Yesterday the European Central Bank published a paper outlining a proof of concept (PoC) for central bank digital currencies (CBDC). The project aimed to balance the desire for anonymity with anti-money laundering (AML) and counter-terrorism (CFT) requirements.
It involved constructing a simplified payment system which has separate requirements for low-value transactions which can remain anonymous. For these sort of payments, the user can choose which intermediaries, if any, see the transaction details, and it’s not visible to the central bank. Lower-value transactions use “anonymity vouchers”. In contrast, larger sums require AML and CFT procedures which involve proving identity.
In the model, it was assumed that the CBDC was a two-tier currency, issued by the central bank but distributed via intermediaries such as banks or others that might have access to central bank accounts. The PoC also used a dedicated AML authority which rejects transactions to banned users.
This AML authority issues time-limited anonymity vouchers to users at regular time intervals, say €150 a day. A user can spend anonymous digital cash up to the limit of the vouchers without having to comply with AML and CFT requirements and without recording the amount that particular user spends.
Whether or not a payment remains anonymous or goes via the AML authority is decided by logic that sits at the intermediary bank.
No p2p transactions?
While not explicitly mentioned by the authors, in this model, there is no scope for person to person (p2p) transfer of cash without going through an intermediary. The AML/CFT occurs at the transaction level, which is similar to the current banking system.
This differs from cryptocurrencies which instead impose AML/CFT at the onramps or edges. Given that payment details are pseudonymous on many blockchains, they can be traced.
However, from an AML/CFT perspective, the current cryptocurrency methodology can allow bad actors to keep below the radar. That’s if they acquire bitcoin or other cryptocurrencies without going through AML/CFT, for example, by using physical cash. Non detection is only possible if they never cash out or if they cash out without going through an exchange. It also assumes the people with whom they transact the cryptocurrency are unable or unwilling to identify them.
The paper makes clear that the ECB has not decided to issue a CBDC, and the project is just a PoC, not a practical implementation.
The European System of Central Bank’s (ESCB) EUROchain research network ran the initiative with help from Accenture and R3.
Accenture is heavily involved in other CBDC initiatives including for Canada, Singapore and most recently Sweden’s Riksbank for a retail CBDC pilot. Additionally, the consultancy partnered with SAP to enable national payment systems to support digital currencies alongside existing payment networks.
No crowding out?
The ECB paper also states that central bank initiatives should not discourage or crowd out market-led solutions. But it’s difficult to see how they would not, at least to some extent.
Consider a startup that thinks there’s even a 50% chance of a central bank initiative. While there is always the potential for niches, it will likely impact the innovator’s decision making and that of its funders.
Potentially the only crowding out that might be avoided is for the substantial initiatives such as Facebook’s Libra. And that’s because Facebook’s audience is bigger than any central bank’s domain.
