The Digital Euro and the P Word

Central bank digital currencies (CBDCs) have had quite a few growing pains. Somehow all the significant problems start with the letter “p” – privacy, programmability, and, above all, politics.

Privacy is especially problematic with CBDCs issued for retail payment use in developed economies, including the so-called “digital euro.”

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

In end-June, the European Commission proposed legislation on the digital euro, so that it could be issued legally should it ever be issued. The European Central Bank has been investigating the possibility of a digital euro, and this October it will near-certainly conclude that the investigation has been a success, and a realization phase will begin. How long will that phase last – only politics can tell.

In public consultations on the digital euro, privacy came up as the most important feature for both citizens and professionals.

Why is privacy a problem? We talk about privacy because most CBDCs would be issued as a blockchain-based token which allows the issuer, i.e. the central bank, to have all the data on how this token changes hands. Europe is not even formally committing to using tokenization, and privacy concerns are one of the reasons for this.

Legally, however, it is extremely unlikely that mass surveillance will ever be permissible by a G7 central bank. The EU rulebook will certainly make sure this is not the case.

Institutionally, the ECB has zero interest and insufficient resources to launch a CBDC so it can snoop on the individual spending decisions of eurozone citizens. To argue otherwise is unsubstantiated speculation, inconsistent with the way the ECB behaves.

Technologically, privacy in online payments can be convincingly safeguarded. The ECB has made it extremely clear that the digital euro will be distributed via intermediaries, just like normal euros are. Thus, the information on individual digital euro payments will be shielded from the ECB, just like normal digital payments are.

A core principle of the digital euro is that the ECB and the payment service providers shall implement technical and organizational measures, including state-of-the-art security and privacy-preserving safeguards, to ensure the identities of digital euro users cannot be accessed by the ECB via its front-end solution.

Actually, tokenized payments even between identified wallets give more options to create privacy protections, not less. The legislation itself requires the ECB to explore pseudonymization or encryption to preserve privacy.

Yet, we talk about privacy. We do because it is not the only priority. It competes with the priorities of anti-money laundering and counterterrorism financing. Digital payments already provide less anonymity and privacy than cash payments. Retail CBDCs are clearly advancing because central banks anticipate the disappearance of cash.

As such, the ECB is looking to replicate some cash-like features, like paying offline or not needing a bank account. But in designing these experiences there will be a choice on what are the limit above which identify verifications are needed. And, to advance anti-money laundering goals, the limits are likely to end up lower than those that we de facto have with cash. If the digital euro gradually replaces cash payments, some of the privacy of cash will be sacrificed.

The ECB is so aware of these citizens’ concerns that in parallel with the digital euro proposal, the Commission launched a proposal to enshrine the right for cash to circulate EU economies. This is an insurance policy against privacy-themed criticism and populism.

We also talk about privacy because the power to abuse privacy in payments needs to be resolutely and purposefully taken away, by law and by design, from both the central bank and the private sector intermediaries – be they banks, payment providers, or Big Tech.

The increased access to data, on individual payments and on an aggregate basis, can empower both central banks and private sector intermediaries to take advantage of it. The latter could choose to price-discriminate against whole classes of citizens, for example, based on their spending patterns.

To avoid this, in my opinion, is critical for the safe future of payments. In Europe, both citizens and institutions agree such safeguards are important.

Ultimately, we talk about privacy because it is an extremely politically-sensitive topic. This legislation will be negotiated in Brussels between now and the next EU elections. To approve the legislation, EU Member States and elected Members of the European Parliament ought to get on board with it and explain to their electorate why. In the lead-up to elections, the political sensitivities of the digital euro will take on a life of their own.

Thus privacy becomes a conduit for the difficult politics of a retail CBDC in well-banked markets. It is a convenient vector of attack regardless of why part of the industry or a decision maker may have reservations about the CBDC.