Over the past year, with high-profile cases of fraud plaguing cryptocurrency ventures such as FTX and Terra Luna, financial regulators around the world have aggressively looked to rein in bad actors in the crypto-asset marketplace. But some policymakers also seem to have dismissed blockchain—the decentralized digital ledgers that serve as the foundation for cryptocurrencies. The White House has followed suit. In March, the Economic Report of the President devoted 30 pages to arguing against any positive use of cryptocurrencies and the technologies behind them. Some of Washington, it seems, has a one-dimensional strategy for blockchain: Stay away from it.
Yet it’s myopic for the Biden administration to dismiss blockchain outright. Fundamentally, blockchain is a technology that enables data to be verified and transmitted dynamically across networks rather than through single, linear points of transmission. That technology cannot be ignored at a time when data—and how it is maintained and leveraged—has become critical for technological advancement and strategic global competition.
Other global powers are taking note. China and Russia, in their quest to combat U.S. economic power, are developing and implementing blockchain-based digital ecosystems. In June, the European Commission published a draft legislative proposal to develop a digital euro—potentially based on blockchain—as the eurozone’s central bank digital currency (CBDC). This aligns with the EU’s proactive stance toward digital financial innovation. Recently, the bloc approved a framework to regulate crypto-assets and formed a body to coordinate blockchain infrastructure development among member states.
And last week, the European Commission adopted a strategy to lead on a so-called Web 4.0, which it describes as the expected fourth generation of the world wide web that will integrate digital technologies, such as blockchain and artificial intelligence, with real-world environments and objects.
This is a pivotal moment for shaping global financial transactions and the future of the internet. But the new technological direction fusing data, money, and the internet of things presents thorny challenges to personal privacy. If everyone’s real-world activity is represented through digital infrastructure and plugged into AI, what are the technical and policy barriers that prevent private- and public-sector abuse of financial data?
It is not easy to preserve financial privacy in such a system. The United States needs to step up and become the international standard-bearer for the digital financial system. Otherwise, democratic nations that uphold privacy will fall behind in the race to set the guidelines for the future of finance.
Washington is sending mixed messages on blockchain. In early 2022, the White House Office of Science and Technology Policy updated its list of critical and emerging technologies deemed important to U.S. national security. The list includes financial technology, which comprises digital assets, digital payment technologies, distributed ledger technology, and digital identity infrastructure (the systems created to verify user credentials). Since then, however, the U.S. government has not prioritized all these technologies.
Blockchain, for instance, was noticeably absent in the U.S. National Strategy to Advance Privacy-Preserving Data Sharing and Analytics released in March. The strategy got a lot of things right: It explained that greater data collection and analysis may have tremendous economic and social benefits. These benefits, the document warned, will “only be fully realized if strong safeguards that protect privacy—a fundamental right in democratic societies—underpin data sharing and analytics.” This is spot on. Our digital lives are generating more and more data that is potentially useful to businesses and government agencies—but that, without adequate privacy, may support digital authoritarianism.
Yet the strategy document has a glaring omission. It barely alluded to the fact that much of today’s cutting-edge research on financial privacy occurs in the crypto space. Most of the key approaches that the strategy highlighted as essential for digital privacy already feature prominently in crypto and blockchain projects. But the report conspicuously avoided the words “blockchain” or even “distributed ledgers.”
Indeed, open blockchains, ironically, have incentivized privacy innovation. In public blockchains, where transactions are visible to anyone online, the lack of privacy is a feature, not a bug. This transparency ended up spurring blockchain developers to create applications that seek to obfuscate trails of crypto transactions and hide the identities of crypto-asset wallet holders. For years, policymakers and national security watchers—myself included—have warned of the illicit financing risks that crypto obfuscation tools bring. Those risks are well documented and must not be discounted. Yet now, such tools also offer social and national security benefits.
These growing privacy-enhancing technologies offer ways to protect personal identity data while complying with legal and national security requirements, such as the U.S. Treasury Department’s requirement that financial institutions ensure that they are not transacting with individuals and entities on the U.S. sanctions list. Many of these approaches have been discussed for decades in computer science academia as research topics without much real-world implementation. But now, as privacy concerns mount, crypto ventures are devoting significant resources to develop them and bring them to the mainstream market.
One example is zero knowledge proofs (ZKPs), a cryptographic method whereby a party can validate information without revealing the content of the data. ZKPs first emerged as a concept in research papers in 1985 and gained popularity in the blockchain space in 2016. Today, dozens of software firms are integrating ZKPs into blockchain services in order to support transactions that can offer privacy and compliance with various rules or conditions.
Washington should encourage the research and development of advanced cryptography techniques such as ZKPs, which are set to become strategically important for an internet-based, data-driven economy. For instance, the U.S. government could implement a ZKP system that complies with federal labor requirements, whereby a prospective employee could demonstrate their eligibility to work in the United States without having to reveal their social security number in the initial application process. In this approach, a separate authentication body would validate the social security card, the card’s data would be encrypted, and the prospective employer would check the cryptographic proof to confirm work eligibility. This would ensure that the social security number is not needlessly spread across multiple organizations that would have to store and safeguard it.
Supporting privacy-enhancing technologies would ultimately help the United States develop a digital financial system that secures fundamental freedoms around personal privacy. That does not mean pushing for an anonymous financial system. Of course, businesses, regulators, and law enforcement need access to some personal financial data to deliver services, protect consumers, and prevent crime. But anti-money laundering safeguards should not have to come at the cost of unnecessary data collection and a high risk of data leaks, hacks, and exploitation.
As business and commerce become increasingly digitized, Washington needs to ensure that financial institutions are prioritizing optimal privacy in data collection and transactions. One driving principle behind the advancement in digital payments should be data minimization, so that only data absolutely necessary for a transaction or required by law is shared with other parties. For example, a transaction might require confirmation of a consumer being over a certain age, but does not need to collect the consumer’s date of birth.
Another principle should be data transparency. Users should be able to know the precise data points that platforms are collecting from them, as well as who can access their data. And digital platforms should give users the option to withhold data from other parties unless mandated by law, such as when U.S. Customs and Border Patrol requires a U.S. importer receiving foreign goods for commercial purposes to provide a social security number for tax purposes before the goods can clear customs.
A digital financial ecosystem in the United States and abroad that is grounded in these principles would prevent not just abuse by corporations, but also government overreach—a potential issue that other countries are already starting to grapple with. In Brazil, for example, a software developer auditing the source code for Brazil’s CBDC pilot voiced concerns that the CBDC’s programmability could give government officials too much power to manipulate and freeze user’s funds.
The world needs thoughtful rules of the road to guide digital financial innovation. Instead of deeming an entire technology unworthy of attention, the United States should turn to crypto to reinforce democratic principles in the international order. As other states look to advance new digital financial technologies, Washington’s role as a leader in global finance is at stake. Maintaining leadership does not mean succumbing to hype. But it does entail smart, reasonable regulation that allows industry to innovate within defined guardrails. Only then can Washington use crypto to bolster national security and maintain a global financial system that reflects its values.
