Compliance of Central Bank Digital Currency with AML/CFT Regulations without Invading Users' Privacy

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.

Analysis

International privacy law presents a set of concise, binding standards that states must take into consideration when determining what framework should regulate the implementation of CBDC.

Really?

Privacy is a fundamental human right recognized throughout international bodies and treaties. Invasion of one’s privacy can be considered both as criminal and civil conducts. The United Nations General Assembly Resolution 68/167 called on state to protect the right to privacy in the digital age and note that international human rights law provides the structure to examine instruments’ and actions’ compliance with the right to privacy.

Article 17 of the International Covenant on Civil and Political Rights (ICCPR) creates an external limit on the innovation of CBDCs, as central banks themselves may not have incentive to pursue the most anonymous form of currency. Article 17 imposes two umbrella standards to consider for any potential infringement of privacy: lawfulness and arbitrariness. Until now, people value the privacy provided by currency. There are legitimate reasons people may prefer some degree of anonymity in regard to their payment activities. Cash is a way to avoid customer profiling and limit exposure to hacking. However, banks today are required to notify regulators of large or suspicious deposit and withdrawal activities as well as are expected to surrender customers’ account information to the authorities on a written request, without a court order or a search warrant. It is hard to imagine there is any government would instruct or allow its central bank to create accounts with greater privacy protection against national government that commercial bank accounts have.

Further, if states choose to pursue CBDC, central banks should recognize the fundamental tension between international privacy laws and central bank incentives. Central banks may lack incentive, besides compliance with international privacy laws, to issue a digital currency that would be validated by a distributed ledger system and circulate anonymously. Due to this lack of incentive, central banks should take specific note of the balance of the pursuit of the aim and limitation on the right to privacy and cautiously approach CBDC with the goal of preserving access to anonymous payment methods. Importantly, individual consumers value anonymity in currency. Previous attempts to digitize payments on a state to individual basis have already raised many concerns in states such as Australia and represent the extension of government regulation into personal autonomy and private life.

Conclusion

The introduction and development of CBDC do not only impose central banks to more alternative forms of currency, but also the risk of protecting consumers’ right to privacy as the consequence of digitizing cash. Proposed CBDCs should be analyzed under article 17 of ICCPR because of the sensitive nature of the mass aggregation of financial data. Central banks that choose to pursue CBDC should ensure that their currencies are lawful and not arbitrary. Crucially, under the arbitrary infringement analysis, CBDC must minimally impair privacy and must not infringe on privacy more than they pursue a legitimate policy goal.

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