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In recent years, central banks around the world have begun researching and developing their own versions of digital money, known as Central Bank Digital Currencies or CBDCs. Some countries are well-advanced in their efforts, while others are taking a wait-and-see approach: According to the Bank for International Settlements, 86 percent are exploring the possibility and 14 percent are up to the pilot stage. Whether proactive or reactive, these national projects have global implications: If one government achieves greater visibility and control over their own financial systems via a CBDC, it might also collect data on all who transact with it, including trade partners and individuals overseas.
«For democratic nations,
privacy should be prioritised
not only in the design
of their own CBDC,
but in response to
how other states proceed».
Privacy deemed a trade-off
Central banks are not only responsible for monetary and financial stability, they also administer physical bank notes. At the current moment however, they are not hosting online transactions between regular account holders: When we use existing electronic payment systems and credit cards, or make a transfer via internet banking, we are not using central bank money but rather commercial bank money – a liability that the private sector financial institutions hold to the central bank. The commercial bank or authorised financial provider will convert this electronic «I owe you» (IOU) into cash at the customer’s command and honour customer payments assuming it has sufficient balances to do so. Financial services then interact with technological infrastructures that are maintained by central banks and intergovernmental organisations and used to reconcile accounts.
A CBDC potentially eliminates the commercial bank IOU by creating the equivalent of digital cash yet doing away with the anonymity that cash provides and the arms-length (and highly regulated) arrangement between private sector financial services and government. Depending on the design, governments may see data on every transaction and match that data with other information. For any government, the appeal of a direct CBDC is that it could make it easier to combat money laundering, tax evasion and terrorism financing. The flipside of these law enforcement benefits is greater capacity for state surveillance and the ability to coerce citizens and firms by stopping payments.
It is not fully clear yet what stance most central banks will take: In their reports on CBDCs, they discuss privacy in terms of trade-offs rather than losses, weighing up the tantalising opportunity to trace payments with the possibility of cryptographic privacy preserving technologies. Some, such as the Bank of England, explicitly state that their mandate is to provide monetary stability, not to provide untraceable or anonymous payment methods – yet specify the need for a CBDC to be compatible with privacy laws including the General Data Protection Regulation (GDPR).
How CBDCs are designed, including the degree to which the separation between state and private financial services is maintained, is of utmost importance. These are the three options:
- At one extreme, a central bank may grant consumers an account with the central bank, effectively creating a retail arm of the central bank. «Digital cash» of this nature could be exchanged in a peer-to-peer fashion without the need for an intermediary service.
- At the other extreme, a government would licence one or more financial service providers who would store their customers’ funds in a central bank account. The companies then receive a central bank liability in return that they could package as a stablecoin (a digital currency…