This blockchain will function based on the Libra protocol, a set of rules that allows a group of nodes, called validators, to reach consensus and therefore confirm transactions.
The members of the Libra Association will operate these validator nodes. To begin with, these initial members will consist of social impact partners (SIPs), corporations and academic institutions. However, membership will eventually become available to anyone who holds a minimum amount of Libra and helps maintain the network by running a validator node.
The Libra Blockchain will use a consensus mechanism called LibraBFT, which will allow the network to function even if one-third of its validator nodes fail in some way. This approach has several other benefits, including high energy efficiency, substantial transaction capacity and low latency.
The Libra Blockchain started out as a permissioned system, meaning that only specific entities (in this case, the founding members of the Libra Association) will be responsible for establishing consensus. However, the Libra Association aims to change this over time, making the system permissionless. This means that anyone can contribute to this consensus by contributing certain resources to the network. As a result, the association has stated that one of its "directives will be to work with the community to research and implement this transition, which will begin within five years of the public launch of the Libra Blockchain and ecosystem."
Even before the Libra Blockchain reaches this point, anyone who wants to build financial services products on the platform will be able to do so. "Open access ensures low barriers to entry and innovation and encourages healthy competition that benefits consumers. This is foundational to the goal of building more inclusive financial options for the world," the Libra Association said.
In terms of throughput, the association noted that it aims to allow 1,000 transactions per second to begin. This is far greater than the Bitcoin blockchain, which allows seven transactions per second. The Libra Blockchain also offers users pseudonymity. Users will be able to have one or more addresses, which they can use to conceal their true identity.
What Is Calibra?
Facebook created a wholly owned subsidiary named Calibra so that it could "ensure separation between social and financial data and to build and operate services on its behalf on top of the Libra network." This subsidiary will be responsible for conducting due diligence on its customers, which means it will put them through the know-your-customer (KYC) process. If a large number of users make use of Libra, Calibra will gather significant amounts of consumer data.
This new subsidiary plans to issue a wallet, also named Calibra, for Facebook's new digital currency. Facebook announced this in June 2019 and revealed that it planned to make this wallet available through WhatsApp, Messenger and a separate app expected to launch in 2020.
What Is The Libra Investment Token?
The Libra Association has created a second digital currency, called the Libra Investment Token. This digital asset will function like a security, in that it will be sold to help fund the Libra Reserve. After certain operating expenses are paid, a fraction of the remaining funds will go to early investors in this token in the form of dividends.
The Libra Reserve only plans to invest in low-risk assets that are not expected to produce strong yields. The funds held in the reserve would need to expand significantly for the early investors to receive a return.
Libra is a digital currency designed to help empower people around the world by giving them a universal medium of exchange. This cryptocurrency is a stablecoin that will be backed by the Libra Reserve, which will hold low-risk assets, and will trade on the Libra Blockchain.
Investors should keep in mind that the Libra token can potentially be incorporated into portfolios as a means of reducing volatility because it is a stablecoin backed by a basket of underlying assets. However, Libra does not have the substantial upside potential that other digital currencies do. At the same time, the Libra currency lacks significant downside potential.
Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…