Thursday, June 27, 2019 /12:30PM / By Fitch Ratings / Header Image Credit: Getty Images
Libra Blockchain, a joint effort among payments, technology and other organizations, led by Facebook, represents a step toward a potentially viable cryptocurrency, says Fitch Ratings. The digital currency is also another example of large technology companies moving into financial services. We believe Libra incorporates and improves upon elements of existing blockchain technology, while resolving certain inherent drawbacks, namely price instability and governance challenges. Libra also seems to be designed with regulatory acceptance and lawfulness in mind.
Facebook will lead the effort only through 2019 but the company's parallel development of the Calibra wallet and 2.7 billion user base could give Facebook immediate scale with the Libra cryptocurrency. Further, we view Facebook's technology leadership, substantial financial flexibility and strategic focus on expanding its platforms across the developing world as increasing the chances Libra gets off the ground.
A potential advantage of Libra versus other cryptocurrencies is its full backing by a reserve basket of fiat currency assets managed in a reserve fund implemented like a currency board. The size of the reserve fund will be a function of transactional demands, not an arbitrary supply limit or other algorithm as in other cryptocurrency implementations. These measures could preserve price stability, avoiding the speculative nature of existing cryptocurrencies and improving its utility as a medium of exchange and store of value, which is the key to long-term viability.
From a technical perspective, Libra combines a purpose-built programming language called "Move" to standardize contracts and improve security, along with a Byzantine fault tolerance (BFT) approach to consensus over a proof of work approach used by other blockchains, which is likely to improve performance and energy consumption materially. These characteristics, along with the choice to begin as a permissioned system as opposed to a permission-less one with the goal of becoming permission-less over time, could make it more likely Libra Blockchain becomes successful.
We believe Libra's conceptualization is fundamentally aligned with achieving high standards for prudent regulation and consumer protection. However, systemic risk could arise so regulation will be an important mitigating factor.
Initial governance by the founders, which includes Facebook and major payments companies, such as Mastercard, Visa, PayPal (BBB+/Stable) and Stripe, and eventual expansion of membership to organizations meeting certain criteria should align financial resources, increase stability and reduce incentives to circumvent laws and regulation.
Such governance should help build trust with consumers but regulatory acceptance is ultimately necessary for Libra to become viable. Comments last week by the Governor of the Bank of England suggest Libra would face tough regulatory scrutiny but would be considered with an open mind given the cryptocurrency's potential to improve financial inclusion and lower costs of domestic and cross border payments. The Libra Association estimates 1.7 billion adults, 1.0 billion of which have a mobile phone and 500 million internet access, are underserved by banks. The association believes this unbanked population can be served by its cryptocurrency enabling near costless transactions and remittances of amounts less than $1 and even approaching just a few cents.
While certain design elements of Libra signal the potential to make it a scalable cryptocurrency, competition may challenge efforts. The apps Signal, Kakao and Line are reportedly pursuing similar digital currencies and Telegram apparently has plans to launch blockchain platform Telegram Open Network. It is possible other technology companies such as Alphabet, Apple and Microsoft (AA+/Stable) could look to develop or support competing efforts. Apple's plan to introduce a credit card, the Apple Card, this summer is another example of how big technology companies are moving into financial services. Asian competitors, such as Tencent (A+/Stable) with WeChat, already have financial functionality built into their apps. US FinTech leaders Visa, Mastercard, PayPal and others are already investing heavily in technological capabilities to make it easier, quicker and cheaper to send money globally.