Zero-knowledge proofs vs. CBDCs: the fight for privacy amid central banks’ bid for control

Privacy preservation is becoming an increasingly important and scarce resource in the current ‘Information Age’ — particularly regarding financial transactions.

The rise of central bank digital currencies (CBDCs) has been proposed to create more secure, accessible, and efficient methods for financial transactions.

However, privacy concerns remain surrounding CBDCs — due to the underlying caveat that your faster and more efficient transactions can be monitored.

Zero-knowledge proofs (ZKPs) — cryptographic methods of proving a statement’s truth without revealing any details — have emerged as a potential solution to these concerns.

CBDCs: The rise of digital national currencies

The European central bank (ECB) and the Australian central bank (ACB) — among many other central banks — have already begun exploring and adopting CBDCs as a solution to the evolving digital financial climate.

ECB president Christine Lagarde warned central banks that they could be “losing the role of anchor that we have played for many, many decades.”

“Where do we stand, we Central Bankers? We have been operating as a monetary anchor in relation to Commercial Banks and private money.”

Streamlined, secure, and cost-efficient

CBDCs can reduce transactional costs, streamline payment systems, and improve financial inclusion.

Furthermore, CBDCs minimize reliance on intermediaries while enabling real-time transactions — improving payment systems’ security and resilience.

Big Brother ‘could be’ is watching you

Despite the benefits CBDCs offer, CBDCs also open up speculation and significant concerns surrounding privacy and financial dependence upon the system.

CBDCs introduce pathways for financial institutions and governments to monitor financial transactions — potentially leading to a loss of privacy for individuals using CBDCs.

This increased access handed to centralized entities makes it possible to surveil and control the finances of a given individual — potentially to suppress dissent or target political opponents.

Particularly in an authoritarian — or worse yet, totalitarian — regime, eradicating privacy and mandating financial dependence on the system is possible via CBDCs.

As dire as some of these concerns may seem, ZKPs offer a remedial solution to the CBDC privacy dilemma.

ZKPs: Trust without sacrificing privacy

ZKPs make it possible to verify a transaction without exposing the details of the transaction itself — such as the party/parties’ identity or the amount transacted.

In the reality of CDBCs and monitory technology, ZKPs can help maintain privacy in digital transactions while ensuring transactional validity and security.

Popular ZKP example: “Ali Baba’s cave”

ZKPs eliminate the need to reveal sensitive information to prove the validity of claims. To help break down how it works, we’ll use the popular “Ali Baba’s cave” example:

1. John enters the cave via entrance A or B — out of Sally’s sight.
2. Sally — waiting outside the cave — randomly chooses entrance A or B, calling John to come out from the selected entrance.
3. John uses a secret password to open the door and come out from the entrance Sally requested.
4. The pair repeats this process to increase Sally’s confidence in the validity of John’s claim.
5. Eventually, Sally becomes increasingly convinced John knows the password — as he always exits from the entrance she requests.

In this example, John’s claims are increasingly proven valid — as he consistently exits from the requested entrance — yet, John never reveals the password.

In short: John can prove his knowledge of the password without revealing it — preserving John’s privacy and validating his claims.

Monero (XMR) and Zcash (ZEC) cryptocurrencies have already incorporated ZKPs to increase user privacy.

What if you combine ZKPs and CBDCs?

Taking a step back to look beyond the contrasting perspective of ZKPs versus CBDCs — the combination of the two has the potential to strike a relatively harmonious balance.

CBDCs paired with ZKP tech would offer the accessibility and efficiency of digital currencies and the privacy offered by cryptocurrencies that employ ZKPs.

Using these cryptographic techniques, CBDCs could tap ZKPs to maintain all the benefits of CBDCs while providing users with financial privacy — removing the primary concern currently surrounding CBDCs.

Regulation, regulation, regulation

Though combining ZKPs and CBDCs could offer a symbiotic relationship for the future of digital finance, discerning the right balance between regulatory oversight and privacy is challenging.

Regulators and privacy do not offer as smooth a symbiotic relationship —mainly due to regulations surrounding money laundering, terrorist financing, and tax evasion.

Avoiding such illegality necessitates a careful weigh-up between user privacy and selective transparency — of which transactional information is made accessible to regulators.

Who wins?

Amid the Information Age, the struggle for privacy remains an ongoing and complicated battle.

ZKPs and CBDCs can evolve financial transactions and provide improved privacy — but finding the right balance between regulatory oversight and privacy remains a challenge for CBDCs.

Further research and collaboration between privacy solutions, governments, and central banks are needed to develop a solution that harnesses all the benefits of CBDCs — while preserving privacy for the digital age ahead.

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