Europe's CBDC Designers Wrestle With Privacy Issues
The European Central Bank will likely to opt for a centralized solution for its new digital euro, raising questions about state snooping.
Privacy appears to be dropping down on the priority list of those designing a new digital euro, and experts are warning that the design choices being made could make privacy harder to achieve.
There have been no formal policy decisions about whether to issue the euro in a new, digital format, but there’s clearly momentum behind the idea. Euro finance ministers will discuss the issue on Monday, and a consultation is due from the European Commission imminently, a likely precursor to new laws.
Ensuring that a digital euro safeguards privacy emerged as the No. 1 issue in a consultation the European Central Bank carried out last year. Understandably so, as data about spending habits could reveal sensitive details about a person’s lifestyle, tastes and political leanings.
But privacy concerns don’t seem to be a sacred cow anymore. More recent ECB research, this time based on discussions with panels of EU citizens, emphasizes other, competing concerns people might have, such as security and universal acceptance, and ECB board member Fabio Panetta now speaks of a “trade-off” among those goals.
Finance ministers from the currency zone are also set to give their views at a meeting next week, and they are unlikely to want new kinds of financial secrecy undermining anti-money laundering and tax evasion norms.
A fully anonymous digital currency would raise “serious concerns,” says the internal policy paper that will form the basis of their discussion and that was seen by CoinDesk.
That fits with the trend seen in conventional cryptocurrency markets, where national governments – and, as of Thursday, the European Parliament – have been keen to bring in customer identity checks for even small bitcoin payments, despite industry complaints about invading privacy.
Questions about privacy
According to the policy paper, the ECB would have access to data about transactions to the extent necessary to fulfill its functions, such as settling payments and carrying out financial oversight, but the paper said that the trove of payment data shouldn’t be “fully visible” to any central entity.
Panetta has brushed away concerns over state snooping, telling the European Parliament’s Economic and Monetary Affairs Committee on Wednesday that the ECB has “no commercial interest in use of this data,” and “will respect until the last comma” privacy laws – unlike, he suggested, companies that are just looking to make a profit.
He also argued that details of how much privacy to offer – like whether to offer carve-outs allowing small payments to remain secret and offline – remain matters for governments and lawmakers to decide, not central bankers, saying that “privacy … is not a technical issue; this is a political issue.”
But experts have criticized his characterization, and warned that overly centralized systems might make meaningful privacy much harder to achieve.
Marina Niforos, an affiliate professor at the business school HEC Paris, told CoinDesk she rejects Panetta’s claim that privacy concerns are related only to profit-driven, commercial use of data and said people would be right to worry about governments amassing so much control over data.
“We’ve seen, in other jurisdictions, a sovereign concentrating that kind of power may not only be for a benign purpose,” said Niforos, a crypto tech expert who has previously contributed to the EU Blockchain Observatory on the digital euro’s design.
State actors “have less commercial motivations, but that doesn’t mean that there’s not a danger of misappropriation and misuse of that data,” she said.
What’s more, privacy controls can’t be added just on on a policymaker’s whim, but may depend on the kind of technology that is picked.
Distributed blockchain technology “might ultimately be the only solution left, in terms of being able to embed privacy by design” into the digital euro, Niforos said.
That echoes a warning from a March report produced by the EU Blockchain Observatory, a body sponsored by the European Commission to make recommendations for the role the EU can play in the Web 3 technology. That report said that unduly centralized CBDCs would mean central banks “undertaking mass surveillance on a scale that raises profound privacy concerns,” and offer a “honeypot” of information to tempt spies and other malicious actors.
Yet Niforos also warns there are plenty of open questions and gray areas that might make the ECB reticent to opt for that more decentralized approach. “Blockchain as a technology itself faces several issues” and lacks “much-needed clarity from a regulatory and legal perspective,” she said.
Panetta does indeed seem to be flirting with a centralized model in which citizens’ assets would be held in accounts at the central bank, rather than a more distributed system where tokens flow relatively freely.
In his remarks on Wednesday, Panetta fretted over the “undesirable implications” of letting foreigners get their hands on large quantities of digital euros – something that would be impossible to avoid in a more distributed model.
Yet the account-based solution he apparently favors “would come with a set of different problems,” Niforos said.
“It’s not a panacea. It requires serious reengineering of the way that the ecosystem is set up,” she added, warning that banking and regulatory systems in some countries just aren’t prepared.
The ECB’s own study shows that many people don’t realize what a digital euro is, or why you would bother to have it, and that’s already a major obstacle for Panetta to overcome. For others, that apathy veers into downright concern about damage to the EU crypto world.
“For the moment, we perceive it [the digital euro] more as a threat than an opportunity,” Faustine Fleuret, CEO of French crypto industry lobby group ADAN, told CoinDesk.
Fleuret said the digital euro plan could undermine innovation, because it could end up supplanting, rather than complementing, euro stablecoins, without the flexible protocols needed to support decentralized finance.
Central bankers rushed into issuing their own digital currencies when they saw the threat posed by the industry-backed, and now defunct, Libra project.
In the push to stop the likes of Meta Platforms (Facebook's parent company) muscling in on their patch, some worry the ECB could be about to damage, not just people’s privacy, but innovation in the EU.
UPDATE (April 4, 2022, 10:56 UTC): Clarifies status of EU Blockchain Observatory.
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