27 June 2019

Facebook released the white paper of its much awaited cryptotoken, known as Libra, last week. Libra is the offspring of a collaborative effort between Facebook and several other notable institutions across payment and technology sectors.

At this stage, Libra will be controlled by the Libra Association, which is described as “an independent, not-for-profit membership organization, headquartered in Geneva”. 

How is Libra different to existing cryptotokens? And what are the legal implications of this ambitious project? Will Libra be the One Coin to rule them all? Below we touch upon the key characteristics of Libra as a standalone cryptotoken and compare it to other similar projects to-date.

1 A New Coin on the Block-chain

Libra is going to use a bespoke open-source blockchain on which anyone can develop apps and promote new innovative solutions through the deployment of smart contracts.

However, while the blockchain itself is open source, and its code can be readily copied, consensus (i.e. validating transactions on the blockchain) rests with a select handful of entities which are entrusted with the task – at least for now. These entities comprise of founding members of Libra. By extension, the native blockchain of Libra is a permissioned network as only the founding members can validate the transactions, while parties that meet strict objective criteria can apply to become nodes on the network.

1.1 The Rules of Validation

Validators will own what are known as Libra Investment Tokens (LIT) which will be purchased in exchange for their investment in the ecosystem and will give certain voting rights both in validating transactions as well as the general direction of the project. The LIT may also grant access to dividends for the founding members where funds are available.

To validate transactions, the blockchain uses a consensus protocol. This is the code that outlines the methodology of how a transaction is committed forever on the blockchain e.g. through a voting system, random selection of a validator, or through solving mathematical problems etc. Different consensus protocols impact the speed of transactions as well as their expense.

Bitcoin, for example, uses proof of work which requires solving mathematical problems in the process of committing new blocks on the chain. Once a solution is found, a unique stamp is placed on the block that is virtually impossible to replicate without undertaking the work again, but that easily proves the block was properly validated. This method, however, is expensive in terms of energy required to solve the problems and indeed was the reason it was not considered for Libra.

The consensus protocol used by Libra, instead, is known as LibraBFT and initially appears very similar to the Ripple Consensus Algorithm. Both Libra and Ripple follow a procedure akin to voting between the validators until they agree on the correct state of the blockchain. They also both use what is known as a Byzantine Fault Tolerance protocol, which you can read more about in Section 5 of the Blockchain White Paper.

1.2 From Permissioned to Public

The Libra Association eventually intends to move its governance to the general public. This means decision making will leverage on the ownership of the actual Libra coins as opposed to the LIT.

The move will also involve a change in the consensus protocol mentioned above. They suggest a move to a Proof of Stake consensus protocol (see Section 9.2) whereby parties that wish to be part of the protocol will have to stake a certain amount of Libra coins as collateral. In doing so, one expects them to remain honest when validating transactions as wrong validation could result in the loss of their stake. This type of consensus is also going to be used on the Ethereum blockchain (the most prolific blockchain when it comes to smart contract deployment) further to system updates. However, as recognised by the Libra Association Proof of Stake creates the possibility of dependence on a few parties so Libra Association will explore more options.

In any event, before they get to this point they note that:

  1. the ecosystem needs to be sufficiently large to prevent disruption from a single bad actor
  2. they require a large number of owners of Libra that just want to use their coins for transaction purposes that wish to delegate any decision making powers to third parties, and
  3. there remain some technological and usability challenges.

2 The Coin

What is the purpose of Libra then? To act as a global currency. Libra, unlike XRP, Bitcoin, Ether, Litecoin and other notable tokens, is going to be a stablecoin. The idea is to create trust in the coin – you’re hardly going to use it as a global currency if it isn’t stable! Stablecoins tie their value to something else to reduce volatility. There are different things you could tie the coin to, and Libra is not the first cryptotoken to do this.

For example:

  • Tether - Stability through fiat reserve: backed up by a reserve of “traditional currency and cash equivalents and, from time to time, may include other assets and receivables from loans made by Tether to third parties”, or
  • Digix Gold – Stability through commodity reserve: backed up by a gram of gold per token.

 2.1 The Reserve

In order for Libra to be a stablecoin, each Libra will be backed by a reserve similar to Tether. The reserve will comprise of the funds the founding members paid for the LIT, as well as money received in exchange for the actual Libra coin from the public through partner exchanges. The funds from the reserve will then be invested in low yield liquid assets. The reserve will then be used for:

  • Moneys used to pay back for Libra exchange for fiat currency
  • Expenses of the Libra Association, and 
  • Dividends to early investors where there remain available returns.

The reserve will be decentralised both in relation to the assets held as well as their location. The former is to ensure that Libra can be readily exchanged in different fiat currencies, and the latter to ensure that there is no single point of failure. 

 2.2 The Calibra Wallet

Facebook, one of the key drivers behind Libra, has developed Calibra – a subsidiary that is also a founding member of the project. Calibra will be tasked with the deployment of Libra compatible virtual wallets for use through Messenger, Whatsapp and as a standalone application. Calibra is envisaged to enable the execution of Libra transfers, as well as certain micropayments at first stage (see Calibra FAQ).

3 Preliminary Legal Considerations

3.1 Libra – A Financial Instrument?

Firstly, the LIT appears to hold elements of a financial instrument as it carries characteristics of a security. 

For founding members, the LIT will grant them decision making powers and the right to potential dividends. However, the process to acquire the LIT requires passing several technical and business hurdles such as a market value of over $1bn, and devoted personnel and hardware to run the validation process. Therefore this is likely to be akin to an offer to qualified investors only, as opposed to the general public.

The Libra coin itself has characteristics of a payment/utility token as opposed to an investment instrument as its purpose is to facilitate transactions/transfers on the Libra financial network. That being said, the coin may be treated as a security token down the line (depending on how people use it), which could then trigger various obligations and requirements for parties that deal in it. 

3.2 All About the Data?

Targeted advertising is an entrenched practice in the 21st century, and users of Libra could inadvertently be shining more light in their spending patterns as well as their funds. This leaves open the possibility for a potential boom in price discrimination with offers ‘too good to refuse’. As such consumer protection, GDPR and the Privacy and Electronic Communications Regulations (PECR) rules will become more pertinent than ever.

Despite the fact that users will be using public keys (that will remain anonymous), for the purposes of their transaction history, there could still be concerns when it comes to their financial account data on Calibra, and Facebook's access to it (indeed, similar concerns on Facebook's ability to access data from subsidiaries have materialised in the past in the context of antitrust). To curb such data concerns, Facebook states that, “Calibra will not share account information or financial data with Facebook or any third party without customer consent”. The key to success is consumer trust – something that Facebook and the founding members will have to earn before the official launch of Libra in 2020. For now the project is heavily scrutinised by US Congress.

4 One Coin to Rule them All

Libra’s ecosystem shares characteristics with many other systems already in place - such as IBM’s World Wire, Ripple, Stellar, and the expected JPM coin.

It’s a very ambitious project that attempts to plug the hole of the unbanked, those that currently have no access to financial services which the Libra Association estimates to be 31% of the world’s population. Ripple, JPM coin and World Wire all seem to be focused on financial institutions either for remittance or payment purposes, while Libra seems to be more consumer friendly (like Stellar, but on a whole other scale).

At the same time, the Libra Association is developing its native programming language called Move in an attempt to further the ecosystem’s ability to develop smart contracts on the network and potentially undercut other existing smart contract supporting blockchains. 

As the Blockchain White Paper notes however, “[b]oth the protocol and the implementation described in this paper are currently at the prototype stage” (see Section 10). The Libra Association will provide feedback on how to deploy Libra as an “open financial structure”.

We shall see whether the cryptowar has finally come to an end, and if market consolidation can begin.

Written by: Paschalis Lois, Trainee Solicitor.

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