Facebook Coin Libra: What do Economists Think?

Authors: Jonas Gross, Philipp Sandner

After some time has passed since the initial publications of Libra back in June 2019, more and more well-known economists apparently have understood Libra and (sometimes) blockchain technology. Now, they start discussing Libra and its expected consequences. This research by economists is necessary to estimate Libra’s impact on the financial system and therefore to quantify the threats for financial stability. This is essential to set proper regulatory guidelines for Libra and — in the end — to get an approval from worldwide regulators.

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Are Libra bank runs likely?

Cecchetti and Schoenholtz (2019) argue that Libra poses systemic risks for the worldwide financial system due to an increased likelihood of bank runs. However, it can be argued that the likelihood of bank runs can be mitigated by a proper design of Libra. This can e.g. be reached by (1) always ensuring a 100% backing of Libra by the Libra Reserve and (2) by ensuring that Libra can always be converted to fiat currencies without barriers. These factors depend on the degree of transparency provided by the Libra Association and how the conversion process of fiat currency into Libra is designed via “authorized resellers”. Both is not yet clear. It is obvious that systemic risks can arise from Libra. However, these risks can be mitigated by a proper design of Libra.

Can the value of Libra be expected to be stable?

Cecchetti and Schoenholtz further argue that using a currency basket consisting of the special drawing rights (SDR) by the International Monetary Fund (IMF) as a proxy for the Libra Reserve, the value of Libra is not expected to be stable over time. However, according to simulations by Groß, Herz, Schiller (2019) the value of Libra — measured in EUR or USD — can be expected to be quite stable in the long-run (see Figure 1) even if in the mid-run fluctuations might occur and an exchange rate risk is apparent. On the very short-term, that is getting money today and spending it tomorrow, Libra can also be expected to be relatively stable. Therefore, when discussing the value stability of Libra, it is always important to specify the time frame. For developing economies with weak currencies, Libra can provide an attractive means of payment and a relatively stable store of value to hedge against depreciation and inflation risks — even if slight fluctuations occur.

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Figure 1: EUR and USD relative to exemplary Libra basket

Source: Groß, Herz, Schiller (2019).

Is the Libra Blockchain centralized?

In his recent publication Eichengreen (2019), a well-known economist, discusses what is currently known about Libra and what is still unclear. He concludes that it is not clear that Libra will be 100 percent backed by the respective reserve assets. This is surprising since it is clearly stated in the white paper of the Libra Reserve that “the reserve will be fully backed across time.” Therefore, if it is ensured that the Libra Association indeed commits to this statement and fully backs Libra by the Libra Reserve, risks stemming from a fractional backing are currently not justified.

Further, Eichengreen states that Libra’s DLT infrastructure will not be decentralized but rather highly centralized. If looking in the technological white paper about the Libra Blockchain, one can see that a Byzantine-Fault-Tolerance (BFT) consensus is applied. Therefore, every validating node has to participate in the confirmation process to reach a consensus. Only if ¾ of the nodes confirm the transaction, the transaction is conducted in the end. Of course, this blockchain system is by far not as decentralized as e.g. the Bitcoin blockchain. However, the system can be seen as significantly more decentralized than the current financial system: The Libra Association intends to reach an amount of 100 validator nodes, which will confirm transactions jointly (!). Therefore, this can be seen as an improvement to the current financial system, where — with current financial infrastructure in place — only one single entity controls transactions.

Decentralization and centralization are not black and white, neither are they good and bad. There are hybrid systems possible which can make very much sense — for example to achieve a high transaction throughput.

Remarks

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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 (jonas.gross@fs-blockchain.de), LinkedIn (https://www.linkedin.com/in/jonasgross94/) and via Xing (https://www.xing.com/profile/Jonas_Gross4).

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@philipp-sandner.de), via LinkedIn (https://www.linkedin.com/in/philippsandner/) or follow him on Twitter (@philippsandner).

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