PYMNTS MonitorEdge May 2024

CBDC Scrutiny Underscores Role of Compliance in Scaling Digital Innovations

The technology for central bank digital currencies (CBDCs) already exists.

And as dozens of countries around the world have proven, in less time than it took to read this sentence, digital money issued by a sovereign bank can effectively settle in near real-time using distributed ledger technology (DLT). That fact alone could change a lot about commerce — if it is allowed to do so.

On Thursday (May 23), news broke that the U.S. House of Representatives passed a bill stopping the issuance of any U.S. CBDC without explicit authorization from Congress, potentially making the U.S. the first country in the world to ban a CBDC. Meanwhile, in the week prior (May 17), the Hong Kong Monetary Authority (HKMA) announced it had partnered with the People’s Bank of China (PBoC) to expand the scope of its own CBDC pilot. In light of these new policies, grasping the full spectrum of what CBDCs could mean for the future of finance is top of mind for banks and businesses with their eye on money movement innovation.

Both the HKMA initiative and the CBDC Anti-Surveillance State Act (H.R. 5403) are centered around retail CBDCs, which are essentially digital versions of a country’s fiat currency designed to be used by the general public for everyday transactions.

But retail CBDCs aren’t the only tokenized form of fiat currency that may one day exist. Wholesale CBDCs are being piloted by nations across each of the four hemispheres, too.

Wholesale CBDCs represent digital currency designed for use by financial institutions to settle interbank transactions and streamline the broader financial infrastructure by providing more efficient, transparent and secure settlement processes between banks and other financial entities.

Wholesale CBDCs are an entirely different beast compared to their retail cousins. Their adoption could open the door to innovative financial products and services, such as atomic swaps and smart contracts, which can automate complex financial transactions and reduce the reliance on intermediaries.

Still, regardless of whether a CBDC is designed for retail or wholesale use, ensuring that these digital currencies operate within a secure, transparent and regulated environment via real-time compliance is crucial for any next step.

Read more: BIS: CBDCs Need Risk Management Framework to Counter ’Operational Risks’

The Importance of Compliance in Scaling Financial Innovation

In the wholesale CBDC context, compliance is essential for maintaining the stability and security of financial markets. It ensures that all transactions are conducted within existing regulatory frameworks, preventing market abuse and financial crime. Additionally, real-time compliance can facilitate better risk management and enhances the ability of regulators to respond swiftly to emerging threats.

As experimentation with digital currencies continues to progress, the interplay between technology, regulation and innovation will shape the evolution of CBDCs and their impact on the global financial landscape.

“It’s time to make compliance a force for growth,” Kevin Akeroyd, CEO at Sovos, told PYMNTS.

Integrating wholesale CBDC capabilities into existing financial systems presents its own set of challenges, including interoperability with current infrastructure, scalability concerns and the need for a comprehensive regulatory framework to oversee DLT-based transactions.

“In order to scale, you need to bring existing regulated money, central bank-backed money onto the blockchain. That hasn’t been done yet,” Jorn Lambert, chief digital officer at Mastercard, told PYMNTS last July — a comment that still holds true nearly a year later.

Read moreTop Central Banks Approaching Critical Go-Forward Mark With CBDC Research

Still, the adoption of wholesale CBDCs holds the potential to reduce interbank settlement times and lower transaction costs, while enhancing the efficiency of things like cross-border payments.

By using a shared ledger, financial institutions can achieve real-time gross settlement, minimizing the counterparty risk and operational inefficiencies associated with traditional banking systems. At the same time, leveraging DLT can help enable better tracking and auditing of transactions, improving the overall transparency and integrity of the financial system.

If that all sounds great, it’s because innovations often do — at least, until they run into the realities of marketplace implementation and scalability. Overcoming these obstacles will involve collaboration between central banks, governments, financial institutions, technology providers and the public.

As Catherine Gu, head of CBDC and protocols at Visa, told PYMNTS, “I think this is at least five-plus years away from where we are today.”

And yet, it isn’t the technological feasibility that is holding CBDCs back. Rather, it is behavioral conditions, interoperability needs and other concerns — all areas that an effective compliance program can mitigate.