A central bank digital currency (CBDC) could still be anonymous, says the ECB.

The trade-off in a central bank sponsored digital currency (CBDC) appears impossible. How to strike a balance between allowing privacy in electronic payments, yet ensuring compliance with regulations aimed at tackling money laundering and the financing of terrorism (AML/CFT regulations)?

An ECB-coordinated project, conducted by the  European System of Central Banks (ESCB), has established a proof of concept (PoC) for anonymity in digital cash, reports COINTELEGRAPH.

The experiment does not indicate that the ECB will actually proceed with a CBDC. It’s just that – a prototype, so to speak.

A central bank digital currency (CBDC): Blockchain-based solution

The ESCB’s EUROchain research network (with the support of Accenture and R3) used distributed ledger technology (DLT), or the blockchain, in the CBDC experiment. The user can choose whether her identity and transaction history is visible to the central bank or its intermediaries.

The system works with “anonymity vouchers.”

These accumulate the total amount of anonymous transfers made by the user over a defined period. Beyond that amount, the system delegates additional controls to an AML authority. Moreover, the entire procedure is automatic with a digital procedure for AML/CFT compliance.

The PoC, therefore “demonstrates that it is possible to construct a simplified CBDC payment system that allows users some degree of privacy for lower-value transactions while still ensuring that higher-value transactions are subject to mandatory AML/CFT checks,” the ESCB report says.

The PoC assumes that the CBDC has cash-like features. Moreover, the central bank alone can issue CBDC units or remove them from circulation. Further, an independent and dedicated “AML authority” performs the AML/CFT checks. Lastly, the system revolves around intermediaries (Tier2) that will interact between the users and the central bank (Tier1). They have access to central bank accounts and can draw on balances to issue CBDC to the users.

The prototype runs on the Corda DLT platform.

Is the US considering a CBDC?

In October, Federal Reserve Bank of Dallas President Rob Kaplan said the Fed was “actively looking at and debating” issuance of a US digital currency.

The Fed could be mulling a US digital currency on fears that an upstart cryptocurrency could gain global adoption. The new currency could dislodge the US dollar from its perch as a global reserve currency. If a new digital currency dethrones the US dollar, demand for US assets could decline. This would dramatically push up the interest rate that the US pays on its debt.

“It’s $200 billion a year and all of a sudden we’ve got a tremendous problem here, so it’s something we’re watching very closely,” Kaplan said of the amount of additional interest payment the USA would have to shoulder.

[Related Story: Inevitable That Central Banks Will Start Issuing Digital Currency: Fed’s Harker  ]