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TaxDAO’s Response to the Reserve Bank of New Zealand consultation paper Digital cash in New Zealand

To the Reserve Bank of New Zealand:

TaxDAO is pleased to have the opportunity to respond to the key issues at the intersection of digital assets and tax law raised by the Finance Committee. Founded by senior tax and financial executives from the Web3 field on February 20, 2023, TaxDAO is dedicated to becoming a pioneering organization in the Web3 financial and tax sector. We have cumulatively handled hundreds of Web3 financial and tax cases, amounting to billions in value. TaxDAO bridges tax regulation and industry practice by providing tax compliance guidelines to the community and facilitating two-way interaction with regulators. Our goal is to help the community better deal with tax compliance issues, bridge the gap between regulation and industry, and conduct foundational research and development during the early stages of industry tax regulation to help future compliance development.

New Zealand’s exploration of digital currency marks an important step in the field of digital finance. As a highly developed economy, New Zealand faces both opportunities and challenges in its exploration of CBDC. We believe that CBDC are prone to digital financial monopoly and unfairness, and can undermine the transparency of digital transactions, and overall we do not recommend the issuance of CBDC. Notwithstanding the above, if the Federal Reserve Bank of New Zealand wishes to issue CBDC, it is important that it fully recognises and evaluates the potential risks and develops a corresponding response strategy to fully unlock the innovative potential of CBDC. Based on this, we offer the following response.

This response aims to address the key issues raised in the Reserve Bank of New Zealand’s consultation paper Digital Cash in New Zealand, providing a comprehensive analysis of the potential risks associated with the implementation of CBDC and offering a series of recommendations for the New Zealand government to deal with these risks.

We look forward to collaborating with the Reserve Bank of New Zealand to support industry innovation and promote sustainable economic development.

Sincerely,

Harry TaxDAO Web3 Policy Analyst

Angelia TaxDAO Web3 Legal Analyst

Ray TaxDAO Senior Web3 Legal & Policy Analyst

Leslie TaxDAO Senior Web3 Legal & Policy Analyst

1. Concerns about New Zealand’s CBDC Issuance

RBNZ is actively exploring the possibility of launching a CBDC, and this move reflects the broader trend of digital transformation of the global financial system. The CBDC, as a digital form of fiat cash, has the potential to bring a more efficient and inclusive payment system to New Zealand, but it also faces technical, regulatory and privacy challenges. Although CBDC enhances security and scalability through centralized management, it still needs to overcome a number of technical and legislative challenges in the actual implementation process. We believe that the issuance of CBDC in New Zealand will face challenges at three levels: technical, legislative and social.

1.1 Technical Aspect

1.1.1 System Performance and Stability

In the implementation of Central Bank Digital Currency (CBDC), New Zealand may face numerous challenges. Foremost among these is system performance and stability. The CBDC system must maintain low latency and high throughput in a high-concurrency transaction environment, posing a significant challenge to the existing technological infrastructure. In a country like New Zealand, with diverse geographical environments and relatively dispersed population distribution, ensuring the stable operation of the CBDC system under various network conditions is crucial. Although New Zealand’s overall network infrastructure is advanced, the quality of network service in rural and remote areas still has room for improvement, potentially affecting the uniform usage of CBDC across the nation.

It is noteworthy that, in theory, CBDC can enable offline payment functionality, which to some extent can ease the issues arising from insufficient network coverage. However, offline payments face the severe risk of double-spending—where the same digital currency could be used more than once. This risk arises because, in an offline environment, it is impossible to verify the validity of transactions or update the ledger in real-time. Double-spending could lead to an increase in fraudulent activities, thereby compromising the integrity of the monetary system. To mitigate this risk, it is generally recommended that CBDC offline payments be used only for small-value transactions, potentially necessitating transaction limits or the use of special hardware security modules. This implies that for significant transactions, CBDC still needs to rely on network connectivity, so CBDC faces challenges related to network conditions. For instance, in some remote mountainous areas of the South Island or agricultural regions of the North Island, network coverage might be inadequate, affecting the experience of CBDC users, especially during significant transactions, which could result in transaction delays or failures.

To deal with these challenges, the design of the CBDC system needs to consider optimizing offline payment functionality, developing transaction confirmation mechanisms that adapt to various network conditions, and ensuring that offline transaction data can be quickly synchronized once the network is restored. Moreover, it must effectively detect and handle potential double-spending transactions. Overall, while CBDC offers the possibility of offline payments, the quality and coverage of the network infrastructure remain crucial factors affecting its widespread adoption and use, particularly in the context of significant transactions. Therefore, as New Zealand advances the implementation of CBDC, it needs to concurrently improve the national network infrastructure, especially in remote areas, to ensure that the CBDC system can operate stably, efficiently, and securely under all conditions.

Another key challenge for system performance is handling peak transaction periods. During major holidays and special events, transaction volumes may surge unexpectedly, and the system needs sufficient elasticity to cope with such situations. For example, during the Christmas shopping season or significant sports events, transaction volumes might be several times higher than usual. If the system cannot effectively manage such sudden high loads, it may lead to transaction delays, slow system response, or even system crashes, which would severely impact user experience and public confidence in CBDC.

1.1.2 Cybersecurity Risks

Cybersecurity is another critical issue that cannot be overlooked. As a vital component of the national financial infrastructure, the CBDC system will inevitably become a potential target for cyberattacks. Particularly in the face of increasingly sophisticated cyber threats, effectively preventing distributed denial-of-service (DDoS) attacks, protecting user data and transaction information, guarding against internal threats, and ensuring the long-term security of encryption algorithms are formidable challenges. For example, in recent years, there has been a significant increase in cyberattacks on financial institutions worldwide, with methods becoming ever more complex. As a developed country, New Zealand’s CBDC system may become a prime target for hacker organizations. If the system suffers a successful cyberattack, it would not only result in direct economic losses but also severely undermine public confidence in the CBDC, affecting the stability of the entire financial system.

1.1.3 System Reliability

The reliability and disaster recovery capabilities of the CBDC system are also critical considerations. New Zealand is located in an earthquake-prone region and is also threatened by other natural disasters such as volcanic eruptions and extreme weather events. Ensuring the continuous operation of the CBDC system under various emergency situations is a significant issue that needs careful resolution. 

For instance, the 2011 Christchurch earthquake caused severe infrastructure damage. If a similar event were to occur, the CBDC system must have sufficient redundancy and backup mechanisms to ensure service continuity. This challenge involves not only technical aspects but also considerations of geographic distribution, power supply, communication networks, and other factors.

1.1.4 Technology Integration and Interfacing

Integrating CBDC with the existing financial system is a complex process. The CBDC needs to seamlessly interface with core banking systems, traditional payment networks, clearing systems, and other existing financial infrastructures, which involves addressing complex issues of technical compatibility and interoperability. 

New Zealand’s current financial system is relatively mature, encompassing interbank payment systems, retail payment networks, and more. The introduction of CBDC requires careful consideration of how to coordinate its operations with these systems to avoid disrupting existing services while leveraging the full benefits of CBDC. This likely involves intricate system integration work, necessitating close collaboration among banks, payment service providers, regulatory authorities, and other stakeholders.

1.2 Legislative Aspect

1.2.1 Inadequate Regulatory Framework

The popularization of digital cash faces a series of challenges and problems. For example, how to safeguard the security and privacy of digital cash, and how to prevent digital cash from being used for illegal activities. And New Zealand’s existing financial regulations may not be sufficient to cover the uniqueness and complexity of CBDC, so new legal and regulatory frameworks need to be formulated to regulate its use and management.CBDC has the characteristics of real-time transactions, seamlessness, and smart contracts, which are significantly different from the traditional monetary system, and it is difficult for the lagging of the existing centralized regulatory model to comprehensively cover all of its use scenarios and potential risks. And New Zealand’s existing regulations, such as the Reserve Bank Act and the Financial Market Conduct Act, are mainly designed for the traditional financial system, making it difficult to comprehensively cover all the usage scenarios and potential risks of CBDC, such as cross-border payments, anonymous transactions, and smart contracts. Meanwhile, the existing financial regulations are usually designed for the traditional financial system and lack targeted provisions on digital cash technology and new financial products, and the legal interpretation of new technologies and concepts is not clear enough, which is prone to legal disputes and uncertainty in actual operation.

In addition, the existing regulatory framework for CBDC is inadequate and presents significant challenges, particularly with regard to cross-border transactions. Ensuring the international compliance of CBDC becomes particularly complex as cross-border transactions of CBDC involve the legal and regulatory requirements of multiple countries, requiring clear and consistent frameworks across different jurisdictions. Existing legal systems and regulatory mechanisms are overwhelmed in dealing with these emerging digital currencies, and the lack of harmonized standards and clarity leads to potential legal conflicts and regulatory differences between different countries. This legal and regulatory incoherence not only hinders the smooth use of CBDC in international trade and cross-border payments, but also increases uncertainty and risk in the financial market.

1.2.2 Privacy Protection Issues

There are obvious shortcomings in the existing privacy protection framework on CBDC in New Zealand, especially when large amounts of user data are collected and processed, how to protect users’ privacy and prevent data misuse and over-monitoring has become a key issue.

Digital cash should be private and secure. People will be able to use and spend their digital cash as they wish, the Reserve Bank of New Zealand will not be able to (and will not want to) impose any restrictions on how digital cash can be used, will not be able to regulate or see how it is used, and will set out rules on how third parties can collect, use, share and delete users’ information. However, we should not let our guard down. This is due to the existence of: ① Transaction transparency and data leakage risk: CBDC’s transaction records are likely to be monitored in real time by the government and financial institutions, which, while helping to prevent criminal activities such as money laundering and terrorist financing, may also lead to the exposure of personal transaction privacy, especially in the process of data storage and transmission, and data leakage incidents may occur if there are no strict security measures; ② Identity tracking and Monitoring Risk: Transaction records in the CBDC system are usually associated with user identity information, which makes it easy for the government or other organizations to track users’ consumption behavior and fund flows; ③ Data misuse risk: The large amount of user transaction data collected may be misused by insiders or attacked by external hackers if it is not properly protected, leading to the leakage and misuse of users’ private information, which may even be used for commercial purposes or other improper uses; ④ Risk of centralized information management: the CBDC system usually centralizes the management of a large amount of users’ transaction and identity information, and while this centralized management helps to improve management efficiency, it also increases the risk of a single point of failure, which may lead to a large-scale privacy leakage incident in the event of a data leakage or system failure; ⑤ Risk of cross-border data transmission: in the case of CBDC’s cross-border payment and international cooperation, users’ transaction data may be transmitted and shared between different countries, which may lead to the theft or misuse of users’ private information in the cross-border process if there are no strict privacy protection measures in the cross-border data transmission process.

However, current privacy protection laws are not adequately prepared for the unique needs and challenges of CBDC and are unable to comprehensively cover and address these emerging issues. The newest law of New Zealand which aims to protect personal privacy is the Privacy Act introduced in 2020, which primarily sets out 13 information privacy principles for the protection of personal information, including the collection, use, retention, disclosure, access and correction of information, which are designed to protect the privacy of personal information; give individuals the right to access and correct their data, enabling individuals to understand, access and correct their personal information that has been collected ; limits the scope and purpose of data collection by requiring that data collection must be lawful, legitimate and transparent and be used only for the purposes specified at the time of collection; requires data controllers and processors to take reasonable security measures to protect personal information from unauthorized access, modification or loss; and requires that when transferring personal information overseas, it must be ensured that the receiving country has a comparable standard of privacy protection or has put in place appropriate protective measures ; and establishes a Privacy Commissioner to oversee the implementation of the Privacy Act, handle privacy complaints and disputes, conduct investigations and issue guidance. Although the Privacy Act has more detailed provisions on general data protection and privacy management, the coverage and specific provisions of these laws are still insufficient in the face of emerging issues such as management of real-time transaction data, anonymity and user identity protection, cross-border data transfers, data misuse and restrictions on business use, technical and system security, emergency response and vulnerability management brought about by CBDC. For example, the management of real-time transaction data: CBDC transaction data are recorded and transmitted in real-time, which contain detailed information on the time, location and amount of the transaction, and the Privacy Act has insufficient provisions for the protection of such real-time data, lacking specific requirements for encryption and access control of real-time data; another example is the issue of anonymity and user identity protection. Under the current legal framework in New Zealand, there is no clear legal protection for anonymous transactions by users. CBDC needs to protect the privacy of users’ identities while ensuring lawful transactions, which has not yet been clearly stipulated in the current law, and may lead to users’ fear of privacy leakage when using CBDC; and then the issue of data misuse and restrictions on commercial use: the current law does not have a sufficiently clear limitation of the scope of use of data, the transaction data in the CBDC system may be used for commercial purposes or other unauthorized uses, which requires stricter laws to prevent data misuse; and then there is the issue of emergency response and vulnerability management: the existing laws do not clearly specify how to respond to emergencies and security vulnerabilities in the CBDC system. The lack of an emergency response mechanism and legal support in the event that the CBDC system malfunctions or suffers an attack may result in security risks to user data and funds. Therefore, there may be loopholes and imperfections in New Zealand’s existing laws on data protection and privacy management, which make it difficult to effectively guard against the risks of data leakage, illegal access and excessive monitoring. Measures need to be taken to prevent the Reserve Bank from arbitrarily accessing users’ sensitive information.

1.2.3 Financial Freedom Issues

If the New Zealand Government were to mandate the promotion of CBDC or restrict other payment methods, it could severely limit the financial freedom of its citizens. While part of the reason for New Zealand’s CBDC is to protect monetary sovereignty, this does not mean that citizens’ financial freedom can be sacrificed as a result. Citizens should have the right to choose whether or not to use CBDC, rather than being forced to accept and having to give up traditional paper money payment methods, as well as other forms of digital cash such as cryptocurrencies. However, existing laws and policies do not adequately safeguard this freedom, and may result in the government taking a more coercive approach to the introduction of CBDC, ignoring citizens’ right to choice and autonomy. Although the New Zealand government and central bank are not currently adopting coercive measures in implementing CBDC, there are still some potential risks and possibilities, and these may indirectly affect citizens’ right to financial choice. For example, as CBDC is issued and digital payment methods become more popular, the use of cash may diminish, resulting in certain groups of people (e.g., the elderly or technologically disadvantaged) being inconvenienced in practice, even though there is no official policy mandating the use of CBDC; and also as a result of infrastructural changes, if the majority of merchants and service providers begin to primarily accept CBDC payments, the option of paying in cash may be be limited in practice. Such a change in environment may force citizens to use CBDC more often, although not mandated by the government, but with similar practical effects. This could not only trigger public discontent and resistance, but could also have a negative impact on social stability and the financial system.

1.3 Social Aspect

The spread of digital currencies may exacerbate the digital divide in New Zealand society, particularly for technologically disadvantaged groups such as older people and rural dwellers, who may have difficulties in adapting to new technologies. There are significant digital inequalities in society. Internet coverage and speeds are lower in rural areas, limiting the digital participation of people living in these areas. Older people often face more difficulties in using new technologies due to age and experience limitations, and lack for the necessary digital skills and technical support. In addition, some of the more economically disadvantaged communities have difficulties in accessing and using modern digital tools and services owing to insufficient resources and education.

2.Our recommendation for A Decentralized Cryptocurrency Solution and Its Reasons

Based on the technical, regulatory and social issues that exist at this stage of the CBDC, we propose a decentralized cryptocurrency solution. Decentralized cryptocurrency is a digital currency based on blockchain technology that uses a distributed ledger and decentralized management model that does not rely on a central authority or intermediary. Decentralized cryptocurrency can automatically regulate supply through algorithms and smart contracts to anchor their coin value to NZD. 

We believe that decentralized cryptocurrency offers significant advantages in the following main areas.

2.1 Technical Aspects

2.1.1 High Reliability of Distributed Ledgers

Decentralized cryptocurrency uses distributed ledger technology, which avoids the risk of a single point of failure by recording and validating transaction data on multiple nodes. Unlike the centralized management of a CBDC, Decentralized cryptocurrency relies on multiple nodes across the globe working together to maintain the ledger, thereby increasing the reliability and resilience of the system. For example, the Bitcoin network verifies and records transactions through thousands of nodes, allowing the entire system to remain up and running even if some nodes fail or are attacked. In addition, a Decentralized ledger prevents tampering and data loss, ensuring the authenticity and integrity of transaction records.

2.1.2 Stronger Network Security

Decentralized cryptocurrency guarantees the security and privacy of transactions through cryptography. Each transaction is processed by complex encryption algorithms, and only legitimate holders are allowed to carry out transaction operations, thus greatly reducing the risk of cyber-attacks. In contrast, the CBDC system, due to its centralised management, is a potential target for cyber-attacks and has greater security risks. The Decentralized structure of Decentralized cryptocurrency makes it difficult for attackers to effectively attack the entire system, and even if certain nodes are attacked, the security and operation of the overall system will not be affected.

2.2 Legislative Level: Decentralized Management Reduces Regulatory Burden

The distributed management model of Decentralized cryptocurrency reduces the reliance on centralized institutions and reduces the complexity and cost of regulation. In contrast to CBDC, which require the development of extensive new legal and regulatory frameworks, Decentralized cryptocurrency are self-managing and self-regulating through smart contracts and community governance. For example, the Decentralized finance (DeFi) project automatically executes transactions and settlements through smart contracts, reducing reliance on traditional financial institutions and regulators, and improving transaction efficiency and transparency. At the same time, Decentralized cryptocurrency emphasises financial freedom and autonomy, and users are free to trade under compliance conditions, helping to protect their right to choose.

2.3 Social Level

2.3.1 Enhancing Social Trust

Decentralized cryptocurrency enhances social trust and transparency through transparent blockchain technology. All transaction records are publicly available, and anyone can view transaction history through a blockchain browser, preventing fraud and corruption. This transparency helps boost public confidence in digital currency and promotes the development and prosperity of the digital economy

2.3.2 Community Governance and Participation

Decentralized cryptocurrency emphasises community governance and user participation, and users can participate in project decision-making and management by holding tokens, which enhances their sense of participation and belonging. For example, the Ether community achieves community governance through Decentralized autonomous organisations (DAOs), where users can vote on the development direction of the project and the use of funds. This community governance model not only improves the transparency and fairness of the project, but also stimulates the enthusiasm and innovation of users.

Overall, Decentralized cryptocurrency demonstrates many advantages at the technical, legislative and social levels. Compared with CBDC, Decentralized cryptocurrency is more in line with modern society’s pursuit of transparency, justice and autonomy, and is better able to address the challenges faced during digital transformation.

3. The Following Should Be Done When Insisting on Promoting Digital Cash

If the New Zealand government persists in promoting CBDC after fully considering the above risks, then we suggest that the following measures could be considered to regulate the above issues.

3.1 Technical Aspects

3.1.1 System Architecture

For the successful implementation of CBDC, New Zealand needs to undertake comprehensive technical preparations. Primarily, in terms of system architecture, an advanced distributed system design should be adopted, combined with cloud computing technology, to build a highly scalable and elastic CBDC infrastructure. This might involve the use of containerization technology and microservices architecture to enable flexible deployment and rapid scaling of the system.

For instance, leveraging container orchestration platforms such as Kubernetes, along with service mesh technologies like Istio, can help construct a highly dynamic and scalable system architecture. This architecture would be capable of automatically adjusting system resources in response to changes in transaction loads, ensuring optimal performance even during peak periods.

3.1.2 Establishing Data Centers and Redundancy Systems

In addition, it is essential to establish geographically distributed data centers and redundancy systems to ensure business continuity in the event of local failures or natural disasters. This might involve setting up multiple data centers in different regions of New Zealand and implementing real-time data synchronization and failover mechanisms. For example, data centers could be established in major cities such as Auckland, Wellington, and Christchurch, utilizing an multi-active data center architecture to ensure that the system can continue to operate even if one data center completely fails.

For disaster recovery, it is crucial to implement off-site backups and real-time data synchronization mechanisms, as well as conduct regular large-scale disaster recovery drills to test and refine emergency response procedures. These drills might include simulating various disaster scenarios such as earthquakes, floods, and cyberattacks to evaluate the system’s recovery capabilities and response times. By continuously optimizing disaster recovery strategies and procedures through these drills, the CBDC system can be prepared to respond quickly and effectively in the event of actual disasters.

3.1.3 Network Updates

On the network level, it is essential to optimize nationwide network infrastructure, particularly by enhancing network coverage and quality in rural and remote areas. This may require collaboration with telecommunications operators to deploy advanced network technologies such as 5G, while also considering satellite communication as a backup solution to ensure the widespread availability of CBDC services. 

For example, partnerships with major telecommunications operators in New Zealand, such as Spark and Vodafone, could be considered to deploy small-scale 5G base stations or utilize low Earth orbit satellite communication technology in remote areas to provide stable network connections. This approach would ensure that all regions, including those with less developed infrastructure, have access to reliable CBDC services.

3.1.4 Security Systems

In terms of security, New Zealand needs to establish a multi-layered security framework. This includes employing strong encryption algorithms, multi-factor authentication mechanisms, and real-time threat detection systems. Given the advancements in quantum computing, it may be necessary to research and deploy post-quantum encryption algorithms to ensure the long-term security of the CBDC system. For example, adopting post-quantum cryptographic techniques such as lattice-based cryptography could provide long-term security protection for the CBDC system.

Additionally, a stringent key management mechanism and access control policies must be established to minimize the risk of internal threats. This might involve using Hardware Security Modules (HSMs) to store and manage encryption keys, and implementing role-based access control (RBAC) and the principle of least privilege.

To defend against DDoS attacks, deploying advanced traffic scrubbing devices and intelligent analysis systems can be considered. For instance, machine learning algorithms can be used to analyze network traffic patterns in real time, quickly identifying and filtering malicious traffic. Furthermore, utilizing Content Delivery Networks (CDNs) can help distribute traffic load and enhance the system’s DDoS resistance.

3.1.5 Utilizing Web3 Technology for Financial Innovation (Technology and Application Scenarios)

3.1.5.1 Smart Contract Technology

Smart contracts are self-executing computer protocols on the blockchain that aim to enforce, verify, or execute the terms of a contract. They automatically execute transactions and agreements through code within a distributed network, reducing the need for intermediaries and enhancing transaction transparency and security.

The application of smart contract technology can bring more innovative possibilities to CBDC. New Zealand can consider integrating smart contract functionalities into the CBDC system to support more complex financial transactions and automated business processes. For instance, smart contracts could enable conditional payments, automated financial derivatives trading, or disbursement of subsidies based on predefined rules. Technically, a platform similar to Ethereum could be adopted for smart contracts, but it would need optimization to meet the performance and security requirements of CBDC. This might involve developing a dedicated smart contract execution environment to ensure efficient execution of contracts and overall system security.

Specific components of smart contract technology include:

  1. Smart Contract Programming Language: A specialized, secure programming language needs to be designed for writing CBDC smart contracts. This language should be user-friendly while preventing common security vulnerabilities.
  2. Contract Execution Engine: This engine interprets and executes smart contract code. It must be highly optimized to ensure high performance when processing large volumes of transactions.
  3. State Management System: This system stores and manages the state information of smart contracts. It needs to be highly scalable to handle numerous concurrent state updates.
  4. Contract Auditing Tools: Tools to automatically analyze smart contract code, detecting potential security vulnerabilities or logical errors.
  5. Contract Upgrade Mechanism: A mechanism to safely update and upgrade deployed smart contracts without service interruption.

Through these components, the CBDC system can support various innovative financial applications. For example, automated government subsidy disbursement can be implemented, where subsidies are automatically distributed to eligible citizens based on predefined conditions such as income level or age. Alternatively, the system could support complex financial derivatives trading, such as options or futures contracts, which can automatically execute when specified conditions are met.

3.1.5.2 Zero-Knowledge Technology

Zero-knowledge proof is a cryptographic technique that allows one party to prove to another that a statement is true without revealing any information about the statement itself. It ensures the privacy and security of data while verifying its authenticity.

The application of zero-knowledge proof technology can effectively address privacy protection issues in CBDC. With zero-knowledge proofs, it is possible to prove the legality of transactions and the compliance of fund sources without disclosing specific transaction information. This is crucial for balancing user privacy protection and regulatory requirements. Technically, mature zero-knowledge proof protocols like zk-SNARKs or zk-STARKs can be considered. These protocols need to be deeply integrated with the CBDC transaction processing flow to ensure privacy protection without compromising overall system performance.

Specifically, zero-knowledge technology can be applied to:

  1. Transaction Privacy Protection: Using zero-knowledge proofs to validate transactions without revealing the transaction amount, sender, and recipient details.
  2. Balance Proofs: Allowing users to prove they have sufficient balance for a transaction without disclosing the exact account balance.
  3. Identity Verification: Proving that users meet certain conditions (such as age requirements, credit scores, etc.) without revealing specific identity information.
  4. Compliance Proofs: Enabling financial institutions to prove to regulatory bodies that they comply with anti-money laundering (AML) and know your customer (KYC) regulations without disclosing detailed customer information.

Implementing these functionalities requires the integration of specialized zero-knowledge proof generation and verification modules into the CBDC system. These modules need to be highly optimized to ensure proof generation and verification are completed without significantly increasing transaction processing times. Additionally, it is essential to consider the secure management and updating of public parameters used for zero-knowledge proofs.

3.1.5.3 Distributed Ledger Technology (DLT)

New Zealand also needs to consider adopting Distributed Ledger Technology (DLT) to enhance the transparency and auditability of the CBDC system. Although CBDC is centrally managed, incorporating DLT can increase the system’s credibility and efficiency. For example, a permissioned blockchain can be used to record transaction history, allowing authorized nodes to participate in transaction verification and ledger maintenance. This approach can increase system transparency and tamper-resistance while maintaining control by the central bank. For technical implementation, enterprise-grade blockchain platforms such as Hyperledger Fabric or R3 Corda can be considered, with customization based on the specific needs of the CBDC.

DLT can be mainly applied to the following areas:

  1. Transaction Records: Using distributed ledgers to record all CBDC transactions, ensuring the immutability and traceability of transaction history.
  2. Consensus Mechanism: Designing a consensus algorithm suitable for CBDC that ensures fast transaction confirmation and maintains system security. Given the centralized nature of CBDC, efficient consensus algorithms like Practical Byzantine Fault Tolerance (PBFT) can be adopted.
  3. Smart Contract Deployment: Leveraging the smart contract capabilities of blockchain platforms to deploy and execute business logic related to CBDC.
  4. Cross-Border Payments:Utilizing DLT to achieve efficient and transparent cross-border CBDC transactions, potentially interoperating with other countries’ CBDC systems.
  5. Regulatory Audits: Allowing regulatory bodies to participate as special nodes in the network to monitor system operations and transaction flows in real-time while protecting user privacy.

When implementing DLT, performance optimization and privacy protection should be given special attention. For instance, sharding technology can be used to increase system throughput, and privacy-enhancing technologies like zero-knowledge proofs can be employed to protect sensitive transaction information. 

3.1.5.4 Cross-Border Payment Solutions

Additionally, New Zealand needs to focus on the cross-border payment capabilities of CBDC. This may involve interoperability with CBDC systems of other countries or traditional cross-border payment networks. Technically, it is necessary to design flexible interfaces and protocols that support efficient conversion and settlement between different currencies and payment systems. This could require the development of specialized cross-currency bridging protocols or participation in the formulation of international CBDC interoperability standards.

When designing cross-border payment solutions, several specific details need special attention:

  1. Exchange Rate Mechanism: Designing a real-time, fair exchange rate determination mechanism, possibly involving real-time integration with international foreign exchange markets.
  2. Cross-Border Settlement: Developing an efficient cross-border settlement system, which may require establishing direct settlement channels with central banks of other countries.
  3. Compliance Checks: Implementing automated compliance checks for cross-border transactions, including anti-money laundering (AML) and counter-terrorist financing (CFT) reviews.
  4. Cross-System Communication Protocols: Establishing standardized communication protocols for cross-CBDC systems to ensure seamless interoperability between CBDC systems of different countries.
  5. Multi-Currency Wallet: Developing digital wallets that support multiple CBDC, allowing users to hold and use digital currencies from different countries.

When implementing cross-border CBDC payments, New Zealand could consider starting with pilot projects with major trading partner countries, such as Australia, China, or Pacific Island nations, and gradually expanding to more countries after gaining sufficient experience.

3.1.5.5 Technical Cooperation and Standardization

Finally, New Zealand needs to establish a comprehensive CBDC technology governance framework. This includes formulating detailed technical standards and operational protocols, establishing continuous security assessment and upgrade mechanisms, and defining clear data governance policies. Additionally, it is essential to build extensive cooperative relationships with financial institutions, technology companies, and academia to continuously promote the research and innovation of CBDC-related technologies.

Specific feasible plans include:

  1. Technical Standards Committee: Establish a dedicated committee responsible for formulating and maintaining CBDC-related technical standards to ensure system consistency and interoperability.
  2. Security Assessment Mechanism: Develop a regular security assessment process, including internal audits and external penetration testing, to continuously identify and address potential security vulnerabilities.
  3. Technical Roadmap: Create a long-term technological development plan, including the research, testing, and integration timeline of new technologies.
  4. Open Innovation Platform: Establish an open innovation platform for CBDC technology, encouraging participation from fintech companies and academic institutions in the development of CBDC-related technologies.
  5. Talent Development Program: Collaborate with universities to train technical talents related to CBDC, providing human resource support for the long-term development of the system.
  6. International Cooperation Mechanism: Actively participate in the formulation of international CBDC technology standards and establish technical exchange mechanisms with central banks of other countries.

By implementing these comprehensive technical preparations, New Zealand is poised to build a secure, efficient, and innovative CBDC system, laying a solid foundation for the digital transformation of the national financial system. However, the success of CBDC depends not only on the maturity of technology but also on the collective efforts of policymakers, financial institutions, technology providers, and the public. The Reserve Bank of New Zealand needs to adopt a prudent and gradual implementation strategy, continuously collect and analyze feedback, and optimize and improve the CBDC system to ensure it can bring long-term positive effects to the New Zealand economy. Additionally, it is crucial to consider the potential impacts of CBDC on monetary policy, financial stability, and economic structure, ensuring that its introduction enhances the efficiency and inclusiveness of New Zealand’s financial system without causing significant disruption to the existing financial ecosystem.

3.2 Legislative Aspect

3.2.1 Completion of Legal and Regulatory System

Currently, New Zealand is taking a more cautious approach than other countries that are vigorously pursuing CBDC. Recognizing that the crypto industry is still in its infancy, the New Zealand government has emphasized the importance of adaptive rules that can evolve with the industry and align with global crypto regulation. Prior to the development of new specific legislation, the focus is on how existing regulations apply to cryptocurrencies and crypto service providers.

We believe that a sound legal and regulatory system begins with clarifying the definition and categorization of CBDC to ensure their legal status within New Zealand and to protect the legitimate rights and interests of holders. Clarify the status of CBDC in the New Zealand legal system so that they become part of legal tender. The legitimacy of CBDC can be ensured by amending the existing Reserve Bank Act or enacting a new Digital cash Act. Also clearly define CBDC and its difference from other digital currencies to ensure the accuracy of the legal provisions and the operability of the implementation. In addition, in terms of usage specifications, it is necessary to standardize the transaction process of CBDC, clarify its application scenarios, and formulate unified technical standards to ensure interoperability and compatibility. Develop detailed CBDC transaction processes and specifications to ensure transaction transparency and security. This includes, but is not limited to, transaction confirmation time, handling fee standards, and transaction record keeping.

In terms of regulatory measures, it is necessary to establish a sound regulatory framework, formulate risk prevention and control measures, especially for the effective prevention of risks in cybersecurity, money-laundering and terrorist financing, and strengthen auditing and transparency. In addition, we believe that it is necessary not only for the New Zealand government to regulate unilaterally, but also to cooperate with international regulators and private sector information providers such as blockchain analytics firms, cryptocash trading platforms, research institutes and fintech companies. Multi-body, all-encompassing regulation will help maximize market stability.

In addition, the privacy issue is also an important challenge that CBDC will face. In our view, in response to the privacy risks mentioned earlier, New Zealand can regulate them through the following legislative measures to safeguard the privacy and security of users: first, requiring all CBDC transaction data to be strongly encrypted during transmission and storage, and formulating unified security protocols and technical standards; second, permitting anonymous transactions within a certain amount to protect users’ privacy, and restricting the identification of users to mandatory disclosure; at the same time, formulate strict access control regulations to ensure that only authorized personnel and institutions have access to the CBDC system and user data, and require regular independent audits; in addition, limit the scope of use of CBDC transaction data, prohibit data misuse, clarify the data protection responsibilities of each participating institution, and promote decentralized data management solutions to reduce the risk of single-point failure; finally, formulate cross-border data transfer protection regulations to ensure the privacy protection of user data in international cooperation and cross-border payments, and actively promote international standardization to ensure the security of cross-border data transfer.

In addition to the macro-level policy initiatives mentioned above, we believe that an attempt could be made to introduce “anonymity for small transactions”. Through technological and policy measures, this anonymity could be similar to the anonymity of the use of cash. We suggest that New Zealand could allow anonymity for micro-transactions to protect user privacy when implementing CBDC. Specifically, when implementing CBDC, New Zealand can safeguard users’ privacy by setting a reasonable upper limit on the amount of small transactions (e.g., several hundreds NZD) and allowing transactions within that amount to remain anonymous; explicitly permitting small anonymous transactions through legislation and formulating a stringent privacy protection policy and regulatory mechanism to ensure that anonymous transactions are not abused, and at the same time, conducting strict authentication and monitoring to prevent money laundering and other illegal activities; and implementing regular audits to review the CBDC system to ensure the legality and compliance of anonymous transactions and guard against potential privacy risks. By doing so, New Zealand can achieve anonymity for small transactions similar to the use of cash, which protects the privacy of users while taking into account the needs of financial regulation, improves public acceptance of CBDC, and promotes the widespread use of digital currencies in daily life.

Lastly, we suggest that the New Zealand Government, in implementing CBDC, should conduct in-depth studies and learn from the successful experiences and failures of other countries in implementing CBDC, so as to avoid repeating the mistakes of the past. For example, China’s Digital RMB Pilot Project has achieved a certain degree of success in terms of technological innovation and user experience, and it is worthwhile for New Zealand to learn from its strategy in large-scale user testing and promotion; while Sweden’s e-Krona Project emphasizes privacy protection and financial inclusion, and New Zealand can make reference to its experience in terms of legislation and technological design, so as to ensure that the CBDC can achieve widespread use while safeguarding user privacy; And in the Bahamas, the implementation of the Sand Dollar project highlights micro-transactions and offline payment functions, which provides important insights for New Zealand in advancing the popularization of CBDC. By analyzing the practices of these countries, New Zealand can better avoid potential risks and formulate a CBDC policy that is in line with the actual situation of the country.

3.2.2 Strengthening Tax Administration

It should be noted that the application of CBDC can bring significant benefits to New Zealand’s tax administration – through the real-time tracking and transparency of digital currencies, the government is able to monitor and collect taxes more accurately, reducing tax evasion and money laundering; the application of CBDC technology improves the real-time and accuracy of tax data, making tax collection and management more efficient and refined. To this end, New Zealand can implement the following supporting policies to strengthen tax administration:

First, the technical foundation and security framework of the CBDC system should be established and improved to ensure the security and reliability of transaction data and prevent data tampering and hacking, so as to protect the information security of taxpayers.

Second, clear tax laws and regulations should be formulated to clarify the legal status and application rules of digital currencies in the field of taxation, to ensure the legality and transparency of CBDC transactions and to prevent them from being used for tax evasion or other illegal activities.

Once again, the degree of technologization and automation of tax administration is being strengthened, and the real-time monitoring function of the CBDC is being used to improve the efficiency of tax data collection, analysis and utilization, so as to identify and respond to tax risks in a timely manner.

Finally, public education and information disclosure efforts will be carried out to enhance taxpayers’ understanding and acceptance of the application of CBDC in taxation, and cooperation and international exchanges will be strengthened to promote tax cooperation on a global scale and jointly address cross-border tax challenges. These policy measures will help New Zealand fully utilize the potential of CBDC in tax administration and achieve a fairer, more efficient and transparent tax system.

3.3 Social Aspect

3.3.1 Guaranteeing Citizens’ Right to Vote

Although the Reserve Bank of New Zealand has indicated that CBDC will not replace physical cash and that New Zealanders can choose to use digital cash or regular bank accounts, credit cards, cash or other payment methods, and that digital cash will simply provide people with more choices when making payments, there is a need to be vigilant about citizens’ right to financial freedom. In order to safeguard this, there is a need to ensure that the use of CBDC is voluntary and that citizens are not forced to use digital currencies; that a wide range of payment methods are available to safeguard citizens’ financial freedom; that, in addition, a clear legal framework should be established to ensure that citizens’ privacy and data security are adequately protected in the use of CBDC and to prevent any form of misuse or surveillance; and that there should be extensive public education to improve citizens’ understanding of and ability to use the various payment. There should be extensive public education to improve citizens’ understanding of and ability to use various payment methods, and to ensure that everyone is free to choose the payment method that best suits his or her needs; at the same time, the New Zealand government should continuously monitor and evaluate the implementation of CBDC, listen to public opinions, and adjust its policies in a timely manner, so as to ensure that the right to financial freedom is respected and protected at all times. These measures will ensure that in the process of promoting CBDC, the right to financial freedom of New Zealand citizens will not be infringed upon, and that a truly diversified and liberalized payment environment will be achieved.

3.3.2 Enhancing Digital Inclusion

The consultation paper released by the Reserve Bank of New Zealand states that the Reserve Bank can use digital cash to improve financial inclusion and that the private sector can use its existing products and services to improve digital inclusion, but at the same time the paper recognizes that there is not always an incentive to do so. Therefore, in order to enhance digital inclusion for New Zealand citizens, the government and relevant agencies should take a series of measures, including: increasing investment in Internet infrastructure in rural and remote areas to improve network coverage and speed; providing specialized education and training programs to help older adults and technologically disadvantaged groups acquire the necessary digital skills; establishing community-based technical support centers to provide all citizens with easily accessible technical help and guidance; promote affordable digital equipment and services so that even more economically disadvantaged communities can enjoy modern digital tools and services; and promote digital inclusion policies through public-private partnerships to ensure that the promotion of digital currencies does not further exacerbate social inequalities, but rather enables truly inclusive finance and promotes social equity and inclusion. Those measures would help to narrow the digital divide and ensure that all New Zealand citizens could participate in and benefit from the development of the digital economy in an equitable manner.

4. Questions & Answers

We would like to end this post by focusing on answering two questions raised in the consultation report released by the Reserve Bank of New Zealand.

Question 1

Do you think digital cash can bring long-term innovation to New Zealanders? What innovative features should digital cash or its platform possess?

Answer: We believe that digital cash, as an emerging form of currency, indeed has the potential to bring long-term innovation and economic benefits to New Zealand. This innovation may manifest in several areas, including but not limited to financial services, payment systems, economic policy implementation, and business model innovation.

First, the introduction of smart contract functionality will greatly change the execution of financial transactions. Smart contracts are digital protocols that automatically execute based on preset conditions, significantly improving the efficiency and accuracy of financial transactions. Integrating smart contract functionality into the digital cash system will simplify and automate complex financial products. For example, mortgage repayments can be automated via smart contracts, insurance claims can be triggered automatically when specific conditions are met, and trade settlements between businesses can be completed based on predefined conditions. This not only reduces human error but also significantly lowers transaction costs and enhances the overall efficiency of the financial system.

Second, the implementation of micropayment functionality will pave the way for new business models and pricing strategies. Traditional payment systems, due to fees and other factors, often struggle to support very small transactions. However, technological innovations in the digital cash system can make micropayments economically viable. This functionality will support new business models like pay-per-use and granular pricing strategies. For instance, the media industry could adopt pay-per-second content consumption models, public transportation could charge based on precise travel distances, and electricity companies could implement more granular billing. This not only improves resource allocation efficiency but also provides consumers with more flexible and personalized choices.

Third, the concept of programmable money will revolutionize policy implementation and fund management. Digital cash can be endowed with specific attributes or usage conditions, which can play a crucial role in various fields. In terms of government subsidies, funds can be restricted to specific uses, enhancing the precision and efficiency of policy execution. In business management, expense accounts with specific usage restrictions can simplify reimbursement processes and strengthen expense control. In personal finance, parents can set allowances with usage restrictions for children, fostering financial management skills while ensuring fund security. This programmability not only increases the flexibility of money usage but also provides new tools for social governance and personal financial management.

Fourth, optimizing cross-border payment functionality will provide critical support for international trade and global economic integration. If New Zealand’s digital cash system can achieve interoperability with other countries’ systems, it will greatly simplify cross-border payment processes. This not only reduces the cost and time of international remittances but also simplifies the settlement process of cross-border trade. For a country like New Zealand, which relies heavily on international trade, this functionality will significantly enhance its competitiveness in the global economy. Additionally, the facilitation of cross-border payments may also promote the emergence of new international financial products and services, opening new development avenues for New Zealand’s financial industry.

Fifth, enhanced data analysis capabilities will provide strong support for economic decision-making and financial innovation. The operation of the digital cash system will generate vast amounts of transaction data. While this data should be anonymized to protect privacy, it can still provide valuable insights for economic analysis and policy formulation. For example, analyzing the velocity and usage patterns of digital cash can offer a more accurate grasp of economic trends, aiding in the formulation of monetary policy. Furthermore, this data may inspire new financial research directions and innovative products, driving the development of the entire financial industry.

However, while advancing these innovations, it is crucial to carefully consider potential risks and challenges. Firstly, balancing the encouragement of innovation with the maintenance of financial stability is a key issue. Overly aggressive innovation might introduce systemic risks, while an overly conservative approach could miss development opportunities. Secondly, ensuring that these innovations do not exacerbate the digital divide or financial exclusion is essential. We need to ensure that all groups, including the elderly, low-income populations, and residents of remote areas, can equally benefit from the conveniences brought by digital cash. Lastly, data security and privacy protection are also critical concerns. While leveraging data to create value, protecting user privacy and guarding against cybersecurity risks require both technological and institutional safeguards.

Question 2

What role might your company or organization play in the digital cash ecosystem and what support would you need from the Reserve Bank? What products and services would you offer based on these options? What design features do you need to support you? What core functionality should a digital cash platform provide and what functionality should a marketplace provide? What key governance measures would you expect the Reserve Bank to provide in the digital cash ecosystem?

TaxDAO, as a Web3 financial and tax organization, provides cryptocurrency financial and tax consulting services for major compliance regions globally. We also offer FinTax, a cryptocurrency financial and tax management software. We hope to establish a partnership with the Reserve Bank to help users better manage digital currency assets.

We fully understand the importance of data security and privacy protection. FinTax is committed to strictly adhering to all relevant regulations and the Reserve Bank’s guidelines, utilizing the most advanced encryption technologies and security protocols to protect customer data. We recommend establishing a stringent data access framework, whereby we can only access CBDC transaction data with explicit customer authorization.

The professional team at TaxDAO has extensive experience in handling sensitive financial data. We have successfully managed hundreds of Web3 financial and tax cases involving billions of funds, demonstrating our exceptional capability in safeguarding customer privacy and data security. We believe that through close cooperation with the Reserve Bank, TaxDAO can contribute significantly to the development of New Zealand’s digital economy. We can help streamline tax management, improve tax compliance, and provide valuable insights for policymakers. TaxDAO looks forward to further discussions with the Reserve Bank on establishing a secure and efficient data-sharing mechanism and balancing the protection of personal privacy with the promotion of financial innovation.

Overall, TaxDAO believes that while Central Bank Digital Currency (CBDC) represents a modernization of traditional sovereign currencies, they bring convenience while potentially posing a threat to individual privacy, liberty, equality and security of property. Decentralized cryptocurrency, by contrast, ensures the transparency and security of transactions. This technology not only protects the financial system from manipulation, but also promotes innovation by supporting a diverse range of financial services and applications.

We expect the New Zealand government to continue to support Decentralized cryptocurrency and promote an open, inclusive financial system that empowers individuals with greater autonomy while preventing excessive centralization of power. Choosing Decentralized cryptocurrency instead of CBDC is the choice for the future of finance, and it’s about the ability of the technology to promote the democratization of finance, rather than being a tool for centralization. In short, TaxDAO supports a financial future where freedom, transparency and innovation are the cornerstones, rather than a future subject to centralized control.

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