Regulatory framework for CBDs and GSCs: IMF's policy paper, "Digital Money Across Borders: Macro-Financial Implications"
On October 19, 2020, the International Monetary Fund (IMF) published a new policy paper. “Digital Money Across Borders: Macro-Financial Implications” (the Report). The Report discusses the pros and cons of two important virtual currencies: central bank digital currencies (CBDCs) and global stable coins (GSCs). In particular, the Report concludes that CBDCs “do not qualitatively change the economic forces that lead to the international use of currencies but quantitatively could reinforce the incentives behind currency substitution and currency internationalization.” Such incentives include financial inclusions of unbanked, hygienic disbursement of government funds to households and firms during emergencies such as the coronavirus disease 2019 (COVID-19) pandemic, and lower cross-border transaction costs, especially for small transactions. In the case of GSCs, they may widen access to services on social networking and e-commerce platforms of global scale.
The Report also discusses the potential risks imposed by digital money adoption across borders, such as pressures for currency substitution, vulnerability from currency mismatches, and concerns that “without appropriate safeguards, [the use of digital money across borders] could facilitate illicit flows and make it harder for regulatory authorities to enforce exchange restrictions and capital flow management measures.” GSCs that represent new and independent units of account could impose additional challenges.
CBDCs are a digital form of fiat money that is issued and fully backed by a central bank. CBDCs are built upon distributed ledger technology (DLT) or similar blockchain technology-equipped networks and can have specific functionalities built into the digital form itself. These new functionalities can provide a real-time picture of a country’s economic data for GDP estimates and other economic activities, as well as eliminate multi-layered clearance and settlement infrastructural impediments. Globally, many central banks are exploring the possibilities of issuing CBDCs to complement cash as a new means of payment, but not as a new monetary unit. In general, CBDCs fall into two categories: (i) “wholesale” CBDCs, which help to build more efficient clearing operations between a central bank and its member banks, and (ii) “retail” CBDCs, which would be used by the general public as a digital form of fiat money that could be legal tender. In the Report, IMF’s focus was on “retail” CBDCs.
GSCs are stablecoins. The Report defines GSCs as “a type of private digital money, issued by Big Techs with the potential for widespread adoption,” and noted that “stablecoins may differ from traditional e-money schemes as they do not necessarily guarantee redemption at a pre-established face value denominated in the unit of account.” The Report also notes that GSCs would not be currency nor a payment instrument, unless the law in a particular country otherwise so determined. Compared to other cryptoassets (eg, bitcoins), GSCs will not exhibit large price volatility as their valuations are linked to other existing assets (eg, assets denominated in one official currency or as a basket of globally utilized official currencies), algorithms or tangible assets (eg, gold or other precious metals).
In addition to the discussions of the potential benefits and risks imposed by CBDCs and GSCs, the Report states, “Regulatory frameworks also have a crucial role in shaping the scale and scope of CBDC and GSC use.” The Report further presents recommendations of such legal frameworks, which mainly focused on the anti-money laundering and combating the financing of terrorism (AML/CFT) framework, as follows:
- Adoption and use of CBDCs and GSCs require a careful review of the existing legal framework and likely amendments to the monetary, central bank, financial, contract, property, insolvency, and tax laws.
- Effective implementation of a robust AML/CFT framework is needed to mitigate the risk of digital money becoming a tool for criminal activities. The Report notes that while some AML/CFT measures, such as transaction monitoring, may be easier to implement in a DLT context, others, such as verification of the identity of the end users, may be challenging. The Report also emphasizes the need to establish a framework for the licensing or registration of professionals dealing with virtual assets and for risk-based monitoring.
- Care needs to be taken with the design of CBDCs to ensure the sound and effective functioning of the AML/CFT framework. In the case of a retail CBDC, AML/CFT measures will be implemented by the participating commercial banks and other service providers, with little change to the traditional implementation of the AML/CFT framework. In the case of a wholesale CBDC directly operated by a central bank, the central bank itself may need to implement AML/CFT measures, including adequate customer due diligence measures.
- GSC service providers will need to be (i) licensed or registered and (ii) subject to effective supervision or monitoring. The Report notes that GSCs could have serious AML/CFT concerns due to their potential mass-market use and greater offerings for person-to-person transfers.
- International cooperation will be critical to change the AML/CFT framework. The Report shows the continued efforts among central banks, international organizations and the world’s political and financial leadership structures to establish a harmonized regulatory framework and international standards and best practices for the application of DLT and blockchain technology to traditional financial systems and cross-border transactions and payments. The legal framework would call for international cooperation on the multilateral platforms in order to reduce the risks to monetary and financial stability of a country, criminal activities, cyber-attacks, and breach of consumer data protection and data privacy laws.
Learn more about the implications of the Report by contacting either of the authors.
