On Monday (10 September 2018), the International Monetary Fund (IMF) released a 58-page report in which it warned the Republic of Marshall Islands (RMI), a small sovereign island nation in the Pacific Ocean, not to go ahead with the plan to launch its own cryptocurrency, the Sovereign (SOV), as a second form of legal tender (along the U.S. dollar).
On 26 February 2018, the country passed the "Declaration and Issuance of the Sovereign Currency Act 2018", the purpose of which was "to declare and issue a digital decentralized currency based on blockchain technology as legal tender". The bill stated that this new cryptocurrency, called the Sovereign (SOV), would be issued by the Ministry of Finance and introduced via an initial coin offering (ICO).
However, now, the IMF is saying that using crypto as a second form of legal tender would be risky:
"The issuance of a decentralized digital currency as a second legal tender would increase macroeconomic and financial integrity risks, and elevate the risk of losing the last U.S. dollar correspondent banking relationship."
And the IMF makes the following recommendation regarding the issuance of SOV tokens:
"The potential benefits from revenue gains appear considerably smaller than the potential costs arising from economic, reputational, AML/CFT, and governance risks. In the absence of adequate measures to mitigate them, the authorities should seriously reconsider the issuance of the digital currency as legal tender."
The report makes the following observations about the Marshall Islands and its plans for the Sovereign (SOV):
- "RMI is vulnerable to climate change because of its low elevation, and it has experienced droughts and floods repeatedly."
- "The economy is highly dependent on external aid, with annual grants averaging about 35 percent of GDP over the past decade."
- "The country has one domestic commercial bank, Bank of Marshall Islands (BOMI), which is at risk of losing its last U.S. dollar correspondent banking relationship (CBR) with a U.S.-based bank as a result of heightened due diligence by banks in the United States." The CBR is currently reviewed annually.
- "If RMI’s only domestic bank lost its last U.S. dollar CBR, external aid and other flows could be disrupted, which would result in a significant drag on the economy."
- "A foreign private company—an Israel-based start-up with limited financial sector experience—will be in charge of the issuance and receive half of the initial SOV issuance."
- "The authorities expect sizeable revenue gains from the other half of the SOV issuance, which would help prepare for the reduction of U.S. Compact grant after FY2023: 20 percent of the initial coins accruing to RMI will be distributed to the resident RMI citizens to jump-start the use of the SOV, while the rest of initial coins will be allocated to trust funds to supplement the current Compact Trust Fund, support citizens who were affected by the previous U.S. nuclear tests, and finance infrastructure projects."
- "As a first step, a law was passed in February 2018 to recognize the SOV as second legal tender, signal the RMI’s strong commitment, and help the foreign private company secure the financing needed for the development of the technology for the new digital currency."
- "Unless strong AML/CFT measures are implemented, the issuance of the SOV, as contemplated, will elevate the already high risks of losing the last U.S. dollar CBR."
- "The law requires that all users of the SOV undergo standard “Know Your Customer (KYC)” procedures and that their identity be recorded on the blockchain."
- "However, neither the content of the 'standard KYC procedures,' nor the modalities of their implementation have been established."
- "In addition, other key measures such as transaction monitoring, reporting of suspicious transactions, compliance monitoring, and sanctioning of compliance failures are not addressed."
- "... the issuance of the SOV without effective implementation of comprehensive AML/CFT measures could offset recent progress in strengthening the AML/CFT framework, leading to increased scrutiny from the AML/CFT standard setter and potential countermeasures, including, possibly, the immediate loss of the CBR."
- "SOV issuance in the currently planned form and in the absence of a monetary policy framework could also result in monetary instability and pose significant challenges to macroeconomic management."
- "The SOV will, by design, be an international currency and subject to large volatility in its exchange rates."
- "The SOV also raises cybersecurity and other operational risks. In the case of the SOV, these risks are compounded by the fact that the development and management of the SOV protocol are outside of the authorities’ control and in the hands of a foreign private company."
- "The limited telecommunication infrastructure in RMI will likely be an obstacle to the SOV becoming a widely used medium of exchange for some time."
On September 5, 2018, the Executive Board of the IMF concluded the 2018 Article IV consultation with the RMI. According to the report, this was the RMI authorities' view of the risks highlighted by the IMF:
"While acknowledging the risk from issuing the SOV, the authorities were confident that advanced technology would provide for sufficient risk mitigation. They anticipated that the risks of the SOV being misused for ML/TF purposes will be sufficiently mitigated by the fact that the identity of the SOV users will be recorded on the blockchain and that the SOV could only be traded through global cryptocurrency exchanges approved by the RMI government. They also added that the risks of monetary instability would be limited by a mechanism which will automatically adjust the SOV supply to prevent excessive price volatilities. The authorities noted that the SOV would only be issued once the planned issuance and use of the SOV are deemed to comply with Financial Action Task Force (FATF) standard and U.S. regulations and its use in transactions in the U.S. financial system has been approved by the U.S. government (as in the case of other countries’ fiat currencies). The authorities also added that they would shift their focus to addressing challenges to macroeconomic management at later stage. Considering all of these preparations, they expected it would take few years to issue the SOV. They noted that there would be no financial costs for the RMI because the Act explicitly provides that the costs related to the issuance of the SOV are to be borne by the foreign private company."