SANDBOXING: A FINANCIAL INNOVATION

Azerbaijan aims to become a regional leader in financial innovation. To achieve this, the Central Bank of Azerbaijan (CBA) has created a so-called sandbox—a special regulatory regime where startups and financial giants can test their most ambitious ideas.

The Sandbox is not just a playground but a rigorously controlled environment where financial innovations are tested. Just as laboratories enable scientists to create new materials, this platform allows financial engineers to develop new instruments—from cryptocurrencies to cutting-edge payment systems.

Why is this significant? Well, Azerbaijan, like many other nations, aims for financial inclusion, ensuring every citizen has access to financial services. Innovation is crucial to achieving this goal; new technologies can enhance the accessibility, convenience, and security of these services.

It works like the following: startups and companies submit applications to the CBA. If the idea is innovative and promising, it receives approval, and testing begins. The CBA closely oversees the entire process to ensure the innovations do not pose risks to the financial system.

Process and Criteria for Participation

Participation in the special regulatory regime involves five stages: deciding on the application of the regime, accepting and pre-evaluating applications, conducting a final evaluation, testing, and terminating participation. The Central Bank has set several criteria for product innovation: products must be new to the local market, enhance financial inclusion, ensure safety, and be ready for real-world testing. Additionally, their implementation should not create potential systemic risks or increase the likelihood of money laundering and terrorist financing. Therefore, it is necessary to analyse the risks and identify measures to mitigate them, including ensuring user data confidentiality. Participants must also have sufficient financial and human resources to deliver the product safely.

So far, the CBA has received 21 applications for participation in the special regulatory regime. These applications pertain to testing products in virtual assets, payment services, and insurance. Their preliminary assessment has already begun, taking 20 working days, with the possibility of extension if additional documents or information are required. The number of applications received reflects significant interest from market participants and readiness to innovate.

Once contracts are finalised, the products will undergo testing for 12 months. A decision will then be made regarding their potential continuation for further market introduction; however, new regulatory arrangements will need to be established. Otherwise, the project will be closed.

Currently, the Sandbox is not accepting applications for innovative products as the application period has expired. In some countries, Sandboxes operate in phases, while others remain open year-round for testing innovative products.

Potential benefits of the special regulatory regime could enhance financial inclusion, consumer protection, and confidence in the financial system. Successful testing of products and services is also expected to lead to a new regulatory framework that ensures stability and transparency across the entire market.

International Experience

The CBA plans to develop a specialised regulatory regime, which in the future may become an open application system to allow for continuous testing of new products and services. This will contribute to the constant updating of financial technologies and maintaining a high level of innovation in the market.

For consumers, this means a wider range of financial services, more convenient payment and investment methods, and importantly, job creation.

It's clear that Azerbaijan is just starting this journey, but the "sandbox" is not just an experiment; it's a strategic initiative that could position the country as a regional leader in financial technology.

The Azerbaijani model, with its unique attributes, generally aligns with international trends. However, further development requires studying experiences from other countries and adapting best practices to local conditions.

This includes the UK, one of the first nations to implement a regulatory sandbox focused on fintech, blockchain, and cryptocurrency. Singapore has also developed a robust innovation ecosystem that actively attracts fintech startups from around the globe and is recognized as one of the most progressive jurisdictions for regulating digital assets. Singapore's "sandbox" allows cryptocurrency exchanges to test new products and services in a controlled setting. Switzerland is known for its liberal approach to financial technology regulation and favourable conditions for cryptocurrency firms, including access to banking licenses. Australia emphasizes collaboration between regulators and the private sector, while the UAE aims to establish itself as a regional fintech hub with attractive conditions for foreign companies.

Focus on Crypto Exchanges

Sandboxes for crypto exchanges are crucial for the growth of the digital asset market. They allow innovators to test new ideas in a secure environment while enabling regulators to manage risks and protect investors.

The Central Bank of Azerbaijan is preparing to test crypto exchanges, as relevant projects are among the submitted applications. Currently, the Central Bank continues its study as part of its strategy to regulate the cryptocurrency market. The country's chief banker, Taleh Kazimov, stated that a decision will be made next year. "Cryptocurrencies are already being traded in Azerbaijan, so control and regulation of this market are essential," he asserted.

The goal of creating sandboxes for crypto exchanges is to foster a favourable environment for developing and implementing new technologies in digital assets while minimizing risks for investors. This involves establishing a safe and transparent trading environment for digital assets and ensuring stability in the financial system through the regulation of crypto exchange activities. According to global practices, crypto exchanges wishing to participate in the sandbox must undergo stringent licensing and registration procedures. Regulators assess financial stability, team experience, compliance with regulatory requirements, and effective internal control systems during this process.

The sandbox may also impose restrictions on transaction types—such as prohibiting margin trading or derivatives—and limit the amount of funds clients can invest in digital assets.

Cryptocurrency exchanges are required to maintain a high level of security for user data and funds. This includes mandatory multi-factor authentication, storing funds in cold wallets, conducting regular security audits, and implementing systems to prevent money laundering and terrorist financing.

Given these requirements, crypto exchanges must provide regulators with detailed reports on their operations, including trading volumes, customer numbers, and financial results. "Sandboxes" also enforce strict consumer protection mandates by ensuring transparency regarding risks associated with investments in digital assets.

Thus, establishing and developing the sandbox marks an important milestone in strengthening the country's position in financial technologies and enhancing its competitiveness on the international stage.