Digital Euro and Privacy

Central bank digital currencies (CBDCs) have encountered several challenges. These problems can be categorized into three main areas: privacy, programmability, and politics.

Privacy poses a significant issue, particularly for CBDCs used for retail payments in developed economies, such as the proposed “digital euro.”

Dea Markova is a managing director and head of digital assets at Forefront Advisers.

In late June, the European Commission introduced legislation for the digital euro, ensuring its legal issuance if ever implemented. The European Central Bank (ECB) has been exploring the possibility of a digital euro and is expected to declare the investigation a success in October, leading to a realization phase. The duration of this phase will depend on political factors.

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During public consultations on the digital euro, privacy emerged as the most important feature for both citizens and professionals.

Why is privacy a concern? The discussion revolves around the fact that most CBDCs would be issued as blockchain-based tokens, allowing the central bank to track all transactions involving the token. Europe has not committed to using tokenization, partly due to privacy concerns.

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However, it is highly unlikely that a G7 central bank would ever permit mass surveillance legally. The EU rulebook will ensure this is not the case.

Institutionally, the ECB has no interest or sufficient resources to develop a CBDC solely for monitoring eurozone citizens’ spending decisions. Claims to the contrary lack evidence and contradict the ECB’s behavior.

Technologically, privacy in online payments can be effectively protected. The ECB has made it clear that the digital euro will be distributed through intermediaries, just like physical euros. Consequently, information regarding individual digital euro payments will be shielded from the ECB, similar to regular digital payments.

A fundamental principle of the digital euro is that the ECB and payment service providers must implement measures, including advanced security and privacy safeguards, to prevent the ECB from accessing the identities of digital euro users through its front-end solution.

Interestingly, tokenized payments, even between identified wallets, offer more options for privacy protection. The legislation itself mandates the ECB to explore pseudonymization or encryption to preserve privacy.

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However, privacy is just one aspect of the discussion. It competes with priorities such as anti-money laundering and counterterrorism financing. Digital payments already provide less anonymity and privacy compared to cash payments. Retail CBDCs are advancing because central banks anticipate the decline of cash.

Therefore, the ECB aims to replicate certain cash-like features, such as offline payments and the elimination of the need for a bank account. However, there will be a choice in designing these features: determining the threshold at which identity verification becomes necessary. To achieve anti-money laundering objectives, the thresholds are likely to be lower than those currently applicable to cash. If the digital euro gradually replaces cash payments, some privacy aspects of cash will be sacrificed.

The ECB is well aware of these concerns among citizens. In conjunction with the digital euro proposal, the Commission introduced a proposal affirming the right for cash to circulate in EU economies. This serves as an insurance policy against privacy-related criticism and populism.

Privacy is also a topic of discussion because the potential for abuse of payment data needs to be actively addressed through legislation and design, both for the central bank and private sector intermediaries such as banks, payment providers, and Big Tech.

Access to data, both individual payments and aggregated data, can empower central banks and private sector intermediaries. The latter could potentially engage in price discrimination based on spending patterns. Avoiding this scenario is crucial for the secure future of payments, and both citizens and institutions in Europe recognize the importance of implementing safeguards.

In conclusion, privacy is an extremely sensitive political topic. The legislation for the digital euro will be negotiated in Brussels leading up to the next EU elections. Approval of the legislation will require the support of EU Member States and elected Members of the European Parliament, who will need to explain the reasons to their constituents. The political dynamics surrounding the digital euro will intensify as the elections approach.

Therefore, privacy serves as a means to address the challenging politics involved in implementing a retail Central Bank Digital Currency (CBDC) in well-established banking markets. It conveniently provides a vulnerability to criticize the CBDC, regardless of the reasons or reservations held by a particular industry or decision-maker.

Edited by Ben Schiller.