Digital money is not physical money

President Biden’s March 2022 Executive Order on “Ensuring the Responsible Development of Digital Assets” was, as the Financial Times stated at the time, short on policy details but it included an order for the Director of the Office of Science and Technology Policy (OSTP) and the Chief Technology Officer (CTO) of the United States to submit a report on central bank digital currency (CBDC) to the President. This report on “Technical Assessment of a US Central Bank Digital Currency System” has just been released.

The report (spoiler alert) makes no recommendations on what a US CBDC should look like and whether it might involve blockchains or otherwise, but rather presents some choices and their likely impact on the architecture. The document defines eight strategic objectives. He says that a “FedCoin” should:

  1. Delivering benefits and mitigating risks for consumers, investors and businesses.
  2. Promote economic growth and financial stability and mitigate systemic risk.
  3. Improve payment systems. Many critics of the US payments system (e.g. me) believe that bringing in digital currency competition, rather than regulation, would be the best way to both reduce costs and drive innovation and, as I have always stressed that it is important that a CBDC infrastructure is developed alongside, and not in addition to, existing e-money systems. This is to increase the overall resilience of the payment system, which is vital national infrastructure.
  4. Ensure that the global financial system has transparency, connectivity, and interoperability or portability of platforms and architecture. In particular, they said the CBDC should facilitate transactions in cash and with other CBDCs. They also note that the CBDC system should be designed to avoid risks of harm to the international monetary system (IMS).
  5. Advance financial inclusion. As part of this policy objective, the OSTP specifically and clearly states that “offline capability should be integrated”, a subject that I have already covered here and will be back shortly.
  6. Protect national security, including compliance with anti-money laundering (AML) and anti-terrorist financing (CFT) requirements as well as, of course, sanctions. Curiously, and presumably for political reasons, the policy goals are that the CBDC system “allows the collection of information necessary to meet these requirements, but no more”, which I have taken to mean that the CBDC itself- even will not implement the AML, CTF and sanctions. I also note that in the context of national security, the report states that the CBDC should support “American leadership in the global financial system, including the global role of the dollar,” an area I highlighted in my book. 2020 on the subject, “The cold currency war.”
  7. The CBDC system should be able to incorporate technical protections that prevent the CBDC from being used in ways that violate civil or human rights. Without being too controversial, I might just observe that writing software of the “if (violates-human-rights)-then…” type of software will be a challenge. The report also states that the CBDC system should also be “protected from abuse during times of high political volatility”, which I consider to be an American system of checks and balances so that a president or the head of the Federal Reserve does not can’t just turn it off.
  8. Align with democratic and environmental values, including privacy.

I think that last point is really interesting. I am not qualified to comment on environmental values, but I am (I think) qualified to offer an opinion on OSTP’s view that the system should maintain privacy and protect “against arbitrary or unlawful surveillance”.

Not even apples and oranges

Without rehashing all the arguments about anonymity, I will only say that the bogus comparison between e-money and physical money that often prompts CBDC privacy discussions often leads to calls for anonymity that would be disastrous.

The CBDC should indeed be private, but not unconditionally anonymous. Any argument that e-cash should mimic physical money’s privacy characteristics is false, because e-money and physical money are fundamentally different things. It’s not even apples and oranges, which are at least the two kinds of fruit. Other than the use of the word “cash”, physical money and electronic money have nothing in common.

Anonymity? No privacy? Yes.

So what to do then? The answer is to build security and privacy into the solution. There is no need to dwell on the need for security. Security is fundamental. If we can’t protect information, we can’t keep it private and it makes no sense to talk about privacy requirements for unsecured data. Unsecured data is in principle data that anyone can see and therefore cannot have any meaningful privacy. So we need a CBDC that secures transaction data.

We want this secure data to be private. No sane person wants anonymous electronic money, whether from the central bank or anyone else. The idea of ​​giving a free pass to criminals and corrupt politicians, child pornographers and crooks is misguided. To say that cash is anonymous, therefore electronic money should be anonymous makes absolutely no sense, since (as noted) these are entirely different propositions. Likewise, it cannot be fair for every transaction to be public, or for it to be traced, traced and delivered to the government, police, advertisers or pressure groups. None of these absolutes makes sense.

What makes sense is rather to ask what a democratic society expects from electronic money, and then to implement it. The right way to approach discussing electronic money is the same as the right way to approach thinking about electronic identity rather than physical identity. It’s not about having a discussion about how to digitize the analog structures we have now to do the job in a suboptimal and sometimes downright dangerous way in the online world, but rather getting back to the first principles and to ask what do we want from electronic money and what do we expect from electronic identity. Technologists can then design the best solutions.

The priority for the industry must therefore be to inform the debate and engage with stakeholders to help them understand the trade-offs between different technology options to achieve the goals set out in the OSTP report. For example, as a fan of pseudonymization as a way to raise the bar on privacy and security, I am all for exploring this line of thinking, similar to the updated FATF guidelines: While someone knows who a counterparty is (eg, Citi), it is not necessary for everyone (eg, a foreign government) to know who a counterparty is.

Technology gives us the means to provide appropriate levels of confidentiality in this type of transactional system and to do so in a safe and efficient manner within a democratic framework. In particular, new cryptographic technology gives us the seemingly paradoxical ability to keep private data on a shared or public ledger, which I believe will form the basis of new financial institutions (the “glass bank” that I like use as keyframe) that work in new types of markets.

We now have zero-knowledge proofs, blinding, homomorphic encryption, and many other proven techniques that can be used to keep data private under normal circumstances but can reveal it under special circumstances, such as producing a court order. Let’s be optimistic about the apples of privacy and put aside the anonymous oranges.

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