• Kirsten Saliba
  • 11 February 2022
  • 5 mins
  • 313 views

While it has taken them a while to catch up, governments are finally realising the importance of moving into the digital age and adopting digital currencies as a standard form of finance. Now that they know that cryptocurrencies are only getting stronger, they have had to formulate their responses and action plans to accommodate this new way of living.

One of these responses is the creation of Central Bank Digital Currencies (CBDCs) as an alternative to Fiat currency.

What is a CBDC?

Central Bank Digital Currencies are digital tokens, similar to cryptocurrency, that are issued by a country’s central bank and is tied to the fiat currency of that country.

Many countries are developing CBDCs, and some have even implemented them into their financial systems. Because so many countries are researching ways to transition to digital currencies.

But as with the response to cryptocurrencies themselves, there is no uniformity in different governments’ approaches to this issue.

More advanced economies like the US and UK are still debating on whether there is a need for CBDCs, with the UK’s Hous of Lords Committee stating that “While a CBDC may provide some advantages, it could present significant challenges for financial stability and the protection of privacy.” While more forward-thinking regions like India, South Korea and France have already launched their own versions of CBDCs.

CBDC vs Cryptocurrency

There are many differences between these two types of digital currency, so here are some of the core distinctions between the two.

Decentralisation

The biggest difference between the two is the fact that the whole tenet of cryptocurrency is founded on the idea of decentralisation of finance and authority is delegated to the user base which makes decisions by reaching a consensus. Using CBDC networks, the central bank decides the roles

Blockchain

Cryptocurrencies are built on permissionless blockchain but CBDCs use permissioned blockchains. Permissioned blockchains are a centralised structure

Anonymity

While cryptocurrency users are afforded anonymity in their dealings, CBDC users will have their identity tied to an existing bank account and an equal amount of personal information.

Use Case

CBDCs can only be used for payments and other monetary transactions. Cryptocurrencies can be used for speculative purposes and payments as well.

What are the Risks?

As with any shift into a new paradigm, there are inherent risks that need to be considered. One of the bigger sticking points is the centralisation of CBDCs, which could amplify cyber vulnerabilities already connected to fiat currencies and increase the pints of failure and vectors to attack, including central banks themselves and the economy overall. Just as the failure of any one bank can lessen the confidence in banking in general, failing or corrupted CBDCs could have the same effect on central banks, negating the benefits of their strategic risk-sharing structures.

Privacy and consumer protection are other issues. CBDC access credentials are needed for accessing and transferring funds. Such credentials can be given in the form of a passphrase that could be communicated in writing or token form via private keys. Regardless of the form it takes, the threat of theft and credential loss could be significant meaning account funds and data could be compromised.

Add to that, if passphrases or hardware tokens are lost/damaged due to whatever circumstances, CBDC users should not simply lose all their funds and data. Therefore, the system should have built-in credential recovery mechanisms.

This leads us to the possibility of Compliance oversights on Know-Your-Customer (KYC). The lack of uniformity of KYC and AML regulatory oversight between jurisdictions could lead to issues of traceability and lack of transparency in the case of cross-border payments, causing frictions in checks.

The lack of interoperability and standardisation in cross-border transactions means that Anti-Money Laundering and Combating the financing of terrorism checks could be hindered.

The Solution?

The AML/CFT challenges presented by CBDCs mean that organisations have to implement suitable technology solutions to ensure they are in keeping with regulatory compliance and able to manage the vast amounts of digital customer and transaction data that they would be required to accumulate.

It would also be positive that these automated solutions offer significant speed and accuracy benefits over manual risk-screening, considering the influx of data it would entail. Smart technologies promise a range of advantages for complying with CBDC focused regulations.

Machine learning would be imperative in this situation. IT allows organisations to categorise and prioritise CBDC data efficiently and make better decisions based on previous data sets. This can help spot unforeseen risks, such as suspicious client behaviour and new patterns and trends emerging in volatile digital currency markets.

For added security, smart technology may be employed to put vigorous protections in place. biometric verification, two-factor authentication, and end-to-end encryption. Beyond protecting customer data and assets, smart technology can prevent criminals from misusing CBDC financial services to launder money and fund terrorist activities.

Versatility is also hugely important, which could be a difficult hurdle. The digital currency landscape is evolving at a pace; smart solutions allow companies to adapt to changes in the regulatory landscape at a quicker pace, leaving less scope for fines or being penalised due to a lack of knowledge or slow reaction. Similarly, smart software enables firms to react quickly to changes in criminal methodologies, deploying more effective AML responses based on emerging trends and threats.

CBDCs are becoming a reality and it is best to be prepared for any eventual outcome of their implementation. If you or your project need an effective and dynamic AML solution, why not get in touch? We’ll be happy to discuss how we can make our tech work for you.

About Sekuritance

The Sekuritance RegTech platform provides a single platform for every eGRC need, including end-to-end AML/CTF, CECL, FCPA, vendor management, beneficiary onboarding, investor check, card processing MFA checks, blockchain wallet checks, cyber-risk assessments, and other RegTech or Business Process Management requirements.

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