Central Banks Ruminating On Privacy Issues of CBDCs

Jul 23, 2021

As “decentralized” digital currencies such as Bitcoin are becoming more mainstream, the world’s central banks are beginning to take notice. Many are exploring ways to jump on the virtual bandwagon, lest the money evolution passes them by.

As central banks explore the use of a “digital complement” to cash, the term for this currency has become known as a Central Bank Digital Currency or (CBDC). Just like physical cash, the CBDC is essentially money issued by the central bank that can be used for ordinary payments, in its national currency, and is exchangeable with commercial bank money.

China became the first major economy to release its first trial digital currency in April 2020. It is estimated that more than 150 million RMB ($23 million US) of the yuan in digital form is currently in circulation. 

Although the US is lagging behind in its own exploration, Fed Chair Jerome Powell and Secretary Janet Yellen have indicated that the US will begin pursuing the “digital dollar” more intently. 

The Balance Of Privacy And Transparency

Of course the elephant in the room that must be addressed is the ongoing issue of privacy and transparency when it comes to digital currencies. 

The tension is more accurately seen if CBDCs decide to provide full transparency. That would require all transactions to be fully visible to law enforcement. This solution would  be violating the human rights law on privacy and data protection. 

On the flipside, if full privacy is provided without any limitation, where no identifiable information is given on these transactions, then the result will be providing an arena fully vulnerable to abuse and a vehicle for illicit purposes. This can have a devastating impact on the society. 

Citizens and businesses are convinced that there should be at least some “regulated access” by financial authorities on the monetary and data flow in order to catch any suspicious activity. 

Can CBDCs Ever Be Anonymous?

When it comes to complete anonymity, cash is king. Why?  It does not disclose the identity of the person who pays or the recipient. Cash payments do not leave a trail. 

However, this is not possible for CBDCs.  Here are the reasons:

 

  • CBDC Payments Are Digital.

 

The fact that it is a digital payment means that it is traceable. As it moves, it leaves identifiable “digital footprints.” These footprints can facilitate the transaction to be followed. If there is no remote ledger and the tokens are stored locally, payments can still be traced if someone gets a hold of the device.

 

  • All CBDC Payments Have A Remote Ledger.

 

The ledger itself will record all transactions. Even though the identities of both the      

payer and payee are unknown, the information recorded will include the time of payment, digital wallets, and the encryption keys.

 

  • Digital Payments Are Required By Legal Regulations To Be “Non-Anonymous”.

 

In the EU, the regulations state that “account-based systems” must have registers in order to determine the identity of the owner of each account. Even CBDCs that are stored remotely will need to adhere to this regulation, regardless if there are tokens or not. 

Governments Continue To Explore Virtual Currencies

Depending on the economic condition of each country, the reasons that governments would consider pursuing virtual currencies are many.

According to the IMF, the transfer and management of cash is prohibitive and using this technology can vastly reduce these expenses. They also believe that it will promote “financial inclusion”, meaning those unbanked would have easier access to funds via their phone. 

Also, private companies thrive on competition and therefore need to meet “transparency standards” as well as restrict illegal activity. Finally, through CBDCs, monetary policy can move seamlessly.

Only time will tell if the right balance of privacy and transparency will be achieved with the most effective solutions.

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