The Role of Digital ID in the Implementation of Central Bank Digital Currency

Introduction

The COVID-19 pandemic has changed the way most consumers work and live. Government’s recommendation to conduct activities virtually by utilizing various technologies have led businesses to expand their digital offerings and consumers to rely increasingly on mobile and online channels to conduct day-to-day activities. This increase in digital activity caused a rise in the volume of digital payments.

The existing US payment system is generally effective and efficient to serve this phenomenon, however technological innovation has recently ushered in a wave of digital assets with money-like characteristics, known as “cryptocurrencies”. These cryptocurrencies have not been widely adopted as a means of payment in the US. They remain subject to extreme price of volatility, are difficult to use without service providers, and have severe limitations on transaction throughput. Many cryptocurrencies also come with a significant energy footprint and make consumers vulnerable to loss, theft, and fraud .

To address the above-explained risks of the lack of financial inclusion as well as rise in the usage of cryptocurrencies and stablecoins, the Federal Reserve is considering how a Central Bank Digital Currency (hereinafter “CBDC”) might fit into the US money payments landscape. For the purpose of this paper, CBDC is defined as a digital liability of the Fed that is widely available to the general public. CBDC could potentially serve as a new foundation for the payment system and a bridge between different payment services, both existing and new. It could also maintain the centrality of safe and trusted central bank money in a rapidly digitizing economy.

Conversely, as many as its benefits for the payment system, CBDC also raises many concerns, including privacy issue and its compliance mechanism with anti-money laundering and countering the financing of terrorism (AML/CFT) regulations without invading users' privacy. Know Your Customer (KYC) is the most used mechanism by financial institutions around the world in terms of their compliance with the AML/CFT regulations. However, since CBDC is expected to have similar characteristics with cash, in particular its anonymity, it is quite challenging to apply KYC mechanism for the CBDC. Therefore, there has been many discussions regarding the development of digital ID for CBDC.

Analysis

Cash and some cryptocurrencies provide users with the ability to anonymously or pseudonymously make transactions and store wealth. This has advantages on one side, including providing users with privacy, but on other side, it brings disadvantages, particularly facilitating illicit activity. A decision would need to be made about what level of user privacy should be provided, bearing in mind that a CBDC could potentially substitute for cash, cryptocurrency, and digital payments.

Were individuals allowed to have unfettered access to CBDC, total anonymity (as offered by cash) would be unlikely, and privacy would be harder to maintain under central bank accounts. But total anonymity is not a feature of traditional payment systems either, banks and other electronic payments providers must comply with AML and bank secrecy laws. Complete CBDC privacy would be inconsistent with the enforcement of those laws.

According to Governor Brainard, "If (a CBDC) is designed to be a financially transparent and provide safeguards against illicit activity, a CBDC for consumer use could conceivably require the central bank to keep a running record of all payment data using the digital currency."

Following the 2008 market crash, transparency problems in the markets caused many issues regarding the identification counter parties in transactions. When the stock market crashed, thousands of funds and trusts were unidentifiable and the fall caused mass confusion. The lack of transparency put financial institutions and banks in a vulnerable position. Furthermore, when capital markets and banking went digital, the need for common identifier rose which caused a lot of hassle with regard to identity in regulating the corporate world and financial markets. Therefore, regardless of the specific design model involved, the rise of CBDCs needs to be accompanied by the development of digital ID to ease the KYC mechanism.

In this sense, Sweden banks give an interesting example. Private banks first introduced the Swedish federated digital ID scheme in 2003, then such eIDs are now accepted as a form of identification by government authorities. In April 2019, the Riksbank announced that it was studying the introduction of an e-krona, which primary goal would be to increase the safety and efficiency of electronic transactions. Another example would be Singapore, where the government introduced a digital personal data platform known as MyInfo in May 2016 to streamline identify verification during online transactions. Since its introduction, the MAS does not require financial institutions that have been given access to a customer's MyInfo data to obtain additional documents to verify the customers' identity and we expect the same rule to also apply if a local digital currency were to be introduced.

Those two examples show us that the overall level of digitalization of a society's financial services is a key factor in relation to CBDCs. More specifically, governments should consider the practical aspects of identity verification process involved in the issuance of their digital currency, as these are likely to have an impact on which design model is best to adopt for their CBDC.

In terms of implementation of digital ID in CBDC, for the wholesale model, central banks can adopt the concept of Legal Entity Identifier (LEI) code which is a G20 endorsed, globally verifiable unique identify code and it contains a record with information about a company such as its identity and group structure. While for the retail model, the Federal Reserve can adopt the concept of Singapore's MyInfo? and work with a Payment Interface Provider to verify the customers' identity.

Conclusion

Having a functioning digital ID scheme for the provision of financial services already in place, like the LEI codes, could be an incentive to adopt a wholesale CBDC model that leverages an existing and .

You cite not one shred of authority for the proposition that any international legal obligation constrains how states organize their payment systems. If this is to be the point of the essay then you must present some evidence in support of a proposition that appears facially untrue.

In general, improving this draft involves putting the writing in touch with sources. You make no links even to statements of fact, let alone put yourself in dialogue with anyone else's analysis.

Your technical analysis is incomplete. Central bank digital currencies are certainly under study, but anonymous digital cash is once again a policy alternative in the mix. See, e.g., HR 7231 introduced in the US House of Representatives on March 28.

-- AlberthaDewandari - 11 Mar 2022