A digital currency against climate change: The way of the Marshall Islands

Author: Jonas Gross

Central bank digital currencies (CBDC) are on the rise. More and more CBDC projects are now reaching the test stage and are approaching the actual issuance of the digital currency. In addition to China, this also includes the Pacific island nation of the Marshall Islands. But what distinguishes this project from other CBDC initiatives? With the help of an own CBDC, the Marshall Islands aims to combat the consequences of climate change.

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Marshall Islands: SOV as second legal tender

As early as 2018, the Republic of the Marshall Islands, with its almost 50,000 inhabitants, released plans to issue its CBDC, the so-called Sovereign (SOV). A first-class team was assigned to the project, including Dr. Peter Dittus, former Secretary General of the Bank for International Settlements (BIS). Up to now, the Marshall Islands has not had their own national currency — the US dollar has been legal tender. This is now to change. After its introduction, the SOV will be the second, exclusively digital, legal tender. The respective legislation has already come into force in 2018.

Advantages of the SOV: Lower transaction costs and higher financial inclusion

But what are the advantages of the SOV? The traditional payment systems in the Marshall Islands has so far been relatively inefficient. The costs of money transfers often amount to more than 10%. The SOV aims to significantly reduce transaction costs and thus increase the efficiency of payment systems.

Moreover, a large part of the Marshall Islands’ population is currently excluded from the digital financial system. By far, not everyone has a bank account. Therefore, another goal of the SOV is to increase financial inclusion, since no bank account is required for in SOV-denominated transactions.

SOV reduces dependence on the USA

In addition to social motives, the Marshall Islands also follows financial motives with the SOV. Currently, the Marshall Islands is highly dependent on financial aid from the USA. Financial aid currently amounts to 20% of annual gross domestic product (GDP). However, the financial support by the USA will end in 2023 so that the Marshall Islands also intends to reduce their financial dependence on the USA with help of the SOV. 50% of the 24 million SOV units in total will be retained by the Marshall Islands to be gradually sold and thus generate continuous income flow. 10% of these revenues will go to the “Marshall Islands Green Climate Fund” to counter the dangers of climate change. According to the World Bank, the Marshall Islands is among those countries that are most vulnerable to climate change — and the associated rise in sea level. On average, the islands are only about two meters above sea level — 99% of the population live on the coast. In addition to floods, imminent dangers include droughts and typhoons. The fund is to be used to reduce the impact of these threats and to increase sustainability in the Marshall Islands.

DLT as the technological basis

But how is the SOV implemented technologically? A distributed ledger technology (DLT) is used as the technological basis also because the Marshall Islands does not have an own central bank. The SOV is based on a permissioned DLT protocol developed by Algorand. The annual increase in the money supply is specified in the protocol and thus cannot be altered. Initially, more than 20 “block producers” approved by the Marshall Islands will verify transactions, with further validators being selected at a later stage.

Monetary policy of the SOV

Monetary policy of the SOV is directly recorded in the DLT protocol, and the money supply is determined to increase continuously by 4% per year. Consequently, the money supply cannot be increased on a discretionary basis to a large extent, as it is currently the case in the USA or the Euro area, for example. The SOV follows the so-called k-percent-rule, developed by the Nobel laureate in economics Milton Friedman. The additionally issued SOV units are to be distributed pro-rata, among others, to the holders of the SOV that will practically earn interest on the SOV.

Such transparent and predictable money supply management can increase the confidence of users in the SOV. A massive “dilution” in the form of an excessive increase in the money supply can be ruled out for the SOV. However, such a monetary policy also implies that the Marshall Islands cannot counteract an appreciation or depreciation of the SOV by adjusting the money. Therefore, a high volatility of the SOV seems possible.

With regard to monetary policy, the main difference to other current CBDC projects, for example in China, becomes apparent. While the Marshall Islands focuses on a stable money supply — accompanied by fluctuating prices — all other currently advanced CBDC initiatives focus on a stable price — accompanied by fluctuations in the money supply.

How does the project continue?

Access to the SOV will also be possible for foreign investors. According to the homepage, transactions in SOV will be able to be made anywhere in the world. Currently, interested parties can register for the time-release monetary issuance (TRMI) of the SOV. Over the next 18 months, 9.6 million SOV units will be distributed piece by piece. Thus, the SOV will soon be reality.

Further material

About the author

Jonas Gross is a research assistant at the University of Bayreuth and project manager at the Frankfurt School Blockchain Center. His research focuses primarily on central bank digital currencies (CBDC) and stablecoin projects such as Libra. You can contact Jonas by mail (jonas.gross@fs-blockchain.de), LinkedIn (https://www.linkedin.com/in/jonasgross94/), and Twitter (@Jonas__Gross).

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