Pakistan is considering the issuance of digital government bonds. This shift in the management of public debt promises several benefits, including faster settlement and lower risk. It facilitates auditing and reduces the need for manual record-keeping. These gains are real. Our system has high costs and thin markets, so these improvements deserve support.
At its simplest, a tokenised bond is still a standard government bond. The state pays interest and repays the principal just as it always has. Only the way records are kept changes. Ownership is registered on a blockchain, a decentralised, tamper-proof digital ledger that records transactions across a network of thousands of computers. The ownership token updates automatically on the blockchain when someone buys or sells the bond. This is therefore not a new type of claim but rather a digital means of tracking ownership.
There are, however, potential pitfalls that Pakistan should consider to avoid financial distress arising from reliance on blockchain. Although tokenised government securities are legally separate from cryptocurrencies, they could easily become entangled in the periodic turmoil affecting cryptocurrency markets.
In a traditional setup, a bitcoin crash has almost no impact on a person holding a Pakistan Investment Bond (PIB). Tokenisation changes that. If bonds are traded on crypto platforms or used as collateral for digital loans, a ‘flash crash’ can trigger a domino effect.
Economics thrives on stories. Nobel laureate Robert Shiller argues that economic narratives spread like diseases and influence behaviour more than data. In our case, the narrative might not distinguish between a failing asset and a useful technology.
International investors would then reassess everything linked to blockchain. Funds holding Pakistani tokenised bonds may see investors request a return of their capital. Managers often sell their most liquid assets first to raise cash. Since these bonds are designed to trade easily, they become the first candidates for sale, regardless of Pakistan's ability to pay its debts.
Banks and brokers would also react by raising collateral requirements and tightening risk limits. Investors who borrowed money to buy these bonds would have to sell quickly, causing prices to drop fast. Government announcements could make it worse. If regulators pause the system to ‘review’ it, uncertainty increases. Investors might assume that additional restrictions are forthcoming and sell quickly.
Consider the effects of contagion on the banking system. Pakistani banks hold huge amounts of government debt as ‘Available for Sale’ securities. Under international accounting standards, any decline in the market price of these bonds constitutes a loss. These losses reduce the bank's capital even if the bank does not sell the bond. This would restrict the banks’ ability to lend and the ensuing uncertainty about the loss exposure of each bank could cause the inter-bank lending market to freeze (shades of what happened in the US financial markets in 2008 come to mind). The entire credit market could come to a screeching halt.
There is also the ‘stablecoin trap’. Most digital asset trades are settled using stablecoins, which are private digital currencies that are pegged to the U.S. dollar. However, stablecoins are not regulated like fiat currencies, and their reserves backing the peg can be opaque. If a crypto crash occurs, investors would flee to stablecoins. However, in a market panic, they would also likely decide to redeem stablecoins for actual dollars.
If stablecoin issuers must sell their reserves in a fire sale to meet redemptions, they may find that their securities aren't as liquid as they thought. Besides, fire sales depress prices. The stablecoin, therefore, becomes unstable. If a stablecoin trades below its peg (one dollar), liquidity evaporates.
Pakistani digital tokens would be priced using stablecoins. But if the medium of exchange is no longer worth a dollar, the real price of a bond becomes impossible to figure out, and trading grinds to a halt.
Forced liquidations would accelerate as hedge funds dump Pakistani tokens for whatever they can get. Banks that accepted these tokens as collateral would face a double whammy: tokens plunge in value while the stablecoins used to value them are unreliable. This would trigger massive collateral calls and more selling. There is then the likelihood of a sizable yield gap appearing between traditional bonds and tokenised bonds, with Pakistan’s debt costs soaring.
Note that the nightmare scenario above required only a loss of confidence in settlement instruments, not fraud or sovereign distress.Pakistan should therefore develop a regulatory framework that insulates the legitimate use of blockchain for debt management from the volatility of the crypto-economy.
First, the State Bank of Pakistan (SBP) should mandate a ‘Walled Garden’ infrastructure. Tokenised government bonds should not reside on public, ‘permissionless blockchains’. Instead, they should be issued on a private, ‘permissioned blockchain’ managed by the SBP or a central clearing entity. This prevents the ‘narrative contagion’ by ensuring that Pakistani bonds are physically and digitally separated from speculative crypto assets.
Second, we must avoid the ‘stablecoin trap’ by prohibiting the use of private stablecoins for settlement. Instead, the SBP should introduce a wholesale central bank digital currency (wCBDC). This digital rupee would be a direct liability of the central bank, ensuring that it remains at par with the physical rupee. By using a wCBDC for the settlement of tokenised bonds, we eliminate the risk that a de-pegging of a stablecoin like USDT (Tether) could freeze the bond market.
Third, collateral eligibility rules must be strictly defined. Regulators should prohibit banks from using tokenised bonds as collateral for any crypto-related borrowing or lending.
Fourth, we need enhanced disclosure and accounting standards. Banks must clearly distinguish between traditional bonds and tokenised bonds in their reporting. The SBP should require ‘stress tests’ specifically designed for digital assets. These tests would ask: ‘What happens to the bank's capital if the digital settlement layer experiences a 24-hour outage?’ By forcing banks to plan for these technical risks, we ensure they are not caught off guard by hardware or software glitches.
Fifth, bank exposure to tokenised securities should be limited to, say, 15 per cent of capital and require higher risk weights relative to traditional securities. This prevents excessive concentration that could sink individual banks.
Sixth, to prevent concentrated selling pressure, no single non-government entity should hold more than 5 per cent of any tokenised bond issuance.
Seventh, market makers and primary dealers in tokenised securities should be required to maintain rupee liquidity buffers equal to 20 per cent of their token positions. This ensures they can absorb redemptions without forced selling.
Eighth, banks using tokens as collateral must apply a minimum haircut of 25 per cent (100 million tokens count as only 75 million in collateral value) to provide a cushion during periods of price volatility.
Ninth, retail investor access to tokenised securities should be restricted to amounts below 10 per cent of their net worth. Finally, any platform trading Pakistani tokenised securities must: be licensed by the SECP with minimum capital requirements; segregate customer assets from company assets (no commingling of customer funds with operational balances); maintain proof-of-reserves with real-time auditing; submit to SBP oversight for Anti Money Laundering (AML)/Combating the Financing of Terrorism (CFT) compliance; and prohibit lending customer assets without explicit consent and disclosure.
Cryptocurrency volatility is inherent and inevitable. The guardrails we build today determine whether blockchain strengthens our financial system or becomes the spark that ignites our next financial crisis.
The writer is a group director at the Jang Group. He can be reached at: [email protected]
