You can trust us to run a digital currency – we're Facebook: Exec begs Europe not to ban Libra

Re: 1:1 inequivalence

The 1:1 backing means that each Libra token is underpinned by a basket of currencies in fixed proportions held in reserve by the association, each stored in an appropriately denominated custody account. For example, the basket underpinning one Libra might be $0.90 and £0.10. The intrinsic value of the currency comes from a promise to redeem tokens on request for the current value of the basket. The use of custody accounts means this should (in theory) work even if the association goes bust.

This means that from the point of view of any particular currency, the value of Libra (as seen from the perspective of a given currency) will vary over time. If the dollar is at par with the pound (to keep the maths simple) and with the above basket, it would cost £1 or $1 to buy a Libra token - *excluding trading costs*. If the pound subsequently drops to $0.80, then the value of Libra in pounds rises to 0.90/0.80+0.10=£1.225, but in dollars drops to $0.90 + 0.10*0.80 = $0.98.

It’s basically an ETF with improved visibility of tokens in issue. The real world collateral management and auditing still relies on trusted third parties and has to be very robust.

Whether this makes sense for unsophisticated retail customers, let alone the unbanked, is a whole other question. It replaces very liquid markets for fiat money - whose intrinsic value is underpinned by government guarantees that it can be used to extinguish tax liabilities - with a token underpinned by a reserve held by a private organisation is a whole other question. It also exposes holders to currency fluctuations, which is probably highly undesirable.

Regarding maintaining 1:1 backing, this is solvable. When the bulk resellers buy x tokens, the association will purchase currencies in the correct quantities - e.g. with the above basket purchased using USD, and dollar at par with the pound, they’ll buy £0.10*x in USD on the FX market. They might have to pay say $0.1002*x to do this, depending on transaction costs, the (moving) exchange rate, market depth and bid-offer spread. They charge the reseller ($0.9+$0.1002)*x, put $0.90*x into a dollar reserve account, put £0.10*x into a GBP reserve account, and mint x tokens. Everything balances.

The reseller takes on trading costs and an unhedgable market risk during the issuance (or burn) transaction, acting as a market maker. They continue to be exposed to market risk for as long as they hold the tokens, and may choose to hedge this risk or not. When buying and selling on exchanges, they will buy and sell to consumers (or other intermediaries) with a wider spread to compensate for all these costs.

There is a problem if you have a basket of three currencies and can only get one of the necessary FX trades done. In practice that’s vanishingly unlikely give the depth of liquidity in the Common FX currency pairs.

What is interesting is that their white paper mentions rebalancing the basket, e.g. changing the ratio of currencies, but not how it will work. It’s valuable in some circumstances but hard. Firstly because when the association does it, they will incur large trading costs to buy and sell currencies to bring the collateral into balance, and this will break the 1:1 collateralisation without an external capital injection.

Re: not with zuck's head stamped on it.

But what if we use Zuck's actual head as the stamp...? You know, between each coin and 250 ton hydraulic press.

Re: Banks don't typically issue their own currencies

There speaks someone who's never tried to spend a Scottish fiver

Strictly speaking they are not legal tender, even in Scotland.. The only reason that the Scottish banks are allowed to issue the notes in the first place is that they are required to back the currency as a form of promissary note rather legal tender (and the banks are required to have a sufficient amount of GPB in the form of banknotes or gold to cover said promises)

Some places in England will accept them - especially in the English side of border area. Most of the nothern motorway service stations will also accept them. Outside of that most shops won't accept them but you can (usually) exchange them in a local bank (if you can find one).

Re: Poor comment

Nick Kew,

You don't understand fractional reserve banking at all.

FRB is about cash. A bank must hold a certain reserve of cash-y money (and electronic) so that it can settle all calls on cash for a certain period. This stops them running out of cash and having panics and so a bank run. This is because your theoretical notional bank has lots of loans (its assets) which it can't call in immediately and lots of saving accounts (its liabilities) where the customers can all theoretically demand their money back all at once.

Because that's what banking is. Liquidity Transformation. Taking short-term deposits and turning them into long-term loans - which allows for long term investment in the economy.

When it all goes titsup then you require a Central Bank to be able to loan them unlimited cash at punitive interest rates - as happened in 2008, all of which loans were paid back by 2010 at a nice profit to the government.

That covers cash. Liquidity. A problem for banks that perform liquidity transformation. Hence the requirement for Central Banks to save the day by loaning emergency liquidity.

But banks also have to be solvent (if they're not they don't get loans from central banks they get taken over). To be solvent means their assets must at least equal their liabilities. And again, they lend at risk and long term - so their assets may fall in value. While their liabilities don't change.

Thus banks must hold reserves of assets. This isn't cash required to remain liquid - these are the assets owned by the bank itself (it's shareholders). And they're designed to cover the losses if say the housing market crashes, and all those mortgages get paid back at 80% of book value. The last Bank of England stress test I saw talked about the big banks holding something around 13-14% of their total balance sheet in their own assets (the minimum requirement was around 11%) - which theoretically allowed them to weather a 2 year recession with a 20% drop in house prices and inflation of -1% (i.e. deflation) and still have sufficient assets to meet their minimum liquidity requirements. Which Basel III sets at around 7% (from memory too lazy to check).

Re: Poor comment

"Full-reserve banking simply means the bank has to be able to cover all immediate liabilities at any one time; the making of illiquid loans simply requires the acquisition of illiquid deposits(which already exist in the form of CDs). The price of borrowing would go up, but the cost of failure wouldn't be as widespread as FRB tends to make it."

I know this is very late but I was strolling through and I thought I might sas well point out another major flaw in full-reserve banking.

If you require a complete match-up between liquidity, then all consumer savings accounts would have to pay negative interest or have lock-in.