How Digital Asset Technology Is Shaping Banking
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The brisk adoption of the tokenization of real-world assets (RWA) among traditional banking systems and financial service providers paves the way for the development of Central Bank Digital Currency (CBDC), on track to become the most prominent digital currency in the world.
During his session at the 35th Annual ACFE Global Fraud Conference, David Utzke, CFE, CDFE, CFI, advised law enforcement, investigators and fraud examiners to adopt new investigative methods as digital asset (anything digital that has value, establishes ownership and is discoverable) technologies evolve. Utzke, Wave Digital Assets senior director of Digital Asset Security and Emerging Technology Research and Education, discussed the common structures and delivery methods available for retail CBDC and their inherent cybersecurity vulnerabilities.
CBDC Types and Structures
Utzke dove into CBDC by defining some key terms. Known as “digital fiat currency” (government-issued currency not backed by a commodity) or “digital-base money,” a CBDC is a virtual e-currency that acts as a digital representation of a country’s fiat currency. He also differentiated between retail CBDC, a digital fiat currency issued and controlled by the central bank for use by the public, and wholesale CBDC, a digital fiat exclusively for financial institutions that hold reserve deposits with the central bank.
Retail CBDC delivery systems can be:
Account based: An e-currency system that requires an account to be held by each person with a payment system that clears transactions controlled by a central authority or trusted third party.
Tokenization based: An e-currency system in which households and businesses hold digital wallets, which allow the Federal Reserve to know the dollar quantity in circulation, which users hold how much and what transactions have been conducted.
Value based: An e-currency system that issues a prepaid value that can be stored locally on a card or a mobile phone app.
Utzke outlined these CBDC structures:
dCBDC (direct CBDC) makes it possible for everyone from big banks to informal workers to deal directly with the central bank. “This may work in smaller countries. The U.S. Federal Reserve couldn’t handle that many accounts,” Utzke clarified.
iCBDC (intermediary CBDC) is a direct payment claim against the central bank, but accounts are held, and obligations are paid by intermediary banks. “This introduces some of the biggest banks to be intermediaries to deploy their digital currency,” he said.
sCBDC (synthetic CBDC) is a public-private partnership in which a licensed e-money provider stores client funds in a central bank. In return, they receive a central bank liability packaged however they see fit into a publicly tradeable digital currency that remains fully backed by central bank reserves. “This is also called a hybrid system. It’s not just built around the public sector but also the private sector. That’s something in the U.S. that’s being tested,” Utzke explained.
Making CBDCs a Reality
Two countries recently launched retail CBDC projects that resemble conventional payment systems. In 2020, the National Bank of Cambodia launched Project Bakong, and the Eastern Caribbean Central Bank launched the Sand Dollar project.
In the U.S., BNY Mellon revealed in 2022 that it would provide custody services for digital assets with plans to “develop an entire suite of digital asset services, including execution and tokenization.” As of June 2022, BNY Mellon had $43 trillion in assets under custody and/or administration and $1.9 trillion in assets under management.
Last year, HSBC announced it had partnered with Swiss-based institutional digital asset custody and trading firm Metaco to offer a custody service for digital assets, including tokenized securities.
Asset Tokenization
Utzke detailed the use of distributed ledger technology (DLT) to represent ownership or rights to an asset as a tradeable on- or off-ledger token. RWAs are physical assets, such as precious metals, commodities, real estate, land, equipment or natural resources, that have an intrinsic value due to their substance and properties. According to Utzke, asset tokenization is among the most promising use cases, with DLT having an estimated value of more than $100 trillion annually.
Utzke outlined four classes of assets that can be tokenized and transacted on a digital ledger:
Tangible: assets that exist in material form, such as a house.
Intangible: assets that aren’t in material form and often only exist due to law, such as patents and copyrights.
Fungible: tangible or intangible assets that can be replaced by another item of identical quality and quantity, such as precious metals, energy and cash.
Nonfungible: tangible or intangible assets that can’t be divided due to their unique qualities, such as art and music.
Digital Asset Challenges
With more mainstream banking and financial institutions stepping into retail CBDC and tokenization of digital assets, Utzke warned of cyberattack vulnerability. Specifically, he cautioned CBDC adopters to be aware of security threats posed by credential theft and loss, users with privileged roles, system integrity and “double spending,” and quantum computing.
Utzke outlined some problems with digital assets, including the risk of real-time gross settlement fraud and the threat to banking stability posed by a digital run within the dCBDC system. He warned the overall CBDC ecosystem will be a high-value target once deployed, attracting attention from organized crime syndicates and nation states capable of large-scale attacks.
He identified four cybersecurity treats to CBDC:
Credential theft and loss.
Users with privileged roles.
System integrity and “double spending.”
Quantum computing.
As developments in CBDCs continue to unfold, Utzke pointed out that many questions remain unanswered. “Will physical currency still be allowed to circulate simultaneously? Will transactions between private and public retail CBDCs be allowed? Will retail CBDC deposits be protected by FDIC?”
