What is CBDC and how it can stand against money laundering

Can the transparency of CBDCs effectively track and block $3 trillion in illicit financial flows? Let’s find out.

The world is facing a surprising problem: illicit funds and money laundering. More than $3 trillion illegally flowed into the global financial system in 2023, according to a report by Nasdaq-owned financial crime technology company Verafin.

This includes activities such as drug trafficking, human trafficking, terrorist financing, phishing scams, and bank fraud schemes that collectively cause billions of dollars in losses globally.

To combat these challenges, central banks around the world are exploring Central Bank Digital Currencies (CBDCs). Since May 2020, the number of countries considering CBDCs has increased from 35 to 134 countries and currency unions; this represents 98% of global GDP.

Of these, 68 countries are in advanced stages of exploration, including development, pilot or launch; 19 G20 countries are in advanced stages and 11 are currently in pilot stages.

But progress on retail CBDCs has stalled in the US, creating a gap between the US and other G7 banks. In response, the European Central Bank (ECB) is preparing for the digital euro by conducting practical tests with transactions carried out in a controlled environment.

Proponents argue that CBDCs could offer unprecedented transparency and potentially disrupt the illicit financial flows that plague our world.

But critics fear the untraceability of CBDCs could push illicit activity deep beyond the reach of formal banking systems.

Despite this, the potential of CBDCs to disrupt illicit financial flows remains an important area of ​​research and debate. Could CBDCs be the long-awaited solution to the scourge of black money and money laundering? Let’s find out.

How could CBDCs solve illicit money concerns?

CBDCs offer a promising solution to combat money laundering due to their digital nature and underlying technology blockchain. Here are several ways CBDCs could theoretically address money laundering concerns:

Transparency and traceability: CBDC transactions are recorded on a blockchain, providing an immutable and transparent ledger of all transactions. This transparency can help authorities track the flow of funds and detect suspicious activity more effectively than traditional cash transactions.
Automated monitoring: CBDC systems may include automated transaction monitoring tools powered by artificial intelligence (AI) and machine learning algorithms. These tools can analyze transaction patterns in real-time and flag potentially suspicious activity for further investigation.
Enhanced due diligence: CBDCs can facilitate enhanced due diligence processes by providing more detailed transaction information. This can help financial institutions and regulators better understand the source of funds and the parties involved in transactions.
Global cooperation: CBDCs can promote global cooperation in the fight against money laundering by enabling seamless cross-border transactions. This could facilitate information sharing and increase the effectiveness of international anti-money laundering (AML) efforts.
Regulatory compliance: CBDCs can facilitate regulatory compliance by embedding AML regulations into their design. This can ensure that CBDC transactions comply with AML laws and regulations from the very beginning. Best Use Cases for CBDCs

CBDCs offer a number of promising applications across various industries. Basic use cases are:

Domestic payments: CBDCs provide a digital alternative to physical cash, enabling electronic transactions within a country, increasing convenience and efficiency while reducing reliance on traditional banking systems.
Cross-border payments: CBDCs benefit businesses, individuals and economies by streamlining cross-border transactions, making them faster, cheaper and more transparent than traditional methods.
Remittances: CBDCs offer foreigners a cost-effective and efficient way to send money home, reducing the fees and processing times associated with traditional remittance channels.
Financial inclusion: CBDCs enable individuals to participate in the formal economy by bridging the gap between the unbanked or unbanked population and formal financial services.
Government benefits and subsidies: CBDCs allow governments to distribute social welfare benefits and subsidies directly to citizens’ digital wallets, increasing transparency and reducing administrative costs.
E-commerce: CBDCs facilitate seamless online payments, encouraging the growth of e-commerce by providing merchants and consumers with a secure, low-cost and effective payment method.

Recent sandbox experiments conducted by Swift and 38 global institutions have demonstrated the potential of CBDCs in a variety of complex scenarios.

These experiments demonstrated interoperability between different digital networks, automation of merchant payments through smart contracts, and facilitation of atomic delivery (DvP) to payment across multi-asset and cash networks.

The experiments reflected how CBDCs could simplify trade flows, spur growth in tokenized securities markets, and enable efficient currency exchange.

More importantly, they showed that financial institutions can achieve these benefits by leveraging their existing infrastructure.

Participants from central banks, commercial banks and market infrastructure providers emphasized the importance of interoperable networks in the CBDC ecosystem to prevent fragmentation and ensure seamless transactions.

This collaborative effort marks a giant step towards realizing the potential of CBDCs and other digital currencies, paving the way for a more efficient, inclusive and interconnected digital economy.

Is crypto a big bad guy and can CBDC help?

In an interview with Crypto.News, baseVC Head of Development Hubert Krawczyk and AMLBot Head of Lawyer and Compliance Consulting Mykola Demchuk shared their views on the potential of CBDCs in combating money laundering and money laundering.

When asked about the misconception that cryptocurrencies encourage money laundering and whether CBDCs could offer a solution, Krawczyk explained that the relationship between crypto and money laundering is flawed. He compared owning crypto to owning a gun, emphasizing that usage is what determines the outcome:

“Cryptocurrency may be associated with encouraging money laundering, but this is a common misconception. Crypto does not encourage anything other than owning your own assets without relying on a third party.”

Krawczyk also pointed out the similarity in ledger technology between CBDCs and cryptocurrencies, underlining that both make it easier to track funds. However, he pointed out a very important difference:

“The biggest difference between CBDC and crypto is the government’s ability to seize funds and control supply. “This, combined with declining cash use globally, leads to potentially dangerous patterns, as seen in countries with social credit scores.”

Meanwhile, Demchuk addressed the misconception that cryptocurrencies are often used for money laundering purposes and pointed out that fiat currencies are mainly used for illegal activities. He emphasized that:

“To begin with, there is a misleading understanding among people that cryptocurrency is often used for money laundering purposes… While the estimated annual amount of money laundered is approximately $800 billion, blockchain analytics show that only $24 billion is linked to illegal addresses on various blockchains… This Therefore, the statement that Cryptocurrency is generally used for money laundering purposes is not true.”

Demchuk emphasized that the adoption of CBDCs could be a solution to reduce money laundering schemes, especially if users need to create an account at a central bank. This will make it much easier to track and stop illegal movements of CBDCs.

He explained:

“One of the reasons why CBDC could be a solution is that CBDC transactions can be tracked using blockchain… The other reason is that CBDC transactions can be intercepted, stopped and/or funds seized by the central bank in some cases. “So all these features will make it extremely unattractive for criminals to use CBDC for money laundering purposes.”

However, he noted that if CBDCs offer good anonymity, they could be used for illegal activities at the same level as crypto.

In summary, both experts agree that although CBDCs offer some potential in combating black money and money laundering, proper implementation and regulation are essential.

Balancing the benefits and risks of CBDCs

While Central Bank Digital Currencies (CBDCs) offer promising solutions to combat money laundering, both experts highlighted potential drawbacks and risks associated with their implementation. Demchuk noted that CBDCs could potentially reduce money laundering schemes, but there are privacy concerns:

“One of the biggest concerns of CBDC is privacy because the central bank will have data on every transaction and even some data on users.”

He warned that extensive data collection in countries with issues such as corruption and the rule of law could lead to additional challenges for businesses and individuals.

Krawczyk echoed these concerns and noted that CBDCs could enable comprehensive government oversight. He warned that such surveillance could lead to the misuse of financial data for political or social control purposes:

“With CBDCs, a centralized system will track every transaction, location, and various other key performance indicators.”

Meanwhile, both experts noted that cybersecurity is a major risk associated with CBDCs. Demchuk pointed out the potential for cyber attacks that could threaten monetary and financial stability:

“The potential for the system to be hacked and exploited by criminals developing new methods could threaten monetary and financial stability.”

Krawczyk also noted the risk of data leakage from government systems and expressed concerns about the centralization of financial systems, which could affect global trade and finance:

“If banks aren’t currently storing our money, what happens if government infrastructure becomes the target of malicious actors like terrorists? “This could paralyze entire countries and impact global trade.”

Demchuk noted that while CBDCs offer potential benefits such as financial inclusion, they also raise concerns about data privacy and security.

These risks highlight the need for appropriate regulation and cybersecurity measures to ensure the safe and secure implementation of CBDCs.