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Norway’s digital currency project raises privacy questions

by SuperiorInvest

The small Nordic country of Norway may not be particularly notable on the global crypto map. With 22 blockchain solution providers, the nation doesn’t even stand out at the regional level.

However, as the race to test and implement central bank digital currencies (CBDCs) accelerates by the day, the Scandinavian nation is taking an active stance towards its own national digital currency. In fact, it was one of the first countries to start working on a CBDC back in 2016.

Throwing away cash

In recent years, amid the rise of cashless payment methods and concerns about illegal cash transactions, some Norwegian banks have moved to eliminate cash options altogether.

In 2016, Trond Bentestuen, then director of the large Norwegian bank DNB, proposed to stop using cash as a means of payment in the country:

“Today, approximately 50 billion crowns are in circulation [the country’s central bank] Norges Bank can only account for 40 percent of its use. This means that 60 percent of the use of money is beyond any control.”

A year before that, another large Norwegian bank, Nordea, also refused to accept cash, leaving only one branch at Oslo Central Station to continue handling the cash.

This sentiment came in parallel with Bitcoin (BTC) enthusiasm, like DNB enabled its customers to buy BTC through its mobile app, local courts required drug dealers to be convicted pay your fines in cryptocurrenciesand local newspapers widely discussed investing in digital assets.

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Last year, Torbjørn Hægeland, executive director for financial stability at Norges Bank, outlined to the project’s aim to replace the use of cash in the country:

“In this context, the decline in the use of cash and other structural changes in the payment system are key drivers of the project.”

The experimental phase of the Norwegian CBDC will last until June 2023 and will end with a recommendation from the central bank as to whether the implementation of the prototype is necessary.

Ethereum is the key

In September 2022, Norges Bank released the open source code for a digital currency sandbox powered by Ethereum. The sandbox is available on GitHub designed offer an interface to interact with the testnet enabling functions such as minting, burning and transferring ERC-20 tokens.

However, the second part of the source code, the release of which was announced in mid-September, has not yet been revealed. As stated in v blog postThe initial use of open-source code was not “a signal that the technology will be based on open-source code”, but “a good starting point to learn as much as possible in collaboration with developers and alliance partners”.

Norges Bank in Oslo. Source: Reuters/Gwladys Fouche

Earlier, the bank revealed its main partner in building the infrastructure for the project – Nahmia, the Norwegian developer of the layer 2 scaling solution for Ethereum of the same name. The company has been working on this scaling technology for Ethereum for several years and has its own network and tokens. At the moment, the testnet for the Norwegian CBDC does not use the public Ethereum ecosystem, but the private version of the enterprise blockchain Hyperledger Besu.

At the end of 2022, it became Norway part of the Icebreaker project, joint research with the central banks of Israel, Norway and Sweden on how CBDCs can be used for cross-border payments. As part of it, three central banks will connect their domestic proof-of-concept CBDC systems. The final project report is scheduled for the first quarter of 2023.

Local specifics, universal problems

In terms of hopes and fears, what defines the Norwegian CBDC project, among other things, is the national regulatory context. Like its geographic neighbors, Norway is known for its cautious approach to the digital asset market, high taxes and the relatively small scale of its domestic crypto ecosystem – a recent study by the EU Blockchain Observatory estimated its total capital funding at a modest $26.9 million.

Norwegian serial entrepreneur Sander Andersen, who recently moved his fintech company to Switzerland, doubts that the upcoming project will coexist peacefully with the crypto industry. There are already more than enough problems for tech entrepreneurs in the country, he said in a chat with Cointelegraph:

“Despite the country’s strong infrastructure for entrepreneurs in other sectors, such as low energy costs and free education, these benefits do not extend to the digital sphere. The tax burden that digital companies face makes it almost impossible to compete with businesses based in more business-friendly jurisdictions.”

As central bank digital currencies have the potential to compete with private cryptocurrencies and the goal of every government is to control financial transactions as tightly as possible, Andersen does not see Norway as an exception:

“The Norwegian central bank’s CBDC project may also pose a threat to the legal status of private stablecoins in the country. The introduction of a CBDC may trigger increased regulation and oversight of private stablecoins, making it more difficult for these companies to operate.

Michael Lewellen, head of solution architecture at OpenZeppelin, which contributes its contract library to the Norges Bank project, does not sound so pessimistic in an interview with Cointelegraph. Technically, he stressed, there is nothing stopping private stablecoins from trading and operating alongside CBDCs on both public and private Ethereum networks, especially if they use common, compatible token standards such as ERC-20.

However, from a policy perspective, there is nothing to prevent central banks from conducting financial gatekeeping and enforcing Know Your Customer (KYC) standards, and this is where CBDCs seem like a natural evolution. Banks will not sit idly by as the blockchain ecosystem grows, as there is a lot of shadow banking activity taking place on the chain, Lewellen elaborated, adding:

“CBDCs offer central banks the ability to perform better gatekeeping and enforce KYC rules on CBDC holders, while enforcing the same standards against entities using non-governmental stablecoins is much more challenging.”

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Could Norway’s CBDC offer some comfort when it comes to user privacy? From both a technological and a strategic point of view, it’s hardly possible, Lewellen said. Today, there is no mature solution that allows for privacy consistent with the use of CBDC.

Any national digital currency would almost certainly require every address to be linked to an identity using KYC and other means we see in banks today. In fact, if done on a private ledger like the one Norges Bank is currently testing, the CBDC will offer not only less privacy for a single customer, but also less public transparency with regard to blockchains.

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