The Role of Digital Identity in Building Central Bank Digital Currencies and the Direction this Development is Going

Abstract: Recent years have witnessed an influx of private digital currencies. The ease of creation of private cryptocurrencies has raised concerns about the stability of the entire financial system. The decline of cash usage, the entrance of big tech into the financial sector, and the emergence of cryptocurrencies have prompted central banks to start working on the central bank digital currencies (CBDCs) that can be seen as a way for central banks to maintain control in the monetary system. As CBDCs are still in their early stage, the trajectory of their design still has many unknowns. In this paper, it was evaluated that retail CBDCs being accessible to the general public can have the most impact. Besides, CBDC has to be tied to digital identity to ensure regulatory compliance, prevent illicit finance, and account for the traceability of digital transactions. Digital identity is central to the efficient design of CBDC, but it is also at its early stages of development. The progress in the digital identity space has been slow and there may not be a one-fits-all solution, but it is vital to establish unifying standards for both CBDC and digital identity to ensure interoperability and efficiency. A decentralised digital identity that gives control of their data to the users shows a lot of potential and can tackle some of the key concerns in the CBDC design, such as privacy. CBDC and digital identity both are new concepts but can have a major impact on the financial sector and beyond, and both need to develop simultaneously to ensure their efficiency and maximise the benefits they can bring.