September 3, 2018 Reading Time: 4 minutes


Financial privacy does not get much attention from central bankers. Perhaps they are uncomfortable with the role they play in providing the underworld with the world’s most popular anonymity-providing financial technology: banknotes. An exception to this rule is a trio of Federal Reserve economists — Charles Kahn, James McAndrews, and William Roberds — who have been publishing on the topic of money and privacy for almost two decades.

Kahn, McAndrews, and Roberds kicked this effort off in 2000 with “A Theory of Transactions Privacy,” followed it up with “Money Is Privacy” in 2004, and have published a string of related papers since then. Those with long memories will remember that I cited them in a previous article for Sound Money, “Anonymous Digital Cash.”

A general theme of these papers is that cash isn’t just a means for criminals to cloak their activity but also a way for regular people to conceal vital personal information, say their identities and addresses. If the information provided by transactions can be exploited — the seller might secretly plan to pawn off the data to annoying telemarketers, or identity thieves might desire the data to run a scam — then consumers will prefer to forgo some transactions, opting to protect themselves instead. The existence of cash empowers consumers by allowing them to retain the sole right to their information. Transactions that were previously exploitable are now rendered safe and can proceed, social welfare improving as a result. 

It’s worth reading Kahn’s most recent contribution, “Payment Systems and Privacy,” in which he gathers many of these themes together in a very readable essay. He also brings in the topic of a central bank digital currency, a topic I often blog about. 

Kahn puts forth two reasons why someone might desire privacy in a legal transaction. First, the buyer might desire privacy from the other parties to the transaction — that is, the seller or someone else privy to the exchange (see paragraph below). Second, he or she might desire privacy from the operator of the payments system. For example, Visa customers might trust Visa and their banks not to snoop on their data, but might doubt the ability of these organizations to protect these data from hackers. Anonymous payments media like cash are a way to protect against data breaches, an increasingly common occurrence in today’s society. 

Backtracking to Kahn’s first reason, buyers might desire privacy from sellers and other third parties because they cannot afford the lawyers’ fees arising because of non-anonymity. When identities are known, a single transaction can unintentionally evolve into a long-term relationship. Kahn points to the growing incidence of cases in which, long after a transaction, it is subject to clawbacks, extraterritorial rulings, and new forms of product liability. As protection, a buyer might insert into the initial payment a set of clauses dealing with each eventuality. But for those who do not have access to legal departments, this form of contracting can get expensive. The ability to use some sort of anonymous payment system at the outset ensures that a single transaction does not become a long-term, and potentially costly, burden.

This leads to current developments in payments. Use of banknotes in day-to-day transactions is slowly giving way to digital alternatives like credit and debit cards. In response, central bankers around the world are discussing the idea of issuing their own e-money, sometimes known as central bank digital currency. Many of the proposals that have been put forth could be capable of providing the public with some of the same cloaking abilities as cash. 

Kahn questions whether central banks have any sort of comparative advantage in providing the public with electronic privacy. To begin with, central banks might not have as much technical skill as private sector banks do in protecting privacy. Secondly, he doubts whether the public would trust a central bank issuer’s promise of anonymity any more than it would trust a private issuer. As evidence, he cites the public’s difficulty in understanding what central banks do and the growing tendency to scapegoat central bankers in the post-crisis era. 

Kahn entertains the possibility that a transparent central bank e-money might render the product more trustworthy. We trust paper money’s anonymity, after all, even though it is a government product. But Kahn points out that we only know that a banknote cannot track us because this property is easy for anyone to verify. All we need to do is to feel the paper (or plastic). An electronic version of cash, however, cannot instill this same sense of confidence, says Kahn. Only a small percentage of the population has the expertise to verify that the code doesn’t have a backdoor for the NSA or some other spy agency.

This seems to me like an indictment of not only a transparent central bank e-money, but all sorts of other e-money schemes, including Bitcoin. Only a small fraction of the millions of Bitcoin users can actually read Bitcoin’s source code—or even Satoshi Nakamoto’s less technical white paper, for that matter. Yet this hasn’t stopped Bitcoin from becoming widely trusted by its users. Likewise, it seems possible at least that an open-source central bank e-money would be able to build a user base that trusts its anonymity. 

Kahn ends his essay by making an appeal for a plethora of privacy-providing products. Each one could provide a different type of privacy, users selecting a product according to the specific requirements of the transaction they plan on making. One e-money might specialize in providing privacy from third-party snoops; others might focus on providing privacy from the system operator itself. The role of central banks will no longer be to provide privacy, believes Kahn, but to set and harmonize standards for privacy protection.

Questions about privacy are becoming increasingly important, especially as we learn more about the degree of involvement governments and large technology companies have in gathering and sorting through our data. In this context, the work of Kahn and his colleagues Roberds and McAndrews on financial privacy is becoming ever more relevant.

J.P. Koning


J.P. Koning is a financial writer and blogger with interests in monetary economics, economic history, finance, and fintech. He has worked as an equity researcher at a Canadian brokerage firm and a financial writer and publisher at a large Canadian bank. More recently, he has written several papers for R3, a distributed ledger company, on the topics of central bank cryptocurrency and cross border payments. He founded the popular blog Moneyness in 2012. He designs economics and financial wallcharts at Financial Graph & Art.

Koning earned his B.A. in Economics from McGill University.

Get notified of new articles from J.P. Koning and AIER.