Design and analysis of privacy-preserving and regulations-compliant central bank digital currency

Abstract

Significant advances has been made in the field of Central Bank Digital Currency (CBDC) in the last five years. These advances are available not only in the academic world but also in central banks. Currently, more than 130 countries continue their CBDC studies at research, pilot and proof of concept levels. The increased interest in CBDC can be attributed to various factors such as the increasing progress in digital payment technologies, the widespread use of cryptocurrencies in the digital money market and the advantages brought by this technology. In addition to these advantages, there are challenges and problems that have not yet been resolved in order for CBDCs to reach the maturity level. One of these problems is the conflict between efforts to protect the privacy of digital currency users and the compliance mechanisms introduced by states to ensure financial stability and social order. States try to prevent and monitor financial crimes through regulations such as combating dirty money and preventing financing of terrorism. However, such regulations could lead to citizens' lives being completely monitored in the transition to digital money. In addition to this conflict, a significant part of the existing CBDCs are operated on a blockchain-based system. Due to the transparent structure of the blockchain, parties included in the network can track and monitor users' transactions, but transaction privacy is ignored. In the present study, solutions to the mentioned privacy problems are introduced with cryptographic techniques such as zero knowledge proofs, threshold cryptography, and homomorphic encryption. In the proposed system, the user's balance is kept homomorphically encrypted in the blockchain. To perform a transfer transaction, the sender encrypts the amount he wants to transfer with his own public key, the receiver's public key, and the regulators' public key. The sender then creates a zero-knowledge proof that the amount is the same in all three ciphertexts. Since the transaction is processed through encrypted texts, the user must create a range proof that the balance he has is sufficient. After creating all the proofs and transmitting them to the blockchain, the nodes confirm the transaction and the user's balance is homomorphically reduced via the ciphertext and the recipient's balance is increased. In any suspicious case, the user's transaction history can be traced back by government institutions called regulators. However, threshold encryption was used to ensure that this control was not left to the initiative of a single institution. These institutions must reach a consensus and after reaching the threshold value, they can see the transaction details. Additionally, techniques have been suggested so that commercial banks can continue their services in this system.