June 24, 2019
Libra Basics – What you Need to Know
Posted by Andries Verschelden
A Network Effect
Throughout history, money — whether it’s rare shells, gold, notes or bits of data — is only money when a network effect enables people to trust it as a store of value, a medium of exchange and a unit of account. Rare shells can operate as money when we are all willing to accept shells as payment. Other projects attempting to disrupt payments and monetary value transfer using blockchain have struggled with user adoption (i.e., creating a network effect).
But Facebook has a network like no other. If even a fraction of the Facebook user network were to adopt Libra, the coin would have a higher adoption level than any other cryptocurrency currently in the wild.
After a hailstorm of “GlobalCoin” and “ZuckBuck” memes and endless speculation, with the release of Libra’s white paper, the industry finally has some clarity regarding Facebook’s project Libra. While tribalism has guided many conversations in the space, the utility of Libra (or any cryptocurrency) lies on a spectrum based on a series of tradeoffs. These tradeoffs — decentralization vs. centralization, security vs. scalability and user experience, on-chain vs. off-chain collateral — are not categorically good or bad, but tradeoffs do present positives and negatives for different individuals and use cases.
We now have a white paper with aspirational language about banking the unbanked through a “simple global currency and financial infrastructure.” If this were an ICO in late 2017, we would have chuckled and thought, Another vague solution coin. The idea of banking the unbanked using a secure, trustless, decentralized network that allows for peer-to-peer payment is not at all new. Why, then, is Libra different? Or is it? Why will it work? Or will it?
What we know for certain may be very little. But we can use what information has been made public, as well as the lessons learned from a decade of the social and crypto economic experiment that started with Bitcoin, to examine the introduction of Project Libra. We can assess the impact Libra may have on the use of open blockchains and the native or tokenized assets represented on them.
What We Think We Know
Libra proposes its own blockchain, with a native Libra Coin that is used for gas fees to use computational resources on the network. Gas fees are expected to be kept minimal, and their purpose is to disincentivize malicious actors from requesting unlimited network resources.
Libra uses a continuously updated Merkle tree (called a “Merkle tree accumulator”) to append transactions to the data structure. Each new version of this Merkle tree is signed by the validators, effectively confirming every transaction (in Libra’s history) with every new release of the Merkle tree. Therefore, previous versions of the data structure can be “pruned,” that is, not stored. This system is very different from the “proof-of-work” chain described by Bitcoin creator Satoshi Nakamoto in the Bitcoin white paper.
Other key points include:
Libra uses incentive and dividend tokens for validators. The proposed system includes Libra Investment Tokens, which will be distributed to founding partners and validators of the network in proportion to the amount invested. The tokens grant access to dividends, rewards and gas fees from network activity, as well as governance powers.
Libra is meant to be stable in purchasing power. Libra Coin is planned to be a stablecoin, pegged (and asset backed) by a basket of international currencies and other low-risk, low-yield instruments, such as short-term government securities. The exact specifications have not yet been determined.
Libra has planned out its on-ramping and ecosystem. Gateways for individual users to buy and sell Libra Coin will be (1) the new Calibra wallet application, both standalone and integrated with your Facebook, Instagram and WhatsApp accounts, and (2) a number ofthird-party partners that the white paper calls “resellers” (most likely digital asset exchanges and future retail vending or Libra ATMs).
Libra uses known technology for validators to reach agreement on transactions. The consensus mechanism is a derivative of the Byzantine fault tolerance (BFT) algorithm — LibraBFT. It’s designed to be secure as long as two-thirds of validator nodes are altruistic.
Libra uses an “account-based” system. This design is similar to Ethereum, in contrast to the UTXO model used by Bitcoin and Litecoin.
Libra will likely allow users to transact with some level of anonymity. Current plans are that Libra can be used pseudonymously, without a connection to a Facebook, Facebook Messenger, Instagram or WhatsApp account, and users can have more than one wallet.
Libra is planning a technology that can scale for serious throughput. The Libra Association foresees 1,000 transactions per second at launch and 10-second finality of transactions on its blockchain. Other public blockchains have struggled with scale and throughput because they can mean trade-offs in security.
Libra envisions an open-source renaissance where developers build the programmable money of our future. Libra will be open source, so any developer can build apps to work with it. A new language, called Move, will be introduced for development in the Libra ecosystem. Move promises to be intuitive and secure, ideally suited for smart contract development.
The process for becoming a validator on the network is restrictive. Initial validators will consist of “founding members” upon launch, and this will slowly expand to perhaps a thousand validators over the next five years. Thus, Libra currently is a “permissioned blockchain,” as consensus on the state of the ledger is determined by a predetermined individual, with the idea of further decentralization over time.
The governing group — the Libra Association — will be registered in Geneva, Switzerland, and will consist of the Libra founding members, the Libra Council, and social impact partners. Together, these parties will govern the technical roadmap, reserve basket, distribution of dividends and funds, and other governance matters.
Libra’s Raison D’être
Libra may offer access to a frictionless payment mechanism for many millions of the unbanked.
Libra will not offer the benefit of earning interest on Libra Coin in a Libra wallet, so individuals without bank accounts won’t get this bank-like perk from Libra either. Instead, the interest on fiat deposits and other financial instruments in the basket will pay for operating expenses, investment in the ecosystem, engineering research and grants to nonprofits. What is left will be paid in the form of dividends on the Libra Investment Tokens (held by Association members).
This is partially by necessity. If Libra paid interest on your fiat deposit, it would qualify as a regulated security in many jurisdictions around the world, burying the project in red tape at its inception. Paying dividends rather than interest is also an incentive to drive adoption for Association members.
If a billion Libra users held an average of US$10 in Libra, and the Association earned a simple 2% on those fiat deposits, the Libra Association would have an annual operating budget of $200 million. If adoption grew tenfold, which seems possible, a budget of $2 billion would likely generate some exciting returns to Association members.
But keep in mind that membership will likely grow to a hundred and perhaps even a thousand businesses and other organizations. This income model ensures more than enough resources for the Association, whose members will have some skin in the game of making Libra a success.
This incentive model is fundamentally different from Bitcoin and Ethereum, where the entire userbase in incentivized to drive adoption and on-platform innovation because they stand to benefit from it directly. This sometimes turns the cryptocurrency market into a casino, but it also creates an internet-based money Olympics (or cage fight, depending on how you look at it).
Everyone is in a race for their technology, their coin, their tribe, to become one of the ultimate winners. For all the distraction and adoption challenges this creates, it has arguably led to the incredible pace of innovation in cryptocurrencies. Limiting returns to influential companies and organizations is closer to conventional investing models.
And the benefits go beyond interest on reserves. The bigger returns for founding members differ by category. Retailers (eBay, Spotify, Uber, etc.) hope to lower their transaction costs. Facebook wants to introduce banking services to the range of digital products they offer. Venture capitalists want a piece of the new businesses created on top of Libra. And existing payment solutions (PayPal, PayU, etc.) are trying to hold on to their install base moat; by adding another payment option, they will try to prevent users from migrating off their payment platform.
There is also a defensive motivation for certain members of the Association. The cryptocurrency startup ecosystem has gradually but steadily been attracting some of the brightest entrepreneurs, engineers and developers. Most Association members are industry incumbents that stand to lose from new cryptocurrency projects gaining widespread adoption and replacing them.
If Facebook and partners are successful in getting Libra into the hands of a critical mass of consumers, then the Libra Association may quickly become a very powerful player in capital markets. Assuming a billion Libra users, with an average daily volume (in Libra) of US$100 value per user, the Libra Association will be managing a complex basket of cash and cash equivalents totaling $100 billion. In banking the unbanked, they may bank themselves.
One feature of existing public blockchain networks that support value transfer in a native token — or token built thereon, such as ERC-20 tokens — is that trustless value transfer is one-way and not reversible. Unless, of course, there is some trust between transacting parties and your counterparty agrees to return some of that overpayment you made in Bitcoin.
It is still unclear whether the Libra system will support chargebacks or other similar mechanisms between wallets. Will the Association need to develop mechanisms for acting as a central authority when users’ wallets are hacked? What role will they play in freezing funds thought to be linked to restricted activities? Who will play arbiter? What jurisdiction’s laws will apply? Only time will tell.
Find out more about Libra’s implications for the crypto industry, and what this means for your business.
“Money is like manure; it’s not worth a thing unless it’s spread around encouraging young things to grow,” wrote playwright Thornton Wilder
Andries leads the Blockchain practice and brings a passion for growth to his clients. He works with a variety of crypto and blockchain projects and exchanges, helping them navigate accounting, audit, tax and risk best practices as they grow. He also helps non-crypto industry clients transform their business through blockchain technology enablement.
Prior to joining Armanino, Andries was CEO at The Brenner Group, a boutique Silicon Valley financial services firm. Before that, he was a partner at Moore Stephens Belgium. He started his career at PricewaterhouseCoopers. He grew up in Belgium, and lived and worked in New York and Shanghai before moving to California.
Co Authors :
Jeremy is a manager in Armanino’s Blockchain practice, with more than 4 years of experience performing compliance, internal and blockchain-technical audits. He has experience leading and participating in cryptocurrency/blockchain engagements for exchanges, crypto-startups, and stablecoins. Jeremy authors Armanino’s blockchain audit memos, and he has helped develop proprietary procedures to test digital assets for reliance during an audit.
A Certified Blockchain Professional and member of the Cryptocurrency Certification Consortium, Jeremy is also a Certified Public Accountant (CPA) and Certified Management Accoutant (CMA). He holds a Bachelor of Business Administration, Accounting from California State University, Chico.