Jim Harper
Last week, the Board of Governors of the Federal Reserve System (the Fed) published a discussion paper addressing whether it should produce a central bank digital currency (CBDC). Otherwise preliminary and tentative, the paper evinces certainty about any US CBDC’s tentative structure: It would be an account-based system in which all transactions flow through financial services providers of one kind or another. That presumption has negative implications for Americans’ financial privacy. Rather than committing to an account-based system, the Fed should remain open to a tokenized CBDC.
The paper sounds entirely reasonable in its initial finding that a potential US CBDC would be “privacy-protected, intermediated, widely transferable, and identity-verified.” For students of privacy and identity, though, the list is a bit of a head-scratcher. Transferability is the point, but an “intermediated” and “identity-verified” system would be in deep tension with privacy.
Payment systems are readily divided into two types: token-based and account-based. At our recent AEI confab on cryptocurrency (1:26:42), former Commodity Futures Trading Commission Chairman Chris Giancarlo articulated the distinction well. “With a token system,” he said, referring to all that has acted as money over history, “It’s the identity of the token itself that needs to be validated, not who you are, where you bank, and how much money you have.”
The Federal Reserve building in Washington, DC, via Reuters
Historically, physical tokens worked only locally, Giancarlo said, so the growth of trade required the growth of credit. “Whether you use Zelle, or Venmo, or credit cards, or debit cards, or a check,” Giancarlo continued, “in every case, you’re not using a token; you’re using the credit of an institution. And in every case, your identity needs to be validated. We need to know where you bank, how much money is in your bank, [and] did your bank credit another bank.” This latter system is information-hungry and privacy-threatening.
The advent of cryptocurrency released tokens from the limitations of location. Cryptocurrencies allow people to transfer metaphorical digital tokens as they would dollar bills or lumps of precious metal. People can transfer value without being in the same place as the recipient and without the expense or privacy costs of intermediaries.
The Fed’s paper nowhere says so directly, but it appears committed to the pre-crypto status quo. It would only work if institutions transfer CBDCs for customers. The paper queries on page 17 whether the Fed should “limit the amount of CBDC an end user could hold.” As far as I know, such a policy is only possible in an account-based system.
“In the intermediated CBDC model that the Federal Reserve would consider, intermediaries would address privacy concerns by leveraging existing tools,” the paper notes on page 19. Privacy would not spring from the protective uses people make of a CBDC. It would be what is permitted by government policy and the policies of the institutions that transfer people’s funds. The Fed report would marry a US CBDC to the financial surveillance infrastructure we have today, which has quite arguable utility even if you ignore the privacy costs.
The paper says in its executive summary that a CBDC is “a digital form of paper money,” but no account-based system I can conceive of matches the privacy-protective characteristics of cash.
Privacy is a lot of things but is better understood in this context as the subjective condition people enjoy when they have control of information about themselves and when they exercise that control consistent with their interests and values. Cash lets people pay their psychologist, donate to their church, or support a controversial cause without creating lasting or widely accessible records, which expose them to risks. An account-based system exposes people to risks of embarrassment, discrimination, and reprisal.
Among the things that keep people from having bank accounts are distrust and privacy concerns. Are those unbanked going to accept dollars that are both digital and under the banking system’s inherent control?
I recently complimented the privacy principles put forth by the Digital Dollar Project (DDP), to which I am an unpaid advisor. DDP founder Giancarlo presented them and more at our above-noted cryptocurrency panel. The DDP includes advisors who are very close to the US financial surveillance system, and its report said, “The balance between privacy and security may not be struck correctly by current policy. In tandem with the creation of a US CBDC, those policies should be reopened for discussion.” I concluded that “the CBDC that is consistent with American values will probably be a lot more like an open cryptocurrency network than not.”
If the Fed more deeply engages with the privacy, security, due process, and transparency issues that should be the essence for American financial infrastructure, I think it may return to considering a token-based, rather than account-based, CBDC. If it does not, the public may gravitate to cryptocurrencies that serve all their interests, including privacy.
Courtesy: (AEI.org)
