On June 18, 2019, Facebook released a white paper declaring that it will launch a cryptocurrency dubbed Libra in the first half of 2020. The currency is still in the testing phase.

In its Libra white paper, Facebook clearly shows that it is determined to make history. It declared its mission as “Libra’s mission is to enable a simple global currency and financial infrastructure that empowers billions of people,”[1] and expanded on this with the following statements:

We believe that many more people should have access to financial services and cheap capital.

We believe that people have an inherent right to control the fruit of their legal labor.

We believe that global, open, instant, and low-cost movement of money will create immense economic opportunity and more commerce across the world.

We believe that people will increasingly trust decentralized forms of governance.

We believe that a global currency and financial infrastructure should be designed and governed as a public good.

We believe that we all have a responsibility to help advance financial inclusion, support ethical actors, and continuously uphold the integrity of the ecosystem.[2]

Libra’s inauguration has sparked a great deal of debate. Over the past month, Libra has dominated the agenda of monetary authorities, international organizations, and financial institutions. Even the U.S. Congress has joined the fray. Despite the controversies Facebook has been involved in, most people have come to realize that digital currencies have entered our economic life after a short period of testing the waters.

Since Libra would enter almost all the economic and financial realms, I am unable to provide a comprehensive analysis of Libra in this paper. As a researcher of monetary economics, however, I am interested in the monetary aspect of Libra and would like to share my thoughts and exchange views with experts on this topic.

I. Libra’s Basic Structure

So far, 27 companies have endorsed the Libra Association founded by Facebook and joined as members. They include traditional payment behemoths such as Visa and MasterCard, technology giants such as PayPal, Uber, and eBay, and leading firms in the fields of investment, blockchain, social media, internet technology, e-commerce, ride sharing, non-profit organizations, music, and travel. The Libra Association is expected to grow to 100 members in the first half of 2020 and to relax its membership threshold in the coming five years to lure global firms into joining. Facebook’s grand ambitions cannot be underestimated.

Presumably, Libra is to be backed by a basket of fiat currencies such as the US dollar, the euro, the British pound, and the Japanese yen. The price of Libra will be pegged to the weighted average exchange rate of this basket of currencies. Though not pegged to a single fiat currency, Libra is expected to be less volatile than traditional currencies. Notably, the renminbi is absent from this basket of currencies. This arrangement highlights the prospect of Libra’s direct competition with renminbi-based monetary and financial arrangements, which warrants our attention.

Libra differs from most existing digital currencies in terms of both its issuance and its use.

The issuance of Libra currency will be occur primarily through an exchange. When users exchange, for example, US dollars into Facebook’s Libra currency, Libra’s blockchain will create an equivalent value of currency through its bookkeeping system. When a customer exchanges Libras into US dollars, the system will write off an equivalent value of Libra points. When a user transfers his/her Libras to another user or makes a payment with Libra currency in a business setting, such as paying for an Uber fare with Libra currency, the bookkeeping computers tracking both sides of transaction will input the record, then issue and receive verification and confirmation from two thirds of the nodes in the chain to complete the deal.

Libras will restore or emulate the “full-reserve banking” of the early history of Western market economies, i.e. the issuance of any non-metal currency must be 100% backed by metal reserve assets. Today, this monetary system only has some remnants in China’s Hong Kong Special Administration Region and Singapore. Libra’s return to full-reserve banking will offer many benefits: It will enable real-time cross-border payments without the hassle of conventional currencies; pegging the value of the Libra to a basket of currencies will diminish the effect of currency fluctuations in any major currency, therefore making the Libra less subject to sudden, sharp swings in value; and it will reduce the tendency of major investors to gamble on currency values, such as George Soros has famously done. The number of Libras available in the blockchain will be controlled by the value of real world currencies, such as US dollars and euros that are exchanged for Libras. Pegging the value of Libra to a basket of currencies will keep the supply of Libras in check and avoid the US dollar’s problem of excessive supply. Without a doubt, these advantages are enticing.

Since Libras would be bought with or exchanged for fiat currencies, the Libra Association plans to maintain a significant reserve pool of fiat currencies, which are expected to be held by investment-grade custodians across the world. Fiat currencies will be invested in bank deposits and short-term government bonds, similar to the way a central bank invests its assets, and the Libra Association will own the proceeds from such investments. The investment income from fiat currencies would be used to cover operational costs, keep processing fees low, and distribute dividends to the Libra Association’s early investors. Libra’s users will not be entitled to share investment income from earnings on fiat currencies. In this sense, the Libra Association would work like a company listed on a stock exchange.

Unlike Bitcoin, Libra is expected to become a medium of exchange whose price will bes stable, making it technically eligible to serve as a currency. The stability of Libra, though, will be underpinned by two sets of systems. First, the value of Libras is based on the weighted average of selected fiat currencies at certain exchange rates. In this sense, Libras will become a “super-sovereign currency” similar to the IMF’s special drawing rights (SDR). But since the price of Libra is pegged to other currencies, the Libra itself is a token rather than a currency.

Another pillar of Libra’s stability will be its assets. Specifically, the pool of reserve assets that grows with the increasing supply of Libras will be invested in the bank deposits or highly liquid treasury bonds of a few countries. The price of Libras will be anchored to the market value of this asset pool. In this sense, Libra will be very similar to a money market fund. The fact that the Libra’s value is based on both a basket of fiat currencies and its asset pool marks a return to the spirit of the Bank Charter Act 1844, the first central bank law in the world.

Under the Bank Charter Act of 1844, the Bank of England offered to hold double the amount of reserves for the banknotes it issued: First, gold reserve, i.e. the Bank of England promised to unconditionally exchange the banknotes it issued into gold at a specified price. In addition, the Bank of England issued banknotes by discounting qualified commercial papers. Namely, it followed the “real bills doctrine.”

 Libra’s value will also be backed by two sorts of assets: While the basket of fiat currencies will bear a resemblance to a gold reserve, the asset pool reserve which is to be invested in bank deposits and high-grade government bonds, falls in the same category as “real bills.” Upon its unveiling, Libra revealed great ambitions by emulating the first central bank law of human society.

The two types of assets that will back the Libra, however, are priced in utterly different ways, and will give rise to arbitrage and arouse deep-seated contradictions that undermine the value of the Libra.

Libra faces licensing, anti-money laundering, and cryptocurrency’s legitimacy questions, most of which can be resolved in the long run. For instance, Facebook’s cryptocurrency subsidiary, Calibra, has obtained licenses from U. S. federal and state governments. Like conventional financial institutions, Calibra must comply with the know your customer (KYC) process, including customer identity validation, due diligence, report suspicious trading activities to the U.S. government, and conduct screening using the sanctioned name list, among other requirements, to meet the Financial Action Task Force’s requirements and anti-money laundering  and combating financing of terrorism rules of various countries.

Many countries have recognized the legality of digital currencies. Libra’s trustworthiness will be further backed by some corporate behemoths that have become members of the Libra Association. Therefore, Libra’s success is highly likely. Despite the uncertainties, Libra represents an irreversible trend in the development of digital currencies.

II. Financial Infrastructures: Accounts and Tokens

Libra describes its vision as to “enable a simple global currency and financial infrastructure that empowers billions of people.”[3] In my view, this statement offers a key entry point for making sense of Libra and the way it works.

To put it simply, monetary and financial problems center around two factors: money and the circulation of money. Accordingly, financial infrastructure can be described simply as an institutional arrangement for organizing the issuance and circulation of money.

Blockchain technology represents an alternative to the bank account system as a financial infrastructure. Both modes serve as mediums of financial assets and their transactions. Due to their overlapping functions, they substitute and supplement each other in complex ways in various settings.

(I) Account Paradigm

A typical framework of the account paradigm is the two-level bank account system in which non-financial sectors such as individuals, firms, and government institutions open savings accounts at commercial banks, while commercial banks open deposit reserve accounts, or settlement accounts, with the country’s central bank. In the account system, the money supply is defined and recorded on the liability side of the balance sheet. At the heart of the accounting system is the central bank’s liabilities, known as “high-powered money,” which includes cash as a central bank’s liability to the public and deposit reserve funds as a central bank’s liability to commercial banks. Treasury deposits are a central bank’s liability to the government. In commercial bank accounts, deposits are the bank’s liability to individuals, firms, and the government.

Under the account paradigm, transactions can be internal adjustments between asset and liability sides of the balance sheet, or synchronous adjustments on both the asset and liability sides. For instance, when a bank issues a loan to a company, the bank incurs a loan to the firm on the asset side and a deposit from the firm on the liability side. Under the partial reserve system, this process may continue and cause loans to increase  multiple times. Accounts cannot be maintained without financial institutions such as banks. As intermediaries of trust, banks must maintain a high credit rating. Yet the credit risks of banks, including counterparty risks, always exist and challenge their status as intermediaries of trust. Credit risks are part of the endogenous problems of financial infrastructure in the two-level bank account system.

In cash transactions, both parties may conclude a deal as long as they recognize the cash as authentic without involving a third-party intermediary of trust. Token transactions are carried out in similar ways, which makes it possible for cash and tokens to substitute and supplement each other.

Under the two-level bank account paradigm, cash transfers and remittances are carried out through bank account operations. For instance, a cash transfer between different accounts of the same bank requires simultaneous adjustments to both accounts’ balances. Cross-bank transfers require adjustments to the balances of the parties’ deposit accounts at their respective banks and settlement between the two banks as well. Settlement between commercial banks also requires an adjustment to the balances of their deposit reserve accounts at the central bank. Cross-border payments involve more complex bank account operations. When it comes to cross-border payments, digital currencies offer a cost-effective alternative to bank remittances.

(II) Token Paradigm

Facebook’s Libra, in addition to settlement currencies between financial institutions, and central bank digital currencies, will be typical types of tokens used in the future.

Under the two-level bank account paradigm, the form and issuance of money are predetermined. In China, for instance, renminbi is the legal tender in the bank account system which comprises commercial banks as intermediaries and the central bank. The credibility of these intermediaries is also predetermined. Yet under the token paradigm, the form and value of the tokens will not be predetermined. Tokens will be circulated under a separate mechanism without intermediaries and without a central bank. All it will take will be the blockchain that encompasses such elements as a distributed network and a cryptographic accounts system.

While the function of the bank account system is to record customer funds, a cryptographic account system records not only customer funds but other types of information such as customer identity data. A more important distinction is that a cryptographic account system works in an entirely different way from the financial account system. A bank must know its customer (KYC) to accept and manage that customer’s accounts. The bank must also have a complete set of personnel, business models, and institutional connections, as well as vast experience, to review each customer’s request for financial services and make decisions accordingly. Such formalities, however, are done away with by token systems that operate using blockchain technology. As a technical system comprising a point-to-point network, cryptography, distributed computing, data storage, and underlying technology, blockchain features sophisticated mathematical algorithms and network-based rules. With this set of rules, a blockchain system identifies improper behaviors and rejects untrustworthy customers. The marginal cost for the operation of this algorithm-based set of rules is zero, making the system financially sustainable.

Transactions lie at the heart of economic and financial activities, and the basis of transactions is credit. Before blockchain came onto the financial horizon, most transactions had to be conducted through an intermediary, which provided the credit necessary for concluding that transactions. Without intermediaries, it would be very hard for both parties to the transaction that did not know about each other to clinch a deal. Yet the token paradigm is free from intermediaries, and credit is provided from the blockchain. Essentially, blockchain is a ‘trust machine,’ which creates an ecosystem of trust in which value transmission, product and labor transactions, and other various economic activities can take place without intermediaries. Blockchain is like a group of robots that supplant intermediaries of trust and enable transactions between strangers based on algorithms without resorting to any third party.

Both the bank account system and the cryptographic account system of a blockchain share the same goal of facilitating transactions and economic activities. In this sense, the traditional bank account system and the rising token system share the same functions.

III. Tokens, Currencies and Sovereign Currencies (Fiat Currencies)

To date, digital currencies are yet to be used as a unit of account due to volatile prices or lack of a reliable pricing benchmark. This problem is, in a large measure, addressed by Libra. Libra will maintain its price stability since it will peg its price to a basket of common fiat currencies, operate in a similar way to a money market fund and invest in a similar way to a central bank while owning a pool of assets with relatively stable value. Even with this stability mechanism, it may only serve as a token; here it is distinguished from other digital currencies merely in terms of the stability of its value. Apart from the stable value, Libra is far from being fiat money.

There are a plethora of definitions of money, but their differences are much smaller than people claim them to be.

According to Karl Marx, in Das Kapital, money is a special commodity that serves as a universal equivalent. Clearly, this definition falls within the tradition of classical economics. In Western society, money is derived from commodity circulation. The earliest currency may not have anything to do with sovereignty. In most cases, and for a rather long period in history, currencies were private and multi-centered.

For a long period of time after the classical school, money was primarily defined from a functional perspective in market economies. Frederik S. Mishkin defined money in the Economics of Money, Banking and Financial Markets, a popular textbook in China, as the “something universally accepted for the payment of goods and services and repayment of debts.”

Notably, as digital currencies emerge in our modern economic and financial life, the definition of money also changes to keep pace with the times. In more recent Modern Money Theory (MMT), money is defined as a “common and representative unit of account.[4]” This new definition warrants our attention since the physical form of money is removed for the first time, leaving behind an abstract concept of “unit of account.”

In MMT, money is always examined from the perspective of national sovereignty in close relation to the economic rights of countries or governments. It states to the effect that “modern monetary theory always follows the same logic: the government creates the currency of account, collects tax and makes payment with money as the unit of price, and receives tax funds paid in its own currency.” That is to say, the issuance of money is not only a matter of national sovereignty; it is closely related to taxation as another economic power of the state. The author went at great length to explain to the effect that,

One of the most important government powers is to collect tax and other money submitted to it, including fees and fines. Why do people accept the fiat currency of government? The reason is that fiat currency is the primary currency—and in most cases the sole currency—that the government accepts in paying for other obligations to the government. To avoid penalty on tax evasion, such as imprisonment, a taxpayer must obtain the fiat currency.

Currency issuance and taxation are two economic pillars necessary for the existence of a country. Currency issuance is necessitated and justified by the need of taxation. Fiat money, or sovereign money, is the money that citizens use to pay for their taxes and obligations and the government must accept. Put simply, currency issuance is predicated upon the exercise of a country’s sovereignty. By this standard, the Libra is far from becoming a real currency. As long as sovereign states exist in the world and earn revenues from the issuance of sovereign currencies, no other form of currency is likely to prevail and the Libra may serve as no more than a token.

IV. The Complexity of Monetary Issues

In light of modern technology development and its penetration into economic and financial realms, MMT further states that “payment for obligations is the best driver of money;” “the obligation to submit money is a necessary condition for driving money—such an obligation can be tax, fees, penalties, or church tithing tax, and even money paid to obtain water or other daily necessities.” By replacing the “need for taxation” with “payment for obligations,” this statement reveals the complexity and multi-tiered nature of money. In other words, many types of currencies exist for the purpose of fulfilling certain types of obligations. While most such mediums of exchange are not sovereign currencies or even tokens, they serve the function of currencies to some extent and within a certain scope. “Everyone can create money; the problem is to get it accepted,” said Hyman Minsky. This statement best captures the nature of money issuance.

To make sense of the reality that anyone can create money under the condition of sovereign money, we must discuss the question of self-organization and self-governance. Elinor Ostrom shared the 2009 Nobel Prize in Economic Sciences with Oliver E. Williamson, Professor Emeritus of Economics and Law, University of California, Berkeley, for her groundbreaking research on self-organization and self-governance.

In traditional economic philosophy, economic order derives from the autonomous decisions of independent entities driven by self-interest under market rules or the dominance of all social relations by a single power center. In other words, economic order derives from either the market or the government. Guided by this concept, people turned to state control when they sensed a glitch in the market mechanism. On the contrary, deregulation, even outright privatization, is seen as the answer to government failure. This either-market-or-government mindset and its associated policy options have been a recipe for countless woes in our world.

According to the theory of self-governance, most orders are neither private nor public as is traditionally claimed to be the case. In reality, many institutional arrangements are somewhere in between private and public ownership. Self-governance theory investigates how interdependent actors can organize themselves for self-governance and achieve common benefits when everyone faces the problems of free riding, evasion of responsibilities, or other opportunistic behaviors. Institutional supply, trustworthy commitments, and mutual supervision are three pillars of self-governance. Designing a set of rules for self-organizers to supervise each other at low cost is the key to self-governance.

Theories of self-organization and self-governance have been applied in addressing issues involving various sovereignties, regions, and entities. They provide a theoretical solution to the “tragedy of the commons”to problems such as terrorism, climate change, and pollution. The advent of the internet has led to the discovery that the third order in between the market and the government exists in the world of the internet: All sorts of online communities from WeChat and Taobao to games and circles of friends share the basic characteristics of self-organization. Self-governance is enabled by new technologies such as big data, blockchain, artificial intelligence, algorithms, and security technology.

In this context, private currencies have emerged as a self-governing tool for self-organizations. Some are circulated within self-organizations. Some are convertible to other private currencies. Others are even pegged to fiat currencies. Since these currencies or tokens are accepted by other people, they serve the function of currencies within a certain scope and to a certain degree. Hence, the co-existence of fiat and private currencies is likely to prevail in the future.

V. Conclusion

Under the existing international order and level of technology, Libra, as a synthesized monetary unit based on a basket of currencies, will be a super-sovereign currency like the IMF’s SDRs. While SDRs are a perfect outcome of human imagination, economies are yet to form a super-sovereign organization, which makes it hard for any super-sovereign currency based on an international organization to dominate the world. By pegging its price to a basket of existing fiat currencies, Libra will not create additional money. Since Libra’s issuance will be 100% based on a pool of fiat currency reserves, it will never generate any seigniorage. Pegging it to existing currencies will make it impossible for the Libra to set any monetary policy in a real sense. Based on these characteristics, we believe that what Libra will lead to is far more than the denationalization of money.

If Libra circulates broadly and gives rise to Libra savings and loans, will there be any money creation? The answer is also no for the simple reason that Libra-based savings and loans will not create new Libras. First, the total amount of tokens remains constant when transferred between different blockchain addresses, and Libra will not be an exception to this. Second, the only way to expand the supply of Libras is to increase fiat money reserves, which eliminates the possibility for the supply of Libras to be multiplied.

What the challenges will Libra pose to China? In my opinion, the first challenge is in the payment realm. In the foreseeable future, Libra’s use will be limited to the payment sphere. Based on a basket of international reserve currencies, Libra will boast a unique convenience for cross-border payments. This strength poses a challenge to China’s payment industry, especially when it comes to overseas payments.

At a deeper level, if China further promotes the Belt and Road Initiative and particularly the renminbi’s internationalization through the initiative, Libra will clearly become a formidable barrier.

For China, therefore, establishing its own cross-border payment system based on digital currencies offers an effective means to safeguard its financial security against financial sanctions from other countries. The emergence of blockchain-based digital tokens of relatively stable values, and central bank digital currencies may change a country’s domestic financial ecosystem and international financial architecture. Therefore, China should encourage its private firms to develop a stable digital token and single-center, multi-center, and center-less distributed financial systems to promote its right of use in global financial transactions.

If we are ready to embrace the challenges inherent in the forthcoming Libra for cooperative competition, the issue of internet censorship policy also must be reviewed since Libra is based on social networks such as Facebook, Google, and Twitter. Allowing Libra to enter into China naturally brings forth the question of whether Facebook, Google, and Twitter should continue to be blocked. This question, however, is a matter of our national security strategy.