Authors: Simon Seiter, Philipp Sandner, Jonas Gross
In the Libra white paper, it is claimed that Libra will be a stable coin. However, we argue that Libra is no stable coin from a traditional currency perspective as it is not pegged to a single currency. Nevertheless, it is “relatively stable” crypto money. The ability to provide a stable store of value will depend on the ability of the Libra Association to manage the Libra Reserve properly.
The Libra Association outlines in the white paper that Libra is designed as a stable coin. However, the sole existence of a reserve is often mixed up with the character of a stable coin. Note that Facebook uses words associated with stable coins but applies them in an imprecise manner. In the white paper it is said:
„[…] users can have confidence that they will be able to sell any Libra coin at or close to the value of the reserve at any time. This gives the coin intrinsic value on day one and helps protect against the speculative swings of other cryptocurrencies.“
The authors mix two different concepts. The first sentence does not imply that any user of Libra will be able to claim his or her coins against the reserve. It means that the value of Libra will implicitly be connected to the reserve (in terms of other currencies and securities being held back), but it does not mean that the owner of Libra coins has the “right” to transfer his or her Libra assets into other currencies. This is different from other concepts of stable coins where one can claim a refund in a specific currency. It is also different with respect to the gold standard, where dollar could be converted into gold from anybody at any time.
The second sentence indicates that the intrinsic value of Libra protects against „speculative swings.“ Libra tends to be an own currency with intrinsic value. So if it is pegged to a reserve, it will not have intrinsic value because fiat currencies do not bear such intrinsic value. It is the key aspect of fiat currencies that they do not have an intrinsic value because they are not backed by, for example, gold as in former times. But the goal of Libra is to stay relatively stable compared to fiat currencies, or more precisely, to a basket. This basket (reserve) however is of course highly reliant on fiat money and government debt.
The Libra Reserve includes national currencies and short term national debt instruments (supposedly securities). It is initially funded by the members of the Libra Association. Additionally, every purchase of Libra will fund the reserve.
Libra’s connection to national currencies bears an internal conflict that is reflected in the economic design of Libra. While Libra opposes national currencies and actually competes with them, the value of Libra is still connected to the value of those national currencies. If — ceteris paribus — the value of one national currency within the basket decreases and the basket is not adjusted, the value of Libra consequently decreases, as well. If people owning this inflated national currency flee into Libra, the effect even increases, as every purchase of Libra would lead to additional funding of the reserve in the respective national currency. Without the Libra Association actively interfering Libra will not be able to keep the promise to protect against speculative swings.
More obvious it can be seen that Libra will not be able to keep really stable (1:1) to a single currency as the term stable coin implies. Consider the following simple example: assume there are 100 Libra and the Libra Reserve would hold 50 EUR and 50 USD and 1 EUR would cost 1 USD. A person can buy 1 Libra now at the rate of 1 US Dollar or 1 Euro.
Let us assume that after one month the Euro loses value and 1 EUR now costs 0,90 USD. The value of the reserve in USD is now 95 USD (50 USD + 50 EUR * 0,9 USD/EUR) and in EUR it is 105,56 EUR (50 EUR + 50 USD / (0,90 USD / EUR)). If the person wants to sell Libra, he or she will receive either 0,95 US Dollar or 1,06 Euro.
Without interference by the Libra Association, Libra will neither be stable to the USD nor to EUR. But it will be stable to the aggregated development of the foreign exchange markets. With more currencies and debt instruments, however it gets far more complex. So the stability of Libra will depend on how the Libra Association manages the reserve.
Figure 1: Euro and US dollar exchange rates of the GDP-weighted basket of Libra currencies
Source: Groß, Herz, Schiller (2019).
David Marcus mentioned in his speech before the Senate Committee on Banking, Housing and Urban Affairs in den USA, that the Libra Reserve will mainly include bank deposits and government bond denominated in US Dollar, Euro, Yen, and British Pound. Figure 1 shows how the euro and US dollar exchange rates of an exemplary currency basket consisting of these four currencies, weighted by GDP, would have developed over the last two decades.
If we analyze price stability of Libra, we have to clearly specify the timeframe we seek to achieve stability of prices: long term, mid term, or short term. On the long sight the value of this currency basket — and consequently of Libra — would have been relatively stable. If a shorter time period is considered, however, the US dollar or euro exchange rate of Libra would have fluctuated +/-30% around the initial value. Therefore, it can be concluded that there exists a relevant exchange rate risk for Libra holders. For specific fiat currency, the exchange rate risk depends on the composition of the Libra Reserve and is the higher, the smaller the currency is represented in the Libra Reserve (see Groß, Herz, Schiller, 2019). On the very short term however — from one week to another — Libra appears to be rather stable.
After all, we would say that Libra is no stable coin in common terms as it is not pegged to a single currency. However, it is relatively stable crypto money. The ability to provide a stable store of value will depend on the ability of the Libra Association to manage the Libra Reserve properly.
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Simon Seiter is a Senior Consultant at Commerz Business Consulting (Commerzbank’s inhouse consultancy) and working for more than two years on DLT use cases within capital markets and cash / payments. Amongst other projects, at last he lead the first DLT security transaction worldwide with both security and cash on ledger, together with the large German industry corporates Continental and Siemens. He is further part of several working groups on national and European level and consulting political bodies as well as clients with regard to DLT use cases. You can contact him via Mail (firstname.lastname@example.org), via LinkedIn (https://www.linkedin.com/in/simon-seiter/) or via Twitter (https://twitter.com/simonlseiter).
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@example.com), via LinkedIn (https://www.linkedin.com/in/philippsandner/) or follow him on Twitter (@philippsandner).
Jonas Gross is a project manager and research assistant at the Frankfurt School Blockchain Center (FSBC). His fields of interests are primarily cryptocurrencies. Besides, in the context of his PhD, he analyzes the impact of blockchain technology on the monetary policy of worldwide central banks. He mainly studies innovations as central bank digital currencies (CBDC) and central bank cryptocurrencies (CBCC). You can contact him via mail (firstname.lastname@example.org), LinkedIn (https://www.linkedin.com/in/jonasgross94/) and via Xing (https://www.xing.com/profile/Jonas_Gross4).