X8CURRENCY VERSUS DIEM – AN IN-DEPTH COMPARISON

MULTI-CURRENCY STABLE COIN COMPETITOR ANALYSIS

Comparison of the characteristics between the two stable coin product models

 

This text aims to describe the characteristics of X8currency by X8 AG and the characteristics of Libra Coin by the Libra Association (renamed the Diem Association), together with similarities and differences that arise out of the concepts presented by the two projects, which are introducing these two different products. During the approximately 30 minutes read this article intends to provide to a reader a high-level insight and through this enable a better understanding of the nature of these seemingly similar solutions without diving into overly complex analytical views that a full length comparison of all of the elements of the two systems would entail.

 

PROJECT BEGINNINGS AND TIMELINES

The X8currency project performed an ICO that completed on 13th January 2018. During the ICO the project raised 3,4 million EUR equivalent in ETH and BTC cryptocurrency. The project entered into the stable coin segment after long-term research of the stabilization and value preservation mechanisms that enable AI (Artificial Intelligence) driven systems to achieve the said objectives.

The Diem Association project started in June 2019 as Libra Association and formally presented their concept of Libra Coin (later renamed to Diem), a multi-currency backed stable coin. The project associated with the Facebook company raised 280 million USD from 28 members that signed up to become members of the consortium. The project changed its name from Libra Association to Diem Association on 1st December 2020.

 

VALUE PRESERVATION BLUEPRINT

Value preservation mechanism is one of the main aspects that users want to understand better. It is also most probably the component, which will enable most objective comparisons between different projects within the same class of tokenized assets in the future. X8currency coin and Libra Coin are both presented as value preservation digital currencies.

X8currency focused on establishment of what we believe to be an optimum fiat currency reserve structure revolving around 8 fiat currencies. The reserve structure chooses the top 8 fiat currencies (USD, EUR, JPY, GBP, AUD, CAD, CHF, NZD) based on the argument that these currencies are all fully convertible and also electronically tradeable against each other for every possible combination in the basket. Each of the eight currencies offers high liquidity levels in the open market. Furthermore, the basket structure based on eight currencies with the before-mentioned characteristics enables objective and efficient risk mitigation mechanisms without relying on the human factor or arbitrary decision-making about the weights each individual currency would have as a member in the currency basket portfolio. In the X8currency system the ARM AI (technical whitepaper link) determines the weights for each currency on a continuous basis, adjusting the basket portfolio in real-time based on price fluctuations in the open currency market.

Libra Coin’s concept rests on the multi-currency backbone, which includes short-term government securities. Libra’s whitepaper mentions that these short-term government securities will amount to at least 80 percent of the portfolio, in addition to cash positions accounting for the remaining percentage. The basket portfolio underpinning the Libra Coin establishes the multi-currency structure through fixed nominal portfolio weights of assets in each separate currency denomination. This approach to the ≋LBR design is similar to what is used by the International Monetary Fund (IMF) in the Special Drawing Rights (SDR). The SDR basket also utilizes fixed weights within their multi-currency structure. According to Libra’s whitepaper, the Diem Association would welcome oversight and control over the basket composition (including currency members and their respective weights) by a group of regulators and central banks or an international organization (e.g., IMF) under the guidance of the Association’s main supervisory authority, the Swiss Financial Market Supervisory Authority (FINMA) as it is further stated in the Diem Association whitepaper.

 

FIGHTING INFLATION

The nature of the implementation of the value preservation concept differs for X8currency and Libra Coin. This section attempts to describe the two different angles used by the two mentioned projects in a way, which is close to users that are not necessarily specialists or professionals in this field.

On the one hand Libra Coin deploys the strategy of holding short-term government paper in order to mitigate inflation risks. Prices of government securities move inversely to interest rates. When interest rates move higher the mentioned securities trade at a lower price (and vice-versa).  In an environment of higher interest rates short-term government securities would trade at a discount to nominal face value. When approaching maturity, the prices of these securities gravitate toward nominal face value. This existing open market mechanism deployed within Libra Reserves aims at locking in short-term inflation expectations and is to be directly linked to how the value of Libra Reserves’ assets moves in respect to these short-term inflation expectations. Libra Coin supported by the portfolio of such bond market instruments borrows from this price discounting principle in an attempt to keep up with inflation and therefore through this mechanism aims at targeting value preservation.

On the other hand, X8currency does not include any short-term government securities. In the X8currency system the inflation risk mitigation is based on one of the fundamental functions of the foreign exchange market – price stability. Foreign exchange markets perform this function by cross-border matching of monetary net emissions on the one side with global productivity potential growth on the other. Nevertheless, since monetary supply is managed on an aggregate macro-economic level and because the products and services arise out of micro-economic entities, the balance between these two sides never remains completely steady and therefore continuously fluctuates. The differential between the prevailing aggregate money supply and productivity potential growth is seen as inflation (negative or positive). In order to solve this fluctuating mismatch, the X8currency system deploys its proprietary Automatic Reserves Management Artificial Intelligence (ARM AI) to convert the volatility around the steady price stability state into an opportunity to further the currency competition on a micro level. ARM AI does this by continuously adjusting the weights of the top 8 fiat currencies in the currency basket portfolio to aim at achieving an optimal transitory composition of the currency portfolio. Each time the temporary mismatch in the currency markets is successfully overcome with the help of ARM AI this activity benefits the broader market and beneficially affects the value preservation of the X8currency basket as well.

 

RESERVES MODEL

From the above it is generally concluded that we are observing three variants of a global multi-currency basket portfolio. The IMF sits in the middle with its model of arbitrarily chosen weights between different currencies that comprise the SDR basket. Libra Coin postulates a variant of a multi-currency basket, resembling the IMF basket from the point of view where the weights in the portfolio are arbitrarily determined, however the assets denominated in any individual currency are mostly held in short-term government securities. Both of these models (IMF’s SDR and Libra Coin’s reserve) postulate a predominately asymmetric distribution of currencies or assets denominated in individual currencies. Asset holdings in one currency (for example the USD) can consistently represent a much larger part of the portfolio than other currencies.

The reserves model of the X8currency is based on a predominately symmetric distribution of fiat currency deposits, which is micro-managed on a continuous basis with the least possible bias toward any individual currency as determined by the ARM AI. While the Libra Coin’s reserve composition changes arbitrarily depending on committee decisions, the composition of reserves backing X8currency changes depending on the prevailing micro fluctuations in individual currency competitiveness assessed by the ARM AI in real-time. In the long-term and on average the eight different currencies in the X8currency portfolio take up a similar proportion of the portfolio and affect the movements of it with similar potency.

The composition of the reserves from the perspective of the selection of currencies is another point where the two products don’t show that much similarity. X8 assembles the reserve portfolio with the mentioned top eight fiat currencies for a very specific reason and does not include any currencies that could not be promptly converted into any other currency of the basket. For this reason, currencies like Norwegian Krona (NOK), or Swedish Krona (SEK) aren’t members of the X8currency basket. They are high quality currencies by themselves, however the market offers only scarce options for fast electronic conversion into every other currency for higher amounts. The top eight fiat currencies, which are included in the X8currency design, represent the current maximum range and number of different currencies that can satisfy the mentioned criterion.

In September 2019, Facebook announced that the reserve basket would be made up of: 50% United States dollar, 18% Euro, 14% Japanese yen, 11% Pound sterling and 7% Singapore dollar. The Diem Association leaves this area somewhat open for future adjustments and is missing guidelines for it. Libra Coin reserves includes currencies like Singapore Dollar (SGD). Singapore Dollar is a type of currency, which is not included in the X8currency system due to its characteristics such as not being fully electronically convertible versus every other currency element included in the basket as explained. Therefore, Libra Coin includes portfolio elements, for which their weights cannot be adjusted in real-time and rebalanced versus all other currencies that make up the multi-currency basket portfolio. Even if convertibility is possible, it comes with increased costs (money-wise and time-wise) and entails further risks compared to the X8currency model, which does not include such portfolio elements.

 

GEO-DIVERSIFICATION OF DEPOSITS

As per the whitepaper of Libra Coin, the assets comprising the reserve will be held within a geographically distributed network of well-capitalized custodian banks in order to provide both security and decentralization of these assets. Risk mitigation practices of the structure relies on the Custodian institutions’ existing practices. The Association would further ensure that the Reserves would not be used for other purposes like lending, pledging or other activities by the custodian that are unrelated to the services provided to Libra Networks. In terms of connecting to the users in the market, Libra plans to engage with Designated Dealers to extend liquidity of the product to end users, where market making activity will be taken up by the Designated Dealers with the purpose of maintaining narrow spreads.

Similarly, the X8currency system predicts a geographically diversified allocation of reserves. However, the X8currency system connects directly to every individual financial intermediary using FIX Protocol and automatically manages the part of the overall portfolio of reserves held with the institution using ARM AI. The Mechanism for Stability of X8currency includes up to 72 such geographically diversified units under the ARM AI umbrella. The allocation of the mentioned units is broker agnostic. The system predicts a set of accounts in up to 8 different currencies held with each financial intermediary, bank or a broker, however the number can also be lower with which the geographical diversification potential increases. The X8currency system does not use this part of its reserves backbone for any product emissions nor market making through such financial intermediaries, banks or brokers nor through any Designated Dealers. The X8currency system performs the mentioned function independently through designated separate gateways to connect directly through portals or indirectly through exchanges in order to reach its end users, where the ARM AI itself determines exchange rates and market spreads offered to the audience. In this sense the custodian framework is separated from the product placement framework.

 

NETWORK ARCHITECTURE

The X8currency product uses the Ethereum blockchain network and ERC20 Smart Contracts. The System connects the functions performed on the Ethereum blockchain to the mechanisms that match the state of the reserves underpinning the X8C in the FIAT realm. This ensures that the number of units in circulation and their prevailing pricings on blockchain are synchronized in order to be kept up to date. The idea of the X8currency system is to offer to users a per-click response and an end-to-end processing of orders in a system that can be assembled in a modular fashion, enabling efficient maintenance. The system takes up each order from any user and puts it through crypto-fiat conversions plus multi-currency diversification gateways (or vice-versa). This is achieved by integrating several different types of institutions with verified existing technologies and assembled into an interconnected eco-system, which responds to the user and executes individual parts of the entry/exit process on a per-request basis. The architecture relies on the availability and response times of integrated institutional facilities for performing the conversions where the system routes executions through a decentralized pool of connections depending on the readily available liquidity and the on-line status of each connection. This approach targets optimization of latency experienced by users when trading with X8C. Finalized end-to-end transactions complete the cycle and result in global X8C orderbook updates within the timeframe of one second to several seconds. Any FIX protocol compliant traditional exchange, cryptocurrency exchange, Bank, broker or Fintech platform can be integrated as a member in the X8currency eco-system, allowing for a diversity of different possible applications.

The Libra Blockchain is designed from the ground up to holistically address some of the requirements that arise out of scalability, security and flexibility necessities. The Association decided upon designing and using a new Move programming language for this purpose. The architecture will use a Byzantine Fault Tolerant (BFT) consensus approach for facilitating an agreement among all validator nodes on the ledger of transactions. According to the association, the consensus protocols are designed to function correctly even if some validator nodes — up to one-third of the network — are compromised or fail. The mentioned consensus protocol enables high transaction throughput, low latency, and a more energy-efficient approach to consensus than “proof of work” used in some other blockchains.

Blockchains like Ethereum are also working on distancing themselves from this “proof of work” approach and are moving to “proof of stake” for similar reasons (PoS vs. PoW explanation). The Diem Association will perform due diligence on prospective validators in order to ensure the quality of the trusted computing base and will also gradually over time open the network to independent third-party developers, which will be able to develop and publish Smart Contracts in order to connect their individual solutions to Libra’s payment system. The Move language aims, among other things, at enabling developers to write code more easily and therefore fulfil the author’s intent without exposure to security risks that would otherwise arise out of unintended programming bugs. The association is aiming at providing a general purpose financial blockchain technology to support different asset classes.

 

PORTFOLIO RISKS AND RISK MITIGATION

Both approaches outlined in this text recognize the risks of loss that could threaten the stability and value preservation of the two mentioned digital currency products. On the surface it seems that the types of risks involved are very similar. However, different asset classes involved in the composition of reserves of the two products require some distinction in the analysis for the reader to consider.

Libra Coin’s reserves held in short-term government securities lead to the conclusion that the inherent value of the reserves is subject to sovereign credit rating risks. Libra Coin will not include corporate debt securities in the reserve. As per the Diem Association’s description, the eligible government securities will need to show a very low credit risk (e.g., A+ rating from S&P and A1 from Moody’s, or higher) and will have to simultaneously show high trading liquidity in secondary markets. This means that potential downgrades of sovereign credit risks can pose a certain risk to the overall reserve portfolio. The liquidity risk in the short-term government securities market is also several magnitudes higher than the liquidity risk in the foreign exchange market. This can have an influence on the maximum size potential of a product based on such securities. The capacity for entry/exit is lower for bond markets than it is for foreign exchange markets. Ultimately, the short-term government securities portfolio value can fluctuate disproportionally in a persistent long-term bear market environment for government bonds even if sovereign credit ratings remain steady. Risk mitigation against such scenarios would require a capital reserve implementation for meeting the capital adequacy rules similar to the capital adequacy requirements imposed on traditional banks. The association explains that the Reserve will be further endowed with a capital buffer in order to help consumers remain protected. At this point it is fair to say that capital adequacy requirements may change and may depend on bigger structural trends in the worldwide financial economy.

In comparison to the risks described in the previous paragraph, of the risk types affecting X8currency, most come from currency price volatility, and more specifically from foreign exchange liquidity risk. As said, the foreign exchange market sports a several times higher liquidity than the bond markets, yet this does not mean that the foreign exchange market could not suffer from events of either temporary or prolonged decreased liquidity, which would then widen the spreads in the market and consequently make transactions more expensive. An increase in the market spreads would also negatively impact the value of the multi-currency reserves backing the X8currency. Increased spreads basically mean that the costs of diversification across the portfolio of currencies move higher while simultaneously increasing the market spreads at which X8currency could be offered to end users. Widening spreads in the foreign exchange market also mean that the fight against inflation becomes more expensive and requires an increased amount of market oscillations for ARM AI to achieve the same relative value preservation effect.

On the other hand, changes in sovereign credit ratings affect X8currency reserves to a lesser degree than Libra Coin reserves. Since the X8currency reserve consists of fiat cash deposits only, what can affect the value of the reserve is a scenario of a default on sovereign debt by one of the countries issuing one of the eight currencies. During history such defaults have influenced the currency exchange rates of the defaulting country (Argentina, Italy and others) in terms of sudden and substantial devaluations that followed the defaults. Nevertheless, such default on sovereign debt would trigger a direct write off of the value in the Libra Coin reserve concept while on the other hand it would trigger only a certain level of depreciation when looking at the X8currency reserve concept.

Large currency movements can also happen during central bank interventions. These usually affect sovereign government securities to a lesser degree and are focused on currency prices. However, as long as the effect is limited to one currency only, the overall impact on the X8currency structure remains controlled because each currency represents a relatively small portion in the overall reserves. This effect is further reduced because the allocation of reserves across different currencies is highly symmetrical in the X8currency system. The worst-case scenario for a symmetrical multi-currency basket is a widespread global currency crisis, which would affect several different currencies simultaneously. As a risk mitigation mechanism acting against such a scenario the X8 project aims to include gold into the basket to act as an insurance during hypothetical worldwide currency market disruption. The gold component can also be instrumental in protecting the portfolio in case of transitions from one fiat currency regime into another. Due to the economic viability threshold and also due to the project’s legal assessment of eligible stable coin structures in Switzerland the X8 project requested FINMA for approval for operations based on eight fiat currencies without the portfolio element of gold. The project commits to include gold into the basket in the future.

 

ELIGIBILITY UNDER G7 GUIDELINES

Stable coins have basically become a new asset class. We expect this asset class to most probably undergo a long-term development trend in which many changes in the types of stable coins are to be expected over the course of the next 5-10 years. Stable coins are currently a synonym for tokenized cash (or near-cash) deposits. While some exceptions rely on various algorithmic systems to ensure stability of the price, any real and sustainable stability is only seen to be coming from assets themselves. However, given enough time this may change and stable coins may develop into hybrids that could share characteristics of cryptocurrencies and tokenized assets. From this long-term perspective substantial importance needs to be placed on compliance according to global guidelines like the ones issued by the G7 in October 2019. Both projects, which are subject of this analysis, are taking separate approaches toward these requirements.

The X8currency project is aware that meeting the requirements from all of the elements will remain a challenge for any project, however in order to open the path for stable coins in worldwide cross-border trade, G7 and similar guidelines need to be taken into account when designing current stable products and also when planning for future R&D efforts. The X8 project’s intention is to focus on developing ARM AI technology further and through it continue upgrading the modern stable coin concept, which will increasingly depend on Artificial Intelligence interfaces for facilitating the exchange of (monetary) value. The Diem Association’s main approach in this sense is the development of the Move programming language, which leaves different open possibilities for integration of broader functionalities into the payment system and can be added to the system during its development. When comparing the two, the former is more exclusively focused on financial processes and risk management, while the latter is more open and leaves greater freedoms for communities in adding different elements coming from different areas and niches. The analysis continues with examining the two products from the perspective of a few main individual points from the G7 stable coin guidelines.

 

G7 GUIDELINES AND MECHANISM FOR STABILITY

The predominant focus of the X8currency project is to deliver a unique and proprietary Mechanism for Stability. In the system of our stable coin the Mechanism for Stability is based on verified investment policy rules and portfolio risk management. Furthermore, at this point we wish to point out that not that many years ago the financial crisis of 2008 triggered a demand for frequent stress-testing within the banking industry. The push for greater resilience of the financial system included demands towards the banks for performing stress-tests in a particular way and within specific reporting standards. At the beginning the processing of this task inside different banks took months to complete, while the point of the stress-tests is to clearly lay out the risks involved in the case of recession, depression and market black swan scenarios plus what effects on the balance sheet are to be expected from them. As a fintech undertaking with origins from traditional finance and traditional portfolio management the X8 project focused on the development of technologies for stress-testing and did this already at the point in time when the initiative for such verifications first started. Although the X8 system is not meant to be a comprehensive stress-testing tool in banking and for all asset classes, we nonetheless placed significant importance on the ability to monitor and control worst-case scenario risks. Along with this we also focused on the ability to make adjustments in real-time and to report partial and also global portfolio risk profiles almost on a continuous basis to the underlying regulators. In our view being able to report Capital at Risk and Value at Risk parameters of a stable coin portfolio in real-time is a key aspect together with objective investment policy rules that make the Mechanism for Stability of our X8 stable coins. This approach also opens up different developmental paths for the X8 stable coin product going forward.

 

ANTI-MONEY LAUNDERING COMPLIANCE

AML is another area of increasing regulation within the blockchain industry. The control over money laundering, terrorist financing and other forms of illicit finance all require a ring-fenced design of the network, which protects the eligible users from outside threats. A great deal of consideration has been put into ways of maintaining integrity of the system, yet in our opinion the control mechanism, despite being highly complex, should not over-compromise on user-friendliness for those that will be using the product in a fully compliant way. The aim of the X8currency project is to impose strict controls without disincentivizing organic growth of the user base when reaching out to friends, business partners and entities that have not adopted the product yet, but remain open to using tokenized stable financial solutions in the near future.

The X8 project’s plan for this is to implement a modular 3-tier AML interface on the blockchain level, which we will be able to upgrade. First, this approach will combine the ability to onboard individual end-user entities either directly through a new KYC onboarding process or through a pre-existing universally verified blockchain identity (in the case when a user already operates with such identity in blockchain). Second, centralized financial entities or cryptocurrency exchanges will be able to onboard as institutions (B2B) by whitelisting their cold-storage addresses without the need to separately process each user address within their local KYC bubbles. Last but not least, the project has proposed to the regulator a system through which decentralized finance (De-Fi) platforms will have an option to apply for onboarding on a case-by-case basis (subject to availability of KYC/AML gateways by such decentralized systems). Modular construction of the Smart Contract design will enable adjustments in order to maintain future-proof cross-border transaction capabilities even in circumstances where regulatory requirements would change and develop separately and in different ways for various jurisdictions. The goal is to connect any two different parties anywhere in the world, allowing for different combinations of how a transaction can be executed, as long as both sides of the transaction comply with local plus global rules. Simply put, if one side of the transaction would not be eligible, then the transaction would not be finalized, while the eligible party will retain all the rights to continue operating even in the absence of knowledge about the counterparty’s eligibility status.

 

ADDITIONAL CONTROLS AND WORLDWIDE COMPATIBILITY

Along with safety and efficiency provided by ARM AI and cybersecurity borrowed from the Ethereum Network the system is further protected by a multi-signature protocol, which requires several independent keys to collectively confirm any minting of newly issued X8C units. Despite the system’s automatism the multi-signature control of this process postulates that each pending mint operation must successfully go through the scrutiny of the protocol by the appointed board of authorized persons. This board will ensure that each new stable coin issuance amount matches valid changes in new deposits that physically back the stable coin. To further protect the user base and to enforce the rules and regulations, the board of authorized persons will also be able to collectively act on externally confirmed AML breaches and respond by blacklisting any rouge wallet address plus ban bad-actor behaviour. In exceptional cases and based on official orders such blacklisted assets may also be seized and transactions also have the potential to be reversed. The project will be able to take such measures only based on confirmed judicial decisions, or in case of obviously malicious hacks. The purpose of the mentioned concept is to instil greater confidence and trust into the system for users to be able to rely on fair and just use of it, plus to discourage non-constructive users from taking advantages of crypto space or use it for scams, frauds and other activities harmful to eligible users. The X8 project is also in the process of adopting International Financial Reporting Standards (IFRS). This effort focuses on bringing the stable coin’s reporting and auditing to the level that will be globally comparable regardless of the jurisdiction where the stable coin will be used. This will be the case for private and for corporate entities respectively. We believe that globally comparable reporting standards may become an important development trend for stable coins if this asset class is to be implemented in accounting processes of different types of users worldwide.

 

MONETARY POLICY COMPATIBILITY

The area of monetary policy is perhaps a point where the two examined stable coin concepts differ from one another most distinctively. The X8currency concept has been developed specifically with monetaristic principle in mind. More accurately, the system was designed in order to offer assistance within the worldwide economy in terms of maintaining price stability, while simultaneously not interfering with internal monetary policies of the authorities as regards to money supply and policies regarding the price of money (interest rates). The system executes reallocations within the portfolio of currencies in such a way that helps filling in those temporary liquidity gaps that influence short-term fluctuations of currency prices. Even more importantly, the ARM AI system does not impose a required price for providing the mentioned service to the market and accepts what is naturally offered in return and by the market for such a service. The system does not impose any restrictions on fair competition. In other terms, the X8currency system gets rewarded by the market forces when the system successfully completes financial work that contributes to overall global stability. All risks and rewards in this concept are proportional, leading to a fair and even distribution of opportunity and benefits. While the central banks can focus on their mandates, the X8 system ensures that there would be no conflicts between their efforts and the efforts of the system. The X8 system also does not work to neutralize or eliminate inflation. There is no specific embedded inflation targeting as the system only works to remove excess inflation by using excess market volatility that drives continuous portfolio reallocations. These parameters are determined purely by the market itself. We believe that a worldwide application of the X8currency system would help the financial environment and that it would help all existing traditional roles of the financial system to continue operating as is.

 

The assessment of Libra Coin’s impact on monetary policy is more difficult. First of all, the composition of the reserves (80% government securities, 20% cash deposits) makes it difficult to conclude how this potentially growing coin would influence the balance between the state and the independent central bank authority. With an already global base of users, an influx of capital into Libra Coin could potentially open discussions about impacts on government deficit spending because cash issued and invested into Libra would already come out from primary bond issuance and could potentially pose a risk of a circular link within the larger monetary system. Money center banks would pledge bonds with their underlying central banks to get access to cash. This happens as one of the fundamental functions of the current monetary system. If then the scenario of Libra Coin reserves management is extrapolated further, the cash that already was put into the monetary system based on the bond pledges with the central bank, then (this same cash) moves again into bonds in the secondary market (or even primary market), this scenario could represent a new unknown risk to the broader global financial system.  The Diem Association does not explain the mechanisms behind the concept hence it remains unclear what kind of impact such a circular loop would have if analysed from a perspective of larger scales. A possibility exists that it may impact the dynamics of the interest rate market’s pricing mechanism in some way and as a result of such potential impact it could also influence the behaviour of participants in this market.

 

INDIVIDUAL CURRENCY BACKED STABLE COINS

In addition to the multi-currency backed stable coin the X8 project has been the first to commit to developing an array of individual currency backed stable coins. The concept of individual currency backed stable coins has a specific structure and also a specific purpose. The project has developed a framework for individual currency backed stable coins for each individual currency that is a member of the multi-currency backed within X8currency, along with a few others. At this point in time the project decided not to include the individual currency backed stable coins into the material for the submission to FINMA. The simple reason for this is that the complexity of such a request would go beyond the scope of the primary aim, which is to work towards regulatory approval for the main product – the X8currency. In spite of this, individual currency backet stable coins within the X8 architecture are still value preservation products and, can as such, work independently of the bigger multi-currency backed sibling. In simple terms, individual currency backed stable coins by X8 are not based on a fixed 1:1 peg and are managed by the ARM AI. Therefore, they are subject to the fluctuations of the exchange rates in the foreign exchange markets.

In contrast to the above, the individual currency backed stable coins by the Diem Association have been described as instruments with a 1:1 peg against the underlying currency of every individual coin. Furthermore, the Diem Association plans to use the principle of the 1:1 peg stable coin type for constructing the multi-currency backed Libra Coin, where each component of the multi-currency backed Libra Coin is a 1:1 stable coin denominated in each separate currency. This represents an inherent dependency between the multi-currency backed coin variant and the individual currency backed stable coins in the Libra’s concept. This dependency is expressed in terms of capacity that the multi-currency backed stable coin could develop and will be based on the established capitalizations of individual currency backed stable coin (sub)products. More on this topic can be read in the payment system section of the Association’s whitepaper.

 

INVESTOR PROTECTION APPROACH

When it comes to protecting investors, one needs to understand that the Diem Association is effectively approaching it from the perspective of a banking license. As per BASL III and BASL IV, banks are required to maintain a specific capital adequacy. In simple terms, this means that a bank needs to keep a certain level of capital and liquidity relative to overall balance sheet size. For this the terminology uses the appellation, capital buffer. However, more importantly, the capital adequacy is calculated based on the quality and the composition of assets. A risky portfolio would require a higher capital buffer amount while a low-risk portfolio would require a lower capital buffer in order to meet the banking regulation requirements. This conclusively means that the quality of sovereign government paper held in the Libra Coin reserve along with its reserve size will inherently determine the level of capital buffer the Association will need to commit in order to comply with the regulations. The Diem Association’s commitment goes further than this. In their whitepaper it is explained that if Libra Networks faces negative yields in the custody of any of its very short-term government securities or cash or cash equivalents, it will have to cover these costs through its other revenue streams (e.g., transaction and other fees). On the other hand, positive interest on the Reserve’s assets, if available, will be used to cover the costs of the Libra system, ensure low transaction fees, augment the required capital buffer, and support growth and adoption. Lastly, the whitepaper states that Libra Coin holders will not receive a return from the Reserve.

Although the designated Libra approach leaves some unanswered points about how the described concept will combine all the elements within one specific licensing regime (banking license and payment system license is necessarily and/or automatically not interchangeable and could be contradictory), the content of the subject is about investor protection. It is also not clear how different risk types, including the heavily US Dollar denomination-oriented portfolio, would affect the required level of the capital buffer for a Swiss-based Diem Association.

As mentioned, the X8 project (also Swiss-based) aims to include the Gold reserve directly into the reserve itself at some point in the future. This concept in itself mitigates the foreign exchange risks within the X8 multi-currency basket. Capital buffer requirements, as a part of the banking regulation framework, are under any circumstance dependent on Swiss Franc exchange rate volatility risks. The X8 project will work toward simplifying its framework to satisfy investor protection expectations by the market and will aim to do so in an effective but streamlined way, depending on the type of the license deemed necessary by the regulator. In simple terms, the most direct way for the mitigation of risk exerted by the foreign exchange rate fluctuations can be most directly handled by a capital buffer denominated in Swiss Francs. In the X8 system the requirement for such a capital buffer is inherently lower because of more even diversification of CHF exchange rate risks across a set of different currency members of the reserve – representing a higher quality of the composition of assets. That is simply because the likelihood of value preservation in Swiss Franc units (CHF denomination) is increased by decreased dependency on any individual currency. Therefore, the risk exposure to only one FX pair (for example the USD/CHF) is divided across a larger number of FX pairs (EUR/CHF, GBP/CHF, CHF/JPY, etc…). This brings in an additional benefit from the fact that the Swiss Franc may not move in one direction against every other currency within such a system, which is a less risky assumption than in the case of a reserve portfolio that is clearly putting most emphasis on one currency only – the US Dollar.

This subject is open for a discussion and depends greatly on the interpretation of the two analysed frameworks by the regulatory authority itself. Last but not least, despite the fact that X8 intends to offer a standardized and homogenous tokenized value preservation solution, the value preservation mechanism itself rests on exchange rate optimization, which can bring benefits to investors from the improved reserve composition without distributing any investment returns while still maintaining the main characteristic of the fight against inflation.

TABLE CHART COMPARISON

Name Libra Coin X8currency
Project start 18th June 2019 13th January 2018
Focus Portfolio management Risk management
Resemblance IMF’s SDR Independent
Basis Move programming language ARM Artificial Intelligence
Backing Short term Bonds (80%), Cash (20%) Cash (100%)
Nr of Elements 5 (Regulator dependent) 8 plus Gold
Blockchain platform Native blockchain Ethereum
Project’s aim Payment system Payment instrument
Money raised 250 million USD 3,4 million EUR*
Targeted License FMIA, Bank, Fintech Fintech
AML TBD** Cross-border matrix
User base >3bn >1.000
Geo diversification Yes Yes
Utility token No Yes (X8X)
Individual currency coins Yes Yes
Individual ccy coins – Peg 1:1 ARM Artificial Intelligence
G7 guidelines relevance Yes Yes
Reporting standard Basic IFRSs
Underlying regulator FINMA FINMA
Domicile Switzerland Switzerland

**Detailed AML concept of Libra Coin does not explain specific points pertinent to Swiss AMLA.*The X8 project raised an equivalent of 3,4 million EUR in Ethereum and Bitcoin, however the actual value converted into FIAT currency was lower.

 

SUMMARY

In summary, it is obvious that Libra Coin and X8currency are two distinct products with many differences. In very general terms, Libra Coin takes a broader approach to value preservation, resting heavily on asset management to meet the target. On the other hand, X8 takes a very monetaristic and an almost academic approach to answering a very old question, which is about a unit of account and a payment instrument focused on stability and independence from various market shocks. Despite not completely distancing itself from concepts of portfolio management X8 rather focuses on risk portfolio management where the unit of the portfolio is an allocation of risk itself rather than any particularly named asset – as long as the asset meets the required standard. The X8 currency was constructed to deliver a very clean monetary solution that is more about compatibility with the financial system’s legacy than simply utilizing eight different currencies for achieving a more diversified stable coin.

All in all, from the risk perspective the two analysed solutions differ from one another mainly by the fact that in the case of the Libra Coin a default on sovereign debt (of any country issuing it) would most likely trigger a write-off in the value of the investment held in the sovereign government debt securities. It remains highly speculative how much of the value could be recouped from the secondary market once such an event would already have occurred. In contrast, the X8currency mechanism does not carry such outright risk from a sovereign debt default. Any adverse market events would rather impact the portfolio from the perspective of the foreign exchange price difference for any affected currency. These currency devaluation events are less binary and manifest themselves in a more incremental way than the default on any particular short-term bond issue.

In the age of Artificial Intelligence, it is almost unnecessary to discuss matters further or speculate about which approach is better and which concept can deliver a more thorough answer to the quest for a stable payment instrument. That subject would simply go beyond the scope of an analysis like the one presented in this text. Over time, most probably the AI itself will be able to show to all of the potential and also the actual end users about which digital currency will come closest to the ideal. Any reader of this analysis should keep the following fact in mind. It is well established that currencies are merely representations of money and that a competition among currencies always exists about which one is able to play the role of the monetary unit most optimally. This holds true for any currency in the present as it has also in the past. The future is bringing forward a variety of solutions for the users to choose from. Blockchain technology is taking this one step further where this choice is wider and freer than ever before.

 

 

Gregor Kozelj
Gregor

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