About the authors: Andrew M. Bailey is an Associate Professor of Humanities at Yale-NUS College and a Fellow of the Bitcoin Policy Institute. William J.Luther is an Associate Professor of Economics at Florida Atlantic University and a Fellow of the Bitcoin Policy Institute.
As money flows online, many believe the United States should develop its own central bank digital currency. Allowing individuals to hold accounts with the Federal Reserve could reap the main benefits touted by cryptocurrency proponents — instant settlement, low fees — without the risks. Countries like China, Sweden, and Saudi Arabia are already testing CBDCs, and more are in the development phase. Issuing this form of currency would help the United States stay competitive: a digital dollar for a digital world.
It seems avant-garde, even inevitable. But CBDCs have a major downside. They offer far less financial privacy than cash, and probably less than traditional deposit accounts as well.
Privacy is a necessary feature of a free society. “If you give me six lines written by the hand of the most honest of men,” said the French cleric and statesman, Cardinal de Richelieu in the 17th century, “I will find something there that will hang him.” A record of every transaction made by a person would greatly facilitate this task. We recognize the danger of pervasive surveillance, as evidenced by the negative legal connotations of a “fishing expedition” and the doctrine known as the “fruit of the poisonous tree”, which renders inadmissible evidence obtained during an illegal search. Without financial privacy, anyone could be found guilty of breaking the law simply because those in power said so.
Physical silver enjoys a high degree of financial privacy. You don’t need to show any ID or open an account to use money. You do not need to connect by phone or the Internet. You can spend your money without permission and without anyone other than your business partner knowing about it. Simply toss it in your fanny pack and pull it out when it’s time to spend.
Cash privacy carriers have limitations, of course. The United States does not issue supernotes, large denominations of $500 or $1,000, for example, which makes it difficult to use cash in large transactions. Large cash reserves have also led to civil forfeitures of assets: an unfair, arguably illegal, and increasingly widespread practice whereby governments accept cash without criminal charges. We could imagine a world in which cash even more privacy, but it already offers some privacy.
Would a CBDC offer this kind of privacy to users? We suspect not.
Despite respecting lip service privacy, typical CBDC designs allow central bank oversight of all transactions, amounts, origins, and destinations by default. Some supporters hide their autocratic ambitions; others are more transparent. While it is technically possible to design a CBDC with privacy safeguards (rather than mere assurances), proponents downplay this fact, emphasizing the need for innovation and quick action.
This approach does not reconcile confidentiality with the need for regulation. Instead, it risks eliminating privacy altogether. A CBDC is not lacking here simply compared to cash, it would also offer fewer protections than dollar balances held in commercial banks or non-bank financial institutions like PayPal.
The Bank Secrecy Act requires financial institutions to collect identifying information from their customers and provide transaction data to the government when a lawful request is made. However, these private institutions create a firewall between the government and transaction data. It’s far from perfect, offering far less financial privacy than cash. But it is more difficult for the government to illegally access transaction data.
When the IRS sued Coinbase for its customer data, for example, Coinbase took the case to court, saying the request was far too broad. The firewall limited the intrusion, resulting in a stripped down summons.
The Federal Reserve says it can offer the same degree of financial privacy through an intermediary CBDC, in which individuals do not maintain direct accounts with the Fed, but instead hold Fed liabilities through commercial banks. Since banks – not the Fed – will house customer data, the intermediated CBDC would appear to have the same type of firewall that exists today for bank and non-bank account balances.
But appearances can be deceiving. As long as the payments pass through a central clearinghouse or ledger maintained by the Fed, the Fed would have the ability to monitor those transactions. We doubt commercial banks could successfully challenge such intrusions in court, as the Fed would be monitoring its own record, not a bank’s. The Fed’s confidentiality assurances are therefore only promises and not guarantees.
The standard case of a CBDC is based on the misconception that we need new digital money for our new digital world. Much of our money is already digital; deposits and transfers from commercial banks are recorded on computers and not on paper registers.
What we need is not a new digital moneymany of which already exist, but instead a new digital cash. Digital cash would not simply facilitate electronic transactions; it would also preserve financial confidentiality. Even if they are intermediated, CBDCs are unlikely to do the trick.
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