Question

In regards to Facebook launching a new cryptocurrency called Libra

Why do you think more than a dozen companies including Visa Inc., Mastercard Inc., PayPal Holdings Inc. and Uber Technologies Inc. have signed up to back the new cryptocurrency, and what are the benefits and downsides of pegging the cryptocurrency to a basket of government issued currencies?

Answer 1

Feature of libra - Libra is being touted as a cryptocurrency, so it’s natural to use existing cryptocurrencies like Bitcoin and Ethereum as mental models for what it could be. But it’s probably better to think instead about traditional peer-to-peer payment networks. Whether you’re talking about PayPal, Venmo, Square, WeChat, or even Western Union, all of these networks are in some way layered on top of the traditional financial system in order to ease some type of transaction (e-commerce, check-splitting, remittances). The problem is that these networks aren’t interoperable, and in many cases the fees can be quite high. Like all these other networks, Libra will be layered on top of the existing financial system, since each coin will be backed by traditional money in the bank to support a stable price. Unlike these other networks, however, there is an opportunity to create payments unification on a global scale, and at potentially a much lower cost. And in theory, anyone will one be able to build payment applications on top of Libra. Some might focus on friends splitting the cost of dinner. Others might be focused on remittance payments to developing markets. In the most extremely successful version of Libra, it’s not so much a cryptocurrency, but a global operating system for moving fiat money around.

Some companies Supporting Libra

Among the various companies signed up to invest around $10 million each in Libra are credit card giants Visa, Inc. (V) and Mastercard, Inc. (MA), digital payments company PayPal Holdings, Inc. (PYPL) and ridesharing powerhouse Uber Technologies, Inc. (UBER). The money raised by members of the consortium will help to fund the launch of the coin. According to the news, Facebook has sought to raise as much as $1 billion in support of the new cryptocurrency project

Benefits of pegging libra to a basket of governement issued currencies

Libra will be pegged to a basket of government-issued currencies in an effort to preemptively counter the extreme volatility which has plagued other digital coins.

Currency pegs provide an extremely stable basis for financial planning to the governments.

Downsides

Speculative attacks on a currency can only happen if it deviates too much from its value. Freely floating currencies do not deviate too much from their value. As soon as there is a deviation, the market mechanism sets in and correction happens instantaneously. However, on the other hand, currency pegs can allow a huge difference in the fundamental value of a currency and its market value. This is because the Central Bank tries to artificially manipulate the value.