CBDC investigation highlights the role of compliance in scaling technology

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 be effectively settled in near real-time using distributed ledger technology (DLT). This fact alone can change a lot about commerce – if it is allowed to do so.

On Thursday (May 23), news broke that the US House of Representatives passed a bill that would stop the issuance of any US CBDC without express authorization from Congress, potentially making the US the first country in the world to CBDC prohibited. Meanwhile, the Hong Kong Monetary Authority (HKMA) announced last week (May 17) that 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, understanding the full spectrum of what CBDCs could mean for the future of finance is paramount for banks and businesses eyeing money movement innovation.

Both the HKMA initiative and the CBDC Anti-Surveillance State Act (HR 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 to become.

But retail CBDCs aren’t the only signed form of fiat currency that could one day exist. Wholesale CBDCs are also being launched by nations across each of the four hemispheres.

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 a completely different animal compared to their retail cousins. Its adoption could open the door to innovative financial products and services, such as atomic swaps and smart contracts, that could automate complex financial transactions and reduce reliance on intermediaries.

Yet, 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 through real-time compliance is crucial to 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 to maintaining the stability and security of financial markets. This ensures that all transactions are carried out within existing regulatory frameworks, preventing market abuse and financial crime. In addition, real-time compliance can facilitate better risk management and improve the ability of regulators to respond quickly 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,” Sovos CEO Kevin Akeroyd told PYMNTS.

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

“To scale, you have to bring existing regulated money, central bank-backed money to the blockchain. That hasn’t been done yet,” Jorn Lambert, chief digital officer at Mastercard, told PYMNTS last July — a comment that almost ‘ still valid a year later.

Read more: Top central banks approaching a critical point forward with CBDC research

Still, the adoption of wholesale CBDCs has the potential to reduce interbank settlement times and lower transaction costs, while improving 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, the use of DLT can help enable better tracking and auditing of transactions, improving the overall transparency and integrity of the financial system.

If this all sounds good, that’s because innovations often do—at least until they run into the realities of market implementation and scalability. Overcoming these obstacles will involve cooperation 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 it’s at least five plus years away from where we are today.”

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