Show me the money

Electronic forms of cash could give governments an unprecedented tool to spy on its citizens. But if anything, observers say central bank digital currencies (CBDC) may provide a far better privacy alternative to proposed corporate offerings like Facebook-backed Diem.

“It’s tricky. This is entirely a new area,” said Cindy Zhang, a financial services lawyer at BLG in Toronto. “Aside from the privacy rules companies are subject to by law, we do not know how each will implement their privacy policies and procedures that are internal to their companies. That’s not the case for government. We can hold them to account.”

“The best guarantor [of privacy] if you design a system well, will be the central bank,” said Katrin Tinn, a professor at McGill University in Montreal. Tinn and her colleague Christophe Dubach recently submitted plans for a hypothetical CBDC to the Bank of Canada (BoC). In their Model X Challenge submission, Tinn and Dubach propose a currency design that only tracks transactions on the part of the recipient, with the sender remaining anonymous. “One of [the BoC’s] main design criteria was privacy.”

At a meeting hosted earlier this month by the Bank for International Settlement (BIS), the regulator for the world’s central banks, governors concluded there’s no urgency for countries to launch fiat currency in digital form. But as more and more purchases happen online and as businesses increasingly interact digitally, bankers cannot be caught flat-footed. More than 85 per cent of central banks, including Canada’s, are looking into this issue, according to BIS. The word “inevitable” often crops up in the CBDC literature.

While the emergence of cryptocurrencies initially piqued interest, events of the last 12 months have accelerated plans. Physical money is still widely accepted and regulators say there’s no scenario of a total withdrawal, but it’s becoming increasingly difficult to buy stuff without a card — offline as well as online. (Canadians take note: Regent’s Park in London now only accepts contactless payment - 32 cents - to use its “loos.”)

To be sure, we already use digital money for most transactions, particularly those involving larger sums. Card payments are hardly new. CBDCs are different from existing forms of cashless systems like direct debits, card payments and e-money because they represent a liability of the central bank itself, just like cash. What CBDC are definitely not like is Bitcoin, which is increasingly being called a speculative asset rather than a payment method.

Whether CBDCs are needed or even desirable at this stage is a matter of debate. Bank of Canada deputy governor Tim Lane recently said a CBDC is not a “foregone conclusion.” But it’s clear that as more and more of the economy moves online, those with no access to card payments will get left behind.

To what extent privacy will be a major selling point for CBDCs is not yet clear. Consumers are not always consistent in their views. The BoC is mindful that convenience and price are likely to top the list of considerations, and any CBDC offering will likely fail if it doesn’t improve on whatever is already out there.

But governments as well as firms like Apple are well aware that consumers are growing wary of being relentlessly pursued over the internet. Canadian legislators are currently in the process of updating the decades-old legal framework for both industry and public institutions, partly as a result of consumer unhappiness at current levels of protection. For its part, the BoC has recognized that privacy is a public good

A consensus on CBDC design — or even goals — has yet to emerge, with the pros and cons of various technologies and models being debated at the international and domestic level. The BoC, along with other jurisdictions, will have to take many factors in consideration when designing a digital dollar, observers say, including stopping bad actors. It will need to balance anonymity with existing know-your-customer and anti-money laundering legislation. It will also have to work within the existing payment landscape, as the regulator is unlikely to want to take up the minutia of retail payments, or stifle fintech innovation. Private firms may have differing objectives when it comes to data collection and processing.

Success will entail balancing all these factors, as well as not destabilising the traditional lending system, observers say.

In the McGill’s entry, for example, spending will be anonymous, but receiving funds less so. The blockchain technology and Zero-Knowledge proofs ensure privacy, as well as scope for innovation and integration with existing payment system. “No-one - not the government, and not even agents managing the system - is digitally able to connect the individual with his/her private coins and with goods and services that she/he buys using these private coins.”

Recently, central banks jointly issued CBDC “core features” and “foundational principles”, which included “do no harm.” Bankers and economists alike see many innovative possibilities with CBDCs, like lowering transaction costs, providing financial services to those who struggle to open traditional accounts, delivering government assistance directly to citizens or even keeping financial institutions’ influence in check. “It could be a way to rebalance power,” said Carsten Sorensen, associate professor in Digital Innovation at the London School of Economics.

In Canada, it’s unclear whether new laws are needed to make sure privacy will remain at the forefront of CBDC design. Neither the Office of the Privacy Commissioner of Canada nor Innovation, Science and Economic Development Canada, which writes the rules for the private sector, said they were looking into this area specifically.

Observers say it’s too early to contemplate such changes.

“Significant questions still remain not only about if the Bank will issue a CBDC, but if they do, how they will do it and how it will work in practice. Until this is better understood, it is very difficult to assess whether any new laws would be needed,” said Christine Ing, a partner at McCarthy Tétrault in Toronto, in an email. “Much will depend on the governance model surrounding the CBDC – who is involved, what their function is, what data they handle and what they are allowed to do with that data.”

What might cause the BoC to pull the trigger on CBDCs? 

The regulator has said in the past that two events could prove decisive: if vendors stopped accepting cash or if the adoption of an outside currency threatened Canada’s monetary sovereignty. With COVID-19 making in-person shopping impossible and handling cash unappetising, that scenario has gotten scarily close. 

Progress on Facebook’s Diem is unclear. Nevertheless, “if private, borderless digital currencies were to gain a substantial portion of the domestic payments market, this would reduce the effectiveness of domestic monetary policy,” said Ing.  “Like other central banks, the Bank of Canada has recognized that a CBDC could counter the threat of private digital currencies.“

“Should money infrastructure be a private company matter? I would categorically say it should not,” added LSE’s Sorensen.