Money, Digital Cash and Cryptocurrencies: Privacy Matters

Lambert here: Or, see, I could arrange to have my 5G account checked and automagically topped up every hundred yards or so, wherever there’s a 5G tower, right out of my digital wallet. Convenient! Unless the Central Bank were running a bail-in, of course…

By Emanuele Borgonovo, Professor, Department of Decision Sciences, Bocconi University, Stefano Caselli, Professor of Banking and Finance, and Vice-Rector for International Affairs, Bocconi University, Alessandra Cillo, Adjunct Professor of Decision Sciences, Bocconi University, Donato Masciandaro, Full Professor of Economics, and Chair in Economics of Financial Regulation, Bocconi University, and Giovanni Rabittt, PhD student in Statistics, Bocconi University.

Alongside liquidity and store of value, is privacy an important attribute of money? Using laboratory experiments, the column shows that privacy matters, and increases the overall appeal of money. The experiments suggest that future competition between alternative currencies will depend on how the three properties are mixed.

The protection of privacy is a crucial issue. In monetary economics, can privacy play a role in explaining demand? In other words, could privacy be a third attribute – with liquidity and store of value – that can explain demand for both traditional and new media of exchange? These media may already exit (cryptocurrencies, for example) or soon exist (central bank digital currencies).

For macroeconomists, there are three interesting trends:

  • The resilience of state-issued paper currencies in the form of large-denomination banknotes (Rogoff 2014, Sands 2016), valued by holders for their anonymity.
  • Innovation in private payment systems, characterised by the issuance of cryptocurrencies (Di Mauro 2018, Cong et al. 2018, Amihud and Cukierman 2018, Cecchetti and Schoenholtz 2018, Aizenman 2019). In this case cryptography is used to protect privacy, and many users like the property of anonymity (Bohme et al. 2015).
  • The debate about central bank digital currencies (Bordo and Levin 2017, Niepelt 2018, Mancini-Griffoli et al. 2019, Eichengreen 2019), for which counterparty anonymity is a crucial issue.

Therefore, a natural question arises: does money demand depend on privacy? Recent research, working on the intuition that any kind of money can be considered a memory store (Kocherlakota 1998), has focused on the association between money and privacy of transactions (Athey et al. 2017, Fernandez- Villaverde 2018, Kahn 2018, Masciandaro 2018). But it is not clear that this relationship is so relevant and general that we should consider privacy as a third property of the demand for money.

Experiments About Privacy and Money

Borgonovo et al. (2019) propose a novel specification of the demand for money as a medium of payment with the following three properties:

  1. Hedging against illiquidity risk. This is associated with the probability that in any exchange a given medium of payment is accepted. This acceptability depends also on the property of being a unit of account (Borio 2019).
  2. Hedging against depreciation risk. This is associated with the probability that the value of a given medium of payment is stable in terms of goods and services.
  3. A story of privacy. This new idea depends on the probability that private information about the user is disseminated when a given medium of payment is used for exchanges (Masciandaro 2018).

We tested the robustness of this new specification with laboratory experiments using the Prince method (Borgonovo et al. 2019).

The experiments used a three-stage procedure. First, the subjects stated their preference among alternative media of payment. In this first stage, the media of payment differ only in anonymity. This reveals the preference for privacy. The second stage tested the relative importance of privacy with respect to liquidity and store of value. Finally, in a context of complete anonymity, we measured the trade-offs between illiquidity risk and devaluation risks.

There were five main results:

  1. Privacy matters.
  2. Hedging against devaluation risk seems to be the most relevant property of money.
  3. Combining the three properties is likely to increase the overall interest in a given medium of payment.
  4. Risk-seeking individuals like privacy more than risk-averse People (this result is consistent with the assumption that agents involved in illegal activities seem to like anonymity and illegal activities).
  5. Given a level of privacy, the sacrifice ratio between illiquidity risks and devaluation risks is relatively high. In other words, individuals call for a more than proportional increase in the protections against devaluation in order to accept higher illiquidity risks.

Paper Money Abides, Cryptocurrency Has Weaknesses, and Digital Cash Has Challenges

If privacy matters as a property of money – as the results suggest – then paper money can maintain its appeal as an anonymous medium of payment, but the more other media can be trusted to offer privacy while balancing illiquidity risk and devaluation risk, the more likely it is that paper money will be crowded out.

There are policy implications for medium of payment suppliers such as private and central banks, and non-banking firms. Banking monies could be challenged as media of payment by a lack of privacy, and if there is a high devaluation risk. In parallel, the success of a cryptocurrency will depend on its ability to overcome illiquidity and devaluation risks, while increasing the credibility of its claim to privacy.

Finally, regarding central bank digital cash – uniquely promising the potential to be both an electronic medium of payment and a public currency – the experiments suggest that its attractiveness will crucially depend on privacy design today, and later its interest-bearing mechanisms. In normal times the illiquidity risk of a central bank digital cash would be zero, but it seems unlikely that individuals will consider it anonymous in the same way as cash is already anonymous. Offering a yield could be a trigger to increase its competitive appeal.

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About Lambert Strether

Readers, I have had a correspondent characterize my views as realistic cynical. Let me briefly explain them. I believe in universal programs that provide concrete material benefits, especially to the working class. Medicare for All is the prime example, but tuition-free college and a Post Office Bank also fall under this heading. So do a Jobs Guarantee and a Debt Jubilee. Clearly, neither liberal Democrats nor conservative Republicans can deliver on such programs, because the two are different flavors of neoliberalism (“Because markets”). I don’t much care about the “ism” that delivers the benefits, although whichever one does have to put common humanity first, as opposed to markets. Could be a second FDR saving capitalism, democratic socialism leashing and collaring it, or communism razing it. I don’t much care, as long as the benefits are delivered. To me, the key issue — and this is why Medicare for All is always first with me — is the tens of thousands of excess “deaths from despair,” as described by the Case-Deaton study, and other recent studies. That enormous body count makes Medicare for All, at the very least, a moral and strategic imperative. And that level of suffering and organic damage makes the concerns of identity politics — even the worthy fight to help the refugees Bush, Obama, and Clinton’s wars created — bright shiny objects by comparison. Hence my frustration with the news flow — currently in my view the swirling intersection of two, separate Shock Doctrine campaigns, one by the Administration, and the other by out-of-power liberals and their allies in the State and in the press — a news flow that constantly forces me to focus on matters that I regard as of secondary importance to the excess deaths. What kind of political economy is it that halts or even reverses the increases in life expectancy that civilized societies have achieved? I am also very hopeful that the continuing destruction of both party establishments will open the space for voices supporting programs similar to those I have listed; let’s call such voices “the left.” Volatility creates opportunity, especially if the Democrat establishment, which puts markets first and opposes all such programs, isn’t allowed to get back into the saddle. Eyes on the prize! I love the tactical level, and secretly love even the horse race, since I’ve been blogging about it daily for fourteen years, but everything I write has this perspective at the back of it.


  1. Jeff

    The mere existence of offshore banking and ‘treasury islands’ proves the necesity of ‘privacy’, for whatever reason.

  2. el_tel

    Have requested the key 2019 paper detailing the methods via Researchgate given that I no longer have the degree of access I had as an academic. But from what I *can* deduce, based on the references that are, and more importantly *aren’t* in the bibliography, is that key academic articles on experimental design and analysis of stated preference studies (from “nobel” prize-winner McFadden onwards) don’t seem to be there.

    Without the full article they reference detailing the method I hesitate to argue with their results….but as a first pass on looking at what they did I’m not filled with confidence. Nevertheless, the finding that privacy matters is anecdotally attractive (like Lambert’s point). The recent stuff I’ve read about the demise of cash in Sweden accorded with my experience there….and I confess I never felt comfortable with how Sweden was evolving its monetary systems.


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