Cash and CBDC, Apples and Oranges
They are not the same thing so stop comparing them.
Dateline: Auckland, 7th November 2022.
President Biden's March 2022 Executive Order on "Ensuring Responsible Development of Digital Assets” was, as the Financial Times said at the time, short on policy detail but it did include 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 the "Technical Evaluation For A U.S. Central Bank Digital Currency System” has just been published.
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Does the U.S. need a digital currency? Who knows.
The report (spoiler alert) doesn’t make any recommendations as to what a U.S. CBDC should look like and whether it might involve blockchains or whatnot, but instead sets out some choices and their likely impact on architecture. The document sets out eight policy objectives. It says that a “FedCoin” should:
Provide benefits and mitigate risks for consumers, investors, and businesses.
Promote economic growth and financial stability and mitigate systemic risk.
Improve payment systems. There are many critics of the U.S. payment system (eg, me) who think that bringing in competition from digital currency, rather than regulation, would be the best way to both reduce costs and spur innovation and, as I have consistently pointed out, it is important for a CBDC infrastructure to be developed in parallel with, not on top of, the existing electronic money systems. This is to increase the overall resilience of the payment system, which is vital national infrastructure.
Ensure the global financial system has transparency, connectivity, and platform and architecture interoperability or transferability. In particular, they said that the CBDC should facilitate transactions with cash and other CBDCs. They also note that the CBDC system should be designed to avoid risks of harm to the international monetary system (IMS).
Advance financial inclusion. Within this policy objective, the OSTP specifically and clearly states that “offline capability should be incorporated”, a subject I have covered here before and will return to shortly.
Protect national security, including compliance with anti-money laundering (AML) and combating the financing of terrorism (CFT) requirements as well as, of course, sanctions. Intriguingly, and presumably for political reasons, the policy objective is for the CBDC system to “allow for the collection of information necessary to fulfil these requirements, but not more”, which I took to mean that the CBDC itself will not implement the AML, CTF and sanctions. I note also that within the context of national security, the report says that CBDC should support “U.S. leadership in the global financial system, including the global role of the dollar”, an area that I highlighted in my 2020 book on the subject, “The Currency Cold War."
The CBDC system should be able to incorporate technical protections that prevent the use of CBDC in ways that violate civil or human rights. Without being too controversial, I might merely observe that writing some software along the lines of “if (violates-human-rights) then…” will be a challenge. The report also says that CBDC system should also be “protected from abuse during periods of high political volatility”, which I see as an American checks and balances thing so that a President or the head of the Federal Reserve cannot simply turn it off.
Align with democratic and environmental values, including privacy protections.
I think that final point is really interesting. I am not qualified to comment on the environmental values, but I am (I think) qualified to offer an opinion on the OSTPs view that the system should maintain privacy and protect “against arbitrary or unlawful surveillance.”
Without rehashing all of the arguments about anonymity, I will only say that the bogus comparison between electronic cash and physical cash that often begins discussions about CBDC privacy often leads to calls for anonymity that would be disastrous. The opposite, transaction tracking as we have for payments cards, would be equally bad. The ECB’s current view is that a digital euro “would provide a level of privacy equal to that of current private sector digital solutions”, which seems like a very low bar to me. Surely we should be far more ambitious in our demands on next-generation digital currency!
What I mean by this is that a CBDC should indeed be private, but not unconditionally anonymous. Any argument says that electronic cash should emulate the privacy characteristics of physical cash is wrong, because electronic cash and physical are fundamentally different things. They are not even apples and oranges, which are at least both kinds of fruit. Other than the use of the word "cash", physical cash and electronic cash have nothing in common.
Anonymity? No. Privacy? Yes.
So what to do then? The answer is to make security and privacy part of the solution. There is no need to dwell on the necessity of security. Security is a fundamental. If we cannot keep information secure, then we cannot possibly keep it private and it makes no sense to talk about the privacy requirements for insecure data. Insecure data is in principle data that everybody can see and therefore cannot in any circumstances have any meaningful privacy. So we need a CBDC that keeps transaction data secure.
We want that secure data to be private. No sane person wants anonymous electronic cash whether from the central bank or anyone else. The idea of giving criminals and corrupt politicians, child pornographers and conmen a free pass cannot be sound. Saying that cash is anonymous, so therefore electronic cash should be anonymous makes absolutely no sense, since (as noted) they are entirely different propositions. Similarly, it cannot be right for every transaction to be public, or to be tracked, traced and delivered up to the government, the police, advertisers or pressure groups. Neither of these absolutes makes sense.
What does make sense is to instead ask what a democratic society wants from electronic cash and then implement it. The right way to approach the discussion about electronic cash is the same as the right way to approach thinking about electronic identity rather than physical identity. It is not to have a discussion about how to digitise the analogue structures that we have now to make them work in a sub-optimal and sometimes downright dangerous way in the online world, but instead to return to first principles and ask what do we want from electronic cash and what do we want from electronic identity. The technologists can then engineer the best solutions.
The priority for the industry must therefore be to inform debate and engage with stakeholders to help them to understand the trade-offs across the different technological options for meeting the objectives set out in the OSTP report. For example, as a fan of pseudonymity as a means to raise the bar on both privacy and security, I am very much in favour of exploring this line of thinking, similar to the FATF updated guidelines: So long as someone knows who a counterparty is (eg, Citi) then it is not necessary for everyone (eg, a foreign government) to know who a counterparty is.
The international legal arrangement for uncovering the “true” identity of a counterparty, under what circumstances and with what protections, are outside my envelope. But they presumably already exist and there must be procedures in place for a U.S. (for example) court to request the identity of a Korean (for example) cryptocurrency crook.
Technology gives us ways to deliver appropriate levels of privacy into this kind of transactional system and to do it securely and efficiently within a democratic framework. In particular, new cryptographic technology gives us the apparently paradoxical ability to keep private data on a shared or public ledger, which I think will form the basis of new financial institutions (the “glass bank” that I am fond of using as the key image) that work in new kinds of markets.
We now have zero-knowledge proofs, blinding, homomorphic encryption and many other tried and tested techniques that can use to keep data private in normal circumstances but that can reveal it in special circumstances, such as the production of a court order. Let’s be optimistic about the privacy apples and put the anonymous oranges to one side.