Nikolas Sargeant
Money has been around in many different forms over the years. It first arose when humans graduated from bartering commodities to using simple pieces of metal, forged by their kings. Later, those coins gave way to paper notes (at least for higher denominations), and in turn, they were replaced by credit cards and debit cards.
It’s thought that as much as 90% of the money in circulation today is digital, according to the Harvard Business Review, and cash is on the decline in almost every part of the world. Some countries, like Sweden, have almost become cashless societies already.
This sets the stage for the next evolution in money, the advent of Central Bank Digital Currencies or CBDCs, which are inspired by none other than Bitcoin.
What are CBDCs, and why do governments want them?
CBDCs are digital money issued by central banks. They’re not designed to replace cash entirely – at least not yet – but they will complement it. With CBDCs, each coin in circulation, be it a dollar, a pound, a euro, a shekel, a reais or a yen, is represented as a digital unit on a blockchain. Those units are stored in digital wallets, and they can be transferred to other people’s wallets via transactions over WiFi, Bluetooth, and NFC.
There are several good reasons why governments and their central banks want to issue CBDCs, but it all boils down to everything being more efficient. One of the main advantages of crypto, which will be carried over to CBDCs, is that transaction costs are significantly cheaper and take less time. Because CBDCs don’t have to worry about decentralization, transactions will be processed almost immediately. At the same time, there’s no middleman, as banks won’t have any role in processing people’s transactions, meaning costs are cheaper. They will even streamline settlements between banks.
CBDCs can also help governments to get money where it needs to be in emergencies, and they can potentially improve financial inclusion in countries with underdeveloped banking infrastructures. So long as you have a simple smartphone, it’s possible to download a digital wallet in order to receive and spend a CBDC. The other proposed benefit is that CBDCs will help to reduce crime, such as money laundering, fraud, and counterfeiting. That’s because the issuing bank will have full control over the CDBC and be able to monitor every user’s transactions.
The objection to CBDCs
Unfortunately, this oversight is also viewed as one of the main problems with CBDCs. The lack of privacy is consistently highlighted as one of the main challenges prohibiting the adoption of CBDCs. People value their privacy, and they don’t want their governments to know about every single transaction or purchase they make.
To use a CBDC, the government is likely going to require everyone to provide quite a bit of personal information in order to set up their digital wallet. The issuing bank will therefore be able to link every single wallet and account to a name and a face, and that means government agencies will more than likely be able to access everything too, without going through a third party.
Other fears besides privacy include the risk of governments using CBDCs to skew interest rates, implement radical and controversial monetary changes, and possibly even censor some kinds of transactions. For instance, a government could program a CBDC so that it cannot be used to purchase certain kinds of goods and services, enabling it to control what people can and cannot buy.
A solution is at hand
Unless central banks can find a solution to address these privacy concerns, CBDCs are likely to face a lot of opposition, and that explains why Israel has chosen to work with a startup called COTI on its “Digital Shekel” project, which is currently in the pilot stage.
COTI is a blockchain privacy-focused startup that has found a way to bring a concept known as “garbled circuits” to the digital asset realm. First theorized in 1982, garbled circuits were invented to solve the “Millionaires Problem”, which is a thought experiment that challenges people to create a solution for two millionaires, Alice and Bob, who want to find out who is richer without either party disclosing their net worth. The technique is designed to protect both Alice and Bob’s data while revealing who is the richest. To do this, multiple participants must contribute portions of encrypted data into a kind of “black box” that processes them and calculates the result. It can then share the result with all participants, without revealing the specifics.
COTI believes this technique can be applied to CBDCs, enabling users to maintain full privacy of their transactions and wallet balances while the central bank can still monitor transactions for fraud.
If COTI and the Bank of Israel can crack this problem, it will likely be a key milestone in the development of CBDCs, and go some way towards building the trust needed for people to adopt them in significant numbers.
Just as it took a huge leap of faith for people to move from the original system of barter to trusting the value inherent in the first coins, it will take another one for people to trust in CBDCs. By embracing privacy-preserving technologies, central banks can take a significant step towards earning that trust.
