Would a US digital dollar let the government track you?

As lawmakers push to create a digital form of the US dollar, some are concerned it could give the federal government access to what consumers and businesses do through electronic transactions.

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US legislators continue to press for the creation of a digital dollar, raising questions about whether the move could make it easy for the federal government to track business and consumer transactions.

Putting all the digital dollars on one electronic ledger operated by the Federal Reserve would also be a tempting target for cyber criminals.

In March, lawmakers introduced a bill that would allow the US Treasury to create a digital dollar and pilot it to determine its viability. That same month, President Joe Biden called for more research on developing a national digital currency through the nation’s central bank. The order highlighted the need for more regulatory oversight of cryptocurrencies, which have been used for nefarious purposes such as money laundering and other criminal activities.

The ECASH Act (Electronic Currency And Secure Hardware Act) would allow a bearer instrument that wouldn’t require payment processing intermediaries, such as SWIFT, the world’s largest payment messaging network. That means payments using ECASH would be near instantaneous — even across national borders — and processing fees would likely be dramatically reduced.

A central bank digital currency (CBDC) would also increase inclusion for “black, brown, and low-income communities” to build and sustain wealth, according to US Rep. Ayanna Pressley (D-MA), vice chair for the Subcommittee on Consumer Protection and Financial Institutions.

Avivah Litan, a vice president and distinguished analyst at research firm Gartner, said while there are solid methods to protect privacy for digital cash transactions, such as zero-knowledge proof technology (ZKP), they still rely on the central bank’s good faith.

A zero-knowledge proof is used in cryptography to prove that something is known without revealing the underlying information directly. For example, for someone applying for a car loan, a ZKP could validate that the person's credit score meets minimum requirements for the loan without exposing the actual score to the seller. Or a ZKP could be used to prove someone meets the minimum-age requirement for purchasing alcohol without sharing a date of birth, or validate a driver's license without exposing the actual license number.

Digital currency, however, doesn't natively incorporate zero-knowledge proofs. As a result, Litan said, citizens using a digital dollar have to trust the government to keep the ZKP protection in place.

“So, the bottom line is that auditor function, which is controlled by the Central Bank, can theoretically change the privacy settings on an individual account at any time. And that’s the bottom line pretty much for any centrally-controlled digital currency, whether it’s ECASH or any other CBDC. In the end, you still have to trust your government to respect your privacy,” Litan said. “That’s a tall order.”

Generally speaking, there are three kinds of digital currency:

  • Cryptocurrencies, such as Bitcoin and Ethereum, which are created and traded using blockchain distributed ledger technology (DLT);
  • Stablecoin, such as Tether and USD Coin, which are backed by fiat currencies like the US dollar;
  • Central Bank Digital Currency (CBDC), or fiat currencies issued by central banks in digital form and not categorized as cryptocurrency
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The ECASH Act requires that all proof-of-concept pilots and field tests be designed as bearer instruments -- that is a plastic card or application on a device that is controlled by the one in possession of it. An ECASH digital dollar must also be capable of instantaneous and final peer-to-peer, offline transactions; and it must be capable of being directly distributed to and owned by the general public.

The US is already well behind other nations in exploring the creation of a government-backed digital currency.

“As digital payment and currency technologies continue to rapidly expand and with Russia, China, and over 90 countries worldwide already researching and launching some form of Central Bank Digital Currency, it is absolutely critical for the US to remain a world leader in the development and regulation of digital currency and other digital assets," Rep. Stephen Lynch (D-MA), said in a statement. Lynch was the primary sponsor of the ECASH Act.

"If we don't create our own, standards will get set by other countries already aware of the advantages of this innovation and the US will be left behind," Ananya Kumar, assistant director of Digital Currencies at the Atlantic Council’s GeoEconomics Center in Washington DC, said in a March interview with Computerworld. "The EO came out very strongly for American leadership on these issues. The US to date has not been focusing coordinated efforts on this."

Lynch introduced the bill, saying electronic transactions could leave much of the population — particularly the unbanked or underbanked, and those who live in areas without reliable internet service —without access to the digital economy.

The US needs an electronic cash system “that can be used by people at the bottom of the economic ladder,” Lynch said while speaking at Boston University earlier this month. “We hope this bill will address many of the challenges we face as we move toward a cashless society.”

In February, the US Federal Reserve tested a design and processing system for a US digital dollar that handled 1.7 million transactions per second. Project Hamilton, as the digital currency effort was dubbed, is a multi-year research project by the Federal Reserve Bank of Boston and Massachusetts Institute of Technology Digital Currency Initiative. Its purpose is to explore a CBDC design and gain a hands-on understanding of a digital currency’s technical challenges and opportunities.

According to the Fed's Report on Project Hamilton, a core processing engine for the test CBDC was able to bring  99% of the digital cash transactions to settlement in under two seconds, and “a majority” in under 0.7 seconds. “However, the ordering server resulted in a bottleneck, which led to peak throughput of approximately 170,000 transactions per second,” the report said.

Christian Catalini, a research scientist and founder of the MIT Cryptoeconomics Lab, said COVID pushed people to use digital transactions during lockdowns. That, in turn, renewed discussion around what kind of public infrastructure should support a digital dollar.

Creating a digital dollar or CBDC based on a central ledger is not necessary, though it would allow the federal government to monitor activity for any nefarious transactions.

“With ECASH, I think the idea is to have something that looks a lot like a physical device — think of it as plastic card with some additional functionality — that behaves a lot like physical cash,” Catalini said. “I can transact with it and it’s a bearer instrument. As soon as someone receives a payment through the system, all they have to know is the payment successfully executed. There’s no central ledger that records everybody’s balances.”

Today, electronic transactions — such as credit card purchases and bank fund transfers — are already tracked on electronic ledger. Those ledgers, however, are both regulated and owned by private companies, not the federal government.

Even the use of cold, hard cash can attract government purview. For example, if a large purchase is made with cash or a large withdrawal is taken from an account (think hundreds of thousands or millions of dollars), the federal government does take notice and it will look into it, Catalini pointed out.

It will be at least five years before consumers see a digital dollar, he said. In all likelihood, it will be even longer because so many technical and philosophical questions remain.

“We do have tools that could bring privacy in a thoughtful way to digital transactions, but a lot of this is still in the works,” he said. “From a societal perspective, I think we always struggle with this balance that on one side people want privacy around their financial transactions, but on the other side there are concerns around full privacy. If you’re trying to perpetrate crime, we want to make sure those transactions are not supported by our financial systems.”

Rohan Grey, an assistant professor at Willamette University who consulted with Congress on the ECASH bill, said the legislation as is would create "a token-based system that doesn't have either a centralized ledger or distributed ledger because it had no ledger whatsoever.

"It uses secured hardware software and it's issued by the Treasury," Grey told Coindesk. "This form of e-cash would support peer-to-peer transactions, and given the nature of its setup, it would support fully anonymous transactions."

The lack of a distributed ledger, or a decentralized digital database, means the current proposed digital dollar would not be based on blockchain, as are other cryptocurrenies.

Unlike cryptocurrencies, such as bitcoin and other blockchain based cryptocurrencies, the ECASH device will be a piece of secured hardware issued and/or authorized by the government for the purpose of receiving, holding, and transferring e-cash balances, the ECASH website explains.

ECASH devices would verify funds locally via a dedicated or trusted computing environment located on the device itself.

“This allows it to facilitate both offline and genuine peer-to-peer transactions without generating transactional data or requiring the approval of third-party intermediaries or network validator nodes,” the site explains.

Even on a secure physical device controlled by a consumer, ECASH would have to have restrictions, Catalini pointed out. For example, there would have to be limits on how much digital currency the device could hold. Otherwise, the bearer instruments could be used for nefarious activities that couldn’t be tracked.

And there are still many questions to be answered. For example, how would digital funds be load onto a card or device? Would a user have to show an identification document to download ECASH?

“I would imagine there would be some sort of know-your-customer technology around loading balances,” Catalini said. “So, I think there will be many different approaches that will compete technologically and from a regulatory perspective to offer the appearance of cash.”