This is an excerpt from Finextra’s report, ‘The Future of Digital Identity 2022: Inclusive, secure, fit for purpose.’

The ability to prove one’s identity will soon be foundational to accessing many life-enhancing services, including healthcare, education, and in particular, financial services. Yet, 1.5 billion people around the world still do not have an officially recognised identity – especially rural residents, poor populations, women, and children. The problem is most acute in the Global South.

One of the roles of governments and the financial services industry is to help close this so called ‘identification gap’. This mission is an enabler of many of the United Nations’ (UN) Sustainable Development Goals, as it is foundational to equitable development.

Digital identification systems are touted by many as the solution to the identification gap. However, things aren’t black and white. The launch of digital systems comes with its own challenges in the long-term: What will people without data access do? Could digital identification systems create administrative overlaps when rolled out alongside incumbent civil registration? Should digital identity systems be centralised? Would this lead to abuses of state power?

In an interview with Finextra, Niall McCann, policy advisor and project manager, legal identity, United Nations, explored the major themes and policy debates underway in the identity space today – and considered their potential impact on financial inclusion.

The evolution of identification systems

“The world is entering a new phase of identity systems,” explained McCann. “The first phase of national ID systems was the national identity register, and the issuance of a plastic or paper ID card. However, you couldn't do anything with the card itself. The next phase was the smart card, where, via microchips, the card could be read and used in the digital space. Today, we are moving toward fully digital systems, where you don’t need any kind of a plastic credential – you simply log into government or private services via a digital ID that does not exist in the physical world.”

The progression is already underway in Belgium, with the ‘itsme’ initiative. Once users have verified their identity at the bank, they are issued a digital identity, which doesn't exist in physical format. The credential can then be used to log into various government or financial services online, noted McCann, who called itsme an excellent model for the future.

“Anything that makes it easier for people to get banked securely increases financial inclusion, which is a good thing,” he said.

Centralisation: One identity to rule them all?

In the future, to what extent should our digital identification systems be universal, and placed in the hands of a single body? There are pros and cons, says McCann.

The pros of centralisation

One of the upsides to centralisation is administrative: “With a decentralised identification structure, if information on someone changes – maybe a woman gets married, or someone’s gender changes officially – then all databases across the nation, including the civil registry, must be updated.” Unfortunately, this rarely happens effectively. In some countries, for instance, there are 10 million people, but 20 million exist on the system because there are so many unreconciled identities, claimed McCann.

Clearly, the maintenance of separate schemes – such as digital IDs, driver’s licences, passports, and civil registers – is complex and financially unsustainable. Pulling all these schemes together in a digital system is operationally efficient.

Cons of centralisation

Centralisation, however, is a horrific idea for privacy advocates because there is a single point of failure. “Universal identification systems are a honeypot for cybercriminals,” warned McCann. With one identity, in one place, a single hack could “destroy someone’s life.” Decentralised systems, at least, can withstand multiple attacks. 

There is also a risk of the state abusing its power: “If you have one authority managing everything, there is a greater risk of surveillance and abuse of human rights, from autocratic regimes,” McCann stated. Decentralised structures, on the other hand, put identity in the hands of multiple agencies, each managing separate datasets.

In conclusion, McCann remarked: “If we are laying out a path to proceed equitably, I would not personally advocate for one identity to rule them all. If there is more than one system, however, there must be ways to link them so that the state and all other involved agencies know they are dealing with the same human being – even if details change.”

Developments down the road

So, what does the next five to 10 years have in store? Will we see digital identification systems become centralised or decentralised? As ever, it depends on who you ask. “The private sector is predominantly pushing for decentralisation, while the public sector is backing centralisation,” declared McCann.

1. A shift in the power balance

If centralisation goes ahead, it will fundamentally alter the balance of power between the state and the citizen, in terms of who holds charge of identity data.

“If there’s a change in the law, which decrees that a digital identity credential issued by the government has greater legal weight than any piece of plastic or paper that I am holding in my hand, then you may start to worry about a dystopian future, where I am no longer who I say I am, or who my physical documents say I am,” noted McCann. “Instead, I am what the digital ID system says I am.”

2. Central bank digital currencies

The other big change on its way is central bank digital currencies (CBDCs), argued McCann.

“In effect, we may soon be directly transacting with the central bank – via digital ID wallets. If that's the case, then it seems your digital identity will become foundational to your interaction with the state.” 

This means there would be the potential to centralise a lot more identity data and identity systems into a single core identity. “I believe it’s what governments want,” said McCann. “They want to have a direct financial relationship with the citizen, via CBDCs, and one digital ID wallet. The dystopian part of this is that if you get fined, could the state simply pull funds from your account?”

In this light, decentralisation – via blockchain and distributed ledger technology – looks appealing. Citizens would be able to share with entities only the elements of their identity they feel comfortable with.

“Ultimately, the more we digitise identity systems – and in particular, centralise them – the more power is placed in the hands of the government,” summarised McCann.

Herein lies the trade-off between the potential benefits of rolling out digital identity schemes – including the ability to open bank accounts, register businesses, or inherit property – versus the increased power that it gives the state.

“At the moment, there is more momentum and impetus behind the centralisation of digital ID systems,” claimed McCann.

What makes a good digital identification system?

Looking to the future, McCann provided two key characteristics that digital identification system designs should adopt, in order to achieve equitable and inclusive development:

1. Accessibility and universality

“Everyone needs to be able to register,” he emphasised. “There is no point in introducing a digital ID scheme if only those in the capital city can use it. In the countryside, populations may not have mobile phone coverage. It exacerbates financial discrimination.”

Perhaps this is why several UN agencies have endorsed the World Bank’s Principles on Identification for Sustainable Development, which outlines the importance of universality.

2. Privacy and security

“We have to make sure that we install modern, up to date, responsive data protection and privacy laws, with an institutional governance framework,” argued McCann. “With a data protection privacy law, you need a data protection ombudsperson, or a data protection authority, which listens to citizens’ concerns and investigates – especially in cases where the government has abused people's identity rights.”

Indeed, new digital identity systems, and these laws, must come hand in hand. If this model had more support, it might do more to combat public fears around the centralisation of identity data.

Digital identity and financial inclusion are tricky issues for the UN. Nation states with, for instance, a 10% birth registration rate and non-existent death registration, are understandably keen to leapfrog into the digital age by implementing a universal identification system. However, if the necessary steps are not taken before this, the country will end up with what looks like a centralised structure – thus exasperating financial exclusion.

“We do not want to be a body that contributes to this,” said McCann.