Abstract
Breakthroughs in financial technology (fintech), ranging from early coins and banknotes to card payments, e-money, mobile payments, and, more recently, cryptocurrencies, portend transformative changes to the financial and monetary systems. Bitcoin and cryptocurrencies bear a significant resemblance to base money or central bank money. This functional similarity can potentially pose several challenges to central banks in various dimensions. It may pose risks to central banks’ monopoly over issuing base money, price stability, the smooth operation of payment systems, the conduct of monetary policy, and to the stability of credit institutions and the financial system. From among several potential policy responses, central banks have been investigating and experimenting with issuing central bank digital currency (CBDC). This paper investigates CBDC from a legal perspective and sheds light on the legal challenges of introducing CBDC in the euro area. Having studied the potential impact of issuing CBDC by the European Central Bank (ECB), particularly on the banking and financial stability, the efficient allocation of resources (i.e. credit), as well as on the conduct of monetary policy, the paper concludes that issuing CBDC by the ECB would face a set of legal challenges that need to be resolved before its issuance at the eurozone level. Resolving such legal challenges may prove to be an arduous task as it may ultimately need amendments to the Treaty on the Functioning of the European Union.
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Notes
It seems that China was the first country that introduced fiat money and the concept of the legal tender. Prior to the fiat money, the history of paper money goes back to more than 2000 years ago in China, where the bills of exchange (used as money) were known as “flying money”. See Prasad [1], Chapter 1; Kindleberger and Aliber [2], 75–6. See also Wolman [3]. There has also been periods during which private bank notes coexisted alongside the government-issued banknotes. See, for example, Weber [4].
Base money or high-powered money is the money issued by central banks and in most economies consists of banknotes and coins, as well as demand/sight deposits held by commercial banks at the central bank.
Thus far, Bitcoin has proved to be one of the most secure financial networks. Other blockchain-based cryptocurrencies may prove less secure. For example, more recently, there has been a few successful 51% attacks to perform double-spend attacks on some cryptocurrencies such as Verge, Bitcoin Gold, MonaCoin and, more recently, on Ethereum Classic. See Haan [11].
Bitcoin itself can be viewed as an invention that emerged to overcome social scalability problem in the first place. Although most discussions about scalability are limited to technological scalability, the problem of social scalability stands at the core of the scalability issues in bitcoin. Indeed, the perceived inefficiencies in the PoW algorithm can be understood in the balance struck between social scalability and computational scalability, which in the bitcoin blockchain the latter is sacrificed to improve the former. For more details, see Szabo [12].
Nakamoto [13].
For a demonstration of the potential problems of the Bitcoin protocol and its implications for its long-term security; see Auer [14].
Although there have been instances of double spend on the bitcoin blockchain, such instances have remained extremely rare. See BitMEX Research [15].
Although at some point, transaction cost of bitcoin transactions soared, it came down eventually. It seems that new developments, such as transaction batching, and second-layer solutions, such as the Lightning Network, are substantially reducing transaction costs. See Poon and Dryja [16].
Primarily known as “cryptocurrencies”.
Also known as “security tokens”.
Also known as “utility tokens”. Cryptoassets could be classified as digital commodities (cryptocommodities) representing raw digital resources, or digital tokens (cryptotokens) representing finished digital goods and services. See Burniske and Tatar [19], Chapter 4. Some of these assets can potentially become a new asset class with potential of maturing into a valuable portfolio diversification instrument. See Berentsen and Schär (First Quarter [20]).
Carstens [27].
For a detailed study of such effects on central banking, see Nabilou and Prüm [28].
Such wallet providers could be regulated as Money Service Businesses (MSBs) requiring money transmitter license, or money remittance service providers, both of which are equivalent to payment institutions in the EU.
Nabilou [37].
Nabilou and Prüm [28].
Barrdear and Kumhof [38]; ibid.
For a study exploring legal aspects of CBDC, see Athanassiou [39], Chapter 7.
Art. 128(1) Treaty on the Functioning of the European Union (TFEU), and Article 16 of the Protocol (no 4) on the Statute of the European System of Central Banks and of the European Central Bank (hereinafter ESCB/ECB Statute).
See Prasad [1], Chapter 1; Kindleberger and Aliber [2], 75–6. See also Goodhart [40], 418. Only in contemporary history has the state had the monopoly over issuing banknotes (legal tender). For example, the first Legal Tender Act in the USA was passed in February 1862 authorizing the issuance of notes (greenbacks) which were “lawful money and legal tender in payment of all debts, public, and private within the United States”. This act was part of the government efforts to finance the civil war. It seems that until 1862, the issuance of banknotes was mainly a private enterprise in the USA, a historical episode sometimes dubbed “free banking era”. Alternatives to standard monopoly on the issuance of notes by the central bank is minimal competition (central bank-issued notes with commercial bank-issued notes backed by the central bank notes on a one-to-one basis, e.g., Scotland and Northern Ireland, where bank-issued notes are allowed, but backed by the Bank of England notes), currency boards and real competition (free banking). See Lastra [41], 33-4.
European Central Bank [46], 45.
Ibid.
The E-money directive (EMD) defines electronic money as “electronically, including magnetically, stored monetary value as represented by a claim on the issuer which is issued on receipt of funds for the purpose of making payment transactions …, and which is accepted by a natural or legal person other than the electronic money issuer”. Directive 2009/110/EC of the European Parliament and of the Council of 16 September 2009 on the taking up, pursuit and prudential supervision of the business of electronic money institutions amending Directives 2005/60/EC and 2006/48/EC and repealing Directive 2000/46/EC, OJ L 267, 10.10.2009, p. 7–17 (e-money directive). As bitcoin is not a claim on anybody, classification of bitcoin as e-money would be a mistake.
See Berentsen and Schar [47].
Although CoBM is not a legal tender, it is predominantly used as a medium of exchange.
European Central Bank [46], 45.
CoBM is sometimes known as scriptural money.
See European Banking Authority [48], 14.
In ECB’s opinion of 26 April 2006 on a proposal for a directive on payment services in the internal market (ECB/2006/21) (2006/C 109/05), the ECB suggests that a definition of scriptural money should be provided. However, it specifies that only central banks and credit institutions (which include e-money institutions) may hold scriptural money. Available at: https://www.ecb.europa.eu/ecb/legal/pdf/c_10920060509en00100030.pdf.
The Payment Services Directive 2 (PSD2) does not contain any definition of scriptural money. However, it seems that the term scriptural money can hardly be stretched to include cryptocurrencies.
Although CoBM can also be used as ultimate settlement asset (especially in some cross-border payments and settlements systems), most international standards as well as national regulations require the use of CeBM in the wholesale payments and settlement systems. See Regulation of the European Central Bank (EU) No 795/2014 of 3 July 2014 on oversight requirements for systemically important payment systems (ECB/2014/28) OJ L 217, 23.7.2014, p. 16–30, Art. 10.
Prasad [51], 14.
A virtually hard cap and inflexible supply schedule on the number of bitcoins beget price volatility in response to the demand shocks, making it a hard sell as a unit of account. The hard cap on the number of bitcoins additionally means that adoption of bitcoin by any country would put hard limits on the monetary policy and effectively remove monetary sovereignty, making bitcoin unattractive for any country to use it as a currency. Therefore, in its current form, price stability under bitcoin standard would be highly unlikely. In terms of monetary policy, bitcoin is dissimilar to CoBM, which is demand driven and very much responsive to the demands for credit. The same applies to the quasi-money created by the shadow banking system.
Although some cryptocurrencies such as bitcoin have limits on their total number issuance, there is no limit on the cryptocurrency brands that could be issued. Currently, there are more than 2000 different cryptocurrencies and proliferation of such currencies are likely to lead to suboptimal or unstable equilibria and affect price stability. See Sanches [52], 13.
Friedman [53].
Dong [54].
Selgin [55], 98.
It is also unlikely that bitcoin can become a substitute for CoBM, as the latter has its unique advantages serving various needs of a given economy.
Raskin and Yermack [50]. However, as the development of banking and shadow banking around bitcoin cannot be ruled out, bitcoin may in the future directly compete against commercial bank, as well as shadow banking quasi-money.
One could imagine a hypothetical scenario where the ECB would accept to grant access to ECB liquidity for, say, certain businesses that issue stablecoins backed by the euro. As part of the access criteria to the ECB liquidity, the ECB might require the centralized scheme governance authorities of such businesses to comply with certain prudential requirements.
Article 18.1, second indent, ESCB/ECB Statute.
As the ECB and NCBs can “acquire and sell spot and forward all types of foreign exchange assets and precious metals”, (Art. 23 ESCB Statute) and as “foreign exchange assets” include “securities and all other assets in the currency of any country or units of account and in whatever form held”, (Art. 23 ESCB Statute) it would be difficult to argue that the ECB might not have the power to acquire and hold cryptocurrencies if need be. If bitcoin becomes a major currency in the future, central banks may engage in buying and intervening in the bitcoin markets under the mandate of managing their foreign reserves. As this scenario appears to be unlikely at the moment, this paper will not discuss it.
For a definition of CBDC and its unique features as compared to CeBM, see Athanassiou [39], 185. CBDC would be different from e-money. E-money institutions are explicitly prohibited from paying interest on the e-money, i.e. e-money is not an interest-bearing instrument. While as the proponents of eurocoins (CBDCs issued by the ECB) are currently formulating, the eurocoins would be interest-bearing financial instruments. This interest could be a negative interest rate. Indeed, one frequently quoted reason for introducing CBDC is that it removes the zero lower bound constraint and opens up the central bank’s hands in monetary policy operations. In the presence of cash or cash-like financial instruments, hoarding physical coins and banknotes, paying zero interest rate, by the users if the central bank decides to impose negative interest rates effectively puts some constraints on the imposition of negative interest rates. One of the first central banks contemplating to issue CBDC is the Sveriges Riksbank. See Riksbank [56], Riksbank [57].
Andolfatto [58].
Meaning et al. [69].
Hockett [72].
The most obvious case to be made for the CBDC is perhaps the efficiency-enhancing argument, namely as the introduction, maintenance and management of cash is costly, turning the physical cash into digital cash would translate into cost savings in cash management. See Fung and Halaburda [73].
Dyson and Hodgson [74], 7.
Raskin and Yermack [50].
Dyson and Hodgson [74].
Raskin and Yermack [50], 11-2.
Directive 2014/92/EU of the European Parliament and of the Council of 23 July 2014 on the comparability of fees related to payment accounts, payment account switching, and access to payment accounts with basic features.
Currently under the payment accounts directive, such exceptions apply. See Art. 16 [4] Directive 2014/92/EU (PAD).
Rogoff [80].
Bordo and Levin [68].
Although the instantaneous settlement would improve the retail payment efficiency, unlike unanchored cryptocurrencies, the downside of using CBDC for cross-border payments will be the exchange fees and risks in the exchange rate fluctuations.
Goodfriend [81].
Barrdear and Kumhof [38], 11.
Article 263 TFEU and Article 35.1 ESCB/ECB Statute.
Art, 127 TFEU. The ESCB’s basic tasks include defining and implementing monetary policy of the Union, conducting foreign-exchange operations, holding and managing the official foreign reserves of the Member States, and promoting the smooth operation of payment systems. Art. 127 [2] TFEU and article 3 ESCB/ECB Statute. For this classification, see also Lastra [82], 255.
Art. 128(1) of the TFEU and Article 16 ESCB/ECB Statute. See also Council Regulation (EC) No 974/98 of 3 May 1998 on the introduction of the euro, OJ L 139, 11.5.1998, p. 1–5 and Council Regulation (EC) No 1103/97 of 17 June 1997 on certain provisions relating to the introduction of the euro. In particular Art. 11 of the Regulation 974/98. See also Proctor [83], Siekmann [84], 13. Lastra [82], 31, 4.; Goodhart [85].
In this view of CBDC, granting legal tender status on the CBDC would require amendments to the TFEU. See Art. 128(1) TFEU and Athanassiou [39], 204.
European Central Bank [86], 7.
Article 22, the ESCB/ECB Statute.
Article 22, the ESCB/ECB Statute.
Athanassiou [39], 182.
Bordo and Levin [68].
Art. 127 TFEU & Art. 2 ESCB/ECB Statute.
Kumhof and Noone [67].
Mersch [87].
Athanassiou [39], 187.
Ibid.; See also Mersch [70].
Athanassiou [39], 195. Thus far, it seems that two competing models in the form of proposals on the design features of CBDC have emerged. They include CAD-coin model and Fedcoin model. CAD-coin is issued on a permissioned blockchain and is intended to be used for wholesale payment services. This coin would be fully backed by cash collateral and will function as a settlement coin to be used by designated entities on a distributed permissioned platform which is linked to a central bank Real-Time Gross Settlement (RTGS) system. On the contrary, Fedcoin is a retail payment medium, issued on a permissionless ledger, while the central bank retains the sole authority to create and destroy coins. For more details, see ibid.
See Sveriges Riksbank [57].
Bech and Grarratt [88]. In their view a central bank cryptocurrency (CBCC) is “an electronic form of central bank money that can be exchanged in a decentralised manner known as peer-to-peer, meaning that transactions occur directly between the payer and the payee without the need for a central intermediary” Ibid. In other words, in central bank cryptocurrency, the money creation leg of currency still remains to be the prerogative of governments (central banks) but the settlement leg is decentralized and organized in a peer-to-peer fashion.
For an engaging read on the CBCC, see Koning [89].
Nabilou and Pacces [92].
See Committee on Payments and Market Infrastructures [93], 16. It is also argued that this cannot be an obstacle for introducing CBDC. Stating that “runs on individual financial institutions, or system-wide runs from bank deposits into cash, are as feasible in a world without CBDC as in a world with CBDC, and given the advantages of CBDC in case it comes to a bank resolution, may be less likely with CBDC”. See Kumhof and Noone [67], 35. See also Barrdear and Kumhof [38], 14–5.
Coats [94], 413.
For example, introducing interest-bearing CBDC to an imperfectly competitive banking sector may even improve bank intermediation by setting a floor for deposit rates under the assumption that the interest rate is properly set. See Chiu et al. [97].
Barrdear and Kumhof define CBDC as “a central bank granting universal, electronic, 24 × 7, national-currency-denominated and interest-bearing access to its balance sheet”. In this view, issuing CBDC would automatically mean direct public access to central bank balance sheet. See Barrdear and Kumhof [38], 7. For more details on public access to the central bank balance sheet and its consequences, see Ricks et al. [98], Menand et al. [99], Ricks [100].
Mersch [87].
Art. 127 [5] TFEU.
Art. 17 ESCB/ECB Statute.
Bordo and Levin [68], 2.
Article 127 of the TFEU and article 2 of the ESCB/ECB Statute.
See Mersch [96].
Rogoff [80].
Mersch [87].
Agarwal and Kimball [102].
Koning [89].
Directive 2014/92/EU of the European Parliament and of the Council of 23 July 2014 on the comparability of fees related to payment accounts, payment account switching, and access to payment accounts with basic features Text with EEA relevance OJ L 257, 28.8.2014, p. 214–246 (Payment accounts directive aka PAD).
It seems that the proliferation of various cryptocurrencies having privacy features would mitigate concerns about privacy. Therefore, if issuing CBDC would not lead to the abolition of other cryptocurrencies or cash, it would only be complementary to other payment methods. See Bordo and Levin [68], 1–2. Physical cash is the main mechanism that facilitates the use of currencies, such as the USD and the euro, as the backup to the global monetary system. Koning [103]. As these currencies are used as a store of value and a fail-safe option outside their own country of issue or currency area, issuing CBDC to replace physical cash would jeopardize these currencies’ role in the global payments and monetary systems, a policy concern that should not be overlooked in the decision over issuing CBDC.
Article 263 TFEU and Article 35.1. ESCB/ECB Statute.
See, for example, Case T-79/13 Alessandro Accorinti and Others v European Central Bank (ECB), (affirming that the theory of legitimate expectations does not apply to monetary policy (Paragraph 67–69)); Case C-62/14 Peter Gauweiler and Others v Deutscher Bundestag.
For the public–private nature of payments law, see Janczuk-Gorywoda [104]. Emphasizing the fact the private initiative has often been insufficient in pushing for improvements of efficiency in the payment system and public or government intervention (in the case in question, SEPA regulation) is often needed.
This development can only be indirectly associated with the ECB. The Euro Retail Payments Board (ERPB) which is chaired by the ECB, requested an action plan from the European Payments Council (EPC) who eventually launched the SCT-Inst.
As merchant costs might be higher for card payments, especially those offering a reward, to compensate those costs, merchants increase the general level of prices for all the customers that eventually leads to cross-subsidization of credit card users by cash, check, or debit cards users.
Regulation (EU) 2015/751 of the European Parliament and of the Council of 29 April 2015 on interchange fees for card-based payment transactions.
White [112].
Art. 127 [1] TFEU.
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The author is grateful to Prof. André Prüm for his insights, comments, and feedback on the earlier drafts of this paper. All errors are those of the author.
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Nabilou, H. Testing the waters of the Rubicon: the European Central Bank and central bank digital currencies. J Bank Regul 21, 299–314 (2020). https://doi.org/10.1057/s41261-019-00112-1
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DOI: https://doi.org/10.1057/s41261-019-00112-1