@adlrocha - An Update to Libra
The Libra Association publishes a new whitepaper.
|Alfonso de la Rocha||Apr 19|
The first publication of my newsletter was dedicated to Libra, a simple global payment system initially proposed by Facebook and based on the use of blockchain technology for its operation. Ten months later, the Libra Association has published an update to its whitepaper, and in this publication I will try to summarize the main changes in this new update.
The Main Changes
Those of you who know me or have been following my publications know that, to me, Libra represents the kind of disruptive changes blockchain technology enables. Initially, it seemed like Libra was trying to replace currencies backed by central banks and financial institutions, by a corporate-backed global currency in order to reduce the costs of a global financial system, fostering financial inclusion and reducing the entrance barriers of innovation and new players to the financial sector (currently monopolized by large banks and financial institutions).
To me, the set of updates presented in this whitepaper can be summarized as “a set of changes to accommodate the technological proposal and the project’s vision to regulatory constraints”. The major changes of this updates are clearly tailored to address the concerns of regulators, central banks, elected officials, and all the global stakeholder that have expressed negatively about Libra (a few examples).
These are the key changes in this updated paper:
The transformation of Libra from a single-currency stablecoin to a multi-currency coin: A key concern that was shared was the potential for the multi-currency Libra Coin (≋LBR) to interfere with monetary sovereignty and monetary policy if the network reaches significant scale and a large volume of domestic payments are made in ≋LBR. Thus, this new proposal suggests the inclusion of single-currency stablecoins pegged to existing currencies initially starting with some of the currencies in the proposed ≋LBR basket (e.g., LibraUSD or ≋USD, LibraEUR or ≋EUR, LibraGBP or ≋GBP, LibraSGD or ≋SGD). Each single-currency stablecoin will be fully backed by the Reserve, which will consist of cash or cash equivalents and very short-term government securities denominated in that currency. Hence, ≋LBR will simply be a digital composite of some of the single-currency stablecoins available on the Libra network. In short, forget about the corporate-backed currency I mentioned above.
The construction of a clear compliance framework: One of the main concerns and criticism to “traditional” cryptocurrencies has been the lack of control and compliance related to matters such as KYC, Anti-Money Laundering (AML), the prevention of illicit activities, or Combating the Financial Terrorism. And it hasn’t been any different with Libra. Thus, Libra is working to develop a comprehensive framework for financial compliance defining different participants in the network, each with a different set of requirements.
The Libra network distinguishes between four categories of participants: (i) Designated Dealers; (ii) Virtual Asset Service Providers (“VASPs,” including exchanges and custodial wallets) that are registered or licensed as VASPs in a Financial Action Task Force (FATF) member jurisdiction, or are registered or licensed in a FATF member jurisdiction and are permitted to perform VASP activities under such license or registration (Regulated VASPs); (iii) VASPs that have completed a certification process approved by the Association (Certified VASPs); and (iv) all other individuals and entities seeking to transact or provide services through the Libra network (Unhosted Wallets). Unhosted Wallets enable financial inclusion, broad competition, and responsible innovation and thus facilitate the creation of services for the unbanked and underbanked. Since their activities may pose a greater risk, they will be subject to balance and transaction limits. Initially, the network will only be accessible to Designated Dealers and Regulated VASPs while the Association continues to develop its certification process for other VASPs and its compliance framework for Unhosted Wallets based on the feedback received from regulators.
Addressing Libra’s governance concerns and its future transition to a permisionless system: Currently, the validation of transactions in Libra is performed by a set of validator nodes owned by members of the Libra Association, but the plan is to transition this permissioned approach to a Proof of Stake-based permissionless network. Regulators raised thoughtful questions about the perimeter of control for the Libra network, in particular, the need to guard against unknown participants taking control of the system and removing key compliance provisions. But wasn’t blockchain technology born to solve this?
Building strong protections into the design of the Libra Reserve: The lack concern the Libra Association looked to address in this update was the concern of regulators for potential systemic risks. For this, Libra has incorporated strategies in the design and structure of the Reserve that backs Libra so that it holds assets with very short-term maturity, low credit risk, and high liquidity limiting the aforementioned financial risks.
What to expect technically
After reading the whole whitepaper I didn’t find any significant change related to the technology. However, in the “What’s next?” section there was an interesting overview of the changes yet to come in the short-term which are mainly focused on ensuring the security, performance, and scalability of the protocol and its implementation:
The Association will construct well-documented APIs and libraries to enable users to interact with the Libra Blockchain.
The Association will institute a procedure for Libra Improvement Proposals (LIPs), open to community participation and scrutiny, where material changes to the protocol and software that support the Libra Blockchain will be discussed and reviewed. Welcome Libra’s EIPs.
The Association will create a framework for the collaborative development of the technology behind the Libra Blockchain using the open-source methodology. It seems like we will be able to contribute to Libra.
The Association will perform extensive testing of the Libra Blockchain, which will range from tests of the protocol to constructing a full-scale test of the network in collaboration with entities such as wallet services and exchanges to ensure the system is working before launch.
The Association will work to foster the development and deployment of the Move language, allowing developers to use the safeguards inherent to the Move language to develop innovative financial applications. This will entail collaboration with regulators on defining appropriate safeguards for third-party publishing of smart contracts as well as an exploration of other financial programming contexts that would benefit from the innovations in Move. Libra doesn’t support the deployment of Move scripts in the current network, and it only hosts Libra’s core Move scripts. I am really looking forward to seeing how to deploy custom Move scripts into the network, and if the security of custom Move scripts would be enforced in any way.
My View of the Changes
This new whitepaper clearly focuses on addressing the regulatory concerns in order to prepare for the launch of the system. Reading the whitepaper I felt more as an economist, a politician or a regulator than an engineer, discussing about financial assets, monetary policies, regulation, etc. I am no expert on this field, and I would have felt more comfortable giving my opinion on technical matters, but “what the heck!”, let me share my view of these changes.
In my first post about Libra I expressed how I felt Libra, with its coin, was trying to issue a corporate-backed global currency, and how the Libra Association would behave as Libra’s central bank. For me, the introduction of the multi-currency Libra have relaxed a bit this perception.
A key concern that was shared was the potential for the multi-currency Libra Coin (≋LBR) to interfere with monetary sovereignty and monetary policy if the network reaches significant scale in a country (i.e., ≋LBR becomes a substitute for domestic currency).
i.e. regulators didn’t like a Libra Association behaving as a central bank messing with their monetary policies. So ≋LBR is now more like a “global translation stablecoin” than a independent currency. If I am making an international transfer to the US using Libra I will exchange LibraEUR for LibraUSD. Nothing new here. However, what if I want to make an international transfer with SEKs and there is no LibraSEK? Here is where ≋LBR comes to play serving as an intermediate asset for the exchange (similar to what Ripple or Stellar do in the exchange of digital assets in their corresponding networks). Thus, a Swede with his newly adquired Libras could still make international payments and transfers, or exchange them for FIAT through a valid exchange.
Single-currency stablecoins simplify the design of ≋LBR. ≋LBR can be implemented as a smart contract that aggregates single-currency stablecoins using fixed nominal weights (e.g., ≋USD 0.50, ≋EUR 0.18, ≋GBP 0.11, etc.). This approach to the ≋LBR design is similar to what is used by the International Monetary Fund (IMF) in the Special Drawing Rights (SDR). Because≋LBR is composed of fixed amounts of single-currency stablecoins that are supported by the network, ≋LBR is fully backed by the Reserve assets backing each single-currency stablecoin.
The Reserve will mint and burn each single-currency stablecoin (e.g., ≋USD, ≋EUR, ≋GBP, etc.) in response to market demand. Additionally, a smart contract will combine these specific single-currency stablecoins into ≋LBR based on specified fixed nominal weights. Since ≋LBR is not a peg to a single currency, as the value of each currency moves, the value of one ≋LBR in any local currency may fluctuate. The Association would welcome the oversight and control over ≋LBR by a group of regulators and central banks or an international organization (e.g., IMF) under the guidance of the Association’s main supervisory authority, FINMA, which could oversee and control the weights and components to minimize volatility.
Ok, I said that the Libra Association didn’t behave as a central bank for ≋LBR, but that’s not entirely truth. In the whitepaper there are a set of so-called “emergency operations” that the Libra Association can perform in order to avoid financial risks.
The Association is focused on implementing a system that mitigates risk, includes appropriate loss-absorbing capital buffers, and facilitates ongoing and comprehensive supervision. Nevertheless, we are mindful of the need to plan for stress scenarios that could result in a run or otherwise threaten the viability of the Libra payment system – even though the occurrence of those stress scenarios and the possibility of the Libra payment system becoming non-viable is highly unlikely. In the context of a recovery and resolution plan, the Association is considering whether to provide for two key components that could be implemented in severe stress scenarios in the unlikely case that the Libra network is unable to convert the very short-term government securities in the Reserve into cash fast enough to satisfy all requests to burn Libra Coins without incurring fire-sale losses:
Redemption stays, which would delay Libra Coin redemptions and allow for additional time to liquidate the Reserve’s assets during a window of time without incurring large fire-sale losses.
Early redemption haircuts, which would impose a fee for instant redemptions and require coin holders to internalize their negative externality (i.e., fire-sale losses) in a run.
But isn’t this the kind of work central banks do to with their currencies? This is why in its whitepaper Libra advocates for the creation of a central bank of digital currencies responsible for managing global stablecoins so that they can completely delegate the responsability of the aforementioned management.
Our hope is that as central banks develop central bank digital currencies (CBDCs), these CBDCs could be directly integrated with the Libra network, removing the need for Libra Networks to manage the associated Reserves, thus reducing credit and custody risk. As an example, if a central bank develops a digital representation of the US dollar, euro, or British pound, the Association could replace the applicable single-currency stablecoin with the CBDC.
Hopefully, this need of “official” stablecoins by Libra (and others yet to come) will push financial institutions and central banks to start taking seriously the benefits of this type of digital assets, and start promoting their implementation (the truth is many are moving this way like the ECB or China).
Something that was clarified in this whitepaper, and which was only slightly mentioned in the previous one, is how are Libras distributed to consumers and corporations:
Libra Networks will not directly interface with consumers, but will instead partner with a select number of Designated Dealers to extend liquidity to consumer-facing products, such as wallets and exchanges. These Designated Dealers will commit to making markets within tight spreads and will be able to accommodate high volumes of trading.
One last addition that I found really interesting in the document is the introduction of “automated protocol-level compliance controls for all on-chain activity” and an “off-blockchain Travel Rule protocol” in the network (actually, if you check Libra’s job openings in the Facebook career site you’ll see how the Libra team is starting to hire experts in AI, I guess one of the reasons is the implementation of these compliance systems).
The Association will develop an off-blockchain protocol to facilitate compliance by Regulated and Certified VASPs with applicable Travel Rule and record-keeping requirements. This protocol will facilitate the exchange of information between these Libra network participants to facilitate their own compliance and will include an open-text field to allow for the sharing of supplemental information. Unhosted Wallet addresses can use this off-blockchain protocol to submit required or requested data to Regulated and Certified VASPs. The Association will maintain a public directory of Regulated and Certified VASPs, and Regulated and Certified VASPs will publicly attest to their compliance with applicable Travel Rule and record-keeping requirements.
For those of you interested in the field of stablecoins, I really recommend you to read the whitepaper. You will take a good insight of the steps that are being taken in concert with regulators and stakeholder to make a compliant stablecoin a reality (spoiler alert! it is not an easy task). In this publication I included all the changes that seemed more interesting to me but, of course, I had to leave many things out, and things that I disregarded may have been of the utmost interest to you (and I apologize for this). Feel free to add your additions in the comments and I will update the publication.
One thing I’m clear about after reading this whitepaper is that the future of the financial system is built upon stablecoins and digital assets, whether the regulators like it or not, so we will have to work together to make this a reality.
As always, I would love to hear your thoughts about this matter. See you next week!