Can CBDCs ensure privacy?
Digital currencies issued by central banks (CBDCs) are becoming increasingly popular, which raises serious concerns in society. The new payment method will allow the government to censor transactions and obtain more information about citizens’ financial activities.
Confidentiality in modern payment systems is a significant concern since user data can be tracked by banks and payment service providers. In the event of a breach, it can fall into the hands of criminals
Confidentiality today
In reality, traditional payment systems do not provide a high level of confidentiality. Each person must undergo identity verification before using banking services, and their personal data is transmitted to intermediaries involved in transaction processing.
According to recent research by the European Union, the volume of digital payments has surpassed the volume of cash payments for the first time. However, the survey showed that citizens highly value the high level of confidentiality provided by cash payment methods.
However, the high level of payment confidentiality has its drawbacks, making it more difficult for financial institutions to comply with the standards of the International Anti-Money Laundering Group, which also combats terrorism financing and the spread of weapons of mass destruction.
How confidential are CBDCs?
Currently, central bank digital currencies (CBDCs) do not have a unified standard, so the level of confidentiality may differ depending on the jurisdiction. For example, the European Central Bank currently sees the following possible forms of confidentiality for digital euro transactions:
- Full transparency, which entails visibility of all transaction data for the central bank, including KYC data;
- Transparency for intermediaries, which involves visibility of the same data as mentioned above, but only for the counterparties involved in the transactions;
- A certain threshold of confidentiality, which provides a high level of confidentiality for small transactions and transparency for transactions with a large sum of money;
- Non-transparency for third parties, which involves not disclosing payment data to both the central bank and intermediaries involved in transaction processing. This is the same level of confidentiality as cash.
Some countries like China, the Bahamas, and Nigeria have already adopted the option with a certain threshold of confidentiality. Although the latter recently acknowledged its CBDC project as a failure. You can read more about this in our article.
It is also worth noting that all transactions that are of interest to the regulator can be traced, regardless of the amount.
New Compromising Approaches
There are already certain concepts (both software and hardware) that would allow central bank digital currencies to have a high degree of confidentiality provided that the necessary legislative norms are observed. Here are some examples:
- The eCash 2.0 CBDC system, which uses blind signatures. In this case, transactions are not tracked, but the central bank keeps records of all coin identifiers. If the funds are stolen, the user can waive their confidentiality and allow money tracking for law enforcement. Switzerland has already initiated the creation and testing of this system.
- Hardware wallets such as cards or mobile apps where CBDC coins are stored locally, which allow for offline transactions. At the request of the central bank, personal identification can be established. This will ensure compliance with the policy of using one wallet per person or other limits such as available currency or transaction amount. Such a card-based system is already being tested in Ghana (Africa).
Conclusions
It appears that there are no technical problems in creating central bank digital currencies that would provide complete confidentiality to their users. A lot depends on political decisions and legislative acts that require monitoring of transactions. If a country wants to introduce the use of CBDCs for its citizens, compromises need to be made to provide a sufficient level of confidentiality.
However, this is not the only concern in society regarding CBDCs. After all, it is also technically possible to impose restrictions on the use of funds, which is already a kind of anti-utopia. The concerns may be exaggerated, as such a possibility already exists in modern banking.
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