Special thanks to Guang-Yi, Legal Counsel at the Ethereum Foundation, for feedback and review. All views expressed are mine
Monetary Law and CBDC Issuance in the US and EU
The United States Federal Reserve and the European Central Bank are considering the issuance of their own Central Bank Digital Currency (“CBDC”) — known as the Digital Dollar and Digital Euro respectively. This article summarises the monetary law issues surrounding the possible issuance of the Digital Dollar and Digital Euro.
- What are CBDCs?
CBDCs are generally defined as a new form of central bank money — a digital liability of the central bank, denominated in existing unit of account, which serves both as a medium of exchange and a store of value.¹ CBDCs can vary in terms of its operational and technical aspects, depending on the central bank’s policy goals.² The two most important design choices a central bank has to decide is whether the CBDC will be: (1) wholesale or retail; and (2) token-based or account-based.
2. What are wholesale CBDCs and retail CBDCs?
A wholesale CBDC is one whose access and use are restricted to financial institutions, while a retail CBDC is one that is accessible by the wider public, including financial institutions.³
This dichotomy reflects the segregation of payment services into wholesale and retail segments, with the former encompassing low-value transactions, and the latter large-value and high-priority transactions.⁴ However, given that a retail CBDC could also be used for wholesale transactions, this dichotomy may arguably become less relevant when retail CBDCs are widely adopted.⁵
3. What are token-based CBDCs and account-based CBDCs?
An account-based CBDC contemplates CBDCs held as balances in a cash current account on the central bank’s books. There is a sui generis contractual relationship between the central bank and the individual or institution holding the account.⁶ Transfers of CBDCs are akin to transfers of book money by debits and credits between such accounts.⁷
A token-based CBDC is analogous to banknotes and coins. It represents a sui generis claim against the central bank, and a transfer of the CBDC amounts to a transfer of the claim.⁸ However, unlike banknotes and coins which are virtually untracked once in circulation, transactions of token-based CBDCs are recorded on the central bank’s blockchain.
4. What are the legal issues related to issuing wholesale CBDCs?
Wholesale CBDCs present much fewer legal issues as compared to retail CBDCs. Wholesale CBDCs are regarded as an extension of the Real-Time Gross Settlement (“RTGS”) systems implemented by central banks, such as Fedwire in the US and TARGET2 in the EU. RTGS systems provide a transaction-by-transaction processing of payment in real-time within the central bank for its account holders.⁹ With wholesale CBDCs, the underlying settlement layer of the RTGS system will be enabled by blockchain or distributed ledger technology.¹⁰
Given the relationship between the central bank and its account holders, wholesale CBDCs operating as a RTGS system are necessarily account-based.¹¹ Thus, the account-based and token-based distinction is not particularly relevant here, unlike for retail CBDCs, which will be discussed below.
5. What are the legal issues related to issuing token-based retail CBDCs?
Generally, a token-based retail CBDC can be issued if the central bank has the power to issue legal tender without limiting it to physical banknotes and coins.¹² In the US, the Federal Reserve has no such powers, while in the EU, the ECB is likely to have such powers.
Analysis Under US Law
Section 5103 of the U.S. Code defines “legal tender” as “coin and currency (including Federal reserve notes…)”.¹³ It is unlikely that the Digital Dollar could be classified as either given that these definitions envision a tangible, physical form of legal tender.¹⁴ To illustrate this, the U.S. Code stipulates the specific diameter and weight of each coin.¹⁵ The analysis for “currency” is more nuanced. The use of the word “including” creates ambiguity as it could be read as providing either an exhaustive or non-exhaustive list of the types of currency.
If read exhaustively, the question is whether the Digital Dollar can be deemed as “federal reserve notes”. This is answered in the negative. Section 16(1) of the Federal Reserve Act authorises the issue of “federal reserve notes” by the Federal Reserve.¹⁶ However, the section also makes references to “engraving plates and dies”, “distinctive paper”, “distinctive letter and serial number”.¹⁷ Based on the context, “federal reserve notes” must refer to paper currency.¹⁸
If read non-exhaustively, the inability of CBDCs to be deemed as “federal reserve notes” is not fatal, and the legal basis for issuance could come from Congress’s broad constitutional power “to coin money”.¹⁹ However, given that the power to issue currency has been designated to the Federal Reserve, it must be conferred with express legal authority to issue a CBDC.²⁰ In summary, the Federal Reserve lacks the power to issue a token-based retail CBDC.
Analysis Under EU Law
According to the European Central Bank (“ECB”), the Digital Euro could be adopted based on Art 128(1) of the Treaty on the Functioning of the European Union (“TFEU”).²¹ Art 128(1) “authorise the issue of euro banknotes within the Union” and such banknotes “shall be the only such notes to have the status of legal tender within the Union”.²²
The question, therefore, is whether Digital Euros can be deemed as “banknotes”. This is likely to be answered in the affirmative. In Dietrich and Häring v Rundfunk (“Rundfunk”),²³ the European Union Court of Justice held that Art 128(1) (and other EU laws) are not intended to exclude the possibility of the EU assigning the status of legal tender to other forms of currency that are not necessarily physical.²⁴ While the court also recognised the possibility of introducing CBDCs in the EU, it did not conclusively determine its legal status.²⁵ Nonetheless, it could be surmised that based on the TFEU’s legislative intent and history, there are no compelling reasons why a token-based retail CBDC would be excluded from the definition of “banknotes”.²⁶
6. What are the legal issues related to issuing account-based retail CBDCs?
Generally, an account-based retail CBDC can be issued if the central bank has the power to open cash current accounts for the public, in addition to financial institutions.²⁷ In the US, the Federal Reserve has no such powers, while in the EU, the ECB is likely to have such powers.
Analysis Under US Law
Under §342 of the U.S. Code, the Federal Reserve is authorised to accept “deposits of current funds” from “any of its member banks, or other depository institution”.²⁸ However, it does not have the power to open cash current accounts for individuals.²⁹
Analysis Under EU Law
According to the ECB, the Digital Euro could also be adopted based on Art 127(2) of the TFEU in conjunction with Article 17 of the Statute of the European System of Central Banks (“ESCB”).³⁰ Art 17 of the Statute of the ESCB provides that “the ECB and the national central banks may open accounts for credit institutions, public entities and other market participants”,³¹ for the purposes stated in Art 127(2) of the TFEU, specifically to implement the monetary policy of the EU.³²
The question, therefore, is whether the Digital Euro can be regarded as part of “monetary policy”. This is likely to be answered in the affirmative. To determine if a particular measure falls within the scope of “monetary policy”, which is not precisely defined in the TFEU,³³ the court will refer principally to the objectives of that measure.³⁴ The ECB has stated that the Digital Euro is, in part, to prevent the euro’s decline amidst competition from foreign CBDCs and private stablecoins.³⁵ This objective will place the Digital Euro within the scope of monetary policy.³⁶ Following Rundfunk, monetary policy “must be understood as encompassing all the competences and powers necessary for the creation and proper functioning of the single currency, the euro”.³⁷ In this regard, an account-based retail CBDC would likely be deemed as a tool of “monetary policy”.
7. Conclusion
CBDCs represent an important milestone in the evolution of money. However, they raise questions under monetary law which must be addressed before implementation. Wholesale CBDCs raise fewer legal issues as they can be implemented through existing RTGS systems. Retail CBDCs raise different legal issues, depending on its nature. Token-based CBDCs require the central bank to issue legal tender in non-physical form, while account-based CBDCs require the central bank to open cash current accounts for the public.
Overall, the Digital Euro will face much fewer legal obstacles as compared to the Digital Dollar given the broader scope of the ECB’s powers. Conversely, the powers of the Federal Reserve are much more constrained. In the absence of new laws and regulation, the US will lack a sufficiently strong legal basis to issue the Digital Dollar.
[1] Markets Committee, Committee on Payments and Market Infrastructures, Central Bank Digital Currencies (Bank for International Settlements, 2018) < https://www.bis.org/cpmi/publ/d174.pdf> (“BIS Report”) at p 3.
[2] See Gabriel Soderberg et al, Behind the Scenes of Central Bank Digital Currency: Emerging Trends, Insights, and Policy Lessons (International Monetary Fund, 2022)<https://www.imf.org/en/Publications/fintech-notes/Issues/2022/02/07/Behind-the-Scenes-of-Central-Bank-Digital-Currency-512174>.
[3] Economic Policy Group, A Retail Central Bank Digital Currency: Economic Considerations in the Singapore Context (Monetary Authority of Singapore, 2021) < https://www.mas.gov.sg/-/media/mas/epg/monographs-or-information-paper/a-retail-cbdc---economic-considerations-in-the-singapore-context.pdf> at p 7.
[4] BIS Report, supra n 1, at p 4.
[5] Ibid.
[6] Wouter Bossu et al, Legal Aspects of Central Bank Digital Currency: Central Bank and Monetary Law Considerations (IMF Working Paper 20/254) (International Monetary Fund, 2020) <https://www.imf.org/en/Publications/WP/Issues/2020/11/20/Legal-Aspects-of-Central-Bank-Digital-Currency-Central-Bank-and-Monetary-Law-Considerations-49827> (“IMF Report”) at p 12.
[7] Ibid.
[8] Id, at p 11.
[9] Marcelo Prates, “Money in the Twenty-First Century: From Rusty Coins to Digital Currencies” (2021) 15(1) Ohio State Business Law Journal 164 at p 203.
[10] See Fabio Panetta, Executive Board Member, European Central Bank, “Demystifying Wholesale Central Bank Digital Currency”, speech at Symposium on “Payments and Securities Settlement in Europe” (26 September 2022) < https://www.ecb.europa.eu/press/key/date/2022/html/ecb.sp220926~5f9b85685a.en.html>.
[11] For Fedwire, see John Crawford, Lev Menand, & Morgan Ricks, “ FedAccounts: Digital Dollars” 89(1) George Washington Law Review 113 at p 138–139. For TARGET2, see European Central Bank, “What is TARGET2?” < https://www.ecb.europa.eu/paym/target/target2/html/index.en.html>.
[12] IMF Report, supra n 6 at p 19.
[13] 31 U.S. Code § 5103.
[14] Nicholas Mack, “Obstacles to Successful Introduction of a U.S. Central Bank Digital Currency” (forthcoming, 2022) 18 Journal of Business Technology Law at manuscript pp 21–22.
[15] 31 U.S. Code § 5112.
[16] Federal Reserve Act, 12 U.S.C. §16(1).
[17] Id, at §§16(3), 16(12).
[18] Paige Paridon, “Legal Authority to Issue a U.S. Central Bank Digital Currency” (2021) Bank Policy Institute at p 3.
[19] US Constitution Art I, §8 , cl. 5. See also Mack, supra n 14, at p 20.
[20] Mack, supra n 14, at pp 23–24.
[21] European Central Bank, Report on a Digital Euro (2020) <https://www.ecb.europa.eu/pub/pdf/other/Report_on_a_digital_euro~4d7268b458.en.pdf2> at p 24.
[22] Treaty on the Functioning of the European Union (“TFEU”) (12012E/TXT) Art 128(1).
[23] Johannes Dietrich and Norbert Häring v Hessischer Rundfunk [2022] ECLI:EU:C:2020:756 (“Rundfunk”).
[24] Id, at [96].
[25] Id, at [82].
[26] See Seraina Grünewald, Corinne Zellweger-Gutknecht, & Benjamin Geva, “Digital Euro and ECB Powers” (2021) 58(4) Common Market Law Review 1029.
[27] IMF Report, supra n 6 at p 22.
[28] 12 U.S. Code § 342.
[29] Paridon, supra n 18, at p 5.
[30] European Central Bank, Report on a Digital Euro (2020) <https://www.ecb.europa.eu/pub/pdf/other/Report_on_a_digital_euro~4d7268b458.en.pdf2> at p 24.
[31] Statute of the European System of Central Banks (“ECSB”) (12016E/PRO/04) Art 17.
[32] Treaty on the Functioning of the European Union (“TFEU”) (12012E/TXT) Art 127(2).
[33] Gauweiler a.o. v. Deutscher Bundestag [2015] ECLI:EU:C:2015:400 at [42].
[34] Id, at [46].
[35] European Central Bank, Report on a Digital Euro (2020) <https://www.ecb.europa.eu/pub/pdf/other/Report_on_a_digital_euro~4d7268b458.en.pdf2> at pp 11–12.
[36] Annelieke Mooij, “European Central Bank Digital Currency: The Digital Euro. What Design of the Digital Euro Is Possible Within the European Central Bank’s Legal Framework?” (2021) BRIDGE Network Working Paper Series No 14 at p 13.
[37] Rundfunk, supra n 23 at [70].
