Central Bank Digital Currency (CBDC) and illicit financial flows

Central Bank Digital Currency (CBDC) and illicit financial flows

June 29, 2021    

Cenfri, with support from GIZ and in collaboration with On Think Tanks, is hosting a series of digital dialogues to explore issues at the intersection of digital governance, digital financial services (DFS) and the Sustainable Development Goals (SDGs) across emerging economies.

The last couple of years have seen cryptocurrencies and other digital currencies rise in prominence. Generally, there are two types of digital currencies: cryptocurrencies that are decentralised (with Bitcoin as the most well-known example), and private or stable cryptocurrencies that are centralised and backed by an organisation (e.g. Facebook’s Libra).

Governments are taking divergent responses to the rise in cryptocurrencies. El Salvador recently became the first country to make Bitcoin legal tender, with government accepting payment in it. Many countries are more cautious, however, with some, like Zambia and China, prohibiting any and all use of cryptocurrencies. 

The reasons for caution include the fact that decentralised cryptocurrencies have limited trackability. Thus, they lend themselves to be used in illicit financial flows. Illicit financial flows are a fiscal drain on economies that extends beyond the use of cryptocurrencies. In Africa alone, it is estimated that as much as US $1.3 trillion (1980-2018) has been lost as a result of tax evasion and illicit financial flows enabled by slow or poor tracking of funds across different financial service providers.  

CBDC poses an official, regulated alternative to cryptocurrencies that would counter the risk of illicit financial flows. It is a form of digital currency that is centralised and backed by the local central bank, making it universally accepted and fully interoperable. It is legal tender in the same way that cash would be. 

Is CBDC the right solution for the illicit financial flow risks created by cryptocurrencies and how can CBDC be implemented in emerging markets?

In 2020, China became the first major economy to announce that it would start testing its own CBDC. A recent BIS survey found that 86% of central banks, globally, are now actively engaging in some type of CBDC work. Significantly, emerging markets represent seven out of the eight countries that are in advanced stages of CBDC work. Increasingly, CBDC is seen as inevitable for forward-looking countries rethinking the future of legal tender in a cashless world.

There are many factors for policymakers and regulators to account in answering these questions regarding the benefits, risks, prerequisites and challenges to implement CBDC. The answers to these and other questions will determine the path towards the adoption of CBDC in emerging markets, but they are by no means clear-cut.

The New Nexus convening on CBDC and illicit financial flows is hosted in collaboration with Digital Frontiers Institute and will be bringing together researchers, development partners and regulatory and policy experts to discuss these questions, looking specifically at the scope of CBDC to counter illicit financial flows. If you are interested in exploring the topic, follow and contribute to the digital board or contact karenk@cenfri.org

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