The BIS says anonymous CBDCs are 'not plausible.' Privacy advocates say that's nonsense.

Even though the central bank digital currency era has already begun, a high-stakes debate over how they could (and should) be designed from a privacy perspective is still brewing.

The CBDC era officially started not with a boom but with a Sand Dollar. The new Bahamian digital currency, which quietly launched nationwide last week, is generally considered to be the first-ever central bank digital currency (CBDC) in production. The Sand Dollar is the first of many CBDCs expected to roll out in the coming years, including those being issued by the central banks of major economies like China.

In anticipation of this trend, the Bank of International Settlements (BIS), the so-called central bank for central banks, recently convened seven central banks — the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the U.S. Federal Reserve, Sweden’s Riksbank, and the Swiss National Bank — to outline the “foundational principles and core features” of CBDC design. 

One section of the report stuck out like a sore thumb to privacy advocates — particularly those who are focused on preserving the financial privacy one gets from physical cash.

“A key feature of cash is that no centralized records of holdings or transactions exist. Some have argued that the main benefit of a CBDC could bring would be some level of anonymity for electronic payments,” the BIS report reads. 

However, the authors conclude that “full anonymity is not plausible” in light of anti-money laundering rules and others designed to combat terrorist financing (AML/CFT).

“Bullshit,” tweeted Rohan Grey, an assistant professor at Willamette University and vice-chair of the privacy working group of the Digital Currency Global Initiative, a collaboration between Stanford University and the International Telecommunications Union, in response. 

“There’s no basis to make that kind of claim,” Grey said in an interview with The Block. First, from a technical perspective, it’s too early to dismiss the possibility that state-issued digital cash can't offer the same kind of anonymity that physical cash does.

Second, there’s no legal reason to assume that full anonymity is not plausible, he said. Digital currency doesn't necessarily have to be lumped in with other forms of digital payment, and governments could theoretically create a whole new legal category for CBDCs. "Arguably the same rules that apply to Federal Reserve notes could apply to the currency instead of the rules that apply to bank deposits," said Grey.

Jerry Brito, executive director at the influential policy advocacy group Coin Center, also took issue with the BIS's blanket assertion about anonymity.

“The authors take for granted that central banks have some kind of obligation to conform to AML/CFT requirements,”  Brito wrote in a recent blog post. That's not the case, he said. “That should be clear from the fact that central banks are the issuers of trillions of dollars of anonymous notes and coins presently in circulation.”

For its part, the Sand Dollar, which The Bahamas has positioned as part of a larger project aimed at modernizing the region's financial infrastructure, is not anonymous, according to the project’s white paper. 

Meanwhile, China’s DC/EP, which is likely the next CBDC to go live, is not expected to offer anything that resembles the privacy of physical cash. Indeed, recently authorized patents suggest the system will put an emphasis on making transactions traceable. One of the patents describes a feature called “controlled anonymity” — essentially real-name identification on the back-end and confidential transactions on the front-end. 

There is a tendency to “abuse the language” when it comes to the term “anonymous" in this context, according to Grey. What China means by “controlled anonymity” is that counterparties can remain anonymous to each other while the government maintains a back door for itself, he said. “I don’t consider that to be anonymous.” 

According to Brito, the BIS’s use of the term “full anonymity” doesn’t make sense either.

“Anonymity is binary, you have it or you don’t,” he wrote. “Either centralized balance and transactions data exists or it does not; either it’s anonymous or it’s not. I’m not aware of any middle way.”