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A blueprint for central bank digital currencies

Britain’s choice of world war two codebreaker Alan Turing to feature on its new plastic £50 note is ironically apt, and for several reasons. His work on cryptography speaks to the new front in monetary debates — how best to protect personal data in an age of digital payments. At the same time, the discrimination the war hero faced for his sexuality shows why privacy is important, including from the government.

In an interview with the Financial Times this week, European Central Bank executive Fabio Panetta said that a digital euro would protect consumer privacy — the public’s greatest concern over a central bank digital currency, according to a consultation by the ECB. Referring to Facebook’s attempt to launch the Libra stablecoin, Panetta warned that if central banks did not provide an alternative they would cede the ground to Big Tech. Companies could then use their dominant market position to set privacy standards.

Central bank digital currencies, however, raise questions about how to protect data from the state. If CBDCs became the dominant money then central banks could have vast data repositories of nearly every transaction in an economy. The need to clamp down on illegal money laundering would mean central banks, just like commercial banks today, would not allow individuals to hold their money anonymously — linking these transactions, however compromising, to individuals.

That might be acceptable in authoritarian regimes like China, where a digital currency project is moving ahead at pace. In democracies it is not. For this reason the Bank for International Settlements is right to call for the preservation of a two-tier financial system in its annual economic report. The so-called central bankers’ central bank advocates an account-based design with regulated private banks dealing with the public and the central bank maintaining digital currencies to make the payment system more efficient. It calls for digital identities tied to these accounts — fighting identity fraud as well as money laundering.

This arms-length structure would preserve privacy — since the state could access records only once a criminal investigation begins — and allow the private and public sector to do what they do best. The BIS argues the central bank coins could work as the plumbing of the system while banks and others could innovate and have responsibility for keeping data secure. Alternative token-based designs for a digital currency could preserve anonymity but facilitate crime.

One such token in the private sector, bitcoin, is the favoured means of payment for hackers’ ransom demands, as well as for some of those avoiding tax; this week the South Korean government seized millions of dollars’ worth of cryptocurrency from 12,000 people accused of tax evasion. Monero, a cryptocurrency that promises even more privacy than the pseudonymous bitcoin, has started to become the choice of many criminals. Cash has the same problem: at one point investigators concluded 90 per cent of £50 notes were in the hands of organised crime.

A two-tier financial system means banks could, as they do at present, have responsibility for checking identities and keeping up with “know your client” rules. While state-run identity schemes such as India’s Aadhar can be used to make sure digital currencies are going to the right place, there are valid ideological questions about government-run ID schemes. The BIS blueprint is a good start for central banks considering digital currencies, but more radical steps such as handing more personal data to the central banks need more widespread consultation and support.

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