The Marshall Islands SOV Deconstructed

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.

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