This is a revised version of a paper I posted here a little over a month ago. It examines a structural vulnerability inherent in the domestic financial architecture of officially dollarized microstates: their dependence on correspondent banking relationships (CBRs). By surrendering the monetary autonomy of an issuing central bank in exchange for the stability of a foreign currency, these microstates make their domestic financial systems dependent on CBRs that global banks are increasingly unwilling to maintain. The existing International Monetary Fund and World Bank literature treats CBR withdrawal primarily as a cross-border payments problem, with prescriptions addressed to that dimension, leaving this distinct domestic vulnerability unaddressed. Focusing on the Federated States of Micronesia, Palau, Timor-Leste, and the Republic of the Marshall Islands, the paper examines emerging digital financial infrastructure and instruments as potential complements to the standard prescriptions, assessing their capacity to sustain domestic monetary circulation independently of conventional CBRs and the extent to which they may allow microstates to recapture economic benefits somewhat analogous to the seigniorage forgone via dollarization. [SSRN]
The revised paper benefited greatly from comments from Christian Pfister, Patrick McConnell, Kristina Fedorenko and Russell Krueger, plus the support of Mark Lurie, Jordan Goldman and Jeremy Coffey of M1X Global. However, comments are still more than welcome!
Scaling Tokenization: New Efficiencies, New Vulnerabilities (IMF)
The IMF published a Global Financial System Report (GFSR) that discusses the potential benefits of tokenization and the constraints to its development and assesses its implications for financial stability. While distributed ledgers promise reduced intermediation frictions, the ecosystem remains nascent, constrained by lacking legal certainty, regulatory clarity, interoperability, and safe settlement assets. Systemic risks are currently contained, but scaling could amplify vulnerabilities like liquidity runs and procyclical leverage, while introducing novel operational fragilities. Indeed, empirical evidence from tokenized equities reveals elevated volatility and structural illiquidity despite continuous trading. Authorities must implement a technology-neutral framework that removes barriers while mandating robust safeguards for an always-on architecture. [IMF]
BTW if you want to see a complete database of my DFC-related posts going back years, including many that didn’t make the Daily Digest cut, click here.
FYI I produce a monthly digest of digital fiat currency (DFC) developments exclusively for the official sector (e.g., central banks, ministries of finance and international financial institution (e.g., the BIS, IMF, OECD, World Bank)) plus academics and firms that are active in the DFC space (commercial banks, technology providers, consultants, etc.). (DFCs include central bank digital currency (CBDC), stablecoins and tokenized deposits.) It goes out via email on the first business day of every month, and if you’re interested in being on the mailing list, please email me at john@kiffmeister.com.
