How a Fatal Weakness Forced Libra To Capitulate

Frances Coppola, a CoinDesk columnist, is a freelance writer and speaker on banking, finance and economics. Her book “The Case for People’s Quantitative Easing,” explains how modern money creation and quantitative easing work, and advocates “helicopter money” to help economies out of recession.

Libra was originally advertised as a revolutionary new payments system. By creating a totally new international currency, it would break down national payment barriers and enable the world’s unbanked to participate in the cashless economy, both locally and internationally. But the second edition of its white paper, released in April 2020, falls far short of this ambition. Instead of bypassing national currencies, it now embraces them. And the international currency, while not absent, has been downgraded to simply a basket of national currencies. Libra seems to have lost its soul. 

Libra’s capitulation to government reminds me of the Biblical story of the Tower of Babel. A bunch of upstart humans challenged God (aka government) by building something that would, by reaching to heaven, threaten his authority. God had a look at what they were building and decided he didn’t like it. But he didn’t close down the Tower. He made it impossible for the humans to finish building it. Instead of a single language, the humans suddenly found themselves speaking multiple languages. Unable to understand each other anymore, they scattered across the world. 

Currency is similar to language. It enables humans to understand each other sufficiently to trade. Through trade, humans build social architectures. When there is a single currency that spans the globe, money flows freely across borders and national boundaries are weakened. The U.S. dollar currently acts as a single global currency. By doing so, it reinforces the global dominance of the United States. Libra’s proposal for a single global currency which was not the dollar or the euro but, crucially, was backed by them, could have left Western governments dancing to the tune of the Libra Association and its Reserve. It had to be stopped. 

And stopped it has been. Indeed, it was always inevitable that it would be. Libra’s apparent power, underwritten by Facebook, concealed a fatal weakness. Unlike Bitcoin, which from the start aimed to create an alternative financial system independent of government, Libra’s architecture wholly depends on the existing fiat currency system – and on the whims of the governments that control it. Governments can’t shut down Bitcoin, or force it to change. But they could shut down Libra. 

So Libra can only succeed if it becomes a quasi-government project. As the second whitepaper puts it, it is “a complement to, not a replacement for, domestic currencies.” And to achieve this, it must comply with government demands. To this end, the white paper makes four major changes.  

If you really want to challenge government authority, you don’t tie yourself into the existing system

Firstly, instead of a single global currency, there will be individual currency stablecoins. Each stablecoin will be 100% backed by reserves in its own currency. Minor currencies that aren’t represented in the reserve will have no stablecoins. 

The international LBR coin will still be issued, but it will effectively become an index consisting of “some of” the national currencies in the reserve, with fixed weights reflecting the proportion of the reserves denominated in each currency. This seems to be stealing a march on the IMF’s SDR, which has made little progress towards becoming an international settlement currency. 

The white paper cheerfully says that LBR “can be used as an efficient cross-border settlement coin as well as a neutral, low-volatility option for people and businesses in countries that do not have a single-currency stablecoin on the network yet.” Of course, the U.S. dollar is already a neutral, low-volatility option for people and businesses in countries that don’t have widely traded currencies. But it lacks an efficient cross-border settlement system.  

The white paper says that if a country’s central bank issues its own digital currency (CBDC), it could be integrated into the Libra network. When this happens, the central bank for that currency will become the issuer of Libra’s stablecoin in that currency.Secondly, Libra will fully comply with KYC/AML and other laws and regulatory controls for individual currency stablecoins and, by extension, LBR itself. The second white paper says that people subject to sanctions, or living in jurisdictions subject to sanctions, won’t be able to use Libra:

Others, especially those who don’t have access to banks, will have restricted access to Libra, such as strict transaction and balance limits. Libra is clearly struggling to maintain its commitment to financial inclusion.

Thirdly, Libra has given up any idea of full decentralization, apparently because it might be possible for subversives to take over the system and remove the KYC/AML restrictions: 

Governments and their agents can’t bear to give up control. The price of getting a payments license from FINMA is abandoning any intention of becoming permissionless. The white paper claims permissionless aspects, like giving  members the ability to compete for the right to run nodes and validate transactions. But this isn’t remotely similar to a permissionless network, such as Bitcoin. Association membership is decided by the Association. Who controls the Association?

The final change prevents movements in the Libra Reserve from destabilizing fiat currencies. To be sure, since Libra’s entire architecture depends on the current system of fiat currencies remaining stable, it was surprising that the original white paper didn’t consider the effect of movements in the Libra Reserve on financial markets and governments. Or perhaps, the original writers just assumed that central banks would quietly backstop the Libra Reserve. Now, the backstop is explicit. 

The Tower of Babel project is over. Libra will comply with everything that governments demand, and in return, it will be absorbed into the existing international financial system. 

The lesson from Libra’s capitulation is that if you really want to challenge government authority, you don’t tie yourself into the existing system. You set up an alternative to it, and you defend it to the hilt.