The Bank for International Settlements (BIS) has set out its recommended approach to fundamental elements of central bank digital currency (CBDC) design, stating a preference for account-based systems built on digital ID.
BIS’s verdict, set out today (23 June) in a chapter of its Annual Economic Report for 2021, will likely be pored over by both public authorities and private companies with an interest in CBDC design options as the institution is effectively the collective voice of leading central banks.
Its publication comes as central banks including the US Federal Reserve and Bank of England step up their exploration and – for some central banks – experimentation with digital money.
BIS’s analysis focuses on retail (also known as general purpose) CBDCs, which would be available to the general population. Compared with wholesale CBDCs, which are for inter-bank use, retail CBDCs are described as a ‘more far-reaching’ innovation.
CBDCs would, the report states, best function as part of a two-tier system where the central bank and the private sector ‘work together to do what each does well’. The central bank would operate the system’s core, ensuring its safety and efficiency, while the private sector, such as banks and payment service providers, would innovate and actually serve customers. Precisely where the line is drawn between organisations’ respective roles depends on data governance and the capacity for regulation of payment service providers (PSPs), BIS states.
In favour of an account-based approach
The 32-page chapter, released ahead of the publication of the rest of the report, explains that retail CBDCs come in two ‘variants’: a cash-like design, allowing for so-called token-based access and anonymity in payments; or an account-based design built on verifying users’ identity ‘rooted’ in a digital ID scheme.
This second approach is, the report says, more compatible with the monitoring of illicit activity in a payment system, and ‘would not rule out’ preserving privacy: personal transaction data could be shielded from commercial parties and even from public authorities by appropriately designing the payment authentication process, BIS states, pointing out that these issues are ‘intimately tied’ to broader policy debates on data governance and privacy.
Privacy was the most-requested feature of a potential digital euro in a consultation run by the European Central Bank.
The chapter’s fourth section (of five sections in total) focuses on digital ID and user privacy, and is likely to prove particularly interesting for those involved in CBDC design and policy.
Assuming that CBDCs are to be account-based, an important question – the report points out – is who should verify a potential user’s identity and how this should be done. The designs and roles of the public and private sector differ substantially between nations, should they have ID schemes at all. Global Government Fintech reproduces at the end of this article, in edited and abridged form, this part of BIS’s report, which cites useful examples from different countries.
‘Cautious approach’ needed on digital ID
BIS also touches on federated identity, which it describes as an ‘alternative, nascent model’ of digital ID, in which a citizen has ownership and control over their credentials. These can be selectively shared with counterparties, who can verify that the credentials belong to a valid issuer. In such a ‘federated’ model, different attributes of each person are recorded and issued by different entities. A federated digital ID could potentially allow for identification alongside decentralised storage of data, BIS states.
Data governance and privacy aspects have emerged as among the most fertile areas of debate in respect of CBDC.
‘While identification (based on a unique digital ID) is crucial for the safety of the payment system and transactions in a CBDC, there is a countervailing imperative to protect the privacy and safety of users,’ BIS states. ‘Beyond theft, the combination of transaction, geolocation, social media and search data raises concerns about data abuse and even personal safety. As such, protecting an individual’s privacy from both commercial providers and governments has the attributes of a basic right. In this light, preventing the erosion of privacy warrants a cautious approach to digital ID.’
The report points out that some CBDC designs aim to protect anonymity through additional ‘overlays’. For example, ensuring the anonymity of small-value transactions by issuing vouchers, maintained by a data registrar, that issues them up to a limit in the user’s name. Another approach, considered in the case of China’s well-progressed digital yuan, is to shield the identity of the user by designating the user’s ‘public key’, issued by their mobile-phone operator, as the digital ID.
BIS also touches on the question of limiting the size of potential CBDC accounts. ‘One caveat with hard caps is that households or firms that have reached their cap could not accept incoming payments, resulting in a broken payment process,’ the report notes. ‘To ensure that households and firms can accept incoming payments at all times, any funds in excess of a cap could be transferred automatically to a linked commercial bank deposit account – the so-called overflow approach’.
Further design questions
The challenges and opportunities created by cross-border use of CBDCs – a growing area of exploration for some groups of central banks – are also discussed.
International efforts towards mutually recognising national ID credentials are a ‘more promising’ approach than a supranational digital ID scheme, BIS states.
In respect of further CBDC design questions, the chapter states that ‘permissioned DLT [distributed ledger technology] designs may have economic potential in financial markets and payments due to enhanced robustness and the potentially lower cost of achieving good governance, as compared with systems with a central intermediary’. But it points out that ‘such resilience does not come for free, as an effective decentralised design that ensures the right incentives of the different validators is costly to maintain’.
On balance, a ‘trusted centralised design may often be superior, as it depends less on aligning the incentives of multiple private parties,’ BIS states.
BIS plans to publish the rest of its Annual Economic Report on 29 June.
IDENTITY VERIFICATION: BIS’s report’s country examples
‘At one end of the spectrum are systems that rely exclusively on private parties to verify ID. Big techs such as Google or Facebook, and Alibaba or Tencent in China, have developed their own digital IDs that are required for many of their services, including payment apps. In some cases, consortiums of private firms provide a harmonised ID that works across multiple providers. The main drawback of purely private IDs is that they are limited to the specific network for which they are designed, and hence may lead to silos and limited inter-operability.
‘Some countries follow models based on public-private partnership. A consortium of banks in Sweden developed the BankID solution, which allows users to authenticate themselves for payments and government services. Similar solutions are offered in Denmark, Finland and Norway.
‘Proceeding one step further are systems in which the private and official sector develop a common governance framework and strive for inter-operability between their services, as seen in France or the Netherlands. Government-led solutions represent the furthest-reaching model. These allow administrative databases to be linked up, further enhancing the functionality and usefulness of digital ID. For example, Estonia provides every citizen with a digital identity that allows access to all of the country’s e-services. In Singapore, the SingPass platform provides a digital identity linked to individuals’ biometrics (facial recognition and fingerprints). The Kenyan Huduma Namba system brings together information from various sources and allows access to a range of public services.’
Text from p19-p20 of CBDC chapter of BIS Annual Economic Report (p83-p84 of full report)
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‘French and Swiss central banks trial cross-border CBDC’ – our news story (14 June 2021) on France and Switzerland’s central banks, as well as the BIS Innovation Hub, working with an Accenture-led private-sector consortium to experiment with the use of wholesale CBDC for cross-border settlement
‘Bank of England sets out five CBDC ‘core principles’” – our news story (9 June 2021) on the UK central bank’s setting out of a quintet of ‘core principles’ to form the backbone of its explorations into a potential digital pound
‘Sweden’s e-krona testing enters next phase’ – our news story (2 June 2021) on Sweden’s central bank teaming up with one of the country’s biggest commercial banks (Handelsbanken) and a Nordic IT services provider (TietoEVRY) as its testing for a potential CBDC takes a step – albeit on an experimental basis – into the ‘real world’
GLOBAL GOVERNMENT FINTECH WEBINAR
Global Government Fintech organised an international webinar, in partnership with Amazon Web Services Institute (AWSI), entitled ‘Delivering Central Bank Digital Currencies (CBDCs): Exploring the Technology Challenge’ on 22 April 2021