Digital currency exposes debate over privacy risk

Since 2020, the Central Bank has been studying how to implement a Brazilian digital currency. But privacy issues still need to be improved as the digital real develops. Data protection, secrecy and traceability are at the heart of the debate both for the national project and for initiatives around the world.

When designing the system of a CBDC (Central Bank Digital Currency), there is a wide range of options for cryptographic techniques and operational arrangements regarding the protection of information and its participants.

Government surveillance of user behavior is among the discussions emerging with the creation of central bank-issued digital currencies. Unlike cryptocurrencies such as bitcoin, they would be an extension of paper money, guaranteed by the state.

Isac Costa, former Capital Market Analyst at the CVM (Securities Commission), highlights the “paradox of total transparency” in operations involving digital currencies.

According to him, full visibility of transactions can be used within a democratic rule of law for “legitimate purposes”, such as preventing money laundering and tax evasion. However, he points out that 100% transparency can be an issue when running an authoritarian government, whether right or left.

“If I have the rise of an authoritarian state, it can try to identify the sources of funding and revenue for certain enemies, it can use the pretext of fighting terrorism to try to stifle revolutionary movements,” he said.

For the specialist in Regulation, Finance and Technology, by opening up the opportunity for the State to have full oversight over citizens, the possibility of abuses of power also arises. “Controlling abuse of state power is always a problem,” he said.

To illustrate, the consultant and professor drew an analogy with the “war on terror” led by the United States after the September 11, 2001 attacks, and also used Russia and China as examples.

The operation of the digital yuan is viewed with suspicion by Western experts, given the Communist Party of China’s interference in the lives of the country’s citizens.

China was also mentioned by Bruno Diniz, professor of innovation at USP/Esalq MBA courses and founding partner of the Spiralem consultancy, in view of the possibility of the Chinese government using digital currency as a way of reinforcing the surveillance state, preventing its citizens to purchase goods and services that conflict with party directives.

“A tool in the hands of authoritarian governments can lead to negative side effects, with greater control of restrictions that already exist, such as the internet itself, taking this to an extreme financial level,” he said.

If complete transparency can be an issue, at the other extreme, a high degree of opacity either in digital transactions or in the agents involved is also not desirable, as it opens up space for scams and fraud. But the privacy of a CBDC goes beyond the binary options of visibility or anonymity.

In Brazil, the BC guidelines on the digital real, released in May 2021, establish that all privacy and security principles and rules determined by legislation for operations in financial and payment systems are guaranteed – such as the bank secrecy law and the LGPD (General Data Protection Law).

Also noteworthy is the provision of a technological design that allows full compliance with international recommendations and legal norms on the prevention of money laundering, the financing of terrorism and the financing of the proliferation of weapons of mass destruction, including in compliance with court orders to track illicit operations.

Rodrigoh Henriques, leader of financial innovations at Fenasbac (National Federation of Associations of Central Bank Servers), defends “controlled anonymity” and says that a currency created for the digital world “can and should be subject to analysis by regulators and the government while preserving transaction secrecy by default”.

“Transactions are confidential to all those outside the financial system, but in case of need the Central Bank, by determining the correct legal instance, could reveal the data for analysis and use in processes and investigations”, he said.

According to Fabio Araújo, coordinator of the BC’s digital real initiative, a possible strategy in the Brazilian case will be “to seek to reproduce the responsibilities that exist today, in which only the information necessary for the conduct of operations is revealed to the participants of the transaction”.

He emphasizes that, even with the fragmentation of information, the entire history must be capable of reconstruction, by means of a court order. “The information must be available, even if in a non-consolidated form, under the custody of the BC or entities regulated by it”, he added.

According to the BC economist, the technologies that allow this type of information governance will be tested throughout the development of the digital real project.

The creation of digital currencies is on the radar of central banks around the world. According to research by the Atlantic Council, an international think tank, 87 countries (representing more than 90% of global GDP) are currently studying the subject. In May 2020, there were only 35 countries.

The Bahamas became a major laboratory in creating the sand dollar, the world’s first digital currency issued by a central bank. Currently, nine countries have launched their projects, including Nigeria.

According to Henriques, there are several experiments looking for the right balance between privacy and traceability. In the Brazilian case, he considers that Pix can serve as an example of a solution designed to guarantee security and secrecy simultaneously.

“We need to make sure that transactions are carried out by people or companies that exist. This is exactly what happens when we register a Pix key, which is always associated in the DICT (Directory of Transactional Account Identifiers) to a validated natural or legal person” , said the coordinator of the Lift Lab (Laboratory of Financial and Technological Innovations).

Some other proposals are being studied, such as solutions that guarantee that the digital currency was issued by the BC or that ensure that the transaction validation does not access the total amount of the fund, in addition to “unlinking” solutions in which transactions from the same person do not can be related.

In March, nine projects were selected by BC and Fenasbac to participate in the Lift Challenge on the digital real. But the start of work was postponed due to the workers’ strike, which lasted from April 1st until last Tuesday (19th), when it was suspended for two weeks. The implementation of the digital currency pilot project, scheduled for the fourth quarter of this year, is also expected to be delayed.