Could Libra be the end of the petrodollar?

Let us start with, “What is the petrodollar?”; The petrodollar system is an exchange of oil for USD between countries that buy oil and those that produce it. The origin of the petrodollar can be traced back to the Bretton Woods Agreement, which replaced the gold standard with USD as the reserve currency. Under this agreement, the USD was pegged to gold, while other global currencies were pegged to USD. However, due to massive stagflation, President Nixon in 1971 declared that USD would no longer be the exchange for gold to boost economic growth for the U.S; this led to the petrodollar system, where the USA and Saudi Arabia agreed to set oil prices in USD. This meant that any country that wanted to buy oil from Saudi Arabia, would first have to buy USD. This leads the rest of the OPEC to also follow the same system. The next obvious question that anyone would ask would be, was this petrodollar good for the U.S?

The petrodollar system elevated the USD to the global reserve currency and via this, the USA enjoys a trade deficit and is also a global economic hegemony. As anyone who needs to buy oil needs to first buy USD, this makes USD the most dominant currency in the world. This gives the USA an exorbitant privilege. This essentially means that the USA can fund its current account deficit by issuing dollar-denominated assets at extremely low rates of interest. However, this could come to an end in the near future.

  • One of the reasons for this is that China and Russia have been setting up deals with Oil rich nations, without the use of the USA.
  • The USA historically has been forcing its foreign policy using the petrodollar. However, in the recent past, the USA was unable to do this. Iran, Russia, and Ukraine have signed a 5-year trade deal worth $20 billion. This will not take place in USD and includes the sale on Iran’s oil. Venezuela and Iran also signed a similar oil trade deal.

Could Libra replace the petrodollar?

Unlike most other cryptocurrencies, Libra is backed by real assets. It’s often referred to as ‘stable coin’ because it is backed by real assets and is linked to a basket of diversified global currencies and low-risk bonds. So, via Libra, you could immediately send money all over the world with negligible fees. Facebook is working on Libra along with companies such as Uber, eBay, PayPal, Visa, etc. So, the global acceptability of Libra should not be an issue. Therefore, as Libra is stable and could be accepted globally, we could price Oil in the international market in Libra instead of USD.

Author
Neil Jha
Team Leader – Fintech
(M.Sc. Finance, NMIMS – Mumbai. Batch 2018-20)

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Libra – Facebook’s cryptocurrency

Facebook has revealed plans for a new global digital currency, claiming it will enable billions of people around the world without a bank account to make money transfers. The digital currency is called Libra and will allow its billions of users to make financial transactions across the globe, in a move that could potentially shake up the world’s banking system.

Facebook revealed the details of its crypto currency, Libra which will let you buy things or send money to people with nearly zero fees. It released its white paper explaining Libra and the technicalities of its blockchain system before a public launch in the first half of 2020.

The effort announced with 27 partners right now ranging from Master Card to Uber and should launch sometime next year with 100 partners, as it hopes. It is a stable coin backed by a basket of actual currencies and marketable securities. Facebook will only get a single vote in its governance of the crypto currency along with its partners.

The currency will be run by the Libra association as Facebook is distancing itself from the direct management. Facebook’s involvement will be run via a new subsidiary called Calibra that handles its crypto dealings and protects users’ privacy by not mingling an individual’s payments with his/her facebook data. By this an individual’s real identity won’t be tied to his/her publically visible transactions. Calibra will also be launching a digital wallet for Libra, as a standalone IOS, android application and also as a functionality within whatsapp and messenger. Libra is the underlying technology but Calibra is likely how most people will interact with the currency. It will be the first crypto currency wallet that millions of people will have access as it takes advantage of facebook’s massive ecosystem with billions of potential users.

One of the biggest problems that the regulators will have to tackle is drug dealers and money launderers from getting their hands on Libra and using it to move money from the eyes of the law enforcement like with any crypto currency.

“The issue is that once you apply traditional regulation to tokens that are backed by money in the bank then those tokens start to look a lot like normal fiat money, after all most money we use today – credit card, apple pay, PayPal etc is just the digital representation of money that the banks promise to ultimately backup. This is the exact same thing except on a blockchain”- Techcrunch

Libra Whitepaper states that unlike previous blockchains which view the blockchain as a collection of transactions, the Libra blockchain is a single data structure that records the history of transactions and states over time. Facebook has created a whole language for writing commands on its protocol called MOVE (programming language), which is an open source prototype in anticipation of a global collaborative effort to advance this new ecosystem.  The facebook has done its homework to cherry pick the best bits and pieces of other crypto project to create Libra.

Like bitcoin there is no real identity on the blockchain; from the perspective of the block chain itself you don’t exist, only public private key pairs exist. Like hyperledger it’s permissioned (at least to start); initially the consensus structure of Libra will be dozens of organisation that will run nodes on the network, validating transactions. Like tezos it comes with on-chain governance; the only entities that can vote at the outset are founding members. Like ethereum, it makes currency programmable and in a number of ways the whitepaper defines interesting ways in which its users can interact with the core software and data structure. For example anyone can make a non-voting replica of the blockchain or run various read comments associated with objects such as smart contracts or a set of wallets defined on Libra. Crucially, Libra’s designers seem to agree with ethereum that running code should have a cause so as to all operations require payment of Libra as gas for it to run. Also like ethereum, it thinks proof of stake is the future but it is also not ready yet. Like binance’s coin it does a lot of burning. Like coda, users don’t need to hold on to the whole transaction history – states Coindesk.

Now needless to say, this is pulling a lot from the latest and greatest crypto ideas and collaborating it.

Facebook launched 2 crypto currencies, addition to Libra the project will also have a Libra investment token, which is how the stake holders (100 or so partners facebook hopes to have lined up on launch) will make money on this, as Libra itself is not supposed to fluctuate in value.

Unlike Libra a currency that will be broadly available to the public, the investment token is a security according to facebook that will be sold to a much more exclusive audience – the funding corporate members of the projects governing consortium known as the Libra association and accredited investors. While Libra will be backed by a basket of fiat currencies and government securities, interest earned on that collateral will go to holders of the investment token. As previously reported ahead of the official announcement, each of the 27 companies that facebook recruited to run validating nodes as founding members of the consortium, invested at least 10 million dollars for the privilege. The investment token is what they received as a financial reward, but that reward will only be meaningful if the network takes off – states Coindesk.

The assets in the reserve are low risk and low yield for early investors which will only materialise if the network is successful and the reserve grows to a substantial size, facebook said in one of the series of documents that supplement the Libra white paper.

This sound a lot like how an Initial Coin Offering – (ICO) has worked over the past of years, except without the expectation of price appreciation as the reward to early investors.

 We will have plenty of time and a lot of information to dig into in the coming months, but my bottom line and initial take is that the money we have today has not worked very well for all of us, furthering the gap between the rich and the poor. Libra (crypto currency) has the potential to bridge this gap but it has to bypass too many regulatory complications.

If facebook succeeds and receives cash for Libra, it and the other founding members of the Libra association could earn big dividends on the interest. If Libra gets hacked or proves unreliable lots of people around the world could lose their personal information and money. But it is clear that facebook has tried to reinvent money, we will have to wait and see if they can pull it off.

Author
Indrajith Aditya
Team Member – Equity Research and Valuation
(M.Sc. Finance, NMIMS – Mumbai 2018-20)


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