June 2021 – The Global Fintech Intelligencer

According to the Bank for International Settlements (BIS), a retail central bank digital currency (CBDC) is a broadly available general purpose digital payment instrument, denominated in the jurisdiction’s unit of account, that is a direct liability of the jurisdiction’s monetary authority. To this I would add, subject to the same rules and regulations as imposed on the jurisdiction’s other units of account. By “general purpose” is meant that it can be used by the public, for day-to-day payments rather than CBDCs restricted to wholesale, financial market payments. A liability issued by a monetary authority that is not in its own currency (i.e., where it does not have monetary authority) is not a CBDC. I’ve summarized this definition in the table below and have added that it can be used for peer-to-peer transactions, which the Banque de France also views as an essential characteristic.

In previous versions of this tabulation, I included legal tender status as a key characteristic. A currency’s legal tender status entitles a debtor to discharge monetary obligations by tendering the currency to the creditor. However, a recent IMF working paper casts doubts on whether a digital currency can, or even should be given legal tender status. For example, designating CBDC as legal tender is not obvious if broad layers in the population are not positioned to technically receive it as a means of payment (e.g., not owning a computer or smartphone). Legally, it may not be possible either, because the creditor without access to the technology cannot accept the payment even if she wants to.

Anyways, this is the definition I’ve been applying to my real-time tabulation of retail CBDC explorers, but I frequently get suggestions to add new entries that don’t fit my definition. However, many turn out to be clearly wholesale CBDC, which are easy to identify and reject. And there are several more subtle ones that pop up, such as the Republic of Marshall Islands (RMI) SOV, and Cambodia’s Project Bakong, that I will briefly run through here. The SOV is easy to reject because there is no RMI monetary authority, and it is not denominated in the country’s unit of account, which is the U.S. dollar.

Cambodia’s Project Bakong has been sometimes called a quasi-form of CBDC but from my read of the white paper, it is arguably at most some form of synthetic retail CBDC. To me it appears to be a central bank-run interbank retail payments system that runs on distributed ledger technology rails that requires that any user balances be parked at the central bank. That makes it possibly a synthetic CBDC, in the same way that China’s AliPay and WeChat Pay are because they are required to park user funds at the People’s Bank of China. But in all these cases, the digital currencies are not issued by and direct liabilities of the central banks, so they’re not CBDC.

And the National Bank of Cambodia’s Chey Serey would seem to agree that Bakong isn’t a CBDC. “Instead, the platform augments the existing Fast and Secure Transfer (FAST), real-time retail payment system and Cambodian Shared Switch (CSS) that facilitate mainly interbank transactions among commercial banks and MFIs. They were launched respectively in 2016 and 2017 and are Cambodian riel (KHR) and US dollar account-based systems that do not interoperate with the twenty or so PSPs that serve mainly the unbanked. With the launch of Bakong, banks, MFIs and PSPs have a ready-made universal mobile app interface to connect users with FAST, CSS and each other.”

However, I have been long maintaining the Banco Central del Ecuador’s Dinero Electrónico mobile payment system in my CBDC explorer tabulation but being somewhat uneasy about its inclusion. The program, which operated between 2014 and 2018, allowed citizens to transfer USD balances in real-time from person to person using basic cell phones. From my read of a recent paper on the Dinero Electrónico it would seem to be a central bank-run USD asset-backed stablecoin. Like with the RMI, the USD is the country’s unit of account, but in this case the digital currency is indeed denominated in Ecuador’s unit of account, and it was issued by, and a liability of, the central bank. Hence, it’s a CBDC by my definition.

However, Marcelo Prates has suggested that digital currencies like the Dinero Electrónico is nothing more than a stablecoin issued by a central bank. Basically if the central bank can’t issue traditional money (reserves + cash), it can’t issue the “digital” version of this money. Hence, by this logic, only central banks that issue their own currency can issue CBDC, which precludes completely dollarized country central banks from issuing CBDC. Besides U.S. territories, these include Ecuador, El Salvador, Marshall Islands, Micronesia, Palau, Panama, Timor-Leste, and Zimbabwe. The same would go for countries in the eurozone and other currency unions. But would countries with currencies anchored to another country’s would still be able to issue CBDC?

BTW some might note that I don’t include in my tabulation the Avant smart card system created by the Bank of Finland in the 1990’s that was the world’s first CBDC. It is indeed a CBDC, but my tabulation seeks to cover CBDC projects that are potentially still live, whereas Avant shut down in 2006. However, I have added a new section to my tabulation for retail CBDC projects that have been shut down.

In that regard, I’m tempted to drop the Banco Central del Ecuador’s Dinero Electrónico from my CBDC explorer tabulation because it is now similarly defunct, and it is questionable whether the Ecuador central bank can even issue a CBDC. But alternatively, I could include the Avant as a CBDC that has launched/ piloted. Any thoughts out there?

In 2018, the Republic of Marshall Islands (RMI) parliament passed the Sovereign Currency Act 2018 (the SOV Act), which established the digital currency Sovereign (SOV) as second legal tender in addition to the US dollar based. As legal tender, the SOV would be able to be used for any purchases as well as all payments of debt and tax obligations. Pursuant to this law, the SOV would be issued by the Ministry of Finance and would be non-redeemable. It was to be introduced via an initial coin offering (ICO), which the appointed organizer – SFB Technologies was tasked to perform. The law also requires transparency over the identity of the SOV users. The SOV would be issued on the Algorand blockchain.

One main purpose of the SOV is to generate revenue for the government. Additional motivations expand financial inclusion and improve RMI’s access to the global digital financial system.

After the initial issuance through an ICO, the number of SOV units would grow by 4 percent per year coded into the blockchain independently of the demand for the currency. Half of the revenue from the initial issuance (24 million SOVs) would be allocated to SFB Technologies and the other half to the RMI government. SFB technologies is tasked with developing and implementing the SOV and would bear all the necessary costs to issue the SOV and perform the ICO.

SFB technologies was planning on organizing a pre-sale of rights to future SOV units, with an eye to “test the markets and technology” and to gather additional information that could inform the government’s decision whether to proceed with the launch of the SOV. The pre-sale as currently conceived is independent of the RMI government and is designed as a private sale.

At a first glance, this arrangement sounds great, but a closer look reveals that it sounds too good to be true. Let us deconstruct the statements above to figure out where the SOV’s fatal flaws lie.

First, introducing the SOV would imply that the RMI would move to a dual currency system. In the absence of a monetary policy framework and a central bank this would impose significant risks to macroeconomic, monetary, and financial stability. The fixed annual growth rate of 4 percent irrespective of the demand for the currency would lead to large fluctuations in the value of the SOV against other currencies, including the U.S. dollar, the primary legal tender. These fluctuations, in turn, could create incentives for households, firms, and visitors to hoard the more stable/appreciating legal tender, while discharging debts and other obligations, including tax obligations, in the depreciating legal tender. This could have serious adverse consequences for the RMI’s public finances. Also, given that the RMI does not have a central bank, the country would effectively outsource its monetary policy to a private sector party creating a strong dependency.

Second, SFB technologies is foreign start-up with limited financial sector experience. The company’s intention was to seek financial support from potential investors to finalize the design of the SOV highlighting the immaturity of their technical concept. Also, SFB technologies’ dual role of issuer and private investor may create the appearance of a conflict of interest.

Third, based on the SOV’s issuance through an ICO as a way of raising revenue can be considered a securities offering. As there is no securities regulation governing either the pre-sale or the actual issuance, the RMI exposes itself to a regulatory vacuum unable to thwart or respond to potential fraud and manipulation.

Fourth, the identity of SOV users is expected to be verified through licensed international exchanges. However, licensing exchanges that will list the SOV is a mammoth task that may exceed this small country’s existing regulatory capacities. Moreover, although the exchanges are responsible for identity verification and establishing white and black lists for financial integrity purposes, the RMI government would still have to manage those lists as well as monitor and enforce compliance. Given the weakness of the country’s anti-money laundering (AML) and counter-terrorism financing (CFT) regime and capacity constraints within the regulatory and supervisory agencies, it remains questionable whether financial integrity risks can be mitigated adequately. The Digital Economic Zone for the exchange of virtual assets would only exacerbate the financial integrity issues.

Fifth, the stated goal behind the SOV is to raise revenue for the government to offset the fallout from revenue from the reduction of the U.S. Compact grants after 2023. However, there is no indication how much revenue the SOV issuance would generate. For revenue to be sizeable, there would need to be strong demand for SOV by foreigners. This seems difficult given the strong competition from existing crypto assets. In addition, through the SOV issuance, the small economy’s revenues would be subject to global crypto market price volatility.

Finally, the country’s frequent power and network outages could hamper the issuance and wide-spread use of the SOV, obstructing the goal to achieve financial inclusion and impeding the country’s access to the global digital financial system. More importantly, the SOV issuance could jeopardize the country’s last U.S. corresponding banking relationship with First Hawaiian Bank exacerbating the RMI’s access to global financial networks.

It is easy to get blinded by the promise of enormous revenue from a state-backed crypto-asset like the SOV especially considering impending revenue fallouts. But issuing, managing and sustainably maintaining a crypto-asset designated as legal tender is a complex endeavor and requires important prerequisites such as an adequate legal and regulatory framework, sufficient capacity to supervise and regulate the SOV as well as the security of the underlying system and a viable digital infrastructure. Rather than embarking on a project of this magnitude and complexity, the Marshallese could consider other options such as rationalizing public spending which is the highest in the Pacific region to unlock extra revenue, lean on regulated stablecoin or e-money providers to expand access to finance, work with development partners such as the World Bank or the Asian Development Bank to expand the country’s core infrastructure and request technical assistance to enhance the country’s legal and regulatory regime.

The government is now considering to repeal the SOV Act and a bill on establishing a Digital Economic Zone was submitted to the Parliament recently.