When the history books tell the story of digital currency in 2021, there will be many remarkable moments.
Elon Musk and Tesla buying bitcoin, sending the price soaring – only to ultimately walk it back and send the price right back down. Dogecoin turning into such a force that it inspired a legion of other dog-themed coins. El Salvador's historic announcement that it made bitcoin a legal tender.
Meanwhile, another seminal shift is also happening right before our eyes: the emergence of full-fledged monetary surveillance regimes that are masquerading as the future of fiat currency.
While crypto markets are distracted with price action and volatility, governments around the world are researching and testing central bank digital currencies, or CBDCs. France is in the midst of extending a wholesale CBDC trial, Sweden is testing an e-krona, and many smaller countries are engaged in similar tests.
The motivations for CBDCs vary. In Europe, the discussion of a digital euro picked up significantly in the wake of the COVID-19 crisis. The driving motivation appears to be a desire to increase the ease of enacting monetary policy, so that the stimulus state can get money into the hands of its citizens more quickly. That desire appeared in the U.S. as well, with the original proposed COVID-19 relief legislation, including the creation of "FedAccounts" to accelerate the distribution of aid. "Banking the unbanked" has also been a big reason why some are pushing for a digital dollar in the U.S.
In China, the motivation appears to be driven by a combination of monetary competition and desire for control. While the People's Bank of China had been researching a digital currency since 2014, it was the announcement of Facebook's Libra in 2019 that supercharged its efforts. Since then, the Chinese Communist Party has aggressively worked to curb the power of private fintech firms like Ant Financial. That crackdown now appears to be shifting to crypto mining, as mines are forced to close and the PBOC places a renewed emphasis on 2017 rules that prohibit domestic financial institutions from handling transactions in crypto.
Crypto and fintech threaten China's ability to surveil its citizens, and so the country is testing a digital yuan – a form of money that gives the country the ability to monitor its citizens and manipulate its currency. There have now been about 10 live trials of the digital yuan, with the size and scale increasing each time.
Much of the discourse in the U.S. about a digital dollar has been shaped by the Chinese example. On the one hand, advocates say, we need our own CDBC to ward off the onslaught of monetary competition from a Chinese digital currency. On the other hand, we are Americans who value privacy and don’t want to be spied on.
Last week, the U.S. House Financial Services Committee held a hearing about a potential digital dollar. Privacy was one of the most important topics for the invited experts, including Rohan Grey, an assistant professor of law at Willamette University and the research director at the Digital Fiat Currency Institute, who wrote in his prepared testimony:
"It is not uncommon to hear policymakers claim that the adoption of a token-based digital fiat currency instrument that could be used anonymously, offline, in a peer-to-peer manner, without requiring any common ledger or record, would be “radical” or “extreme.” I profoundly disagree. Preserving the right to hold currency and make peer-to-peer payments directly without third- party involvement or approval is a small-c conservative response to the socially disruptive effects of digitization and the internet. If we do not take active and committed steps to reverse our decline into information and surveillance capitalism, including ending the so-called “War on Cash” that is slowly transforming every aspect of our transactional lives into a digitized data stream that can be centrally surveilled and censored, we will end up in a world in which token-money, and the freedoms and civil liberties that it affords, are functionally extinct."
Unfortunately, in the context of the current regime of BSA, KYC/AML – short for the Bank Secrecy Act, Know Your Customer/Anti-Money Laundering – it’s hard to imagine a digital dollar that doesn't end up being simply a better tool for surveilling citizens and curbing their freedoms.
But what if – and this is a big "what if" – the system is designed more like Bitcoin, based on an open, transparent ledger? That would serve, not to make a digital dollar more private, but to show what a failure of privacy the Bitcoin-based model actually is.
Anonymous isn't the same as private, and the transparent ledger has proven to be an unbelievable tool for law enforcement to monitor and control the flow of funds. The great irony is that while some in government have been skeptical of bitcoin because they believe it enables crime, the cryptocurrency is, in fact, radically more controllable than something like cash, which can provide true privacy. Enshrining this model in a digital dollar would virtually ensure its utility as a mechanism of greater government control.
In this world of government surveillance coins, what is the way out? The only possible answer is a new generation of privacy coins. Pirate Chain, for example, is built on the principle of "Privacy by Design." It takes advantage of zk-SNARKS (zero-knowledge succinct non-interactive argument of knowledge) to allow users to prove ownership of their assets without revealing any details about the parties in a transaction or the amounts transacted. It is, unlike some other implementations of zero-knowledge proofs, private by default.
The simple reality is government digital currencies are going to create incredible potential for abuse. That will be manifested in both obvious and not so obvious ways, but the net effect will be a continued erosion of human rights and individual liberties. The current models of open ledger systems that shape today’s crypto markets not only don't solve these issues, but actually in many ways make them worse.
Privacy coins are one of the few tools citizens have to fight back.