Facebook-coin Libra: benefits vs. risks — opinions from German economists
In the recent publication of the Ifo Schnelldienst, various German economists have expressed their opinions about Libra. To ensure that Libra is perceived and accepted as value-stable money, it is designed as a stable coin, i.e. Libra will be covered by government securities and bank deposits denominated in fiat currencies and thus has an intrinsic value. In contrast to classical stable coins such as Tether, the value of Libra will not be stabilized against one single anchor currency but against a basket of currencies and government bonds. From a scientific point of view, it is essential and welcome that ever more economists analyze the implications of Libra and stable coins to estimate its potential on worldwide financial markets in order to regulate it properly. This article summarizes and discusses the main aspects brought up by German economists in the recent report. — Authors: Jonas Groß, Jonathan Schiller, Philipp Sandner
Main benefits of Libra
Cheap payments and a solid store of value
The benefits of Libra are similar to the ones discussed in Bekemeier, Groß, Sandner (2019). First, Libra can be expected to become a cheap alternative for cross-border payments, since the planned technological infrastructure saves costs, e.g., with respect to personnel and infrastructure (Mayer 2019). This is rooted in Libra being a so-called “stable coin” which reflects some stable asset running on a blockchain-inspired system. Besides, Libra can be expected to be a stable store of value only with a minor exchange rate risk (Mayer 2019). As shown in Groß, Herz, Schiller (2019) especially in developing and emerging economies Libra could be a comparably stable alternative to fiat currencies and provide a good store of value. In industrialized countries, on the other hand, exchange rate fluctuations might be more concerning. We argue that currently there are already various well-established competitors in industrialized countries, which provide cheap and fast payment solutions and therefore pose substantial market entry barriers for Libra. Conversely, such entry barriers might be missing in developing and emerging countries.
Unit of account and financial inclusion
Furthermore, Mayer (2019) argues, that Libra can be expected to act as a unit of account. Grigo and Hansen (2019) follow the same argumentation. The composition of the Libra Association including large finance and tech companies such as Facebook, Mastercard or Visa suggests that Libra could potentially be used as a unit of account within all these companies.
Eichler and Thum (2019) conclude that a whole financial system could arise in developing and emerging economies, which is based on Libra where e.g. loans could be granted in Libra. This could significantly increase financial inclusion of recently unbanked or underbanked people and, subsequently, local welfare.
Central Bank Digital Currency (CBDC)
Mayer (2019) and also Grigo and Hansen (2019) argue that the Euro area should react to the US-dominated Libra consortium by issuing its own digital currency. Note that mainly US companies have acknowledged their membership in the Libra Association. Interestingly, the German government has explicitly mentioned in its currently released blockchain strategy that it will “further expand the dialogue with the Bundesbank on central bank digital currency [CBDC] in order to keep analyse the current status of the development.”
Main risks of Libra
Besides Libra’s main advantages the authors also discuss risks.
One of the main risks mentioned in the report is data and IT security. Facebook has been involved in various data scandals within the last few years (Grigo and Hansen 2019). David Marcus, Head of Calibra, has explicitly stated that the members of the Libra Association will not use the transaction data for commercial purposes. However, it remains to be seen if the members of the association will indeed commit to this statement. If data security is not ensured, then the whole project is doomed to fail.
Bank run risks
Another risk factor is that Libra can actually be seen as a global mutual fund. This is an aspect, which is deeply analyzed in Groß, Herz and Schiller (2019). Grigo and Hansen (2019) argue that, assuming a high market penetration of Libra, the fund could end up being highly capitalized. Therefore, the composition and management of the fund can influence the prices and returns of the underlying assets. Besides, it is argued that a run on the Libra fund is not unlikely in times of crisis. We discuss systemic risks in Groß, Herz, Schiller (2019) in depth. Our main finding is that a proper setup of Libra and the involved authorized resellers, which provide Libra to the clients, can mitigate the risk of bank runs due to market fluctuations and perceived risks. Especially as Libra is fully backed by liquid assets, the usual dynamics of bank runs are very unlikely to unfold. However, trust issues related to the members of the Libra Association, e.g. due to a data scandal, remain an important issue as also argued by Eichler and Thum (2019).
The market for government bonds
Hornuf (2019) argues, that the Libra Association could evolve to an important player in the market for government bonds, which is one of the two asset classes included in the Libra Reserve. Therefore, the Libra Association’s investment decisions could influence refinancing conditions for the respective governments. Specifically, we estimate that the Libra Association can be expected to hold an amount of approximately 1.5% of all outstanding short-term government bonds assuming a rather high Libra market capitalization of USD 250 billion. Therefore, the influence on the worldwide government bond markets seems manageable. Of course, this would be different if Libra’s market capitalization would be in the end higher. This, however, is relatively unlikely at this point in time.
Since the Libra Reserve also includes assets, like government bonds, it is not surprising that default risks exist (Hornuf 2019). If government bonds default, the value of the Libra Reserve and thus the value of Libra in terms of fiat currency would decrease. However, the Libra Association has stated in its whitepaper, that it will back its currency only with government bonds issued by “stable economies”. Therefore, the likelihood of defaults of high-rated bonds, such as US government bonds, seems only marginal. Considering that stable economies usually act as safe asset providers and that their bonds increase in value in economically tense times, default risks are partly negligible.
Balz and Paulick (2019) argue that the fees for converting Libra into fiat currency and vice versa could be substantial. This is a valid point since in the Libra ecosystem authorized resellers operate as intermediaries who engage with clients and the Libra Association (see Figure 1). At this point, however, the whitepaper does not provide enough information about how the authorized resellers will operate in the Libra ecosystem. This aggravates further analysis of potential conversion fees.
Monetary policy aspects
Monetary policy aspects are also named as significant risks (Balz and Paulick (2019) and Eichler and Thum (2019)). The authors argue that less efficient monetary policy transmissions cannot be ruled out and that Libra could influence monetary policy measures of central banks. However, the size of potential effects depends on the actual market capitalization of Libra, which is currently hard to quantify. Since we argue that Libra will be more widespread in developing and emerging economies as compared to industrialized countries, the short-term impact on monetary policy of the European Central Bank (ECB) seems limited. The key question whether monetary policy is simply “forwarded” by Libra or actually “made” by Libra is related to the rules of the governance of the Libra Association and to the rules how the Libra Reserve is dynamically changing over time — all these rules are not clear yet.
While the authors have correctly identified various advantages of the Libra Association’s endeavor, their scepsis mainly prevails. The positive effect on financial inclusion of possibly billions of people is outweighed by concerns about potential data abuse, risks for financial stability and less effective monetary policy. However, we argue that a proper regulation combined with adequate supervision can mitigate potential disadvantages and unleash the substantial potential of an international currency.
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Jonas Gross is a project manager and research assistant of the Frankfurt School Blockchain Center (FSBC). His fields of interests are primarily crypto currencies. Besides, in the context of his PhD he analyzes the impact of blockchain technology on monetary policy of worldwide central banks. He mainly studies innovations as central bank digital currencies (CBDC) and central bank crypto currencies (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).
Jonathan Schiller is a research assistant at the University of Bayreuth. His fields of interest are macroeconomic modelling and Euro area heterogeneities. His current projects concern the influence of fintech innovations on monetary policy. You can contact him via mail (email@example.com) and via LinkedIn (https://www.linkedin.com/in/jonathan-schiller-305868166/).
Prof. Dr. Philipp Sandner has founded the Frankfurt School Blockchain Center (FSBC). In 2018 and in 2019, he was ranked as one of the “top 30” economists by the Frankfurter Allgemeine Zeitung (FAZ), a major newspaper in Germany. Further, he belonged to the “Top 40 under 40” — a ranking by the German business magazine Capital. Since 2017, he is member of the FinTech Council of the Federal Ministry of Finance in Germany. The expertise of Prof. Sandner includes blockchain technology in general, crypto assets such as Bitcoin and Ethereum, the digital programmable Euro, tokenization of assets and rights and digital identity. You can contact him via mail (firstname.lastname@example.org) via LinkedIn or follow him on Twitter (@philippsandner).