Pakistan is contemplating the issuance of digital government bonds, a move that signifies a shift in how the nation manages its public debt. This transition offers numerous advantages such as expedited settlement processes and diminished risks. Additionally, it enhances auditing capabilities and minimizes the necessity for manual record-keeping, which is crucial given the high costs and limited market activity in the current system.
Essentially, a tokenised bond remains a conventional government bond where the state commits to paying interest and repaying the principal, but the method of record-keeping is transformed. Ownership of these bonds will be registered on a blockchain, a decentralized and tamper-proof digital ledger that documents transactions across a vast network of computers. This means that the ownership token will automatically update on the blockchain whenever a bond is bought or sold, simplifying ownership tracking without changing the underlying claims.
However, there are notable risks that Pakistan must address to avert potential financial distress stemming from blockchain reliance. Although tokenised government securities are distinct from cryptocurrencies, they could become intertwined with the volatility that often plagues crypto markets. In traditional circumstances, a downturn in Bitcoin prices does not affect a holder of a Pakistan Investment Bond (PIB). Tokenisation alters this dynamic. If these bonds are traded on cryptocurrency platforms or utilized as collateral for digital loans, a sudden market crash could instigate a chain reaction.
The narratives surrounding economic events play a significant role in shaping investor behavior. Nobel laureate Robert Shiller posits that these narratives can spread contagiously, often influencing actions more than hard data. In this context, if investors perceive a failing asset, they might reassess all blockchain-related investments, including Pakistani tokenised bonds, leading to capital withdrawal requests. Such a scenario may force asset managers to liquidate their most liquid holdings first to raise cash, which could include these bonds, irrespective of Pakistan”s debt repayment capabilities.
Furthermore, financial institutions and brokers could respond by tightening risk limits and increasing collateral requirements, compelling investors who borrowed funds to buy these bonds to sell quickly, potentially precipitating a rapid price decline. Government announcements may exacerbate the situation; if regulators decide to pause the system for a review, uncertainty could escalate, prompting investors to divest hastily.
Another concern is the potential impact on the banking sector. Pakistani banks hold substantial amounts of government debt classified as “Available for Sale” securities. According to international accounting standards, any decrease in the market price of these bonds constitutes a loss, which could erode the banks” capital even without selling the bonds. This would limit their lending capabilities, and uncertainty regarding each bank”s loss exposure could freeze inter-bank lending, reminiscent of the US financial crisis in 2008.
The concept of a stablecoin trap further complicates matters. Most digital asset transactions are settled using stablecoins, which are private digital currencies pegged to the US dollar. However, these stablecoins lack the regulatory oversight of fiat currencies, and their backing reserves can be opaque. A market panic could prompt investors to flee to stablecoins, leading to mass redemptions that might force stablecoin issuers to liquidate their assets hastily, resulting in depressed prices and instability.
If a stablecoin depreciates below its dollar peg, determining the real price of a bond becomes challenging, leading to halted trading. This scenario would undoubtedly accelerate forced liquidations as hedge funds sell Pakistani tokens in desperation. Banks accepting these tokens as collateral would face significant challenges, as both the tokens and the stablecoins used for their valuation could lose reliability. This could initiate substantial collateral calls and further selling pressure, resulting in a pronounced yield gap between traditional and tokenised bonds, ultimately inflating Pakistan”s debt costs.
To navigate these risks, Pakistan must establish a robust regulatory framework that protects the legitimate use of blockchain in debt management from the volatile crypto-economy. The State Bank of Pakistan (SBP) should implement a “Walled Garden” approach, ensuring that tokenised government bonds do not exist on public, permissionless blockchains but rather on a private, permissioned blockchain overseen by the SBP or another central clearing entity. This strategy would help mitigate the risks associated with narrative contagion by keeping Pakistani bonds distinct from speculative crypto assets.
Additionally, to avoid the stablecoin trap, the SBP should prohibit private stablecoins for settlement purposes and instead introduce a wholesale central bank digital currency (wCBDC). This digital rupee would serve as a direct liability of the central bank, ensuring its parity with the physical rupee. Utilizing a wCBDC for settling tokenised bonds would eliminate the risks associated with stablecoin de-pegging.
Furthermore, strict rules must be established concerning collateral eligibility, explicitly barring banks from using tokenised bonds as collateral for any crypto-related transactions. Enhanced disclosure and accounting standards are essential, with banks required to clearly differentiate between traditional and tokenised bonds in their financial reports. The SBP should also mandate stress tests tailored to digital assets, evaluating the impact of potential technical failures on bank capital.
Limiting bank exposure to tokenised securities to a defined percentage of their capital is crucial to prevent excessive concentration. In addition, measures should be introduced to limit individual non-government entities from holding more than a small percentage of any tokenised bond issuance. Market makers and primary dealers in these securities must maintain liquidity buffers to accommodate redemptions without resorting to forced selling.
Finally, banks utilizing tokens as collateral should apply a minimum haircut to their collateral value, mitigating risks associated with price volatility. Retail investors should have restricted access to tokenised securities, ensuring that their investments do not exceed a defined portion of their net worth.
Any platform trading Pakistani tokenised securities must adhere to strict licensing requirements set by the SECP, ensuring the segregation of customer assets, maintaining proof-of-reserves, and complying with anti-money laundering regulations. The inherent volatility in cryptocurrency markets necessitates the establishment of safeguards to ensure that blockchain integration into Pakistan”s financial system strengthens it rather than precipitating another financial crisis.
