CFA Institute 2024
Could CBDCs destroy privacy?
Overview
The age of digital money, in terms of payments, ledgers and settlement, is already here.
Often faster, safer, and cheaper to process, digital transactions are quickly becoming the global norm. According to a McKinsey study, the share of physical cash used in global payments has declined by as much as 20 percentage points over the past five years.
This shift to digital transactions elevates consumer convenience. From instant payment networks that let people pay with a phone to open banking platforms that make it easier to open an account, digitalization already comes with big benefits. Central bank digital currencies (CBDCs) promise additional advantages. But they also raise concerns about data privacy.
Privacy is a fundamental human right, as enshrined in the UN Universal Declaration of Human Rights. Individuals expect a degree of control over how their information is collected or used. But in the case of a CBDC, whose data is it? Does it belong to the individual who briefly held the CBDC token before making a purchase, or to the central bank that designed it and is responsible for its continued operation?
Widespread concerns
The privacy implications of a CBDC will depend to a large extent on how it is designed. The use of blockchain technology to authenticate transactions, for instance, creates a permanent record every time the unit of currency is transferred, making it possible to trace where it was spent – and by whom. Similarly, if a CBDC is designed to be held in a digital wallet on an app maintained by the central bank, then the wallet holder’s identity could also be shared every time a transfer is made.
In the CFA Institute’s CBDC survey, conducted in February 2023, 63% of charterholders said they were concerned about data privacy in the potential introduction of CBDCs, ranking it one of their top concerns. (See Figure 1).
Figure 1: Worries related to the introduction of CBDCs
“With CBDCs, data privacy is a clear concern for potential users,” asserted Olivier Fines, Head of Advocacy and Capital Markets Policy Research for EMEA at CFA Institute. “Because of its digital nature, a CBDC could also run in conflict with the principles of existing legislation such as the General Data Protection Regulation (GDPR) in Europe.”
Convenience versus control
The economic implications of data privacy are complex, and individual governments have contrasting approaches.
The protection of user data to limit fraud and theft is an obvious benefit to individuals. Information sharing between peers or businesses can also deliver economic benefits that range from a deepening of financial inclusion to a broadening of market competition to support innovation and better services for end users. And knowing more about the customers they interact with, as they track preferences across transactions, can give companies insight that may increase revenue while also benefiting their customers.
Yet, companies also bear a risk of alienating customers if data is breached or used in overly invasive ways. Global commerce is still grappling with these issues, even without the added layer of CBDCs.
“CBDCs could amplify these challenges because it is not just the transaction or POS system that creates or holds data but the financial element itself,” said Fines. “Depending on its design and architecture, a CBDC creates, tracks and is data.”
A CBDC is also the legal construct and possession of its creator, the central bank, in the same way that physical currencies are. And just as central banks see an obligation to control the money supply, they may also expect to control CBDC data – this point remains in discussion as this is being written.
Social implications
CBDCs could further enhance those rules while also introducing the capability to open individual spending habits to central bank review.
As discussed in our article on CBCD design features , central banks have scope to build in extensive monetary control mechanisms. But the technological capacity goes much further.
A CBDC could be designed to turn on or off for certain kinds of transactions or have retroactive features to claw back payments deemed illegal, unjust, or just untoward. Money connected to a child’s account, for example, could be prevented from purchasing cigarettes or alcohol at modern retail outlets. Perhaps recovering alcoholics could voluntarily have their funds made invalid in bars or liquor stores. Could purchases of banned books be shut off?
Some nations might prefer such highly restrictive social features. Others not. The presence or absence of social controls could have additional implications across a society, promoting economic stability to a greater or lesser degree.
To ensure monetary stability, a central bank may wish to include features preventing a single actor from gaining too much control over their CBDC, or other safeguards.
These features, however, would require the ability to identify CBDC holders, compromising their expectations of data privacy. In some cases, this could run contrary to data privacy legislation. These dynamics and potential conflicts have not been fully addressed in many pilot CBDC development projects.
Central banks weigh in
In a central bank survey conducted by the Bank of International Settlements (BIS), data privacy did not rate as highly as a risk factor with central bankers as it did with CFA charterholders. (See Figure 2).
Figure 2: Central bank concerns related to CBDC introduction
“The key difference with the CBDC is that the central bank will have absolute control on the rules and regulations that will determine the use of that expression of central bank liability. And also, we will have the technology to enforce that,” he said.
The US Federal Reserve, however, appears to be more cautious.
“There is also a risk that this type of control could lead to the politicization of the payments system and at its heart, how money is used,” said Fed Governor Michelle W. Bowman.
As with other implications of CBDCs, the impact on data privacy will vary depending on how these instruments are designed. While central banks continue to debate their merits, the potential repercussions on personal privacy deserve close attention.
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