Are CBDCs the ultimate weapon against money laundering?

Could CBDCs’ transparency effectively track and curb the $3 trillion illicit financial flows? Let’s find out.

The world faces a staggering challenge: illicit funds and money laundering. In 2023, over $3 trillion illicitly flowed through the global financial system, according to a report from Nasdaq-owned fincrime technology firm Verafin. 

This includes activities such as drug trafficking, human trafficking, terrorist financing, fraud scams, and bank fraud schemes, collectively accounting for billions in global losses.

To combat these challenges, central banks worldwide are exploring Central Bank Digital Currencies (CBDCs). Since May 2020, the number of countries considering CBDCs has surged from 35 to 134 nations and currency unions, representing 98% of global GDP. 

Of these, 68 countries are in advanced stages of exploration, including development, pilot, or launch, with 19 G20 countries at advanced stages and eleven already in the pilot phase.

However, progress on retail CBDCs has stalled in the U.S., creating a gap between the U.S. and other G7 banks. In contrast, the European Central Bank (ECB) is preparing for the digital euro, conducting practical tests with transactions settled in a controlled environment.

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

Critics, however, fear that the traceability of CBDCs might drive illicit activities deeper underground, outside the reach of formal banking systems.

Despite this, the potential for CBDCs to curb illegal financial flows remains a key area of exploration and debate. Could CBDCs be the long-awaited solution to the scourge of black money and money laundering? Let’s find out.

How can CBDCs solve illicit money concerns?

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

1. 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 identify suspicious activities more effectively than traditional cash transactions.
2. Automated monitoring: CBDC systems can incorporate automated transaction monitoring tools powered by artificial intelligence (AI) and machine learning algorithms. These tools can analyze transaction patterns in real-time, flagging potentially suspicious activities for further investigation.
3. 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.
4. Global collaboration: CBDCs can promote global collaboration in combating money laundering by enabling seamless cross-border transactions. This can facilitate information sharing and enhance the effectiveness of international anti-money laundering (AML) efforts.
5. Regulatory compliance: CBDCs can streamline regulatory compliance by embedding AML regulations into their design. This can ensure that CBDC transactions comply with AML laws and regulations from the outset.

Top Use Cases for CBDCs

CBDCs offer a range of promising applications across various sectors. Here are the key use cases:

1. Domestic payments: CBDCs provide a digital alternative to physical cash, allowing for electronic transactions within a country, improving convenience and efficiency while reducing reliance on traditional banking systems.
2. Cross-border payments: CBDCs streamline cross-border transactions, making them faster, cheaper, and more transparent compared to traditional methods, benefiting businesses, individuals, and economies.
3. Remittances: CBDCs offer expatriates a cost-effective and efficient way to send money home, reducing fees and processing times associated with traditional remittance channels.
4. Financial inclusion: CBDCs bridge the gap between the unbanked or underbanked populations and formal financial services, empowering individuals to participate in the formal economy.
5. Government benefits and subsidies: CBDCs enable governments to distribute social welfare benefits and subsidies directly to citizens’ digital wallets, enhancing transparency and reducing administrative costs.
6. E-commerce: CBDCs facilitate seamless online payments, providing merchants and consumers with a secure, low-cost, and efficient payment method, stimulating e-commerce growth.

The recent sandbox experiments conducted by Swift and 38 global institutions have shown the potential of CBDCs in various complex scenarios. 

These experiments illustrated the interoperability between different digital networks, the automation of trade payments through smart contracts, and the facilitation of atomic delivery versus payment (DvP) across multiple asset and cash networks.

The experiments reflected how CBDCs could simplify trade flows, stimulate growth in tokenized securities markets, and enable efficient FX settlement. 

Importantly, they showed that financial institutions can achieve these benefits while leveraging their existing infrastructure.

Participants from central banks, commercial banks, and market infrastructure providers stressed the importance of interoperable networks in the CBDC ecosystem to avoid fragmentation and ensure frictionless transactions.

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

Is crypto a major villain and could CBDC help?

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

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

“Crypto may be associated with promoting money laundering, but this is a common misconception. Crypto does not promote anything besides owning your own assets without relying on a third party.”

Krawczyk also noted the similarity in ledger technologies between CBDCs and cryptocurrencies, highlighting that both make it easy to track funds. However, he pointed out a crucial difference:

“The major difference between CBDC and crypto is the government’s ability to seize funds and control the supply. This, combined with the decreasing use of cash 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, pointing out that fiat currencies are predominantly used for illicit activities. He highlighted:

“To begin, there is a misleading understanding among people that crypto is often used for money laundering…The estimated annual amount of money laundered is about $800 billion, while blockchain analytics indicate only around $24 billion linked to illicit addresses on various blockchains… Therefore, the statement that crypto is often used for money laundering is not correct.”

Demchuk emphasized that the adoption of CBDCs could be a solution to decrease money laundering schemes, especially if users would need to create an account at a central bank. This would make tracking and stopping illicit movements of CBDCs much easier. 

He explained:

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

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

In a nutshell, both experts agreed that while CBDCs offer some potential in combating black money and money laundering, proper implementation and regulation are essential.

Balancing 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 mentioned that while CBDCs could potentially decrease money laundering schemes, there are concerns about privacy:

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

He cautioned that in countries with issues like corruption and weak rule of law, extensive data collection could lead to additional challenges for businesses and individuals. 

Krawczyk echoed these concerns, noting that CBDCs could enable extensive government surveillance. He warned that such surveillance could lead to misuse of financial data for political or social control:

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

Meanwhile, both experts mentioned cybersecurity as a major risk associated with CBDCs. Demchuk cited the potential for cyberattacks, which could threaten monetary and financial stability:

“The potential that the system could be hacked and exploited by criminals who develop fresh methods, would threaten monetary and financial stability.”

Krawczyk also noted the risk of data leaks from government systems and raised concerns about the centralization of financial systems, which could impact global trade and finance:

“If it’s not banks storing our money now, what will happen if government infrastructure becomes a target for malicious players like terrorists? This could paralyze entire countries and impact global trading.”

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

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