AFIN837: CAPITAL MARKETS

Assignment

FACEBOOK’S PROPOSED LIBRA

CURRENCY

NOVEMBER 4, 2019

MEMBER NAME STUDENT ID

GIA KY NGUYEN 45572178
NGO HUNG HA 45731055
YIZHE CAO 44157533
DUC TOAN VAN 44161018

Macquarie University, Sydney, Australia

Question 1:
Libra is primarily designed with a view to overcoming the shortcomings of existing
cryptocurrencies like Bitcoin and Ethereum (Salami, 2019).
A unit of Account: To be universally classified as money, one must be divisible,
indicating that when it is divided into smaller units, each unit is perceived as equally
valuable; fungible, in the way that the unit suffers no loss of value; and verifiably
measurable (Boundless Business, 2019). When the partner firms, such as Uber or
Spotify, derive their prices and denominate their used currency as the one specified by
Libra, the unit of account function would be fulfilled as well (Seiter, Sander, & Gross,
2019). This can be intuitively explained that the Libra unit is likely to be widely accepted
as a new standard numerical unit of value measurement on the Libra platform, and as a
result, Libra users can easily access Libra to make transactions with other users. One of
the technical advantages over the physical fiat money is that the international
transactions on Libra could be quickly conducted online and the ease of converting one
currency into another makes Libra a superior tool compared to the traditional methods.
Medium of Exchange: One is deemed as money if it is widely accepted as a legal
tender in exchange for goods and services (Stiefmüller, 2019) and is able to overcome
the inefficiencies of contemporary cryptocurrency trading, such as the mismatch
between items adopted for exchange and the absence of coincidence of wants
(Boundless Business, 2019). If successfully implemented, Libra would be widely
exchangeable since it would likely be adopted as a means of payment by many
Facebook users or by its partner companies like PayPal, Visa or Mastercard (Seiter,
Sander, & Gross, 2019). The more companies offer Libra payments, the more popular
Libra will become and it is followed that other corporations will have the tendency to
incorporate Libra into their systems as well. However, things don’t seem to go as
planned when Visa has just recently decided to not join the Libra Association as they
need to further evaluate the Libra project and ensure Libra’s regulatory compliance
(Schroeder, Nair, & Paul, 2019). This could lead to more potential members withdrawing
from the Libra project and thus render Libra qualification as a medium of exchange less
likely.
Store of Value: To be classified as a store of value, one is expected to allow people to
save their own money, earn interest and redeem their savings when they wish to
(Stiefmüller, 2019). More specifically, people could use it to temporarily store personal
wealth, which will possibly be withdrawn and spent on goods and services in the future,
or in other words, it assists in transferring individual’s purchasing power (Boundless
Business, 2019). Regarding Libra, since its exchange rate would be calculated based
on the available balances of bank deposits and short-term government bonds in the
reputable currencies, it would somewhat address the issues facing other
cryptocurrencies’ exchange rates, which are mainly derived from the law of supply and
demand (Salami, 2019). Additionally, Libra is also expected to be economically stable
on a global basis or at least more stable than previously adopted cryptocurrencies.
Moreover, the problem with Bitcoins and other cryptocurrencies that they are lousy
stores of value due to their volatility could also be avoided with Libra, hence making it
more similar to money in terms of store of value.
Would there still be a need for commercial banks if Libra was widely adopted?
Regarding the price stability, it is expected that each Libra will be financed with stable
liquid reserve assets such as USD, EUR, YEN and GBP with a view to allowing Libra
Association to manage the Libra supply and demand as seen in the monetary policy,
hence stable equilibrium price within the system (Kala, 2019). As a result, Libra could
be deemed as the potential threat to central banks, since at some point where Libra is
popular enough, the need for central banks to control the fiat money supply would
disappear. The same could also happen to commercial banks, as they may lose some
existing transactional data insights, because Libra work as an independent financial
services platform like Apple’s app store which will eventually erode the demand for
services provided by commercial banks. However, the existence of commercial banks
may still be necessary since they may cooperate with Libra to provide other banking
services such as wallets and loans, which might not be available on Libra, since the
system would then become too complex to handle if all products and services
previously offered by different types of banks and non-bank financial institutions are all
incorporated into Libra. All in all, we can conclude that Libra has met nearly all the
requirements to function as money. However, it is still being rejected by many big
corporations due to their regulatory issues which will be discussed later on.
Question 2:
According to Paul (2019), Libra can be recognized as a weapon that is created by
Facebook to challenge the age-old traditional financial system.
Libra vs Existing Transfer Services
Comparing with existing transfer services provided by Western Union or banks, Libra
would achieve a remarkable progress in reducing transaction costs and time, improving
capital utilizing efficiency, as well as getting more people involved in the financial
activities. However, it would also have higher financial risks than their counterparts.
Financial risk, transaction costs and capital utilizing efficiency
Tracing to its source, Libra is a new digital cryptocurrency that is created by Facebook
based on Blockchain technology and supported by more than one hundred financial
companies with its own digital wallet (Cash 2019). It anchors five stable currency, which
are US dollar, British Pound, Euro, Japan Yen and Singapore Dollar (Ben 2019). All
reserves will be used to purchase short-term government securities or invest in bank
deposits in these five countries or regions (Ben 2019). Since short-term government
securities from these countries or regions yield low or even negative returns, bank
deposits are the ones yielding the most “acceptable” returns (Bloomberg 2019).
However, bank deposits have more risks involved since Libra would be subject to bank
runs as well. Therefore, there has to be some trade-offs: in order to generate profits,
Libra would either increase its “operating fees” or increase the risk of the Libra Coin by
mainly investing in bank deposits. Unless short-term government bond rates increase
substantially, there would hardly be any other profitable alternatives for Libra (Josef
2019). So in terms of financial risks, Libra might possess similar or even higher risk than
do Western Union or other commercial banks.
However, in terms of transaction costs and efficiency, while a typical transaction
overseas may spend several workdays because of the complicated procedures, Libra
could finalise it in a few minutes due to its technology. This is a great improvement of
capital utilizing efficiency and it could be beneficial for the development of the global
economy.
Getting more people involved into financial activities
According to the report from Facebook, there are more than 1.7 billion people who
cannot attend to many of financial activities. For Libra, however, all it takes is a
smartphone connected to the internet. Libra would make it easier for people to get
involved in financial activities, which offer them the financial opportunities to grow their
capital and transact into broader markets. By doing this, Libra can help them build up
their credit and move up the socioeconomic ladder.
Libra vs Bitcoin
More Users
Libra is mainly created by Facebook who owns 2.414 billion monthly active users on the
internet (Clement, 2019). These users are likely to become Libra users. Comparing with
Libra, a common criticism from other cryptocurrencies users, for example, Bitcoin, is
that there are just a few merchants accepting Bitcoin as a payment method. However,
merchants would be more willing to accept Libra as their payment method due to its
large number of users. Furthermore, many prominent merchants such as Farfetch and
Vodafone have joined Libra Association, which means they would also accept Libra
currency from their clients.
Free Network
A consistent network is the basic element for the widespread of Libra. Although network
seems to be granted for most people living in developed countries, there are still many
people in developing countries who do not have access to the internet, because the
network fee is expensive and unaffordable for them. The solution for this situation by
Facebook is giving them a free access to the internet when they use Facebook and
other relevant APPs. In some countries such as Myanmar and Nigeria, over 50% of
people believe that Facebook is the internet (Connelly, 2019).
Stable Price and Value
Another advantage previously referred to is stability. As mentioned, Libra’s reserve fund
is constructed by five countries’ short-term government securities, and although it will
not be dollar “denominated”, it will be dollar “dominated”, with the U.S. dollar and U.S.
regulators set to play a big role in it (Walsh, 2019). This leads to the consequence that
the price of Libra Coin is theoretically more stable compared with Bitcoin, and it
motivates people to use it for consumption rather than investment.
Question 3:
As above mentioned, the implementation of Libra would spring up many regulatory
issues for the following reasons:
The absence of consistent global regulatory frameworks and policies
First and foremost, global regulators will face an “inconsistent law application” problem
since Libra does not have a “home” operation (Cecchetti & Schoenholtz, 2019). Usually,
every financial institution has a home country so it can comply with its respective
domestic laws, but for Libra, it is a multi-jurisdictional entity whose members are
organizations from all over the world, so it’s hard to classify any single set of regulatory
frameworks for the whole Libra’s operation (Taylor, 2019). What’s more, the lack of
coherent global regulatory frameworks would also make it hard for any regulatory
bodies to continuously supervise and check whether the level of reserves held by the
Libra Association is sufficient and liquid enough to react to a crisis (Stiefmüller, 2019). In
addition, since Libra is backed by a mix of currencies, each of which are affected by
different financial policies, therefore, regulators have raised concerns over which
policies and targets should be applied to Libra (Barber, 2019). And to make matters
worse, in its White Paper and Reserve Paper, even Libra itself could not specify neither
their custodians nor the main regulatory framework that they have to comply with
(Stiefmüller, 2019).
Source of systemic risk in the financial markets
If Libra were to become a global payment system that replaces most of the payments
system that we are having now, then it’s apparent that its failure would be catastrophic
for the whole financial system (Stiefmüller, 2019). As far as I’m concerned, the Libra
issuer – The Libra Association, is operating like an open-end money market fund in
which they are using interest income on the reserve to cover the operating costs and
earn profits (Cecchetti & Schoenholtz, 2019). According to the Libra White Paper, the
reserve would consist of bank deposits or liquid government securities, and it’s quite
obvious that The Libra Association would invest most of its reserve in assets with higher
interests than the others, in this case, it would be bank deposits since the Libra
Association would likely be able to obtain high deposit rates from banks, especially
those dependent on short-term wholesale finance (Cecchetti & Schoenholtz, 2019).
However, investing most of its reserve in bank deposits also means that Libra will be
more subject to a bank run and, given its important position, it will most likely cause a
major instability to the financial market (Cecchetti & Schoenholtz, 2019). Additionally,
since it was the money market fund that was regarded by many as the catalysts to the
global crisis before, regulators certainly don’t want Libra to repeat history here.
Increased underlying risks and instability
Although the value of Libra Coin is depicted as “stable” in theory, from the consumers’
perspectives, shifting from their domestic currency to a currency whose value is pegged
to a number of other currencies in a basket does not mean “stable” at all. For instance,
similar to Libra, below shown the US dollar value of the IMF’s reserve asset, the Special
Drawing Right (SDR), which consists of US Dollar, Euro, Yen, Pound and Yuan. As we
can see, the value of SDR has not been stable throughout the years, suggesting a
similar potential result for
Libra’s side (Cecchetti &
Schoenholtz, 2019).
Additionally, shifting to Libra
also means that the
government’s seigniorage
would decrease and the
central banks would lose
control of the monetary
system and could no longer
maintain price stability (Cecchetti & Schoenholtz, 2019). This is not to mention that the
existence of Libra would create another channel for illegal activities like money
laundering, which sets back all the efforts made by regulators recently to stop them
(Stiefmüller, 2019).
All in all, due to various unanswered regulatory issues as well as substantial risk
attracted, the Libra introduction has been rejected by the majority of regulators, central
bankers, and also payment systems like Visa, in order to maintain the stability of the
financial system.
Question 4:
Suppose Calibra decides to electronically print Libras without backing them with
additional USD or other currency capital. What historical event in the history of
the USD would this be similar to?
Calibra is a digital wallet provider which could print a vast amount of digital numbered
banknotes called Libras that could be sold to everybody. People use their own currency
(real money) to buy Libras at a particular rate for each kind of money (Arthur, 2019).
Then they can exchange Libras for goods or services as well as transfer Libras to other
people. Moreover, Libras could be converted back to real money. Basically, Calibra or
Libra reserve operates like a money market fund which is a collective investment
instrument that holds deposits and liquid, short-term government debt (Stiefmüller,
2019). Therefore, reserve fund is crucial when Facebook and other corporations started
to develop their own cryptocurrency. If Calibra print Libras without any backups such as
USD or other currencies including Euro, Pound or Yen, it could potentially experience a
circumstance when everybody wants to withdraw their funds in terms of US dollars or
they can exchange their money to Libras and convert Libras to USD, leading to a
substantial increase in US dollar demands in such a short time. If Calibra does not have
USD reserves capital in advance, it will fail to satisfy those needs, which could lead to a
major collapse (Griffiths, Kotomin, & Winters, 2012).
A similar situation that can be recalled from a historic event is the financial crisis of the
USD in 2008. Particularly, on 16 th September 2008, US$62 billion reserve primary fund
faced the phenomenon called “broke the buck” which means that the funds were no
longer maintain at the threshold of the share price at $1. After witnessing the collapse of
Lehman Brothers company, many investors were afraid of the effect of Lehman
Brothers bankruptcy to the reserve primary fund and started to withdraw their money.
However, a large portion of their fund was invested in mortgage-backed securities,
which kept losing their value because of the falling of house prices. One day after the
“broke the buck” event of reserve primary fund, the US faced the historic economic
collapse. On 17th September 2008, a huge amount of US$144.5 billion was withdrawn
during a week which was 20-time higher than the amount of the previous week which
was merely US$7.1 billion. These withdrawals amounts were then invested to U.S
treasury which forced the treasury yield to drop negatively. In terms of banks, regularly,
an amount of about US$2 billion dollars was required to be withdrawn but after the
corruption of Lehman Brothers, more than US$190 billion dollars was required due to
mass redemption. Altogether, they lead to the collapse of the whole financial system
(Amadeo, 2018).
What were the repercussions of this event for the USD?
The precursor of this particular event is when these investors no longer trusted the
banks and started to withdraw in order to save their money. A significant number of
withdrawals were triggered at that time and, as a result, many banks failing to meet the
requirements had to declare bankruptcy.
Is there an incentive for Calibra to ‘print’ Libras?
Calibra is incentivized to print Libras to create a decentralized currency and establish a
balance in the money market. In addition, Calibra wants to introduce a currency that is
stable and less volatile (at least in theory). Moreover, Calibra as a Facebook subsidiary
or Libra association, aims to create a "closed-loop" system, which means that
customers could only spend Libras on things available for sale through Facebook and
its associated apps and other services such as Spotify and Uber (Coppola, 2019). Even
though Libra association claims that it is a non-profit corporation, it takes advantage of
blockchain to gain personal information and data to make profits via a huge number of
customers. Once the Libra association expands, more companies and services would
be involved in this association system, which could create a strong business ecosystem.
To sum up, Libras could possibly be a future payment method since it has a lot of
advantages over other traditional financial services as well as cryptocurrencies like
Bitcoin. However, it needs to resolve the regulatory issues in order to ensure the
regulators, the banks as well as other parties that the adoption of Libra would not result
in another historic financial crisis.
References
Amadeo, K. (2018, November 15). Reserve Primary Fund, How It Broke the
Buck Causing a Money Market Run. Retrieved from The Balance:
https://www.thebalance.com/reserve-primary-fund-3305671
Arthur, C. (2019, June 20). Alarming and unnecessary: Facebook’s new
cryptocurrency must be resisted. Retrieved from The Guardian:
https://www.theguardian.com/commentisfree/2019/jun/19/facebook-new-
cryptocurrency-currency-libra
Barber, A. (2019, June 26). Libra must overcome regulatory challenges to
become global currency. Retrieved from Pinsent Masons:
https://www.pinsentmasons.com/out-law/analysis/libra-must-overcome-
regulatory-challenges-to-become-global-currency
Boundless Business. (2019, October 19). Money as a Tool. Retrieved from
Lumenlearning:
https://courses.lumenlearning.com/boundless-business/chapter/money-as-a-tool/
Cecchetti, S., & Schoenholtz, K. (2019, August 28). Libra: A dramatic call to
regulatory action. Retrieved from VOX: https://voxeu.org/article/libra-dramatic-
call-regulatory-action
Clement, J. (2019, August 9). Number of Facebook users worldwide 2008-2019.
Retrieved from Statista: https://www.statista.com/statistics/264810/number-of-
monthly-active-facebook-users-worldwide/
Connelly, A. (2019, June 19). Why Facebook’s New Libra Coin is Good — and
Really Bad — for the World. Retrieved from Medium:
https://medium.com/@anneconnelly/why-facebooks-new-libra-coin-is-good-and-
really-bad-for-the-world-4446a816fa23
Coppola, F. (2019, June 30). The Real Threat From Facebook's Libra Coin.
Retrieved from Forbes:
https://www.forbes.com/sites/francescoppola/2019/06/30/the-real-threat-from-
facebooks-libra-coin/#fa723821dc58
Griffiths, M. D., Kotomin, V., & Winters, D. B. (2012). A Crisis of Confidence:
Understanding Money Markets during the Financial Crisis. Journal of applied
finance, 22(2).
Kala, H. (2019, September 19). THE LIBRA EFFECT: DISCUSSING ITS
IMPACT ON SA CENTRAL AND COMMERCIAL BANKS. Retrieved from RMB:
https://www.rmb.co.za/page/the-libra-effect-discussing-its-impact-on-sa-central-
and-commercial-banks
Salami, I. (2019, June 20). Libra: four reasons to be extremely cautious about
Facebook’s new currency. Retrieved from The Conversation:
https://theconversation.com/libra-four-reasons-to-be-extremely-cautious-about-
facebooks-new-currency-119123
Schroeder, P., Nair, S. S., & Paul, K. (2019, October 12). Facebook's Libra
currency abandoned by major financial companies. Retrieved from Reuters:
https://www.reuters.com/article/us-facebook-cryptocurrency-ebay/mastercard-
visa-others-exit-facebooks-libra-project-idUSKBN1WQ2KL
Seiter, S., Sander, P., & Gross, J. (2019, August 24). Money, Currency or Crypto
Currency: What Exactly is Libra? An Economic Classification. Retrieved from
Medium: https://medium.com/@philippsandner/money-currency-or-crypto-
currency-what-exactly-is-libra-an-economic-classification-8e0fb3074498
Stiefmüller, C. M. (2019). "Libra: Heads I win – tails. Brussels: Finance Watch.
Taylor, S. (2019, July 4). Why have regulators reacted so strongly to Libra by
Facebook? Retrieved from 11FS: https://11fs.com/blog/why-have-regulators-
reacted-so-strongly-to-libra-by-facebook
Walsh, B. (2019, September 23). Facebook’s Libra Currency Will Be Tied, in
Part, to the U.S. Dollar. Retrieved from Barron's:
https://www.barrons.com/articles/facebook-libra-currency-will-be-tied-to-the-us-
dollar-51569265722
Weekly Journal:

Date Ngo Hung Ha Duc Toan Van Yizhe Cao Gia Ky Nguyen

17/10/2019 Task Allocation

Conduct research
about Money's Research about Start researching on Research about the
functions with the question Bitcoin and traditional relationship between
regard to Libra and (regulatory banks and Western Libra and money
20/10/2019 Commercial Bank issues) Union market

Question 3 + Trying to understand

Finishing own's what is “blockchain”
23/10/2019 Question 1 finished reference and "Cryptocurrency" Financial crisis in USA

The required regulation

27/10/2019 Do the reference Reference Check for Libras

Checking
grammar errors
+ consistency of
the whole
30/10/2019 assignment

Checking
grammatical errors
and paraphrasing Edit and rewrite
31/10/2019 some parts question 4

Complete Question 2
and discuss with
Double check Discuss about teammates about the Question 4
1/11/2019 others' parts the assignments whole assignment accomplishment

3/11/2019 Finalize the assignment