Complex Made Simple

Do the crypto stars align for Facebook’s Libra?

Facebook's proposed cryptocurrency Libra could transform financial services but is unlikely to become a reserve currency, an S&P Global Ratings report says.

National governments may prevent it from becoming a parallel source of credit creation outside central banks' monetary policy setting One difference between Libra and other cryptocurrencies is that it will be backed by a reserve of assets intended to keep its value stable If Libra takes off, it will be subject to a substantial regulatory approval process; divergence in the regulatory stances are expected

The aims of the cryptocurrency Libra are ambitious. According to the white paper published on
June 18, 2019: "Libra's mission is to enable a simple global currency and financial infrastructure
that empowers billions of people."
If the Libra is likely to incorporate some of the characteristics of a currency – such as becoming a
means of exchange – it is unlikely to become a reserve currency, an S&P Global Ratings report indicates.

Due to
financial and macroeconomic stability concerns, national governments may
prevent it from becoming a parallel source of credit creation outside central banks' monetary
policy setting, S&P Global Ratings experts said. In that sense, Libra can be seen more like a payment system, similar to PayPal or
WeChat, but with a blockchain and a currency. If Libra takes off, it will be subject to a substantial regulatory approval process. There could be some divergence in the regulatory stance across the globe, similar to that for other
cryptocurrencies
. Although the founding members are targeting a first-half 2020 launch, this level
of scrutiny could imply either delays or limited scope in the initial roll-out, according to report. 

Interestingly, no banks
are among the original list of 28 founding members of Libra. This is either an indication
of skepticism regarding its potential success and concerns about the risks associated with it, or a
sign of the potential negative effect Libra could have on banking business and revenue, the report states.

"Libra resolves some of the main issues we've identified for cryptocurrencies as a means of exchange and store of value. However, due to financial and macroeconomic stability concerns, we believe national governments may prevent the Libra from becoming a parallel source of credit creation outside central banks' monetary policy setting," said S&P Global Ratings credit analyst Mohamed Damak. 

Traditional cryptocurrencies do not
meet the two basic requisites of a currency – an effective means of exchange and an effective
store of value. Firstly, they are still not widely accepted as payment instruments.
Secondly, the volatility in their valuation and market cap is the most meaningful evidence that
they fail the test of value storage.
One difference between the Libra and other cryptocurrencies is that it will be backed by a reserve
of assets intended to keep its value stable. This reserve will comprise
a basket of "safe assets," that is, bank deposits and short-term government securities. Libra as a
currency will thus be similar to currency boards, pegged currencies, or the IMF's special drawing
rights (SDRs), the S&P Global Ratings report states. 

Libra's founding members include large payment companies, technology firms, marketplaces, and
even some service companies. Global brands such as eBay, Uber, and Vodafone are on the list.
This could help create an ecosystem that results in wider acceptance than we have seen for other
cryptocurrencies, the report clarifies. What's more, the use of blockchain and Facebook's broad reach, with about 2.4
billion users, means the Libra will potentially benefit from a wider audience and strong
traceability. The Libra resolves certain governance issues faced by cryptocurrencies because its governance
rules and body will be predetermined, the report indicates.

Libra has the potential to disrupt a number of financial services activities. The
extent and timing of disruption will depend on its acceptance by various stakeholders, including
users and goods and services providers, but most importantly, regulators and governments. S&P Global Ratings analysts expect payment and money transfers to be affected most. They estimate that these activities
represent on average between 10 percent and 15 percent of banks' total revenue globally, but their role in
terms of customer relationships can in some cases be even more crucial

Libra could also resolve problems related to the speed and cost of executing international money
transfers, the report states. According to the World Bank, more than $600 billion is sent to various parts of the world
every year. If widely adopted by retail clients, the Libra could eventually disrupt even corporate
payments. A key to success would be the ease and security of Calibra – the Facebook-backed
digital wallet.

S&P Global Ratings analysts believe that if Libra is to take off, it will be subject to a substantial regulatory approval process.
To date, some governments have been more flexible with cryptocurrencies, while others have
banned their use. The analysts expect similar divergence in the regulatory stance on Libra across the globe.
The Bank of England, for example, has asserted that it will approach Libra "with an open mind but
not an open door." On June 23, 2019, as part of its annual economic report, the Bank for
International Settlement published "Big Tech In Finance: Opportunities And Risks," which urged
regulators to ensure a level playing field between Big Tech and banks under the "same activity,
same regulation" motto. 

"Although the founding members are targeting a first-half 2020 launch, this level of scrutiny could imply some delays or limited scope in the initial roll-out," Mohamed Damak concluded.