Facebook unveils its own cryptocurrency: Here’s how it will work

Dishing out an ironical blow to the founders of blockchain, one of the world’s largest tech corporations, Facebook, unveiled Libra Coin or simply Libra, a new digital currency that is set to launch in 2020.

The big tech giant and its big tech partners think Libra could disrupt global financial and payment systems, but their co-option of blockchain technology—which was invented to disrupt Big Tech and not the other way round—has shaken crypto-purists.

According to CNN, an independent organisation composed of representatives of partner companies and nonprofits—not Facebook alone—will govern the currency.

Also read: Is Facebook becoming too big? Co-founder Chris Hughes thinks so

But first, is Libra really cryptocurrency?

Libra, despite being powered by blockchain, is quite dissimilar to Bitcoin, which is the oldest and most popular cryptocurrency out there.

According to a new white paper, Libra will start off more like a stable coin, in that it will not be a purely digital asset with fluctuating value and has instead been designed to maintain a stable value. According to The Next Web‘s David Canellis, there will be some fluctuation, but Libra will be relatively stable.

It will not be pegged to a single currency but will be “fully backed” by a collection of low-volatility assets, bank deposits, and treasuries from high-quality central banks.

Operating the Libra blockchain will be 28 firms including Uber, Lyft, Mastercard, Visa, PayPal, Vodafone, Spotify, and eBay, according to the paper describing the project.

Together with other geographically distributed and diverse businesses, nonprofit and multilateral organizations, and academic institutions, this governing entity known as Libra Association will offer the preliminary validating nodes to Libra’s blockchain framework.

The consortium is headquartered in Geneva, Switzerland, which has a history of global neutrality and openness to blockchain technology.

Each of these “founding members” has invested around $10 million in the project and it is this digital network that will validate Libra transactions, implying Facebook’s currency runs on a “validator node” and requires permission, as opposed to Bitcoin’s permissionless or public network.

How does a permissioned system work?

Normally, anyone with an internet connection and the right kind of computer can run the Bitcoin network’s software, help validate new transactions, and mine new coins by adding new transactions to the blockchain while ensuring that the network’s data is secure from manipulation.

It is this feature that has earned Bitcoin and Ethereum the reputation for being democratic and resistant to censorship; due to their distributed power structure of public networks, it becomes very difficult and expensive to manipulate the transaction records.

Libra’s permissioned system and its small pool of corporate stakeholders completely defeat the pro-decentralisation and anti-censorship ethos cryptocurrencies were founded on.

According to the company, “Our ambition is for Libra network to become permissionless.” Then why begin as a permissioned network? The paper explains their reasons.

On the bright side

“The challenge is that as of today we do not believe that there is a proven solution that can deliver the scale, stability, and security needed to support billions of people and transactions across the globe through a permissionless network,” authors of Libra’s technical description wrote this week.

Facebook’s Libra hopes to do away with the biggest obstacles to adopting cryptocurrencies today—scalability. Although nearly 35 million people worldwide now have blockchain “wallets” to hold cryptocurrency, it is minuscule compared to the 500 billion non-cash transactions carried out by banks every day.

Public blockchains, including Bitcoin’s, process transactions too slowly to elicit mainstream demand—that is the primary reason no one has been able to convince mainstream consumers to use cryptocurrency to pay for everyday things. 

At launch, Libra will be able to process 1,000 transactions per second, much faster than Bitcoin, which can only process a handful per second (Ethereum can process 25). Facebook’s digital wallet app will plug into Whatsapp and Messenger, allowing users to send the digital currency through their message threads, the same way they send a GIF.

A threat to Bitcoin’s incentive structure

Processing Bitcoin transactions involves immense energy consumption and electronic waste generation, that leaves an adverse environmental footprint. This is owing to its “proof of work” incentivisation structure, which allows the currency to reach agreement among the blockchain network’s nodes.

Last year, the bitcoin network processed 81.4 million transactions consuming nearly 62.3 terawatt-hours.

Having no central servers, it incentivises people to pledge computer resources to help process transactions. Bitcoin “miners” set their machines to solve a computational problem to show “proof of work.” If their block is accepted on the decentralised blockchain, miners get some Bitcoins as a reward.

In five years, Libra will opt for a “proof of stake” approach to solve this problem of contributing large amounts of computer power to the network.

Will Libra beat Ethereum to “proof at stake”?

Facebook’s proof-of-stake validators will instead contribute large amounts of money, which is then locked up like stakes. Validators who misbehave could lose this money.

The onus is on Libra Association (comprising the aforementioned validators) to initiate the switch to a permissionless system in 5 years, and govern and develop the proof-of-stake system. That is a big challenge according to crypto-experts.

Having said that, it is the Ethereum community that is spearheading this proof of stake research, trying to deploy the model to its own blockchain. But the switch is proving to be difficult because Ethereum intends to remain decentralised and free of corporate hegemony.

Now it is worth recalling that Facebook’s global user base of 2.4 billion (compared to Ethereum’s 50 million unique addresses). Facebook and partners on the project, like Spotify, are also design experts, which makes it likely for Libra’s interfaces to be more user-friendly than other cryptocurrency projects have been.

Doubts in the time of data breach

Once hailed as unhackable, blockchains are now getting hacked. It is being increasingly used by militant organisations across the world to fund terror.

On top of that, Facebook’s abysmal record on data privacy generates sufficient concern about Libra’s mass acceptability—because using/holding the coin would effectively involve transactors having to hand over their financial information to Facebook and 28 private sector stakeholders. However, David Marcus, who is the director of the Libra project, has told Decrypt at the outset, that the transaction details and social data will not be ‘commingled’, signalling that the individual’s Libra wallet and social media profile will be separate. He claimed that no transaction data will be harvested by Libra Association.

Speculation is also rife that the $10 million buy-in earns all the validating firms direct access to transaction data.

That still does not answer if and how Facebook will generate its revenue from Libra. Theories include transaction fees, or if the currency catches on, it will be great for Facebook’s brand.

According to Canellis, the Libra ecosystem will effectively inherit the monetary policy of the central banks issuing the fiat currencies managed by its Reserve. There will also be no limit to how many Libra tokens can be “minted” but it will happen almost instantaneously in response to demand from authorised Libra resellers, who will purchase tokens for fiat.

“Libra says this should discourage “bank runs,” and that users should be assured their tokens will be continuously backed by an equal amount of real-world assets,” he writes, admitting “Exactly who these “authorized resellers” will be is yet to be revealed.”

But Libra hinted that it had been discussing “ongoing relationships with principal cryptocurrency trading firms and top banking institutions” to allow users to exchange local currencies for Libra tokens, and pledged to encourage listings on multiple regulated exchanges around the world— something that legislative and regulatory authorities may try to block.

Will this make crypto mainstream?

While COO Sheryl Sandberg told Bloomberg that the movement towards an inclusive cryptocurrency is on course. Marcus promised that Libra will be monitored by a regulated entity to uphold its privacy commitment. He added, “[…]it’s time for the internet to have a protocol for money, and it’s time to try something new for the 1.7 billion people who are still unbanked 30 years after the invention of the web.”

With big plans and a lot of uncertainty, Facebook has launched a test network for its new digital currency and a digital wallet known as Calibra that will manage all Libra developments and transactions for the company. It also plans to scale this up its consortium of validators from 28 to 100 by Libra’s formal launch next year.

The end goal is to encourage people to use digital currency in everyday transactions – from online shopping to carrying out global money transfers to taking out bank loans.

“We have much work to do with all of you to get the prototype we’re unveiling today to production,” Marcus tweeted. “What we are presenting is only the beginning, and there is a lot to improve.”

Prarthana Mitra is a Staff Writer at Qrius