CBDCs protect privacy and break data monopolies

CBDCs protect privacy and break data monopolies

Central banks and corporations are engaged in a race for digital payment infrastructures. A blog post by the U.S. Federal Reserve argues why a government digital currency (CBDC) would be the better solution.

Has cash become obsolete? Surveys show that Germans are increasingly paying digitally as a result of the Corona pandemic. This worldwide trend can be explained by increased hygiene and convenience. Nevertheless, data protectionists are alarmed, because cashless payments Bitcoin Bank provide companies like PayPal, Visa, Google and Facebook with an undreamt-of wealth of data. Could privacy be better protected with a central bank digital currency (CBDC)?

At least that is what Rodney Garrett and Michael Lee claim in a blog post on November 23. The economist from the University of California at Santa Barbara and the researcher from the New York arm of the U.S. Federal Reserve discuss a jointly published paper. The two describe CBDCs as a „low-cost, privacy-preserving electronic means of payment. Bitcoin and Co., however, reject them because of high transaction costs.

Private payment platforms and the data monopoly

Garett and Lee first ask about the effects of privately owned digital payment infrastructure. As is usual in economic research, the considerations of the two authors are based on a number of model assumptions. They assume that companies use data to gain a competitive advantage and that consumers choose between different payment models based on price. Since digital payments promise user data, companies would therefore create incentives for their use. As a consequence, the model suggests that a data monopoly is forming in the market:

A company that gains small information advantages early on sets prices aggressively to increase its share of consumer data and monopolizes the market in the long term. In such a market, we find that the monopoly company controls the vast majority of the data and is able to offer a product that is far superior to its competitors‘ products.

What is advantageous for this company turns out to be a disadvantage for the end users. Only a fraction of the added value generated by their data reaches them. With a CBDC, however, the bill turns out differently.

CBDC: When digital infrastructure meets cash

Digital central bank money offers consumers the same convenience as private payment platforms. However, a CBDC in the Garrett and Lee model offers the same level of privacy as traditional paper.

This gives end consumers an additional benefit. After all, if the private providers want to access consumer data, they must make payment processing via their own platforms cheaper than via a CBDC. It is irrelevant whether consumers actually make use of the digital cash. The mere presence of a CBDC creates incentives for remuneration when consumers hand over their own data.

The argumentation of the two researchers is based on the assumption that central banks are not profit-driven and therefore have no use for user data. CBDCs could therefore help to save the anonymity of cash into the digital age. For liberal democracies, this conclusion may be correct. In the case of China and comparable autocracies, however, it is precisely state digital currencies that open up frightening possibilities for monitoring and control.