Will CBDCs be built on digital identity?

CBDCs digital identity

Economists, governments, financial institutions, and crypto players are showing a growing interest in the development of central bank digital currencies (CBDCs).

The term refers to a digital token of a country’s official currency, providing the public with direct digital access to central bank reserves. Issued and regulated by a national monetary authority or central bank, a CBDC is fully backed by the issuing government.

As of March 2022, 9 countries have officially launched a CBDC, and 87 countries are considering doing so. As CBDCs rapidly expand in scope, complex questions surrounding privacy and digital identity are brought front and centre.

What are the proposed benefits of CBDCs?

So, could central bank digital currencies be the future for money? We can already transfer money digitally, but a CBDC transaction wouldn’t need to pass through different banks and could happen instantly on a single digital ledger.

Proponents of CBDCs argue this will eliminate many of the high costs and inefficiencies of international payments and allow monetary architectures and policies to be simplified. Another alleged benefit is the promotion of greater financial inclusion by providing unbanked individuals with access to mobile money.

Arguably the longer central banks take to bring digital currencies to market, the more opportunity for private companies to issue digital cash alternatives at inflated costs, and which exclude vulnerable segments of society. Especially if any private company were to gain a monopoly.

The question of privacy and identity

For CBDCs to be universal and accessible to everyone, they must be privacy preserving and not linked with an individual’s record or credit history. But as with any financial transaction, there also comes the obligation to prevent the use of CBDCs for money laundering and fraud.

As a result, customer due diligence and KYC procedures will prevent CBDC accounts from being fully anonymous. Central banks or intermediary financial parties will face the task of monitoring customers and transactions. And as all transactions will be recorded on a digital ledger, it should prove easier for authorities to detect illicit activity.

The challenge is collecting the necessary personal data to prevent financial crime, but without allowing this data to contribute to exclusion. Will central banks have complete control potentially eroding the privacy of citizens? Will trusted intermediaries be involved? How much control will account-holders have over who is granted access to their data?

A retail or a wholesale model?

They way in which digital identity verification procedures will be managed, will be heavily impacted by whether a retail or wholesale model is adopted. In a retail model, CBDC customers will have direct access to the digital currency through an account with the central bank. The central bank will then have the role of onboarding customers and performing KYC and identity checks.

In the wholesale model however, banks and financial institutions would administer CBDC accounts. Arguably, this would be more feasible from an identity management perspective, as retail banks (unlike central banks) are already equipped to manage identity verification on a major scale.

This would be a less significant departure from the current system operating in developed economies, but perhaps would be a missed opportunity for digital ID. By integrating or building digital ID schemes to support CBDCs, central banks could effectively manage KYC processes and advance the development of digital identity. An identity infrastructure based on accessibility, ease of use and privacy protection, would reflect the nature of digital currencies and advance the digital ecosystem significantly.

Will ID schemes play a role in the delivery of CBDCs?

One way or another, it seems clear CBDCs will have to be linked with digital identity to manage risk and secure payments. And the status of a national identity ecosystem could be a key determining factor in whether a wholesale or retail CBDC model is adopted.

In Sweden for example, the well-established Bank ID system is administered by a network of Swedish and Scandinavian banks and is used by 95% of the population to access public and private sectors. Leveraging this already strong digital ID scheme could be a driver for the Swedish Riksbank to adopt a wholesale model for the e-krona currently being explored.

Countries less advanced in the development of digital identity or in digitisation efforts in general, might find adopting a retail model for CBDCs could present a huge opportunity to promote greater inclusion and advance financial digitisation through a broader digital ID-based system.

As CBDCs continue to evolve, it is important to consider how our personally identifiable data is managed by various parties, and who we would ideally trust with this in the future. Governments, financial institutions, tech players and end users should consider the impact for digital identity as the monetary systems of the future rapidly emerge.


The conversation continues at FTT DeFi, on 12th July 2022, with sessions powered by Future Identity, exploring how identity systems will evolve as as the internet, the economy and our lives become increasingly decentralised.