Digital Currencies Backed by Central Banks and the Battle Against Illicit Activities

In the rapidly evolving world of finance, two significant developments are gaining traction: Central Bank Digital Currencies (CBDCs) and open banking. These innovations are set to reshape the financial landscape, offering benefits and raising concerns.

CBDCs: A New Form of Digital Currency

CBDCs, digital currencies managed by central banks, are being explored by 130 countries, including major economies. These currencies aim to regain control over unregulated cryptocurrencies and maintain monetary sovereignty. Some countries, such as Jamaica and the Bahamas, have already introduced CBDCs, while others, like China, India, Brazil, Singapore, and Canada, are still testing and preparing for introduction. The European Central Bank plans to pilot the digital euro from 2026 and roll it out by 2029.

CBDCs offer several advantages. They could allow central banks and governments to cooperate internationally to promote collective mechanisms and regulatory frameworks for fighting financial crime. CBDCs could also protect individual privacy by encrypting access to financial data while verifying that transactions are legal and trustworthy. Moreover, they could help combat financial crime by offering improved traceability, greater transparency, automated transaction monitoring, and fraud and money laundering detection capabilities.

However, CBDCs are not without their criticisms. Some argue that they offer excessive state control, potentially impacting privacy and civil liberties. Key concerns include the borderless quality of CBDCs, differences in Anti-Money Laundering (AML) and Know Your Customer (KYC) compliance approaches among countries, international settlement regulations, cooperation among countries developing CBDCs, and the West's current inability to influence global CBDC legal and regulatory standards.

Open Banking: A New Approach to Banking

Open banking, a concept from the 1980s, came into effect in the UK in 2019 and is being introduced in the U.S. This approach gives third-party providers access to transaction data from banks and financial institutions. An example of open banking application is Revolut, which offers personalized banking experiences, allowing consumers to manage all their banking needs in one place.

Open banking increases the number of players and products in the financial space, offering an array of innovations in financial services. However, it also introduces more access points for criminals to steal customer data. Despite efforts to make open banking more secure, the chief concern is that it increases the likelihood of data being stolen by skilled criminals who can target frailties and exploit them.

Digital CBDC transactions can be tracked using blockchain technology, making it harder for criminals to operate. However, this increased traceability could also invite cyber attacks that could undermine CBDCs, threatening monetary and financial stability. Experts argue that the solution to the increased financial crime risk with open banking is to foster better collaboration and intelligence sharing across the financial ecosystem.

CBDCs and open banking, while offering benefits like improved financial inclusions, fiscal stability, and transaction transparency and efficiency, also present challenges that need to be addressed. As these innovations continue to evolve, it is crucial for regulators, central banks, and the private sector to work together to ensure a secure and inclusive financial future.