Last week, the IMF’s Legal Department released a Working Paper on the legal aspects of central bank digital currencies (CBDCs), focusing specifically on central bank laws and monetary laws. The authors raised many interesting questions, such as whether central banks should be granted a monopoly for CBDC issuance or whether token-based CBDCs can carry interest. They conclude their study with multiple recommendations on how best to grant CBDCs legal status.
Ultimately, the legal status of a CBDC depends on its operational and technological design features. Account and token-based CBDCs carry different legal significance. For example, account-based CBDCs are not considered to be a new form of money, but instead are the digital form of ‘book money’, which are credit balances on accounts. In contrast, token-based CBDCs are a new form of money where the banks’ liability is incorporated in the token.
The need for central bank law reform
Central bank laws define the powers of a central bank to issue a currency. Many central banks are authorized to issue banknotes and coins, book money and bills. But some have a far broader remit, such as issuing currency more generally, which could encompass CBDC.
There is currently minimal explicit legal basis for any type of CBDC, whether it is token-based, account-based, centralized, or decentralized. The authors believe this can be easily rectified when it comes to central bank laws.
For token-based CBDCs, central banks need to have explicit permission to issue currency in general rather than limiting their powers to banknotes and coins. Appropriate legislation should be drafted with explicit reference to the currencies being in the form of banknotes, coins, and digital tokens. The authors explain that such emphasis on the explicit legal basis is so that innovative CBDC features are not restricted.
Central banks are generally already legally capable of opening bank accounts, but usually there are restrictions on the account holder. Hence, for account-based CBDCs, legal amendments are needed to allow central banks to open accounts for the general public.
For both types of CBDCs, if the payment system function of central banks is restricted to interbank systems, this must be changed.
The need for monetary law reform
In legislation, there isn’t always a formal distinction between central bank and monetary law. Conceptually monetary law is about the powers of the state to issue a currency and is often outlined in a constitution. It covers the official monetary unit such as the dollar or yen, and the official payment method.
Compared to central bank law, monetary law relating to means of payment is more difficult to amend. That’s because it invokes numerous questions around areas such as the right of the state to issue it, convertibility, legal tender status, private law privileges and criminal law protection from counterfeits and cybercrime. Furthermore, the ability of a country to change monetary laws may be restricted due to its constitution.
To even consider token-based CBDCs to be legally equivalent to banknotes requires significant reform. The IMF questions whether a CBDC should have blanket legal tender status – where people or organizations have to accept the currency as payment – given that parts of the population may not technically be capable of using it. It was suggested that legal tender status be limited to ‘sophisticated entities’ such as the state itself, public bodies, large firms and financial institutions.
The paper considered private laws as too big a topic to cover fully. However, it says it’s very important to consider whether a token-based CBDC can be lent to a bank, or in other words, deposited. Because if it cannot, it is outside the financial system. So what privileges it has under private law needs to be considered. Lastly, it’s important that CBDCs are adequately covered under cybercrime offenses.
For account-based CBDCs however, there is no current recommendation for reform. The authors don’t view it as a currency. Given central bank book money already plays a major role in the existing monetary system, there’s no need to address its legal status.
Problems with interest-bearing tokens
As an aside from the key issues, the IMF envisages a problem if a tokenized currency is interest-bearing. The first issue is that to have interest payments, legally, there would need to be a loan.
And to be a means of payment like cash, the payment amount needs to be the face value. As soon as a token is interest-bearing, just like bonds, its value is determined by the interest rate, not just its face value.
That raises issues with convertibility. In other words, a one-dollar interest bearing CBDC is unlikely to be exchangeable one-to-one for a one-dollar bill.
Overall, before CBDCs are issued, they need a ‘robust, ideally explicit, legal basis’, and only a few central banks offer this. Central bank laws can be easily changed, but monetary ones not so much. Countries will need to carefully consider the potential amendments of existing laws or the creation of laws before CBDC issuance.