By Jim Harper

Last week, the Digital Dollar Project (DDP) highlighted the challenges
involved in producing a central bank digital currency (CBDC) that will preserve
important values such as privacy. Every CBDC effort we have found gives privacy
protection short shrift, even though privacy is of paramount importance. A CBDC
that sends our financial privacy from frying pan to fire quite simply should
not be adopted. The DDP’s privacy principles are an important contribution to
the CBDC discussion.

Inspired in part by my role as an adviser to the DDP (I’m an
adviser, not a spokesperson; the report is the DDP’s, and these comments are
mine), I had American Enterprise Institute researcher William Rau examine
documents discussing the many CBDCs at various stages of discussion and development
around the world. That (unpublished) research finds that their treatment of
privacy is generally wanting. Many documents articulating CBDC projects make no
mention of privacy. Those that do typically treat it as a “to be determined”
item.

That might incline thoughtful people to reject CBDCs out of
hand. Recently, one prominent surveillance expert issued a powerful warning
against CBDCs, calling the genre “a cryptofascist currency . . . expressly designed to deny its users the
basic ownership of their money and to install the State at the mediating center
of every transaction.” That may be hyperbole or appropriate caution. It is poor civic hygiene to install technologies that could
someday facilitate a police state.

Whatever the case, a CBDC that jibes with American values must pass stringent tests. The DDP’s aforementioned privacy principles suggest four such tests.

First, a CBDC should be private, meaning people should be
able to use a CBDC “without making themselves subject to undue government
surveillance. People may benefit from above-board, contractual sharing of
information with financial services providers, or they may refuse it.” That
begs a lot of questions, but I see it as calling for a system that at worst
replicates the challenges of protecting privacy from financial services
providers. As to government, the report says law enforcement access to CBDC
usage data “should be strictly controlled by due process, and other applicable
U.S. law, including the Fourth Amendment.”

Second is security, which has many dimensions: “A U.S. CBDC
should improve and not degrade people’s security against theft, hacking,
illegal seizure, and fraud,” the DDP’s principles stipulate. Private seizure (i.e.,
theft) and public seizure are rightly on the same plane. Security against hacking
of the system and hacks on people’s interfaces with the system — their
accounts, phones, wallet software, and so on — should be as good or better than
the status quo.

It’s not quite a privacy value, but the report next
emphasizes accessibility and low cost for users:

A U.S. CBDC should improve Americans’ and global dollar users’ access to financial services. Because it is a more efficient system, it should cost less to engage in basic financial transactions. And as an open system, it should draw competition into financial services that produces better services at lower costs.

To assure the public that the protections required above are
real, the fourth emphasis of the report is transparency:

The system on which a U.S. CBDC runs should be operationally transparent so that a variety of parties — governments, NGOs, businesses, and academics — can independently assure themselves about its technical functioning, its security, and its resistance to impermissible monitoring or other exploitation.

How do you do all that? I think it’s hard but not
impossible. I’ll treat the report’s focus points in reverse order, being
entirely too brief.

The technical infrastructure that can assure the public of
privacy and security will tend to be open software platforms operated by
heterogeneous actors, not closed software operated by a single institution or
the delegates of a central bank. Openness and dispersion will facilitate
necessary oversight.

To lower costs, I think openness also prevails. It will
produce healthy competition, because it will give no actor an edge over others
on techniques or products the system makes possible.

Openness would also enhance a CBDC system’s security. A
multitude of actors in competition are more likely to discover flaws in the
technical functioning of the system. Manifold actors poring over the consumer
security challenges will also do better than a unified effort, I think.

As to privacy, a rule of thumb I think works here is that a CBDC system must be able to support all information policies, from entirely private transactions equivalent to cash, to closely monitored transaction flows, to public broadcast of, say, government spending. The privacy innovations being developed in the cryptocurrency world such as zero-knowledge proofs probably end up being essential components of a CBDC.

In short (painfully short), the CBDC that is consistent with
American values will probably be a lot more like an open cryptocurrency network
than not.

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