Around the world, people are paying more and more attention to the privacy storage function of currency. In currency transactions, complete privacy protection is consistent with its anonymity characteristics. As a result, an empirical question arises: Does anonymity have an impact on the formation of money demand? This article attempts to answer this question through experiments.
The results of the study show that anonymity is very important, which enhances the overall attractiveness of the payment medium, and this influence is stronger for individuals with higher risk propensities. In addition, people will make trade-offs between liquidity and profitability, and often require a higher than the corresponding proportion of expected returns to accept higher illiquidity risks. Overall, these experiments show that the expected attractiveness of tokens depends on whether the proportions of the three attributes are in line with individual preferences.
The Financial Technology Research Institute of Renmin University of China (WeChat ID: ruc_fintech) compiled the core content of the report.
Privacy protection is an important issue in the information age. We can observe the following three typical cases:
First, we are concerned about public banknotes , mainly in the form of large-denomination banknotes, which are generally praised for their flexibility and anonymity . In recent years, in many developed and emerging economies, the circulation of banknotes has increased, with Sweden and Norway being the notable exceptions. In addition, despite policy changes, such as the European Central Bank Council’s decision on May 4, 2016 to stop the issuance of 500 Euro banknotes before the end of 2018, large-denomination banknotes still account for most of the banknotes currently in circulation. On November 8, 2016, the Indian government issued a radical de-monetization policy statement stating that 86% of the country’s banknotes will be removed. In addition, consistent with personal preference for cash, we have seen an increase in corporate cash. Recently, the new crown epidemic seems to have also increased people’s demand for cash.
Second, the recent wave of innovation in private payment systems is characterized by the issuance of private digital currencies . Private digital currency is a private payment method that uses a decentralized, peer-to-peer transmission system (that is, blockchain technology or distributed ledger technology) for production and distribution. In these payment structures, encryption procedures are used to protect privacy . Among the private digital currency user groups, quite a few people appreciate the anonymity of these systems. In addition, individuals who deliberately use cash for illegal reasons seem to see private digital currencies as similar substitutes. In June 2018, the social media company Facebook released a private digital currency project- Libra , which triggered a new round of attention to this phenomenon.
Third, the issuance of central bank digital currency (CBDC) is an option that academia and central banks are considering carefully. At the same time, many central banks are actively conducting research and technological development in the CBDC field to defend their traditional position as a leader. Riksbank, the central bank of Sweden, is particularly actively involved in the discussion of the possibility of issuing e-SEK. As of July 2020, Ecuador, Uruguay, Bahamas and China have launched their official CBDCs. Given that CBDC can be designed in many ways, and the digitization of currency may lead to the deconstruction and reconstruction of different attributes of currency, the level of privacy (especially in retail payments) is an important issue in this discussion.
Milton Friedman emphasized the potential relevance of privacy costs in stimulating currency demand in his book : “I think the Internet will become one of the main forces that weaken the role of the government. Although it is lacking now, it will not be long. Later, a reliable electronic cash will be developed, a method that can transfer funds from A to B on the Internet without requiring A and B to know each other.” Twenty years later, attention to these issues has increased in the economic literature, as shown below.
Information storage function of currency
This article starts from the definition of currency and memory . Currency is defined as an equivalent with relatively stable value in terms of goods and services, and is used as a medium of exchange, a unit of account, and a means of payment. Memory is an individual’s understanding of the history of all individuals with whom he has direct or indirect contact. If the above two definitions hold true, then it can be said that money is equivalent to a primitive form of memory.
The logic behind this proposition can be simply understood by comparing the currency environment and the memory environment . If the individual is unable to maintain the memory of the past, then self-closing may reach an equilibrium. Therefore, in order to achieve more effective distribution among individuals, money and memory are necessary means. In an environment where money exists, when an individual gives up a certain resource at the moment to receive money in return, he can use these money to purchase resources in the future. In an environment where memory exists, each individual is equivalent to possessing a piece of information similar to a balance sheet, able to take into account its future ability to pay. Therefore, currency plays a record role, and this attribute reveals the new functions of currency .
In addition, if memory is regarded as a complete account-based system agent, the more expensive and imperfect the system, the greater the demand for money. Given the information asymmetry, as the number of traders who cannot trust each other increases, the demand for money will also increase. This intuition is straightforward-if an individual needs to participate in an exchange that lacks trust, he will recognize any exchange medium that can increase the trustworthiness of the exchange network .
The privacy storage function of currency
If the value of currency as a medium of exchange stems from its role as a memory technology, then the development of more technologically advanced account-based networks will make people doubt the role of currency in storing information. In a sense, more advanced memory technology can reduce the value of money . However, there is some contradiction that when an individual is in an environment with imperfect information and asymmetrical, the memory storage function of currency creates the utility of its storage privacy .
Therefore, economic literature has gradually emphasized that in an economy with incomplete information symmetrical, the value of currency may be derived from the privacy protection it provides . In fact, in an account-based network, the identity of the payer must be identified. If the individual to be aware of them and disgusted, will form to support demand payment of privacy .
There are two main sources of demand for payment privacy . On the one hand, individuals involved in illegal transactions may raise privacy requirements and require a medium of payment (MOP) to reduce the possibility of conviction. On the other hand, it is more common that any individual who wishes to avoid risks may desire privacy, not to avoid legal sanctions, but to ensure protection from other parties (such as governments, other individuals) directly or indirectly involved in transactions. , payment providers, etc.) of the external review .
All in all, if currency transactions can lead to the spread of personal information, then the misuse of that information can threaten a person’s reputation, freedom, and sense of fairness. In this regard, the more personal preference characteristics are to avoid risks and censorship , the greater the need for privacy .
Privacy and anonymity
Due to the correlation between privacy requirements and personal information, a natural result is that if privacy requirements are related to personal details of individuals, their highest level is consistent with the requirements of anonymity (that is, all personal details are hidden). In other words, it is impossible for all parties directly or indirectly involved in currency transactions to find any information about individuals after the transaction is completed. In addition, in the general payment combination model, anonymity can be used as a utility contribution feature of currency . Moreover, the lack of personal privacy will bring negative externalities to others .
This discussion had two effects . On the one hand, anonymity in payments is an inherent characteristic of well-defined public currencies (such as cash). Compared with other payment technologies, cash provides more financial privacy. On the other hand, if anonymity does not exist, then any improvement in privacy protection will lead to an increase in the demand for money . In fact, some cryptocurrencies are explicitly based on the ability to facilitate quasi-anonymous transactions. More generally, privacy-protecting currency technology can also be used as electronic cash in payment systems . Electronic cash can be issued by commercial parties, decentralized networks, or central banks to manage different degrees of financial privacy.
Finally, due to the “privacy paradox”, individuals may also choose not to use privacy-protecting monetary technology, which means that there may be a mismatch between the declaration of privacy preferences and the behavior of protecting privacy . In the rest of this research, we will focus on the relationship between anonymity and monetary demand.
Monetary demand and anonymity
From a theoretical point of view, the experiment in this article is based on the specification of currency demand, in which MOP, as the accounting unit, has three economic functions at the same time . The first two are the conventional functions of MOP- medium of exchange and store of value , and the third is the new function of privacy protection- anonymity .
The classic theory of money demand highlights the first two functions of MOP . As Keynes said, in the currency holdings of households and businesses, we can distinguish their liquidity motives for transactions and savings motives for wealth. Accordingly, we first assume that all individuals are concerned about illiquidity, which is related to the risk that MOP cannot perform its functions effectively. Then, we assume that the currency can provide anonymity protection in use.
The experimental results show that the actual value of privacy seems to be lower than expected, because no matter how the individual declares his privacy preference, there will be a decrease in privacy in reality. The experiment in this article only focuses on the situation of complete privacy (namely anonymity), and answers the question of whether the anonymity of currency has absolute value and relative value compared with other attributes in currency transactions.
The experimental results of this article show that:
- Anonymity is one of the very important monetary attributes;
- Opportunity cost is also a related attribute of currency;
- The combination of the three attributes of currency may increase people’s interest in it as a medium of exchange;
- Individuals with strong risk propensity will pay more attention to anonymity;
- In view of the level of anonymity, people will make trade-offs between liquidity and profitability , and often require a higher than the corresponding proportion of expected returns to accept higher illiquidity risks.
Considering that experiments have confirmed the importance of anonymity, we make the following two considerations. On the one hand, cash can maintain its appeal as an anonymous MOP. On the other hand, when weighing illiquidity risks and expected returns, the higher the credibility of anonymity provided by other MOPs , the more likely it is to squeeze out cash.
In addition, these results may underestimate the practical significance of privacy, because our research objects are college students who have received higher education . Given the potential relationship between education and social trust, they are less likely to express their need for anonymity . Moreover, some researchers have pointed out that the need for anonymity may be related to resistance to censorship .
Finally, this article also puts forward several policy implications for MOP suppliers such as commercial banks, central banks, and private enterprises . As a medium of payment, Bank currency may face a lack of anonymity and low expected returns challenges , these features make private digital currency more attractive. The unique feature of the Central Bank Digital Currency (CBDC) is that it belongs to both electronic MOP and public currency. The experiments in this article show that the attractiveness of CBDC depends on its design in terms of privacy level and interest-bearing mechanism. In principle, the illiquidity risk of CBDC is low, and its anonymity is different from cash. Our research results show that the increase in the rate of return can help increase its attractiveness.
Author丨Emanuele Borgonovo, Stefano Caselli, etc.
Source | Journal of Financial Stability
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