By J. D. Fencer
Facebook has announced its intention to set up a cryptocurrency called Libra. Because of the tech company’s formidable financial clout, enormous user base, and global reach, it is important to appreciate the implications of this proposal. In order to do that, it is necessary to be clear about, not only, what a cryptocurrency is, but what money in general is.
Most 2.61 X 6.14 inches pieces of paper are worth little or nothing. If one bears the image of George Washington (plus some other markings), however, it’s worth a US dollar and twice as much again if Thomas Jefferson’s image is on it. The US Government assigns value to those pieces of paper and guarantees to replace them with something of equal value. Such paper (and coins) issued by governments or central banks is called “fiat currency.” The dollar has an immediate tangible value because, crucially, the government will accept it in payment of federal taxes. Tangible value means that most people and businesses will willingly swap fiat currency for the products or services they sell. That, in turn, means that fiat currency becomes a way of assigning value to the work involved in making products or providing services.
Economic factors influence the value of fiat currency. For example, if the government demands more of it to pay taxes, or if a foreign country demands more of it to swap for its own currency. That’s why the rate of exchange a high-street bank quotes to change one fiat currency like dollars into another, say euros, can change from day-to-day. Relative fluctuations in stable countries’ exchange rates, however, are usually minor, which is one reason most fiat currencies are reliable ways of storing wealth.
Each note and coin is unique and, if one is destroyed, its value is lost. A unit of cryptocurrency is also unique in that only one of it exists. Yet cryptocurrencies are different from fiat currencies in various ways. The most obvious way is that a unit of cryptocurrency does not exist in the form of a unique piece of paper or coin the value of which value is guaranteed by a government. Instead, a cryptocurrency unit, sometimes called a “crypto coin,” exists as a unique piece of encrypted software code owned by whoever has the key to unlock that code and so pass it on to someone else. In addition, every user, every crypto coin, and every transaction are traceable because they are recorded in a permanent database of chronologically sequential entries called a blockchain.
To prevent crypto coins being counterfeited, or more than one person claiming ownership of the same coin, the blockchain can only be added to; existing entries can never be changed or removed. That means a permanent chain of evidence exists for every transaction, and anyone with access to the blockchain can review the chain of transactions. In the case of Bitcoin, all users have access to the blockchain in near real time. With Libra (though full details of its intended modus operandi are yet to be revealed), it seems that the related blockchain will not be public, at least initially, but accessible only to the proposed 100 companies involved in setting up the currency. Anyone with access to a blockchain can transfer coins to others in the time it takes to make an addition to the database and have it replicate in the entire network, that is to say, almost instantaneously. Ordinary users will deal in Libras, at least initially, through the founding companies.
The value of the Libra coin will be pegged to a basket of low-volatility assets that will include fiat currencies, bank deposits, and government securities, so every Libra coin’s value will fluctuate only in relation to the cumulative fluctuation of that basket, which is likely to be minimal. Libra and other cryptocurrencies pegged to fiat currencies are known as stablecoins. They are quite different from cryptocurrencies like Bitcoin, whose values are based on little more than a fanciful mass belief in what it should be at any given moment.
An important aspect of Libra is that it will be a reserved currency. That means that every Libra will be backed by an amount of equal value from the basket of assets. Put another way, if you buy one Libra for, say a dollar, your dollar will be invested in a bank or government bond somewhere. As Facebook explained in a recent statement, “the reserve will be held by a geographically distributed network of custodians with investment-grade credit rating to limit counterparty risk.” They don’t intend to pay interest to users, however. Instead, any interest accrued will be used to help fund the running of the system.
Taken together, all these facts suggest Libra should be a reliable way of transferring money around the world cheaply and quickly. In addition, because of its reserved status, users should feel assured that the value of any Libra they hold will be unlikely to fluctuate any more than the value of a standard bank account deposit. Most people will welcome Libra except, perhaps, those banks and other financial institutions that for years have been making significant profits from money transfer fees.
Photo credit: https://www.alpari.org