Last week several U.S. federal departments issued a raft of papers addressing President Biden’s executive order on digital assets. Amongst them is a more detailed paper by the Office of Science and Technology Policy (OSTP) that explores the design options for a central bank digital currency (CBDC).
It makes very few specific recommendations, but it clearly lays out the pros and cons of several potential digital dollar features.
One of the paper’s few suggestions is that a digital dollar should be based on a permissioned system giving the central bank significant control. However, that’s based on the current state of technology. And by permissioned, it does not imply blockchain.
A significant proportion of the feature decisions are based on trade-offs between anti-money laundering (AML) and privacy.
While physical cash is anonymous, we’ve not heard of any CBDC designs around the world that plan to replicate that entirely. Likewise, the OSTP explores the pros and cons of a peer-to-peer (P2P) payment system versus intermediated. It notes the key drawback of a P2P system is the issue of AML processes, although a ledger of transactions enables traceability.
On a related note, it explores a tiered system for risk-based AML, which could be based on the level of due diligence performed on a user account, the transaction amount, or whether the user is a known counterparty. This design feature is strongly tied to the P2P versus intermediary decision because smaller transactions might be allowed P2P or offline and have greater privacy. Larger transactions may be intermediated to enforce AML.
A more direct privacy issue is who, if anyone, gets to see the details of the transaction and which details. Is it the central bank, the intermediary, or nobody?
While there’s no specific recommendation, the paper lists significant drawbacks of the central bank gathering large amounts of data. These include the risk of future administrations surveilling the population even if the data collection supports technical or legal restrictions to access. Clearly, citizens might be reluctant to use such a CBDC.
Interoperability, especially with foreign CBDCs, could improve cross border payments and other payment systems. The downside is it increases cybersecurity and other risks.
One of the issues explored in the paper that’s rarely addressed elsewhere is how to address refunds or remediation like chargebacks or correcting fraud. One option is to delay the final settlement to allow for remediation, but this doesn’t seem like a step forward. It’s more likely that it will be “off-ledger”. In other words, someone makes a decision to create a transaction that reverses the original one. That requires some governance about who can make those decisions. And it might not be practical for P2P transactions that don’t have intermediaries.
The paper explores a number of other issues, including
- using cryptographic signatures
- offline transactions
- programmable money
- the data model: UTXO v account balance
- ledger history
- holding limits
On the same day, the Treasury issued three papers, including one on the digital dollar.