It is widely recognized that blockchain can significantly reduce the cost, speed and complexity of cross-border payments.
But the monumental task of regulating this market has proven a stumbling block on the consumer side – with issues such as collecting and sharing know-your-customer (KYC) data to prevent money laundering taking place. turned out to be particularly tricky.
According to a new report from the Bank for International Settlements (BIS).
The solution proposed by the bank in its May 20 white paper, “DLT-Based Improving the Efficiency of Cross-Border Payments – A Legal and Regulatory Perspective”, is sweeping: rethinking the entire regulatory system to focus on distributed ledger technology (DLT) – the systems on which these transactions take place – rather than individual companies like banks and wire transfer services such as MoneyGram and Western Union.
“Improving cross-border payments presents enough challenges to require a ‘comprehensive approach,'” the document states.
But the work is worth it, said BIS.
No quick fix
“DLTs have raised high expectations,” the authors said, noting that “cross-border payments suffer from high costs, low speed, limited access and insufficient transparency.”
Among these expectations, according to a team led by Dirk Zetzsche, professor at the University of Luxembourg, are that it could provide “faster processing (near real-time), easier reconciliation and greater transparency on fees , while renouncing, for example, the risk linked to intermediaries in the payment chain.
The broader benefits include support for economic growth, trade, international development and financial inclusion, he said.
Beyond that, the immutable and verifiable nature of blockchains and other digital ledgers means that digital identity information could be “shared and verified across a network of organizations aiming for KYC compliance.”
This is why many governments studying central bank digital currencies, or CBDCs, are using or at least studying blockchain and other DLT solutions.
Yet the “distributed” part of the DLT does not really work with the existing international legal framework, which “traditionally assumes that functions are concentrated in a single entity”.
Trying to fit traditional financial law into a DLT framework is like pushing a square peg into a round hole.
This is an increasingly common phenomenon in decentralized finance (DeFi) protocols, which designers say lack a centralized management to take responsibility for — a view the BRI does not share.
See more: Bank for International Settlements calls DeFi decentralization an illusion
Registry or node?
In its paper, the BIS defines the conflict as one between a ledger-based approach to regulation and the existing focus on the “node” – a node being a centralized institution currently required to provide the information needed by the enforcement of AML and other regulations on cross-border payments.
The ledger perspective quickly becomes complex and somewhat academic, as each participant has no real control over the blockchain.
Under it, “the entire network is subject to regulation and each participating entity is only subject to regulation as a kind of reflection through its participation in the network”.
Although it would be difficult to create such a system — especially since it would require international coordination — the use of a DLT-based system would have several important advantages, such as improving competition between payment service providers and reducing the risk of suspicious transactions by standardizing participant identification.
Cross-border payment platforms would be required to integrate smart contracts and other RegTechs that mandate, for example, a specific type of KYC identification. Beyond that, DLT transactions are much easier to trace all the way down the chain.
But it does mean that the rules that cross-border payments platforms have to integrate would have to be agreed upon by all nations using that platform, which is a heavyweight.