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.