Hush money
Only a handful of countries have active CBDCs in circulation but, by the end of last year, over 130 countries had announced plans to develop or pilot their own schemes. China has conducted large-scale trials of its digital yuan. The UK and the European Union have yet to decide which side of the fence their central banks will occupy. It is a political as well as a financial choice. Republican opposition to CBDCs are largely based on claims it would make it easier for government agencies to track individuals’ transactions.
Improved surveillance of how money moves is one reason some believe countries should introduce CBDCs. Pakistani think tank Prime Institute sees digital cash as a way of cracking down on corruption, making it easier to see how large volumes of money move around. Nigeria’s central bank designed the eNaira to be traceable. The blockchain transactions link to the accounts of known users. Coupled with the difficulty of gaining access to the accounts in the first place, take-up has been slow in Nigeria. However, Prime’s analysts believe Pakistan could overcome poor take-up by choosing to pay a universal basic income to citizens using the CBDC.
Some level of surveillance seems inevitable: central banks do not want to give up the ability to track money-laundering operations. The question is how to balance that against a growing understanding that lack of privacy will hinder deployment of CBDCs. However, in a speech at a conference last November organised by the European Central Bank and the Centre for Economic Policy Research, Banca d’Italia governor Fabio Panetta argued the accusation of privacy issues is better aimed at the fintech giants. “Through their involvement in payments, large technology companies have access to extensive customer information, including income, preferences and demand patterns.” And they have strong commercial incentives to use that data, he claimed. A digital euro would have “a notable advantage due to the absence of profit-maximising incentives on the part of its issuer, the ECB”.
The conflicting demands over privacy will probably drive some of the technical choices surrounding CBDCs. Some systems, such as prototypes developed by MIT’s DCI, focus more on limiting how much information each transaction stores and for how long. In one implementation, the system identifies the payer and payee but does not bother to record that information in the final ledger, only the resulting cash balances. This kind of system has the advantage of high throughput through parallel operations. Funds that belong to different people can be exchanged using completely different servers that do not try to align their results on every transaction. Synchronisation takes place later in the background.
Another option is to make it possible to track transactions so that police can examine records in anti-money laundering investigations. But rather than just hand the police permanent access, ‘accountable decryption’ provides some privacy guarantees. Researchers at the University of Birmingham designed one system that builds on top of the trusted execution environments supported by almost all mobile phones, adding a layer that securely logs any successful accesses to the underlying data.
The same cryptoprocessors sitting inside mobile phones may be the key to keeping another important attribute of physical cash: the ability to perform transactions out of reach of the internet. The African payment service M-Pesa already offers notionally offline transactions, but this still relies on access to a network with texting services. CBDCs will need to make it possible to handle unanticipated transactions without a network connection. A basic smartcard armed with a wireless interface could receive the money.
“The private sector can fail in a way that a central bank might not” Carmelle Cadet, CEO of fintech company Emtech
In 2020, Visa described a prototype for these kinds of offline digital-cash transactions that also uses lazy synchronisation similar to MIT’s proposal. But it has additional protections to prevent double spending while offline. Similar to accountable decryption, logs designed to be immutable should prevent attempts to spend the same money multiple times before the devices synchronise with the network. As with online transactions, if the central bank opts for a high-privacy implementation, the logs need not show who paid whom, just how much to deduct or add to each user’s balance.
The Project Tourbillon prototype, developed by a team formed by the Bank for International Settlements (BIS), took a different approach. The designers opted for single-use tokens that have to be loaded from a bank account. This effectively provides payer anonymity, whereas the payee has to identify themselves to see the money deposited into their account.
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