Privacy-Enhanced Payment Systems

Abstract

Technological innovations enable privacy in payments, but pose a fundamental conflict between freedom and control. We study the design of privacy-enhanced payment systems with regards to identity and transaction privacy. In our model, privacy is valued by users making legitimate transactions, but can be exploited by malicious actors for illicit financial activities with technologies that obfuscate their illicit nature. When these technologies are fixed, the optimal design can be complex in the sense that transaction privacy is provided to disjoint intervals of payment volume tailored around the technologies. However, when unlawful users can innovate their technologies, the optimal robust design is characterized by two simple features: an identity requirement and transaction privacy up to a threshold of payment volume. Our framework can be applied to compare a variety of payment systems, from legacy payment systems to public blockchains and crypto tumblers, based on their privacy features and enforcement capabilities; we draw policy implications regarding payment system regulation and the design of central bank digital currencies.

Keywords: Privacy, payment systems, regulation, innovation, blockchain, robustness

JEL Classification: E41, E42, G20, G23, G28