CBDC Designers in Europe Struggle With Privacy Issues

In a consultation conducted by the European Central Bank last year, ensuring that a digital euro protects privacy emerged as the top priority. It’s understandable, given that data on spending habits could expose personal information such as a person’s lifestyle, tastes, and political beliefs.

However, privacy issues no longer appear to be a sacred cow. Recent ECB research, based on interactions with panels of EU residents, stresses other, competing concerns individuals may have, such as security and general acceptance, and ECB board member Fabio Panetta now speaks of a “trade-off” between those goals.

At a meeting next week, the currency zone’s finance ministers will also express their opinions, and they are unlikely to want new forms of financial secrecy to undermine anti-money laundering and anti-tax evasion rules.

According to the internal policy paper that would form the foundation of their discussion and was viewed by CoinDesk, a fully anonymous digital money would pose “severe issues.”

Despite business concerns about compromising privacy, national governments – including, as of Thursday, the European Parliament – have been eager to introduce client identity checks for even minor bitcoin payments in traditional cryptocurrency exchanges.

The ECB would have access to transaction data to the level necessary to carry out its tasks, such as settling payments and performing financial monitoring, according to the strategy paper, but the trove of payment data would not be “completely visible” to any central organization.

Panetta dismissed concerns about government spying, telling the European Parliament’s Economic and Monetary Affairs Committee on Wednesday that the ECB has “no commercial interest in using this data” and “will respect privacy laws until the last comma” – unlike profit-driven businesses, he suggested.

He also argued that the specifics of how much privacy to provide – such as whether to provide carve-outs that allow small payments to remain secret and offline – should be decided by governments and lawmakers rather than central bankers, claiming that “privacy… is not a technical issue; this is a political issue.”

Experts, on the other hand, have questioned his assessment and warned that too centralized systems could make true privacy much more difficult to accomplish.

Marina Niforos, an affiliate professor at HEC Paris, told CoinDesk that she disagrees with Panetta’s assertion that privacy issues are solely tied to profit-driven, commercial usage of data, and that people are correct to be concerned about governments acquiring such power over data.

Niforos, a crypto technology expert who previously helped the European Commission on the design of the digital euro, said: “We’ve seen, in other jurisdictions, a sovereign concentrating that kind of power may not only be for a benign purpose”.

“State actors have fewer commercial interests,” she said, “but it doesn’t rule out the possibility of data misappropriation and misuse.”

Furthermore, privacy measures cannot be established on a policymaker’s whim, but must be based on the technology chosen.

According to Niforos, distributed blockchain technology “may ultimately be the only solution left” in terms of embedding privacy by design into the digital euro.

That reflects a warning from the EU Blockchain Observatory’s March study, to which Niforos contributed. According to the research, overly centralized CBDCs would result in central banks “engaging in mass surveillance on a scale that raises grave privacy issues,” as well as providing a “honeypot” of data to lure spies and other harmful actors.

However, Niforos adds that there are many unanswered problems and murky areas that could make the ECB wary of taking a more decentralized strategy. “Blockchain as a technology confronts multiple difficulties,” she added, adding that it lacks “much-needed regulatory and legal certainty.”

Panetta appears to be toying with a centralized model in which individuals’ assets are housed in central bank accounts rather than a more decentralized system in which tokens travel relatively freely.

Panetta expressed concern in his speech on Wednesday about the “undesirable implications” of allowing outsiders to obtain significant amounts of digital euros, something that would be tough to avoid in a more decentralised approach.

Yet, according to Niforos, the account-based option he appears to prefer “would come with a set of different challenges.”

She went on to say that certain countries’ banking and regulatory systems are simply unprepared: “It’s not a panacea. It requires serious reengineering of the way that the ecosystem is set up”.

According to the ECB’s own research, many people have no idea what a digital euro is or why you’d want one, which is already a huge roadblock for Panetta to overcome. For others, this apathy has turned into outright fear of harm to the EU crypto community.

“For the time being, we see it the digital euro as more of a threat than an opportunity,” said Faustine Fleuret, CEO of ADAN, a French crypto industry lobbying group.

The digital euro concept, according to Fleuret, could stifle innovation by supplanting, rather than complementing, euro stablecoins, because it lacks the flexible protocols needed to allow decentralized finance.

When the industry-backed, but now bankrupt, Libra project posed a danger, central bankers hastened to issue their own digital currencies.

Some fear that the ECB’s drive to prevent companies like Meta Platforms (Facebook’s parent firm) from encroaching on their turf will harm not only people’s privacy, but also innovation in the EU.