Will Libra Usher in an Era of Digital Currencies?

Facebook's plans for a digital currency called Libra have aroused considerable attention. In June, Facebook and 27 partner companies officially announced their plan to launch Libra in the first half of 2020. They said the digital currency - to be managed by a nonprofit institution - would have numerous advantages such as low price volatility and lower transaction costs. Meanwhile, an already established player in digital finance, Bitcoin, has seen its price soar this year as the cryptocurrency market heats up. Does this herald a new era of digital currencies and what effect will Libra have on financial markets?

Zhong Wei

Wang Yongli

Peng Wensheng

At a roundtable discussion organized by China Forex, Chinese economists Wang Yongli, former vice president of Bank of China and chief economist of the Neptunus Group, and Peng Wensheng, vice president of China Everbright Research Institute and global chief economist of Everbright Securities,

shared their opinions on the prospects for Libra and other cryptocurrenices. The conversation, which follows in edited form, was moderated by Zhong Wei, deputy editor at China Forex.

01

Zhong Wei:First, I'd like to welcome our two guests. Since the launch of Bitcoin and Ethercoin, there has been considerable interest in digital currencies. The enthusiasm has extended from cryptocurrency mining to blockchain technology development and cryptocurrency speculation. Many of the terms and definitions in this sector - such as digital currencies, digital assets, and virtual currencies -are similar but not necessarily identical. Could you help us in clarifying some of the terminology?

Wang Yongli:Bitcoin and other web-based cryptocurrencies, without being pegged to any legally protected social wealth, cannot retain stable values. Whether they are called “coins” or “currencies,” they cannot become a real currency. At best they can be treated as “virtual assets” with highly volatile prices.

The value of a currency is determined by its overall concept and functions. It is essential for a currency to maintain stability. This can be achieved only by making the total amount of the currency in a country (or region) correspond to the total amount of the social wealth that can be protected by law within this territory. In this way, a physical currency is turned into pure credit money. The credit refers to neither the credit of the issuer (such as a central bank) nor that of a government (because it is not guaranteed by tax). Instead, the credit of the currency is supported by the wealth of society as a whole and closely connected with a nation's sovereignty and laws. Credit money is also called sovereign money or legal tender.

Now that it is clear what credit money is and where it originates, it can be figured out what a currency is. That is the clue to the question whether Bitcoin or Libra is in fact a currency.

Peng Wensheng:Currency is defined by the Financial Crimes Enforcement Network (FinCEN), a bureau of the US Department of the Treasury, as a jurisdiction's coin and paper money that is designated as legal tender for that jurisdiction and is customarily used and accepted as a medium of exchange in the jurisdiction. On the other hand, a virtual currency is a medium of exchange that operates like a currency in some environments but does not have all the attributes of a real currency. Nevertheless, there is not a clear distinction among virtual currencies, electronic currencies and digital currencies as far as everyday use is concerned. Some Chinese documents even equate virtual currencies with game tokens such as Tencent QQ coins. In a narrower sense, a virtual currency ranges from centralized and decentralized virtual currencies to electronic currencies (e-currencies). The Committee on Payments and Market Infrastructures of the Bank for International Settlements (BIS) defines the latter as the value stored electronically in a chip or a hard disk. The unit of account for e-currencies is the same as that of central bank or commercial bank money. It is also convertible at its face value and redeemable in cash.

Digital currencies are virtual currencies issued through technology such as the blockchain and digital encryption algorithms. They can be either decentralized or centralized.In this sense, the muchdiscussed Bitcoin and Ethercoin are digital assets rather than digital currencies. They do not have the basic functions of a currency, except for a few uses in the area of payments.

02

Zhong Wei:Bitcoin, the most influential cryptocurrency so far, was created on a blockchain foundation. Ex-Federal Reserve chair Janet Yellen has described it as a “highly speculative asset.” Warren Buffett, the third-wealthiest person in the world in 2019, likens Bitcoin to the 17th century speculative bubble known as “tulipmania” - one that ended badly. Are there any essential differences between Bitcoin and the Libra? Why has there been so much concern over Libra?

Wang Yongli:Cryptocurrencies such as Bitcoin have been subject to a huge degree of price volatility, owing to the lack of direct support from legally protected wealth. It can hardly become a real currency and differs essentially with other “stable coins” backed by reserve currencies. For example, USDT is so valued as to mirror the US dollar price, and Libra anchors its value to the price of a basket of national currencies. Nevertheless, these “stable coins” are still the token of legal tender. There is little possibility they will become universal currencies.

So why has Libra attracted so much anticipation? That is because it is linked to a basket of national currencies, instead of being a substitute for a single national currency. It appears to be a super currency with no set borders. Additionally, the world's largest social platform Facebook is taking the lead in this project. People tend to see the 2.7 billion Facebook users as potential Libra users.

Peng Wensheng: Bitcoin is generated on specific, pre-set rules, so its supply is not infinite. Since it is not endorsed or supported by any institution with its own assets, the trust in Bitcoin is mainly from the trust in contracts and algorithms. Bitcoin itself is rather a kind of digital asset than a measure of stored value. Its price is determined by supply and demand.

Libra, however, is meant to be a derivative of a basket of national currencies. Even before its introduction, it has generated a great deal of attention. In addition, Libra has the advantages of scale and better technology as Facebook is a technology giant with a large number of users.

If Libra is to become a real currency in the future, it needs to become a widely accepted form of payment. Afterwards, it must develop its stored value function. That is the key driver of acceptability. Usually something starting from scratch like Libra cannot progress fast at first, but the economies of scale from Facebook cannot be underestimated. Another crucial factor for Libra's development is the attitude of regulators towards finding a balance between innovation and regulation.

Yet there is an “impossible trinity” among decentralization, high-efficiency and security.

03

Zhong Wei:Initial coin offerings link cryptocurrencies with financial technology, such as artificial intelligence, blockchain, cloud computing and big data technology. Can technology create credibility for digital currencies? Can blockchain convince the public that cryptocurrencies are highly efficient and cost effective - and therefore trustworthy?

Wang Yongli:Since the financial sector first came into being, advanced technology has been used to improve efficiency, reduce cost and control risk. The transformation has taken currencies beyond their physical limitations as tangible assets to credit-based, digital money. Presently, cash takes a decreasingly smaller proportion of the monetary aggregate.

Yet there is an “impossible trinity” - or insurmountable contradictions - among decentralization, highefficiency and security. Bitcoin, which claims to be decentralized and borderless as a result of blockchain, is operating outside national boundaries in the real world. On the Internet, Bitcoin and other cryptocurrencies can operate only in their own communities. They are “sovereign currencies” of specific communities, within the borders of a “chain” and not beyond them.

Peng Wensheng:The financial technology which you mentioned each has its own application scenarios. Blockchain is the underlying technology behind digital currencies. Cloud computing is used for the storing and computing of massive data. Economic activities in the later stages of digital currency development, such as arbitrage and investment, need artificial intelligence and big data technology. The combination of all this technology can really promote the application of blockchain and the development of the digital economy as a whole. But initial coin offerings tend to exaggerate technological advantages and in some cases cryptocurrencies are little more than a stunt.

On the side of efficiency improvement and cost reduction, I am not that optimistic. For one thing, blockchain-based cryptocurrencies can achieve these goals to a certain extent due to their distributed networks and peer-to-peer transactions. These have definite advantages over traditional, centralized transaction systems. However, as transactions become ever more frequent, there is an increasing amount of data on blockchain, which becomes a super account book. That requires more network nodes, so capacity expansion is essential. In addition, longer datadownload time in any node in the blockchain will result in a slowdown of transaction efficiency.

For another thing, decentralization makes cryptocurrencies vulnerable to problems of money laundering and terrorist financing. Related regulation may result in efficiency reductions and higher costs.

04

Zhong Wei:When it comes to the relationship between digital currencies and the underground economy, the private token, with the benefits of encryption and anonymity, is often linked to crossborder illegal activities such as money laundering, drug dealing, and even terrorist activities. Do you think Libra will be used in such illegal activities? Who will be responsible for the regulation of Libra on the national and international levels?

Wang Yongli:Libra is a “stable coin” pegged to legal tender or a basket of currencies that are legal tender. Libra offers little space for speculation because the stable coin itself does not attract much speculative interest. Obviously, the possibility of its being used in illegal activities is there and strict financial regulation is a must. At least there should be limited quotas for each person for daily use and the amount of the Libra which can be exchanged with fiat currencies.

Peng Wensheng:Libra is more likely than other traditional cryptocurrencies to become a real currency owing to the large Facebook community. But in the area of cross-border payment, Libra is similar to the others. So it is inevitable that it will have some role in money laundering, terrorism financing, and other illegal activities. Regulators need to be more upfront about confronting these risks.

Also they need to cooperate internationally, as digital currencies can easily cross borders via the Internet. Because each nation has its own vision of necessary research and regulation, there is a need for greater communication and coordination among regulatory authorities. The tasks include establishing international rules governing digital currencies — such as in digital currency exchange centers and electronic wallets. Some existing laws and regulations need further elaboration and interpretation. Moreover, national tax laws need some coordination.

05

Zhong Wei:Zhou Xiaochuan, former governor of China's central bank, has pointed out that digital currencies are not a new technological extension of money, but a way to simplify payments, offering greater convenience, enhanced transaction speed, lower costs, and greater security with “privacy protections.” The electronic currency itself already has already displayed some of the traits of digital currencies. Libra, a would-be digital currency, is a private token in spite of its potential advantages. Do you foresee a real legal digital currency — such as a central bank digital currency (CBDC) — coming into being in the foreseeable future? What indeed are the differences between legal and private digital currencies?

Wang Yongli:It is early days for digital legal tender. This still requires prudence and caution. Any newly designed legal tender must be carefully compared with the existing system in terms of efficiency, costs, potential risks and so on. It cannot be launched with even a bit of uncertainty. From the current assumptions about CBDC, even only as a substitute for cash, there is no convincing conclusion as to its value relative to existing legal tender.

Peng Wensheng: It is necessary for central banks to study the issue of CBDC. We need to avoid any shocks from Libra if it becomes a real currency in the future, or further develops a role in credit creation. China's central bank has been researching the idea of a national blockchain-based cryptocurrency since 2014, as proposed by then-governor Zhou Xiaochuan. The People's Bank of China (PBOC) is now organizing market-oriented institutions to jointly research and develop a CBDC. The program has been approved by the State Council, the country's Cabinet, according to Wang Xin, director of the PBOC Research Bureau.

BIS conducted a survey in January 2019 to review the efforts already made by central banks on CBDCs, examine the motivation of these institutions and assess the likelihood of the emergence of CBDCs. Sixty-three central banks responded to the survey and some 70% of respondents are currently (or will soon be) engaged in CBDC research, a slight increase from the 65% in the 2017 survey. Payment security and convenience as well as financial stability are the most important motivating factors for central banks. As to the question of the likelihood of issuing a CBDC, over 85% of central banks see themselves as either somewhat unlikely or very unlikely to issue a CBDC in the short term (defined as in the next three years). In the medium term (up to six years), over 60% of the banks see the issuance of a CBDC as somewhat unlikely or very unlikely. It can be seen that central banks are proceeding cautiously due to the potential impact of a CBDC on the financial system. However, these banks may accelerate the pace of their efforts as a result of increased competition or if some private token threatens to carve out a role as legal tender.

Most central banks have begun researching CBDCs, but they generally remain cautious and believe we still have a long way to go.

Zhong Wei:Thank you both for your explanation and analysis. In our discussion we have examined some definitions of digital currencies. We have compared Libra with existing cryptocurrencies as to their respective traits, future prospects and possible use in illegal activities. Bitcoin and other cryptocurrencies, with their widely fluctuating prices, are not likely to become a real currency. As to improvements in efficiency and reductions in cost, there could be some early gains but these will be of limited value until we see the currencies in more widespread use. Libra will be legal tender when it is launched and will have advantages in terms of scale and technology. But it still could be used in illegal activities and regulators need to make preparations for future international cooperation to prevent this. Last but not least, we have looked at the prospects for a CBDC. Most central banks have begun researching the issue, but they generally remain cautious and believe we still have a long way to go.