COMMENTARY: Central Banks Are Pondering the Privacy/Transparency Balance of CBDCs

“We are looking very carefully at the question of whether we should issue a digital dollar,” said Federal Reserve chairman Jerome Powell in testimony before the Senate banking committee. “We are the world’s reserve currency and we have a responsibility to get this right.”

As digital currency moves from the outer edge of crypto to a future replacement for fiat cash, governments have had to consider a complicated range of risks and benefits in issuing central bank digital currencies (CBDCs).

 From the vantage point of anti-money laundering (AML) compliance, CBCDs could offer significant advantages in identifying financial crime. Today, with fiat cash transactions, the money is mostly untrackable once outside the walls of the bank. In a hypothetical world of CBDC transactions, financial institutions, regulators, and law enforcement would, in most scenarios, have a clear view of currency use—where it goes, how it is transacted, how people are connected, and what channels they use to pay each other.

In the largest CBDC project to date, People’s Bank of China has been adding cities to its test phase of the digital yuan—and raising concerns about how an authoritarian government might use trackable currency for social scoring.

Can we have both the societal good of more effective suspicious activity surveillance along with safeguards for personal privacy? Possibly. Central bankers should explore how technology could achieve a balance of these two priorities, especially during these early stages of development.

Most countries of global economic significance are, to some degree, researching or piloting CBDCs. But only one true CBDC has entered full circulation: The Bahamian sand dollar, which launched in October. Not to read in too much, but there’s certainly an interesting coincidence in that government’s CBDC and AML efforts. In December, following overhauls to the country’s framework, the Financial Action Task Force removed The Bahamas from its list of jurisdictions under increased monitoring for money-laundering risks.

There’s also the context of how much privacy we gave away long ago in exchange for the convenience of credit and debit cards. Mastercard, Visa, and other payment-network operators have had ample visibility into our transactions, though they mostly have not used it. From a more pessimistic, or realistic, view, we’ve sacrificed so much personal information to the payment networks and card issuers—as well as to Internet providers and social networks—would the increased ability of CBDCs to prevent financial crime with baked-in compliance turn out to be a net positive with few downsides?

On that note, consider Sweden, a country with a population that has long eschewed cash for cards. The Sveriges Riksbank pilot of the e-krona, launched a year ago, has been successful enough that the central bank is reviewing the possibility of a full switch from physical to digital fiat currency.

Among central bankers and international leadership, CBDCs have champions, skeptics, and a great deal of reasonable caution all around. Arguments in favor include greater inclusivity and theoretical upsides to easier interbank settlements and banking correspondent relationships. Concerns about stability and security warrant a great deal of serious research and testing.

Former ECB board member Benoît Cœuré, now at the Bank for International Settlements, has been an important voice for promoting and researching CBDCs, while Powell has in the past downplayed expectations. But the Fed chair frames the issue in terms of “when,” not “if.” The Federal Reserve Bank of Boston has been collaborating with MIT in early research on digital USD, an effort Powell recently deemed a “high priority.”

That CBDCs will eventually, at some point in the future, become commonplace seems like a fairly safe assumption. So why are central bankers facing this moment of reckoning now? Because of Facebook’s looming launch of Diem. Bitcoin miners are one thing, Big Tech is another. In the power balance between governments and corporations, when social networks and large technology companies are gleaning so much information, CBDCs almost have an alternative cachet in bucking that consolidation of control.

Since the early days of Bitcoin, blockchain technology provided transactions that were pseudonymous and transparent—in a sort of paradox of privacy. Stablecoins pegged to fiat currencies have served to transition digital currencies toward the mainstream, in terms of both volatility and reputation. As CBDCs advance, a central challenge for the monetary authorities of free societies will be: Can enhanced AML surveillance and adequate privacy be two sides of the same coin?

—Joe Robinson is chief executive of Hummingbird RegTech Inc., Walnut, Calif.