The surveillance economy has arrived . The popularity of online service platforms has enabled service providers to collect, aggregate, and analyse data about the behaviour of individuals with a volume and scope never before possible. Data brokers have created a marketplace for exchanging information about individuals that can be used to link their various online actions, including but not limited to financial transactions. Such information, including the reuse of credentials over successive transactions, can be used to link the transactions to the transacting parties [2, 3]. Such a linkage can greatly simplify successive transactions, reducing costs for the provider and improving customer experience. However, the potential for monitoring profoundly influences the everyday behaviour of individuals as they conduct their various activities . The value of such control is reflected in an emerging marketplace for record linkage via entity resolution, which seeks to determine the specific individual person associated with any given activity and, correspondingly, the history of activities associated with any given individual person [4, 5].
Cryptocurrencies seem like a natural alternative for exchanging value that can avoid the watchful eye of state actors, powerful corporations, hackers, and others who might be well-positioned to build a dossier of one’s activities. However, a lack of appropriate regulation generally burdens cryptocurrency users with practical limitations and risks. The risks include the lack of financial products and services, the inability to earn interest, basic consumer protection, and the absence of legal infrastructure for adjudicating disputes. Additionally, most cryptocurrencies are not as privacy-enhancing as is commonly perceived, and as state actors attempt to erect a cordon around criminal activity that relies upon cryptocurrencies, the cryptocurrencies that are most respectful of an individual’s privacy are generally denied access to the nascent industry of government-approved services such as exchanges. Furthermore, even the most privacy-enhancing cryptocurrencies suffer from the arguably intractable governance challenges associated with building a decentralised network that respects the interests of its users.
According to a report published by the UK Parliament, the lack of consumer protection and regulated marketplaces for crypto-assets are major drawbacks associated with cryptocurrencies as a medium of exchange , and the possibility that anonymous transactions might promote money laundering is a significant perceived risk, despite that the National Crime Agency has assessed the risk as low . So we have reached an impasse, with institutions demanding control and countenancing surveillance at one extreme, and cyberlibertarians demanding privacy at the expense of regulation on the other.
|Robust to cyberattacks|
|Usable without registration|
|Suitable for taxation|
|Can block some illicit uses|
|Supports monetary policy|
Let us commence this article by introducing a set of “desiderata”: properties that a payment system should have. They are listed in Table 1. We discuss how we can reframe our requirements such that we might achieve a parsimonious set of regulatory objectives while also respecting privacy and fulfilling the desiderata. We follow and extend the ongoing discussion of how to regulate cryptocurrency payments [8, 9], with a view toward respecting human rights .
The paper is organised as follows. In the remainder of the first section, we discuss the regulatory context surrounding modern retail financial transactions, and we introduce cryptocurrencies as a prospective substitute for regulated payments. In the second section, we compare and contrast three methods of conducting financial transactions online: modern, regulated retail banking; classic cryptocurrencies such as Bitcoin; and privacy-enabling cryptocurrencies such as Monero. In the third section, we introduce two candidate approaches that each offer individuals a verifiable means of transacting privately and also provide suitable mechanisms by which institutions can enforce regulatory compliance. In the final section we conclude with a discussion of the opportunities and tradeoffs.
1.1 Institutional Posture
Banks and other financial intermediaries in many jurisdictions around the world are subject to anti-money laundering (AML) or “know your customer” (KYC) regulations that require them to collect data on individual accountholders and others who make use of their services [11, 12]. The penalties for non-compliance are potentially severe, and banks dedicate significant resources to building and maintaining compliance infrastructure.
An international organisation named the Financial Action Task Force (FATF) was established by the G7 in 1989 as a trans-national effort to monitor financial activities, with the stated purpose of investigating and preventing money laundering and terrorist financing . FATF provides one of the mechanisms by which AML/KYC regulations in different jurisdictions are promulgated and coordinated. FATF also publishes a blacklist of nations who fail to enforce rules that facilitate the identification and investigation of individual accountholders, with the purpose of coordinating sanctions that force blacklisted nations to conform .
The financial regulations imposed by economically powerful jurisdictions such as the United States and the European Union share common features. In the US, AML regulations provide for customer identification and monitoring, as well as the reporting of suspicious activities . In the EU, Directive (EU) 2018/843 (“5AMLD”) requires that every financial transaction must be associated with an account, and that every account must be associated with a strongly identified responsible individual . The directive also significantly reduces the maximum allowed value for prepaid cards and stipulates that remote transactions above EUR 50 must be accompanied by customer identification . Note that 5AMLD specifically includes cryptocurrencies as subject to its prescribed regulations on financial transfers.
Although the systematic collection of identifying information for individual accountholders might facilitate important investigations, it also provides a mechanism by which authorities can browse comprehensive or near-comprehensive financial information about individuals without their knowledge. Authorities with those capabilities, and the businesses positioned to aggregate and analyse data collected for compliance purposes, may also be able to conduct statistical evaluations of individuals based upon the information available to their financial institutions. Once aggregated and linked to unitary identities, the transaction data collected by financial institutions offer a detailed look into the habits, patterns, travels, associations, and financial health of individuals.
The risks associated with such surveillance of electronic transactions were recognised fifty years ago by Paul Armer of the RAND Corporation, who identified the risk in a 1968 US Senate deposition  and later argued that “if you wanted to build an unobtrusive system for surveillance, you couldn’t do much better than an [electronic funds transfer system]” . Indeed, payment networks routinely share information about financial transactions with credit bureaus such as Experian , who are in the business of judging individuals by their behaviours and whose judgments form the basis of decisions made by lenders, insurers, and other clients of analytics companies . Additionally, documents released by Edward Snowden have revealed that the US National Security Agency has a division called “Follow the Money” (FTM) that systematically collects and analyses data from payment networks .
Cryptocurrencies have enjoyed popularity in recent years, and people have flocked to cryptocurrencies for a variety of reasons. The idea of accountless digital cash is hardly new, dating at least as far back as the 1982 paper by David Chaum on blind signatures , the technology that he later used to start DigiCash Inc, which folded in 1999 . Other attempts to develop accountless electronic payment systems such as E-Gold  and Liberty Reserve  were designed with privacy in mind, and ultimately ran afoul of authorities when criminals used those systems for nefarious purposes.
By the time Bitcoin emerged in early 2009 , the financial crisis had prompted aggressive responses from central banks around the world, and surely it was no coincidence that the message of circumventing inflationary monetary policy enjoyed appeal among would-be hoarders. However, given the history of privacy as a primary motivation for the adoption of digital cash, we surmise that many of the cryptocurrency adopters (other than speculators) are primarily seeking privacy, whether to circumvent capital controls or just to avoid the “pastoral gaze” of state or corporate surveillance . Some important developments in recent years corroborate this view, most notably the attempts to develop a “stablecoin”: a cryptocurrency that achieves privacy objectives whilst avoiding the spurious volatility associated with the vicissitudes of cryptocurrency trading . The most notorious example of a stablecoin is Tether, a cryptocurrency that was established for the purpose of maintaining a one-to-one peg with the US Dollar [29, 30].
As a replacement for the “legitimate” currencies underwritten by the full faith and credit of sovereign governments, cryptocurrencies are far from perfect. There are structural reasons for this, including:
Absence of financial services. There is a notable absence of reliable organisations that offer routine financial services such as lending, and more importantly, there is a lack of regulatory support for crytpocurrencies. Further, in contrast to transactions conducted via global messaging systems such as SWIFT , there is generally no way to correct or unwind erroneous transactions performed with permissionless cryptocurrencies, a critical operational limitation. For cryptocurrencies to be a true substitute for government-issued currencies, they must support a range of marketplaces and financial products.
Absence of regulated marketplaces. History tells us that unregulated marketplaces for financial products can be harmful to ordinary citizens and businesses alike; consider for example the misbehaviour of brokers and market participants that led to the creation of the US Securities and Exchange Commission . Cryptocurrency markets lack such controls and mechanisms to ensure accountability, and unchecked market manipulation is commonplace [33, 34].
Absence of legal context. There is no generally applicable mechanism for adjudicating disputes arising from transactions that are executed in cryptocurrency. When automatically executable contracts such as those that underpinned the “Decentralised Autonomous Organisation” that roiled the Ethereum community in 2016  are exploited, there is little legal recourse for hapless victims. Although “certain operational clauses in legal contracts” may be automated to beneficial effect , it would seem that a maximalist conception of the principle of “code is law” may not be workable without a suitable legal framework.
Furthermore, cryptocurrencies often fail to deliver on their key promises. For example, they are often not as private as is commonly believed. Analysis of Bitcoin transactions can deanonymise them, and researchers have shown that it is eminently possible to identify meaningful patterns among the transactions [37, 38]. The problem persists not only as a result of prevalent web trackers and the reuse of pseudonyms linked to Bitcoin wallets  but also because inbound transactions to a Bitcoin address can fundamentally be linked to outbound transactions from that address . Indeed, it has even been argued that the explicit traceability of transactions on the Bitcoin ledger, combined with a straightforward approach to tagging suspect transactions , make it even less private than traditional mechanisms of payment. Even cryptocurrencies such as Monero, which are designed for privacy, have been shown to have important weaknesses [42, 43]. Another, perhaps equally important deficiency of cryptocurrencies is that they are not as decentralised as is commonly believed. Although decentralisation is often touted as the raison d’être of cryptocurrencies , in practice the governance, “mining,” and infrastructure services associated with cryptocurrencies have remained stubbornly centralised for a variety of reasons . The problem of decentralisation is intimately related to the more elemental governance problem how to ensure that the system serves the interest of its users. Without institutional support, there is little to ensure that this remains the case.
2 Electronic Payments Today
As electronic funds transfer systems have proliferated in recent decades, so has the expectation that people will make use of those systems, inexorably reducing the infrastructure that supports cash transactions. Individuals and small businesses have various options to conduct transactions electronically. “Electronic” financial transactions include nearly all economic transactions that are not conducted using cash, notwithstanding the use of precious metals, money orders, and barter. For our purposes, all payments involving institutional accounts, including card payments (via payment networks), wire transfers, ACH, and even physical cheques, are conducted electronically, as are payments conducted using cryptocurrency. Next, we shall consider the characteristics of transactions in three examples of electronic payments: those involving institutional accounts, those involving “basic” cryptocurrencies, and those involving “privacy-enabling” cryptocurrencies.
2.1 Modern Retail Banking
Modern retail banking involves electronic transactions between accounts, each of which represents a bilateral relationship between a financial institution (e.g., a bank) and another entity, perhaps an individual. Institutions are generally regulated by governments. Individuals and businesses may agree to exchange value (for example, in return for goods and services), but in reality the transaction takes place between institutions, which mutually agree to modify the state of the accounts such that the account of the “receiver” is incremented and the account of the “sender” is decremented correspondingly. Record of the transactions and their results are generally visible to the institutions, accountholders, authorities, and auditors. Figure 1 offers an illustration of the data flows corresponding to two transactions. Institutions are direct participants in the transactions. Both the accounts and the transactions may be monitored, i.e. “external” observers such as authorities (and in some cases others, such as unprivileged employees of the institutions and hackers) are able to examine the records of the transactions, their results, and the transactions themselves. Since the set of regulated institutions is small, it is efficient for an observer to collect, aggregate, and analyse the data associated with substantially all of the transactions that take place within the system.
By contrast, data on transactions involving cash are relatively difficult to observe in this fashion, and are therefore more private. However, although cash remains a popular instrument for retail transactions, its use is decreasing as consumers become more comfortable with electronic means of payment . Some economists such as Kenneth Rogoff hail this transformation as a welcome development, citing reductions in tax evasion and crime as primary benefits as anonymous payments are curtailed . Others are more circumspect. Citing Sweden’s drive to become cashless, Jonas Hedman recognised the loss of privacy as the primary disadvantage of a cashless society, although he also acknowledged that the transition to cashlessness is inevitable . Assuming that the insistence on unitary identifiers for all electronic financial transactions as proposed by regulations such as 5AMLD  is satisfied, and combined with large-scale aggregation and analysis of the sort already in practice , cashlessness means the creation of a browseable “permanent record” for every individual containing his or her entire transaction history.
2.2 “Basic” Cryptocurrency, e.g. Bitcoin
Cryptocurrencies offer an alternative payment mechanism that avoids some aspects of the surveillance infrastructure that characterises institutionally-mediated retail bank transactions. Modern cryptocurrencies generally take the form of tokens that are effectively bearer instruments. Users are not required to establish accounts or furnish identification information of any sort to receive, possess, or spend cryptocurrency. This is not to say that accounts do not exist; most users of popular cryptocurrencies such as Bitcoin and Ethereum establish accounts with centralised wallet providers such as blockchain.info or myetherwallet . Providers of accounts could be compromised or subverted by state actors or other powerful groups with an interest in surveillance. Some account platforms cooperate with national regulators , and some national regulators have declared that they will limit the scope of the rules that would apply to such platforms . Many if not most cryptocurrency transactions are done by speculators, not those who intend to use cryptocurrency for its fundamental properties , so even if most traders in practice might be indifferent to strong identity requirements crafted by regulators to satisfy AML goals, such rules undermine a key design objective of cryptocurrencies themselves.
In principle, however, users of cryptocurrencies are not required to register with platforms, and they may possess cryptocurrency tokens on their own devices. Figure 2 shows how this works in practice. Assuming that cryptocurrency users take precautions not to reveal their identities whilst transacting, for example by using anonymity systems such as Tor , they might expect to avoid identity-based blacklisting when they receive tokens. However, depending upon the system design, adversaries may still be able to monitor the flows. Because successive Bitcoin transactions are linkable to each other, those able to monitor the network can determine successive transactions associated with specific tokens and ultimately deanonymise the users [37, 38, 40].
The fact that individual tokens can be traced means that cryptocurrencies such as Bitcoin are not actually fungible. Newly-minted, “clean” tokens trade at a premium to “dirty” tokens that have been used , and proposed blacklists of cryptocurrency addresses associated with suspicious operators could exacerbate this distinction . To avoid this problem, a cryptocurrency implementation would need to offer assurance that a transaction by an asset holder would generally not, directly or indirectly, result in that asset holder being linked to other transactions that had taken place previously. Additionally, cryptocurrencies that make use of immutable ledgers and do not protect against traceability may for that reason be non-compliant with data protection regulations such as GDPR that specify a “right to be forgotten” .
2.3 “Privacy-Enabling” Cryptocurrency, e.g. Monero
Some cryptocurrencies, most notably Zcash and Monero, are explicitly designed to address traceability concerns . Monero in particular takes an approach that incorporates several security mechanisms, including:
Ring Signatures, which allow signed messages to be attributable to “a set of possible signers without revealing which member actually produced the signature” .
Stealth Addresses, which refer to methods for key management in which public keys are derived separately from private keys for the purpose of obscuring the public keys , and
illustrates how, in a successfully implemented privacy-enabling cryptocurrency, metadata associated with transactions would be hidden such that the data flows or the ledger would not reveal relationships among transactions or any information about the transacting parties. That said, the Monero design and implementation still do not completely realise this goal; its process for mixing transactions suffers from inconsistent selection probability among all elements of the anonymity set. Monero spokesperson Riccardo Spagni countered that “privacy isn’t a thing you achieve, it’s a constant cat-and-mouse battle” , echoing longstanding arguments by others that privacy is inevitably an endeavour of vigilance and responsiveness .
Some authorities such as the Japanese Financial Security Agency (FSA) [63, 64] and the United States Secret Service  have responded to so-called “privacy coins” by banning the use of privacy-enhancing cryptocurrencies whilst accepting other cryptocurrencies as legitimate by comparison. For a cryptocurrency exchange or other provider of cryptocurrency-based financial services to be compliant under such rules, it would need to restrict its activities to cryptocurrencies such as Bitcoin and Ethereum which do not have the privacy characteristics that have been sought by cryptocurrency advocates for decades.
There have also been some attempts, notably Mimblewimble , to retrofit basic cryptocurrencies with some of the characteristics of privacy-enabling cryptocurrencies, although it remains to be seen whether such approaches will turn out to be more effective than cryptocurrencies designed with better intrinsic privacy features in the first instance.
3 Proposed Hybrid Approaches
|Robust to cyberattacks||●||○||○||○|
|Usable without registration||●||○||●||●|
|Suitable for taxation||◑||●||○||○|
|Can block some illicit uses||○||●||○||○|
|Supports monetary policy||●||●||○||○|
We consider the following challenge facing policymakers, regulators, and technologists alike: how can we achieve realise the benefits of government regulation without incurring the human cost of building a database that associates all persons with all of their transactions? There are two parts to this question. The first part is primarily about technology: can we build a system that securely processes financial transactions conducted electronically without revealing data about the transacting parties? The answer is yes, as described in our discussion of privacy-enabling cryptocurrency, with an important qualification that privacy is really an iterative process that can only really be developed through active commitment and ongoing vigilance. The second part is primarily about government policy:
What exactly are the key government objectives for regulating transactions?
Which objectives are essential, and which can be deprioritised?
Do any of the objectives conflict with the human right to privacy?
The arguments that privacy is a public good [67, 68, 69, 70] increasingly available only to those with sufficient wealth and power [71, 72] are well-established. Table 2 shows how the existing payment methods achieve the desiderata listed in Section 1. (None of the popular cryptocurrencies are known to offer totally unlinkable transactions, continual improvements notwithstanding.) Can we achieve a compromise that does better than the prevailing methods for electronic payments?
In this section we introduce two approaches to frame the discussion of how to resolve the tension. The first approach, institutionally supported privacy-enabling cryptocurrency, provides regulated institutions with tools and procedures for interacting with privacy-enabling cryptocurrencies, creating a structure for legal interpretations of their use. The second approach, institutionally mediated private value exchange, establishes a method by which regulated institutions can conduct financial transactions on a distributed ledger that shares essential characteristics with privacy-enabling cryptocurrencies.
3.1 Institutionally Supported Privacy-Enabling Cryptocurrency
Our first approach starts with existing, privacy-enabling cryptocurrencies such as Zcash or Monero and assumes that regulators have chosen to embrace the new methods for exchanging value and accept, if not support outright, at least some of the various communities that have formed around particular cryptocurrencies to provide governance and software development. Acceptance of cryptocurrencies by governments and other institutions is certainly plausible; for instance, the Bank of England concluded that cryptocurrencies “currently do not pose a material risk to UK financial stability” . It assumes that government priorities include collecting taxes and monitoring transactions undertaken by businesses and regulated institutions.
Figure 4 illustrates how institutions would join existing cryptocurrency systems as full participants. The motivation for broker-dealers and other institutions to participate is well-established; financial services related to cryptocurrencies are in demand by hedge funds and other clients [74, 75]. Of course, this implies that broker-dealers would likely undertake activities related to unregulated markets and marketplaces (i.e., the cryptocurrencies themselves), and presumably the governance of the cryptocurrencies would not be under institutional control. That said, the distributed ledger underlying the cryptocurrencies would ensure that there would be an audit trail of all transactions, even if the details of those transactions might be inscrutable to authorities, auditors, or others without the active participation of the transacting parties.
To facilitate monitoring, auditing, and taxation, we assume that regulators would stipulate that all cryptocurrency transactions undertaken by registered corporations or licensed businesses would take place via regulated institutional intermediaries such as banks, custodians, or broker-dealers. The institutions would carry out AML/KYC compliance procedures as they currently do, and regulators would require that all cryptocurrency disbursements from such registered corporations or licensed businesses, including dividends, interest, proceeds from disposal of cryptocurrency-denominated assets, and payments, including without limitation payments to suppliers, service providers, employees, and contractors, would take the form of remittances to other institutional accounts that hold cryptocurrency. Individuals and non-business partnerships would not be subject to the same requirements and could hold cryptocurrency privately. Figure 5 shows how this would work in practice. Businesses would maintain accounts with institutions and could direct the institutions to remit payments to other institutionally held accounts, including those whose beneficial owners are individuals, and individuals could in turn direct their institutional accounts to remit payments to their private cryptocurrency storage, which might or might not be hosted by a wallet provider. Individuals could then remit payments from their own private storage to regulated businesses, such as merchants, private organisations, or service providers, without necessarily revealing their identities or a link to previous transactions such as those from which they received the cryptocurrency in the first place; Figure 6 offers an illustration.
Dividing the different ways of holding the cryptocurrency into two categories based upon whether or not it is held via accounts associated with regulated institutions may be considered analogous to dividing Zcash into “T” (Transparent) and “Z” (Shielded) addresses .
Because all cryptocurrency accounts held by corporations and registered businesses would be subject to monitoring by regulated institutions, the infrastructure would ensure that the taxable income of such corporations and businesses would be known. Because all payments from corporations and registered businesses must be remitted to other institutional accounts, the infrastructure would ensure that the income of their shareholders, suppliers, service providers, and employees would be known and attributable to the correct legal entities. Authorities would realise other benefits as well. The distributed ledger maintained by the cryptocurrency node operators would be observable by regulators and other authorities and cross-referenced against any cash flow statements of businesses engaged in cryptocurrency transactions. Private transactions suspected of criminal activity could be verified by investigators with the cooperation of one of the counterparties, even if the investigation might not necessarily reveal identifying details of the other counterparty.
One type of transaction under this system that might be of particular concern to authorities is illustrated by Figure 7, in which an individual with a private cryptocurrency store remits cryptocurrency to another individual with a private cryptocurrency store, not involving a regulated institution. The fact that such transactions could take place without the involvement of institutions means that authorities would be unable to completely enforce restrictions on who is able to transact, in accordance with the FATF recommendations . We could argue that value will find its way to criminal organisations with or without the sanctions advised by FATF , or that those willing to break the law have many options to anonymously acquire “legitimate” accounts , or that prospective money launderers with sufficient assets will find other ways to transact outside the the system. Whether or not such arguments are sound, cryptocurrencies might become a dominant form of exchanging value precisely because people value privacy, in which case regulators will need to support cryptocurrency transactions simply because those are the transactions that are taking place. After all, people certainly exchanged value before central banks started issuing currency.
Another, equally important, characteristic of this approach is that without institutional mediation at their core, cryptocurrencies are subject to the vicissitudes of mining pools, hackers, and powerful global-scale actors who might compromise or hijack them, as well as speculators and market manipulators who might simply deplete their value. However, an alternative interpretation of that property is that different cryptocurrencies would compete with each other, not only on the basis of market penetration but also on the basis of privacy. It is difficult to imagine a currency in a monopoly position, state-sponsored or otherwise, having this characteristic.
3.2 Institutionally Mediated Private Value Exchange
Our second approach starts with the assumption that the “public” cryptocurrencies are not suitable for institutional support, perhaps for the reasons cited in Section 3.1. Instead, it proposes the establishment of a distributed ledger for conducting financial transactions, and that each node of the distributed ledger would be owned and operated by a regulated institution, as shown in Figure 8. This could be achieved with a “permissioned” distributed ledger system such as Hyperledger , using an energy-efficient Byzantine fault-tolerant consensus algorithm such as PBFT . Users and governments would benefit from the fact that transacting parties would not need to use cryptocurrency of dubious value but in fact could transact using digital versions of state-issued currency, i.e. central bank digital currency (CBDC), which is currently under consideration by central banks around the world and may offer a variety of economic and operational benefits .
For this approach to be a private value exchange, the regulated institutions must commit to facilitating private transactions. At one level, the institutions must adopt the specific technologies such as ring signatures, stealth addresses, and confidential transactions used by privacy-enabling cryptocurrencies such as Monero. At another level, the institutions must commit to an ongoing effort to audit, challenge, and improve the technology and operational procedures, because privacy-enhancing technologies require vigilance . It follows that the institutions and the authorities of the jurisdictions in which they operate must commit to ensuring that the technology and operational procedures are effective in safeguarding the privacy of transacting parties against politically, financially, and technologically powerful groups who might have contrary interests.
It is assumed that authorities would take the same measures described in Section 3.1 to ensure that corporations and registered businesses use known, monitorable accounts for all of their transactions. Enforcement of such a policy would be qualitatively easier in this case since the entire network is owned and operated by regulated institutions, and regulators could expect the same benefits associated with monitoring taxable income and reconciling line items in cash flow statements against actual, auditable transfers on the distributed ledger.
State actors would realise another important benefit from this approach as well. Because all transactions must necessarily involve a regulated institution, transactions of the sort described in Figure 7, in which private actors exchange value directly via their own private stores, would not be possible. Figure 9 illustrates how a user would make payments privately. A user would initially receive funds into her account with a registered institution, which she would in turn remit to her private store. When she wants to make a payment to a merchant or service provider, she can remit the funds to the account that that organisation holds with a registered institution. The privacy features of the distributed ledger, such as ring signatures, stealth addresses, transaction confidentiality, and any other necessary features that may be developed from time to time, would ensure that when the individual makes the payment, she does not reveal either her identity or any information about her prior transactions, including the transactions from which she originally received the funds.
By ensuring that no single enterprise receives too large a share of any individual’s transactions in the system, the use of a distributed ledger achieves an essential requirement of the design. Individuals would be expected to use their private stores to transact with many different counterparties, via their own regulated intermediaries, so no single intermediary would have a global, “panopticon-like” view of all of the individual’s transactions.
Since individuals cannot transact directly via their private stores, to exchange value they must transact via a regulated intermediary as shown in Figure 10. Individuals conducting transactions might not need to have accounts to exchange value with each other; we surmise that the regulated intermediary would perform the service for a fee. We also suggest that the intermediary would not be required to carry out strong identification of the sort required by the FATF recommendations  but might require a less-stringent form of identification, such as an attribute-backed credential indicating that either the sender or the receiver are eligible to transact . Regulated intermediaries could also provide token mixing services for groups of individuals who satisfy AML criteria, without explicitly requiring knowledge of their unitary identities.
If successfully operationalised, the approach described in this section would offer governments the same benefits to taxation and auditing as the approach described in Section 3.1, and governments would additionally gain the ability to impose blacklists or economic sanctions on targeted recipients. Individuals would receive the same privacy benefits described in Section 3.1 for transactions involving merchants and service providers, and identification requirements of intermediaries for other transactions could be made parsimonious. However, there are two main drawbacks for individuals seeking privacy, the first being that individuals would need to interact with a registered intermediary before they are able to make or receive payments. The other, more serious concern is the question of the mechanism by which the privacy-enabling properties of the system is assured. Inasmuch as cryptocurrencies represent a check on state power , we have reason to believe that the privacy characteristics of cryptocurrencies will continue to improve, despite their demonstrable shortcomings [42, 43].
If the regulated institutions that design, deploy, and maintain the infrastructure for executing transactions are asked to carry the flag for the privacy of their clients, then there could be a misalignment of interests. Clients would need to know the actual privacy limitations of the infrastructure, so adversarial audits would need to be carried out from time to time in the interest of the public. Then, institutions would need incentives and resources to continuously improve the infrastructure and fix any deficiencies on an ongoing basis. A process for admitting new participants would be necessary to ensure that the network remains distributed, and it would need to satisfy an openness criterion to ensure that privacy-threatening procedures do not develop outside the view of the public eye. There would also need to be a diversity of implementations, such that sporadic vulnerabilities do not threaten the privacy of a significant share of the users of the system.
Arguably, such incentives exist among cryptocurrencies, since they must compete for business. It remains to be seen whether effective auditing and competition could assure the privacy-enabling properties of a value exchange operated entirely by institutions.
|Robust to cyberattacks||●||○||○||○||○||○|
|Usable without registration||●||○||●||●||●||○|
|Suitable for taxation||◑||●||○||○||●||●|
|Can block some illicit uses||○||●||○||○||○||●|
|Supports monetary policy||●||●||○||○||○||●|
Framing the ongoing conversation about the future of payments as a set of tradeoffs, we introduced two possible candidate architectures for a privacy-enabling electronic value exchange: institutionally supported privacy-enabling cryptocurrency and institutionally mediated private value exchange. Both architectures require both the design, implementation, deployment, and maintenance of new technology as well as the development of regulatory policy in which such technology will operate. Table 3 summarises the tradeoffs and contextualises our two prospective approaches. Cash has many desirable properties, such as universality (i.e., its use does not require a relationship with a registered institution) and privacy in practice (serial numbers on banknotes can be traced but generally are not). However, it cannot be sent across computer networks and is sometimes used for illicit transactions, including tax evasion. In contrast, modern retail banking requires accounts and facilitates large-scale surveillance. The most popular cryptocurrencies such as Bitcoin do not avoid surveillance, and traceability makes them non-fungible for this reason. Privacy-enabling cryptocurrencies promise to address both deficiencies, although research has shown that the goals motivating their development have not yet been fully achieved.
The various approaches to electronic payments each have their own advantages and limitations, and by elaborating the tradeoffs, we hope to facilitate a more fulsome conversation among the stakeholders and offer a useful framework for discussing future solutions.
We suggest that institutionally supported privacy-enabling cryptocurrency would be strictly better than privacy-enabling cryptocurrency without institutional support, mainly because regulators would benefit from the ability to monitor corporations and registered businesses that use cryptocurrencies. We also suggest that institutionally mediated private value exchange would be strictly better than modern retail banking as currently practiced, mainly because users would avoid payment networks and enjoy an improved expectation of privacy in their ordinary activities. However, neither approach achieves all of the objectives of both parties. For example, the ability to transact without interacting with a regulated institution may be incompatible with the ability for a government to block illicit use. Similarly, monetary policy might not be possible if cryptocurrency governance is exogenous to the state. As the hard choices for the future of payments come to light, we believe that acknowledgment and discussion of these tradeoffs, as well as a commitment to both serious privacy and serious regulation, are prerequisites for advancing the interests of all stakeholders.
The authors would like to thank Edgar Whitley and David Pym for their insightful contributions. Geoff Goodell is also an associate of the Centre for Technology and Global Affairs of the University of Oxford.
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