Physical cash is extraordinary when you think about it.
It lets you pay somebody instantly, and with finality. It works when the power is off. It gives a regular person the ability to hold a financial claim against their country’s central bank. Nobody needs permission to use it, and nobody gets to find out what you spent it on. It is an instrument of personal liberty, but also an enabler of crime.
We are on the cusp of a new era for money as we currently know it, with retail central bank digital currency (CBDC) initiatives already being undertaken by a growing number of central banks around the world.
But how can the personal liberty that physical cash enables be preserved while ensuring a CBDC does not unleash a tidal wave of unstoppable, untraceable illegal activity?
Times are changing
Physical cash is a truly radical product, but it's so familiar to us that we don’t notice its subversiveness. Indeed, central bankers are among the most respected public servants in the country, sitting at the heart of the most powerful political institutions.
However, if cash had only been invented today, its creators would likely find themselves dispatched to an altogether less congenial institution.
However, times continue to change. The usage of cash is declining as more payments are being made digitally and central banks around the world are considering how to respond.
The emerging consensus is that consumers need access to a new form of money. This product would be issued by the central bank, just like cash. However, unlike cash, it would exist in a digital form. Enter the need for a CBDC.
In countries like Sweden, the stark decline in cash payments means that a CBDC may become a complete cash replacement. Elsewhere, it is unlikely that cash will become obsolete, but it will play less of a role in the overall payments system and so the case for a CBDC is something we expect to arise globally.
What about my privacy?
But how should a CBDC work? What features should it have? Some politicians are excited by the idea of ‘purpose-bound’ or ‘programmable’ money, which can be used to make conditional transfers to people with lower incomes who need help with their grocery shopping, for example.
But for every well-meaning politician, there is a citizen who suspects ‘they secretly want to control what I can spend my own money on’.
How can we balance these competing desires for freedom, privacy, and control? How much should I be able to spend per month with a guarantee of privacy? How much should I be able to spend per month on items that the rest of society may regard as controversial?
The correct answer isn’t ‘infinity’, as is effectively the case with cash. But surely, nor in a free society is it ‘zero’?
A recent survey from the Bank of International Settlements found that both the provision of privacy protection and information about privacy benefits increased participants’ willingness to use CBDC by up to 60 per cent when purchasing privacy-sensitive products.
So, this is not just a theoretical consideration; it directly impacts the attractiveness and likely adoption rate of any CBDC offering.
The intermediated model
When it comes to the technology that underpins a CBDC, an intermediated model can potentially serve as an elegant solution to privacy concerns.
Private firms – instead of the government – would have direct commercial relationships with customers and personally identifiable data would be kept away from the core record of financial transactions, also known as the ledger.
This would mean that the central bank only provides the core infrastructure and ledger for a CBDC while private firms would act as wallet providers, which would ease privacy concerns, especially if the privacy promises were backed by the force of law.
We’re already seeing institutions such as the Bank of England explore this model, which it calls the platform model, for its CBDC initiative.
Initiatives like this are built around the idea that a digital currency system should not necessarily mimic the cash system of today, but that there should be some freedom to transact with privacy.
After all, wanting to maintain the right to make an occasional private payment, or spend money on something potentially controversial is surely not that extreme. So, why not strive for consensus on what the limits should be?
Think about the prize on offer: to implement a sufficiently free digital currency that preserves and propagates citizens’ historic rights to spend their money on what they please, while massively mitigating the extreme misuse we see with cash today.
It is only central banks who have the historic privilege and political position to allow it to happen – and only forward-thinking technology providers that have the expertise to make it happen.
Richard Gendal Brown is chief technology officer at R3, a ledger technology and services provider, and a member of the Bank of England's CBDC technology forum
