Understanding Facebook Libra Crypto-currency.

For sometime, here at cod.e have been trying get to understand the new crypto-currency by Facebook, Libra. People all over social media, podcasts, forums have spent the last few weeks furiously debating the pros and cons of Libra, It has been called everything from a blatant attempt to control crypto-currencies by a big enterprise to a vehicle that will make crypto-currencies mainstream and drive adoption.

The Conceptualization of Libra…

In March 2018, Facebook was rocked by the Cambridge Analytica scandal. Over 50 million Facebook users got their private data compromised in one of the worst data privacy breaches in history. The data extracted has been used to build psychological profiles to influence elections around the world. Following this, CEO Mark Zuckerberg was forced to attend a Congressional hearing. Directly because of this scandal, Facebook’s shares went for a tumble. The stocks dropped by a staggering 20% as the company lost $120 billion in value.

However, it was in the middle of a terrible 2018 that the first seeds of Libra were planted. In May 2018, it was revealed that Facebook is establishing a blockchain division which would run under the supervision of David Marcus, who had earlier overseen the creation of Facebook Messenger. This happened four months after CEO Mark Zuckerberg stated in his new year resolution post that he wanted Facebook to  “go deeper and study the positive and negative aspects of” cryptocurrencies.

 Then in December 2018, news came out that Facebook is building a crypto-currency which will make it easy for them to transfer money on WhatsApp. The currency is going to be focused on India since they have 400 million WhatsApp users. To make sure that the currency is not as volatile as traditional cryptos, this one will be a stablecoin.

Finally, in June 2019, Facebook formally announced Libra and released its whitepaper. The coin is set for a 2020 launch.

Libra’s mission is to enable a simple global currency and financial infrastructure that empowers billions of people.

Libra Whitepaper

Reaching Out to the Unbanked

To understand the real power of cryptocurrencies and why Facebook’s initiative could be so game-changing, let’s first understand one of the most significant issues with the world right now. As Business Insider reported back in August 2017, 2 billion people around the globe don’t have a bank account.

Here are some more stats about the unbanked population:

  • More than 20% of unbanked adults receive wages or government transfers in cash, and many people in developing countries pay bills and school fees in cash.
  • Women make up just over half (55%) of unbanked people worldwide.
  • SE Asia alone has 438 million unbanked people, which is 73% of the entire population. According to a study done by McKinsey, reaching to the unbanked population in this region could increase its economic contribution from $17 billion to $52 billion by 2030.
  • India, which is the target market for Libra right now has 190 million unbanked folks, the second largest in the world after China.

So, now that we have a brief idea of the unbanked population let’s look at how Facebook will be able to help them out.

We are well and truly living in the digital age. That’s not just a cliched statement. As the Libra whitepaper puts it,

“The advent of the internet and mobile broadband has empowered billions of people globally to have access to the world’s knowledge and information, high-fidelity communications, and a wide range of lower-cost, more convenient services. These services are now accessible using a $40 smartphone from almost anywhere in the world.”

Let’s look at some numbers to understand why this is not an exaggeration.

  • The number of mobile phone users in 2018 is 5.135 billion, up 4 percent year-on-year.
  • The number of internet users in 2018 is 4.021 billion, up 7 percent year-on-year.
  • The number of social media users in 2018 is 3.196 billion, up 13 percent year-on-year.
  • 4 billion of the world’s internet users spent a combined one billion years online in 2018.
  • Facebook alone has 2.38 billion monthly active users.
  • The largest population on Facebook is from India, with over 270 million users, followed by 210 million from the US.

This is where Facebook is planning to make its most significant impact via Libra. Unlike other crypto projects, Facebook already has a humongous user-base and doesn’t need to start from scratch. They can leverage their 2.38 billion users to adopt Libra and push it into mainstream acceptance. By comparison, “only” 2.5 million people own Bitcoin.

Coordination Game: How Facebook can use their user base to spread Libra

So, the next question to ask here is, why is it extremely likely that Facebook will be able to convince their user-base to adopt Libra. To understand that, let’s look at co-ordination game theory.

Check out this matrix:

This matrix has two active states: (A, A) and (B, B). You can choose either of these states since they are both giving you equal payback (10,10), however, imagine that currently, (A, A) is the more popular option. The main objective of our game is to convince the people from going to (B, B) from (A, A). Now it is ok if we are dealing with a small group of people. They can be easily coordinated with via phone or email. However, since Facebook has more than two billion users, it is exponentially more challenging to do so.

The goal is to make sure that a majority of the group changes their state. The coordination will fail only if a small portion of the people changes their stance.  To understand this, let’s look at something we can all relate to – language.

Language is something that continually evolves with time. However, the changes in language are considered official only if the vast majority adopt it and start using it in daily speech.

Eg. suppose the newly evolved form of English is “Meme English.”

  • Current statement: “You’re making me angry.”
  • New statement: “You are doing me an anger.”

If only you speak using this language, it will be a failure because the majority won’t understand what you are talking about and you will be shunned from conversations aka the payoff for you is very low, and you have no incentive to change.

Now let’s look at the flipside.

Our modern English has evolved from “ye olde English.” 

  • Current statement: “You are stupid.”
  • Original statement in ye olde: “Thou art a knave.”

If someone still tries to use ye olde, they will be instantly ostracized and be considered a joke. As such, they have very little incentive to stay in their original state and must move over and come to the new state.

Let’s bring back our matrix again:

  • (A, A) is the state of people not using Libra.
  • (B, B) is the state of people using Libra. 

If Facebook can convince a vast majority of their users to use Libra, they will be able to convince their friends and family to follow suit automatically and start using Libra, in other words, move from (A, A) to (B, B).

What is Facebook Libra?

According to the white paper, “Libra is a simple global currency and financial infrastructure that empowers billions of people.” Libra has five essential components/features:

  • Built on a secure, scalable, and reliable blockchain.
  • It is a stablecoin which is backed by a reserve of assets.
  • It is governed by the independent Libra Association.
  • Uses the LibraBFT consensus mechanism.
  • Smart contract coding is done through “Move” programming language.

Facebook aims to have 100 members in its Libra Association before the launch, which in on first half of 2020. Final decision-making authority lies with the association but Facebook will maintain a leadership role through 2019. However, the whitepaper states that once the network launches, all the members of the Association will have the same commitments, privileges, and financial obligations as any other Founding Member. All the peers will have equal governance power. Facebook has built a digital wallet called “Calibra” which will be used to interact with Libra. Users will be able to send Libra via their smartphones by using Calibra. To send funds to your Calibra wallet, Facebook will allow you to select from a list of partner payment providers, such as MasterCard, Visa, PayPal, and Stripe. People will also be able to turn US dollars into Libra for their Calibra digital wallet, by going to local or online currency exchanges.

The Libra Blockchain

The Libra blockchain is not really a blockchain in the traditional sense. The Facebook team decided to code their chain from scratch for it to fulfill the following requirements:

  • Must have the ability to scale to billions of accounts. This requires high transaction throughput, low latency, and an efficient, high-capacity storage system.
  • Must be highly secure, to ensure the safety of funds and financial data.
  • Should be flexible, so that it can power the Libra ecosystem’s governance as well as future innovation in financial services.

Facebook Libra: Permissioned moving on to permissionless

Blockchain can be widely categorized into the following:

  • Permissionless
  • Permissioned.

Bitcoin and Ethereum are both examples of a permissionless chain. Anybody can buy some ASICs and become a miner in either of those ecosystems. However, Ripple is a permissioned network since not just anyone can become a part of its networks. Only banks or financial institutions which have been vetted can become a part of the network.

Permissionless blockchains are highly decentralized but they are much slower since they have a huge number of nodes. Permissioned blockchains are faster but not as decentralized as their permissionless counterparts.

Libra will start as a permissioned blockchain, with the Libra Association taking care of the overall network well-being. Their goal is to become a permissionless chain eventually. However, they acknowledge that there are several hurdles which need to be overcome before they can do so. As of now, there is no proven solution which can handle “the scale, stability, and security needed to support billions of people and transactions across the globe through a permissionless network.” The Libra Association will be working closely with the Libra community to research ways to implement the transition from permissioned to permissionless. This research will begin within five years of Libra’s launch.

Is Libra’s Blockchain Technically a Blockchain?

A blockchain is a series of blocks which contains time-stamped data and each block is linked to the other cryptographically. The data inside the block is kept cryptographically secure. Miners in Bitcoin and Ethereum bunch up transaction data and put them in the blocks and adds them to the blockchain via the proof-of-work consensus mechanism.

Libra completely changes this by not having blocks as the core data structure in its architecture. Instead, their system has been described as a “decentralized, programmable database.” The transactions in Libra will form a sequence (numbered with ever-increasing integers) which will be stored in Merkle Trees.

The data structure that you see above is a Merkle tree. In the diagram shown, Hash 0-0 and Hash 0-1 are children of Hash 0, which is known as the parent. You can derive the children from the parent hash. The Top Hash is also known as the Root and you can derive the whole tree through the root.

In Libra, the root of their Merkle Tree will have an authenticator value which is similar to the block hash in a normal blockchain. The authenticator of the transaction will depend on the authenticator of the previous transaction. 

Transaction Structure and Fees

A typical Libra transaction has the following components:

  • The account address of the transaction sender.
  • The public key that corresponds to the private key used to sign the transaction. 
  • A script coded in Move to execute the transaction along with the arguments (if needed).
  • The gas price or the fees associated with the transaction.
  • The gas limit of the transaction. This is the maximum amount of gas that the transaction can consume before it halts.
  • An unsigned integer that must be equal to the sequence number from the sender’s LibraAccount.T resource. After this transaction executes, the sequence number is incremented by one. 

Libra, like Ethereum, works on a gas model. As has been explained above, every single transaction and smart contract operation costs gas. The more complicated the smart contract, the more gas it will consume. The amount of gas consumed will be converted into Libra, based on the gas price which will then have to be paid by the sender. Each smart contract has a gas limit related to it. The contract will run until all the gas associated has been consumed, after which it will halt and revert back to its previous phase.

The model has probably been made similar to Ethereum to boost adoption. Since Ethereum is the most popular smart contract in the world, the developers will be able to use Libra’s system with relative ease because of the similarity. Libra also promises “low fees.”

Stablecoin Properties

Libra is going to be a stablecoin which is backed by the Libra Reserve, which is a reserve of real assets. The assets will be “a collection of low-volatility assets, such as bank deposits and short-term government securities in currencies from stable and reputable central banks.” So, let’s understand why Facebook chose a stablecoin structure and how it works.

A sound currency should fulfill the following three roles:

  • Medium of exchange.
  • Unit of account.
  • Store of value.

While cryptos do a great job as a medium of exchange, it is as a unit of account and store of value where it falters miserably. The reason? It is just not stable enough. If you own something that is extremely volatile, will you trust it as a store of value?

Would you want to safely invest your hard-earned money in an asset which may be worth half of its present valuation in 24 hours?

In fact, let’s do some more research on this.

What are the problems that we face because of the volatility of cryptocurrencies and what are the main advantages of stablecoins?

  • While traders take advantage of this volatility to make their profits, the reality is that they could quickly lose all their money by taking their eyes off the screen. Most of these crypto-crypto exchanges don’t support fiat funds, which is why it is necessary to have a stablecoin where traders can keep their profits untouched.
  • Cryptocurrencies are not ideal for time-based contracts. If someone were to bet 1 BTC on an event occurring in a year, then they are exposing themselves to two major risks. Firstly, the event may not occur at all, and secondly, the value of BTC may drop down in that time. This volatility makes it extremely difficult to do a proper risk assessment.
  • Finally, to have widespread mainstream adoption, stablecoins maybe the best form of the currency to take up that role. This is arguably the most important reason why Facebook wanted Libra to be a stablecoin. To boost adoption and to become a “global currency,” Libra became a stablecoin.

So, where does the stability comes from? For that, we need to understand the idea of “pegs.”

Understanding Pegs

Stablecoins get their stability from pegs. According to Wikipedia:

“A fixed exchange rate, sometimes called a pegged exchange rate, is a type of exchange rate regime where a currency’s value is fixed against either the value of another single currency, to a basket of other currencies, or another measure of value, such as gold.”

 A peg is used to keep the value of a currency stable by directly fixing its value in a predetermined ratio to a different more stable or more internationally common currency (or currencies).

This method is beneficial for small economies, economies which borrow primarily in foreign currency, and in which external trade forms a large part of their GDP.

The Three Kinds of Stablecoins

There are three kinds of stablecoins:

  • Fiat Collateralized.
  • Crypto Collateralized.
  • Non-Collateralized.

#1 Fiat Collateralized

Fiat-collateralization is probably the most simplistic and straightforward execution of stablecoins. The way it works is pretty simple. A certain amount of fiat is locked up as collateral and coins are issued 1:1 against it. Instead of fiat currency, gold, silver, oil etc. can also be kept as collateral.

Tether is probably the best example of this and it also happens to be the most widely used stable coin. Libra is also a fiat collateralized stablecoin.

Unlike Tether, though, Libra’s value will fluctuate in the same manner that the U.S. dollar varies compared with the euro or yen on any given day. A system of exchanges will be established for users to convert fiat for Libra. 

#2 Crypto Collateralized

Crypto-collateralized stablecoins are actually pretty similar to fiat-collateralized coins…with one major distinction. Instead of using fiat as a peg, they use another cryptocurrency.

However, we all know that cryptocurrencies are unstable, unlike fiat currency (comparatively), so how does this system work?

The answer to that question is “over-collateralization.” So, if you want $100 worth of stablecoins then you will need to deposit $200 worth of ether. It is not a straightforward 1:1 ratio.

Dai is an example of this kind of stablecoin.

#3 Non-Collateralized

Finally, we have the non-collateralized stablecoins. These are the coins who are not backed by anything. If you think about it, a privately issued, non-collateralized, and stable currency could pose a radical challenge to the dominance of fiat currencies.

But, how does one execute this?

Back in 2014, Robert Sams came up with the concept of Seignorage Shares and it is based on a straightforward idea. Create a smart contract which would act as a central bank with only one policy, issue a currency which will always trade at $1.

So what happens if the coin is trading at $2?

Since the price is high, the smart contract will automatically create more coins to increase the supply and dilute the price. The extra profit that would be left over in the smart contract, as a result, is called seignorage.

More on Libra’s Stablecoin design

A geographically distributed network of custodians will hold the assets included in the Libra Reserve. The custodians have investment-grade credit rating and will provide both security and decentralization of the assets. The interest on the reserve assets will be used to:

  • Cover costs of the system.
  • Ensure low transaction fees.
  • Pay dividends to the investors (The Libra Association) who provided the capital to begin the jumpstart the ecosystem.

Libra users will not receive any return from the system. The rules of interest allocation will be set in advance and will be overseen by the Libra Association.

With these article, I do hope to have shed some light to you about Libre and the blockchain ecosystem (we have great interest in developing solutions based on it). We keep learning more on this new crypto-currency disrupt!

kivuti kamau

Data Modelling, Design & Development

Press ESC to close