The potential progress of CBDC remained in the headlines throughout 2022. Towards the end of the year, it was announced that the central banks of Sweden, Norway, and Israel collaborated with the Bank of International Settlement (BIS) to investigate how CBDCs can be used for international retail and remittance payments. The Bank of Canada also partnered with MIT to conduct their CBDC research, and in the US, while some Federal Reserves remain “agnostic” after investigation, the White House released new framework that included CBDCs in September.

The second Finextra Digital Asset Series webinar focused on the topic of central bank digital currency (CBDC) and brought together several key voices from different perspectives. As CBDC becomes more of a reality, the practicalities must be considered. Further, what might a country gain from a CBDC, what role can they play in financial crime, and what area of financial services could they be used for?

In 2023, CBDCs are likely to remain an important trend to monitor as the results of these experiments and pilots emerge. It has already been announced this year that the Turkish Central Bank has completed its first CBDC pilot transaction.

In light of this, we decided to highlight some of the most crucial points that were raised during our Digital Asset Series webinars, one of which I moderated.

The webinar was comprised of three speakers, including:

• Lewis Sun, global head of domestic and emerging payments, HSBC
• Brett Walton, business development manager, Fluency
• Faisal Islam, regtech/fintech advisor, Sentinels

Political interoperability

One topic that the panellists kept returning to was interoperability. This refers not only to the technological problems, but as argued in the webinar, political and legal roadblocks can cause more of an issue.

Sun raised this and said that “at this moment, in a lot of locations, potentially managed by different central banks, a lot of proof-of-concept and pilots are being undertaken. Given that there are different service providers using different infrastructures and technologies, I think, at this moment, it is a little fragmented.”

A previous webinar in the Finextra Digital Asset Series on ‘Navigating CBDC unknowns’ covered these contentious issues, particularly the technologies needed to be used to make CBDC a reality and whether distributed ledger technology (DLT) is the way forward.

Walton, who worked with both the Bank of England and the ECB to design their CBDC systems, agreed that “the main thing for us from a tech perspective is the infrastructure. We can’t control regulation; we can’t control monetary policy. We can control technology and how that integrates within somewhere like HSBC and the infrastructure there.”

He added that from working with the ECB and the Bank of England, they are both asking for their own needs. But: “how are the Pound and Euro going to talk?” He continued: “having that interoperability thought of at the forefront of the design [is important], rather than getting to a point and saying right, we’ve issued an eGBP, so how can we talk to an eEuro. That’s a lot of the discussion we’re having right now with the ECB and the Bank of England.”

To this point, Sun argued: “It’s not just a matter of different infrastructures and different technical infrastructures, it is also a matter of the standards and the principles of governance and supervision. And also, the process flow risk tolerance level. Those kinds of soft factors also require a very heavy degree of harmonisation. Otherwise, it will be extremely difficult to achieve that interoperability purely from a technical angle.”

Islam also  believes that the issues going forward with CBDCs are wider than just technology. “Technology is the one we like talking about because it is one that we can actually solve, but that’s not the one that is actually giving us the biggest problem right now at scale.”

Islam explained: “The things that you cannot fix, which will perpetually be a problem and have been talked about in all of the pilot projects, are things that are deeply rooted political and legal troubles.”

Elaborating on this, he said: “The problem is that every one of these countries are deeply nationalistic and also have their own political whims, which can change from time to time. And so, at the heart of whichever currency, and while we might like to think that monetary policy is for the most part independent in most countries, it certainly isn’t.”

Islam later said that one of the aims of a CBDC should always be beneficial to the citizens, and an inherent problem for this will be the legal and political problems across borders which could result in an inefficient CBDC system.

CBDCs will not fix all current problems and using technology as a scapegoat for these problems is not the way forward, in Islam’s view.  “The main route of why a lot of centralised monetary policies, and centralised monetary objectives don’t go forward, is still not going to be fixed as a result. In fact, I’m scared that it will actually hide a lot of the political and legal problems itself because it will distance the actual problem from the scapegoated problem.”

Data security

Returning to the topic of interoperability, Islam also highlighted challenges surrounding data security.  “At some point in time a central bank has to be able to interoperate with multiple other agencies. The sharing of information across multiple agencies is where that leak of identifying information will come from.”

In response, Walton stated: “In our experience with central banks, it would seem that there would be a two-tiered model. You’ll still have someone like HSBC that will be fulfilling the KYC and AML functions from that perspective.”

He continued that at Fluency they see the solution as a ledger stored account-based solution, “from an end user perspective privacy is a major thing and needs to be at the forefront of the design in whichever CBDC. […] Each part of the transaction is only seen by that individual; the information is not shared throughout.”

Sun further added: “Currently, the data privacy and confidentiality requirements are very strict. I think commercial banks and a lot of the big institutions are following industry standards in terms of guidelines and principles to make sure we will meet all the compliance requirements in data privacy.”

Echoing Walton’s point, Sun said, “different parts of institutions will control and only manage their own information, only individuals will have the full picture.”

Civil liberties threatened by CBDCs

Another political problem that comes into play with is around personal data and  citizen rights. Islam argued that “the main flaw of a CBDC having any kind of identifying information attached to it is that it gives credence to decentralised mass cryptocurrencies which essentially give the promise of sovereignty. And while it might be argued that of truly anonymous decentralised cryptocurrency can be used for financial crime, the other is also true which is that perfect privacy of its citizens is essential for a country to not essentially have full control over its people.”

To illustrate this point Islam used an example from Canada in 2022 where the Canadian government froze the bank accounts of truckers who were attending protests against Covid-19 regulation requirements. On this, Islam said: “essentially what we found was that in a Western Democracy that the government was able to enact financial authority on the right to protest.”

Islam further warned: “If you think about this being absolutely transformed into a centralised currency, you have to imagine that at the end of the day it will exert even more power and control from the central bank to its sovereign citizens.”

This concern for the civil rights of countries’ citizens when it comes to CBDCs is something which remains unanswered, and should continue to be a concern as they are further developed throughout 2023.  

The full webinar is available for viewing here: Digital Assets Series 2022: CBDCs and Digital Currencies - Transforming the payments landscape, and we recommend you stay up to date with any new CBDC updates with Finextra’s PREDICT 2023 Series.

If you’re interested in contributing to Finextra’s PREDICT2023 Series, get in touch with us for more information: content@finextra.com