The Libra project is going to provide a financial market infrastructure(FMI) and issue a stablecoin on this FMI. This new FMI and its stablecoin will run in parallel with existing FMI. In view of the global presence and influence of the Libra Association members, this project inevitably causes serious concerns from financial regulators worldwide. This project then pushes central banks to make policies with regard to Libra as well as other similar stablecoins and speed up their own currency digitalization process. This paper explores possible measures central banks may take.
1，It all started with Bitcoin
The birth of Bitcoin in early 2009 can be said to be the big bang origin of the digital asset world. Bitcoin not only directly creates a digital virtual asset, but also produces a more efficient clearing network for the circulation of digital assets. The consensus mechanism in Bitcoin design has also had a profound impact on subsequent development. The consensus mechanism not only continued in the development of blockchain technology in the later period, but also affected the development of an organizational model. In these three areas, Bitcoin started a profound impact on the application of blockchain technology in the financial sector.
Ethereum is the next milestone in the development of encrypted digital assets. It provides a low-level blockchain that allows smart contracts to run automatically. Smart contracts not only have more complex attributes, but also support functions. This provides the basis for customizing various financial instruments. The exchange of value on the blockchain is no longer limited to the simplest financial instrument such as currency but can include more complex financial products such as stocks and account receivables. In the era of Ethereum, the consensus mechanism began to be applied to social organizations. The DAO organization is an attempt by the Ethereum community to adopt a voting mechanism to determine the direction of Ethereum’s technology development. Although the development of The DAO did not go well later, this consensus-based organization inspired more such attempts later.
Since bitcoin was originally designed as a currency, the first application that people thought of was to use blockchain and smart contracts as a new carrier for currency. Although the Bitcoin product has many design highlights, its basic attributes have caused its value to fluctuate greatly, so it is not suitable as a substitute for real-world currency. In the past few years, various projects have begun to develop better digital currencies on the blockchain. At present, the mainstream design is to issue stablecoins on collateralized fiat currencies. From the first stablecoin Tether to recent stablecoins such as USDC and GUSD, the ERC20 standard has been used to develop stablecoins on Ethereum. In addition to these digital stablecoins developed by startups, financial institutions are also experimenting with this. UBS’s USC stablecoin project and JP Morgan’s JPM stablecoin project are all efforts in this regard.
In terms of the organization of these encrypted digital currencies, more companies are beginning to adopt a membership or alliance-based organizational model. For example, company CENTER which promotes the USDC stablecoin adopts this organizational model. Fnality which promotes USC stablecoin is also a form of alliance among financial institutions. In view of the global nature of encrypted digital assets, the adoption of a consensus-based organizational model is more conducive to the promotion of such products on a global scale.
The development of digital stablecoins to date has not caused serious concern from central banks. Stablecoins developed by startups are mainly used in the digital asset trading application scenario. The total volume of digital assets is only about hundreds of billions of dollars. This volume is negligible relative to the total amount of money and assets in real economy. Digital stablecoins developed by financial institutions are mainly used for settlement between institutions. Such stablecoins are more like a tool than a currency. The spillover effects of these stablecoins are not large and therefore will not have an impact on the existing financial system. In general, these stablecoin projects are either very small in scope or limited in impact, so they have not attracted the attention of central banks. However, due to the vast user base of the Libra project and the influence of members of the Libra Association, especially the disruptive nature of the blockchain technology used by the Libra project, central banks have to pay attention to the digitization process of currency and adopt corresponding coping strategies. For central banks, the emergence of Libra is like opening up the Pandora Box. From now on, central banks will have to face the fundamental changes blockchain and crypt assets have brought to the existing financial world.
2，Challenges brought about by Libra
The Libra project consists of three basic components: an underlying financial infrastructure (referred to herein as the Libra Blockchain), Libra stablecoin issued and distributed on top of this infrastructure, and the Libra Association, an organization that supports the project.
The Libra Blockchain is built using distributed ledger technology, so it supports direct transactions and settlements between accounts. It also supports smart contracts. Smart contracts can be used to customize digital stablecoins and other financial products. The Libra Blockchain is not fundamentally different from other blockchain networks in terms of the technology used. Two of the specific features are its consensus mechanism and the language it uses for smart contracts. The consensus mechanism is the HotStuff consensus mechanism proposed by VMWare a few months earlier. Its Move language for programming smart contracts is invented by Facebook for this purpose. According to Libra whitepaper, a notable feature of Libra Blockchain is its plan to migrate from the current permissioned chain to a public chain.
Libra stablecoin is a new financial product developed on top of this financial market infrastructure.
In terms of technology, the Libra project is not fundamentally different from other blockchain projects. Ethereum is now the world’s default public chain. All stablecoins so far have been developed and distributed on Ethereum blockchain. The Libra Blockchain has a long way to go before it can even get close to Ethereum’s market position. Also, since it is a brand new technology implementation, it faces even greater challenges in getting market acceptance. However, one of the three components of the Libra project, the Libra Association is the biggest distinguishing point and is the biggest driving force for this project.
The Libra Association is a not for profit organization registered in Switzerland. It will consist of about 100 members worldwide. Calibra is a company established by Facebook for this association. Calibra will be one of the 100 members. Current 20+ existing members include leaders in financial industry and financial applications such as Visa, Mastercard, PayPal, Swipe, Uber and Lyft. Facebook itself has 2.7 billion registered users in many countries around the world, plus Libra Association members’ users worldwide, this association is a main force promoting the use of Libra stablecoin worldwide. This organization is member-based, operates in a democratic decision-making manner, treats all members equally, and each member can develop financial applications on this infrastructure. Therefore, this is very attractive to prospective members. This association is open to new members worldwide. New members are also expected to be industry leaders in the various currency markets. Therefore, as this stablecoin and the supporting network gradually expand into different fiat currency markets, it will certainly compete with local fiat currency and financial infrastructure. This situation is what central banks have to deal with.
3，The central banks’ prisoners’ dilemma
The emergence of the Libra project has forced central banks to seriously consider their own currency digitization policies and adopt corresponding measures to follow the trend of digitalization of money and assets. If a central bank continues to maintain its existing monetary and financial system while other central banks work together to take necessary measures, then the central bank will certainly fall behind in the process of currency and asset digitalization, become an isolated island in the global financial industry. In order to avoid this situation, each central bank will take this challenge seriously and work with other central banks to collectively develop necessary measures.
4，Central banks don’t like to change the status quo
The view that central bank is unwilling to change the status quo seems to be unfair to central bank, but the central bank’s role is to maintain the stability of the financial market, and the stability of the financial market is an important basis for social stability. Therefore, not only central banks, but also governments of various sovereign countries do not want to have excessive changes in the financial market. The risks brought by the changes may lead to economic and social instability.
When blockchain and cryptoasset technology emerged, in view of its huge potential of impacting existing monetary and financial markets, some central banks tested the feasibility of issuing digital sovereign currencies internally. However, because the new currency form and the underlying blockchain technology have an excessive impact on existing financial market, various risks it can cause may not be predicted in advance, so central banks are very cautious in actually implementing a digital currency strategy.
The digitization of money is more than just a change in the currency carrier. If central banks issue digital currencies and use blockchain technology as the infrastructure, then this will bring fundamental changes to the existing financial market infrastructure because the existing financial market is based on a centralized computing model. Each agency records its own data. When transactions between institutions occur, a central organization, the clearing company, is used to ensure that the records of both parties are consistent and correct. If blockchain technology is introduced, when a transaction occurs, both parties record the transaction and the blockchain technology ensures that the data is correctly recorded. Therefore, there is no need for a centralized clearing system to record such transactions. Since the existing financial markets are operated in such a centralized environment, the business processes and regulations are also based on this. If central bank adopts blockchain technology to support the circulation of its digital currency, such a market structure will undergo fundamental changes (Clearing Company, the First Victim of the Blockchain Era, Commercial Bank, Victim of the Blockchain Era). The various organizations, business processes, and regulations also need to be changed accordingly. This is a huge risk for any sovereign country. Because of this, central banks have not made any real progress in implementing their digital currency policies.
However, the emergence of the Libra project has forced all central banks to consider digitalization policy of their currencies. Due to the global influence of the existing members of the Libra Association and future members (To Join or Not to Join Libra), the global promotion of Libra stablecoin and Libra Blockchain is a high probability event. The process of digitizing money will certainly accelerate. This forces central banks to consider adopting appropriate coping strategies.
5, Each central bank must make its own coping strategy
Every central bank has an existing financial system, so it cannot advance its currency digitization strategy in a green field. It must first consider the impact of currency digitization on existing currency flows and various parts of the financial market. Many questions should be considered before they can make sound currency digitalization policies. Questions such as:
- How many currencies should be issued in the current form and digital form, respectively?
- Should only the central bank have the right to issue digital currency?
- How do commercial banks conduct money lending business based on digital currency?
- How does the use of digital currency affect existing forms of currency?
- Is it technically possible to fully track the circulation of digital currencies?
- How do digital currencies work with other fiat currencies?
- How to ensure the adoption of digital currency is a gradual and controllable process and it will not have an excessive impact on the existing financial market?
Only when central bank has a clear answer to all of the above and more questions, the central bank is likely to advance the process of digitizing its currency.
6, Central banks have to make coping strategies collectively
Collaboration between central banks is probably even more important than each central bank’s own coping strategy. This is because the Libra project is not a regional project, it is an international one from the very beginning. On the technical side, the Libra Blockchain supports transactions on a global scale. In terms of the design of the Libra stablecoin, its collaterals include multiple fiat currencies rather than one single fiat currency and its pegged to a basket of fiat currencies rather than one single fiat currency. In terms of organization, the Libra Association is established as a global organization from the very beginning. The governance of the Libra Association is democratic, and it is open to members around the world. Since Libra’s target market segment, according to the whitepaper, is the unbanked and the underbanked population in all countries, this naturally encourages central banks to work together to address the changes Libra brings. If an individual central bank does not cooperate with other central banks, but instead adopts countermeasures alone, this is going to be a very big challenge.
I expect that such cooperation among central banks is likely to continue the development trends from Bitcoin to Libra, specifically in the following three aspects.
6.1. Cooperate to form an organization similar to the Libra Association
This organization will develop and implement policies to deal with Libra and other stablecoins that will surely appear in the future.
The emergence of blockchain technology has given new life to member-owned business organizations. Prior to blockchain technology, such membership organizations were based on rules agreed by the members and such rules are enforced by the legal system of the region. Therefore, such organizations are usually restricted to a small geographical area or an industry in a legal jurisdiction. However, blockchain technology adopts a technical approach to ensure the implementation and execution of business rules. This mechanism does not depend on legal systems in any jurisdiction. Therefore, a member-type company established in this way is highly scalable on a global scale. The market has already had a consensus on the advantages of this organizational mechanism, so some companies already started using this organization form. Such companies include CENTRE (Why Does Circle and Coinbase-backed USDC Can Develop into a True Stablecoin?), Fnality (Fnality, a Milestone in the Evolution of Financial Market Infrastructure), and the most recent one, the Libra Association. Similarly, I think some central banks will adopt the same strategy to form such an alliance and coordinate their currency digitization policies.
6.2. Will jointly support a financial market infrastructure
Blockchain and cryptoasset technology have been international since the beginning. A user anywhere in the world can open an account on the chain and hold digital assets and can directly trade digital assets with other users on this chain. Bitcoin is the case, as is the Ethereum. The current technical standard for making a stablecoin in the industry is the ERC20 standard of Ethereum. Since all of them are based on the same technical standard, they can all circulate on Ethereum and exchange directly between accounts. When central banks consider issuing digital currencies, they also need to consider the technical standards for digital currency production and the underlying clearing network. Given the increasingly interwoven nature of global economy, central banks have a strong need to adopt the same technical standards and the underlying clearing network. This chain will support digital fiat currencies based on credit and support the organization of commercial bank. Such a financial market infrastructure would be similar to Ethereum, where central banks will build various financial organizations and business processes on top of this infrastructure. Such a coordination among central banks is a high probability event. It is a small probability event that a central bank will insist on using its own technical standard and financial market infrastructure to issue its digital fiat currency.
6.3. Each central bank will issue its own digital fiat currency
The main responsibility of each sovereign government is still to ensure the development of its domestic economy. Moreover, its fiscal and monetary policies cannot avoid the influence of local political factors, so governments cannot jointly support one digital currency based on credit worldwide. Each central bank will for sure issue its own digital fiat currency on this common financial market infrastructure. This is going to be very similar to all those stablecoins issued by the ERC20 standard on Ethereum.
One thing that is very certain is that such a central bank alliance will never issue its digital currencies on the Libra Blockchain. Future digital currencies will exist in two forms (Prediction of Future Stablecoin Forms Based on Monetary Theories). One is digital currency based on sovereign credit and is issued by central bank, the other is a digital currency of commodity money type and which is based on collateralized digital assets and issued in a distributed manner. The Libra stablecoin is in essence a derivative of existing fiat currencies. It is neither a true fiat currency nor a commodity currency. The Libra stablecoin is therefore a transitional one. In the future, it will either transition into a commodity currency or be phased out of the market after central banks introduce their respective digital fiat currencies.