CENTRAL BANK DIGITAL CURRENCIES AND THE THEORY OF MONEY
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CENTRAL BANK
DIGITAL
CURRENCIES AND
THE THEORY
OF MONEY
JUNE 2021
CENTRAL BANK DIGITAL CURRENCIES AND
THE THEORY OF MONEY
The development of Central Bank Digital Currencies (CBDCs) –
a digital representation of fiat money issued by a central bank –
has been accelerated by COVID-19 and the resulting shift to
digital payments. In this briefing, we consider the different
approaches being taken by central banks globally, including the
digital euro, renminbi and dollar, what practical adoption of
CBDCs may look like, the legal structures that might be
employed and the consequences for businesses.
The rise of CBDCs What are CBDCs?
The level of interest in central bank digital CBDCs have been defined by the Bank
currencies (CBDCs) has grown for International Settlements, as "a digital
significantly over the past few years at payment instrument, denominated in the
both a national and international level. national unit of account, that is a direct
Many major jurisdictions around the world liability of the central bank" in a paper
have active research and pilot projects published jointly with several central
ongoing, and we are seeing the first banks in October 2020. "CBDCs can
launches of live CBDCs – the Bahamas, be based on DLT, but they aren’t
for example, launched its CBDC, the necessarily. So, different projects may
Sand Dollar, in October 2020. "Different look at an account-based, or
jurisdictions have very different token-based, models. The concept that a
motivations for pursuing their individual CBDC is a direct liability of a central bank,
CBDC projects. Financial inclusion is a is a concept worth considering when we
top priority for CBDC development, look at the role that the private sector or
particularly across emerging markets and intermediaries might play in a general
developing economies – that was a key purpose CBDC," says Douglas. That can
motivation for the Bahamas' Sand Dollar," be broken down very broadly into direct
says Laura Douglas, a senior associate in models, intermediated or hybrid models.
Clifford Chance's Financial Regulation In the direct model the central bank
Practice in London. Financial inclusion is would interact directly with end users,
generally the motivation for developing a including consumers, although in practice
general purpose or retail CBDC where very few if any central banks are pursuing
end users include the general public. such a model. Most existing projects are
Conversely, financial inclusion is obviously exploring intermediated or hybrid models
a less important motivation for wholesale where there are private sector
projects where access to a potential intermediaries that would facilitate end
CBDC is limited to financial institutions user payments that use CBDCs.
and other players that have direct access
to central bank accounts and central So, for example, focusing on the UK, the
bank money. Bank of England's discussion paper on
CBDCs, published in March 2020,
Wholesale CBDCs are seen as less of a envisages an indirect model where the
priority globally, compared with the Bank of England maintains the core
general purpose CBDC but, at the same technology platform and ledger, but then
time, a number of jurisdictions are looking regulated payment interface providers
at wholesale CBDCs motivated by factors act as intermediaries to provide the
such as improving efficiency of cross- user-friendly interface between the end
border payments, development of user and the Bank of England as
distributed ledger technology (DLT) CBDC issuer.
enabled capital markets, and
enhancement of cyber resilience.
2 CLIFFORD CHANCE
CENTRAL BANK DIGITAL CURRENCIES AND
THE THEORY OF MONEY
It is worth noting that the Bank of What the creation of CBDCs does is to
England has proposed the use of eliminate all of the technical problems that
application programming interfaces (APIs) are created by physical cash," says
to make that connection between the London-based Clifford Chance Partner,
core ledger and the provision of services Simon Gleeson.
to end users similar to what is seen, for
example, in the Open Banking space. He adds: "So we suddenly go into a
world where you can have as much
Intermediated or hybrid models should physical cash as you like taking up no
also be distinguished from so-called space at all, which is remotely
"synthetic" CBDC. This term has been transferrable and doesn’t require chaps
used to describe a scenario where a and guns to look after it. Potentially, that
central bank issues a wholesale only could get you to a world where we don’t
CBDC and then commercial providers in need commercial banks and commercial
turn issue CBDC-backed electronic bank money anymore – everyone can
money or stablecoins to retail end users. settle directly in CBDCs.
However, the CBDC-backed electronic
money or stablecoins do not in fact meet However, this creates a problem.
the definition of a CBDC referred to Commercial banks take in deposits, they
above, as they are not liabilities of the lend those deposits out as loans, and
central bank. Instead, they are liabilities of deposit the difference with the Bank of
or claims on the commercial bank that England. But in a world where all money
issued them – much like commercial is held in the former Central Bank, the
bank money today. question is, where does commerce and
industry get its credit from? It has to go
Different projects are also looking at to the Central Bank. "If you imagine a
different design features and world where everybody does everything
functionalities: whether the CBDC will using CBDCs, what you have actually
allow functionality for offline payments, done is nationalise the supply of credit to
which is obviously important for financial the economy. This has been tried in
inclusion; whether peer-to-peer payments various spots around the world; Russia's
will be possible; the potential 24/7 Gosbank is the best-known example. It
availability of the CBDC; questions around didn’t work terribly well, but the key point
privacy and anonymity and determining is that the introduction of CBDCs
who gets to see what in terms of actors necessarily changes not only the payment
and users of the CBDC and transaction system but also the credit system, and so
level data; and how CBDCs function there are some quite big consequences,"
alongside existing payment methods and says Gleeson.
interact with the existing financial market
infrastructure, both at a national level and The second issue is how CBDCs are
on a cross-border basis. administered. For crypto coins to be
transferred from one person to another
What is the impact will require service providers. The
question arises as to what is the legal
of CBDCs? basis on which that service will be
"If you think about how the banking provided? There are two entirely different
system actually works today, the reality of ways of providing that service. One is to
the situation is that people pay bills with say that it looks like a custody service;
money created by commercial banks. The so, the CBDC remains owned throughout
commercial banks settle between by the customer, the bank undertakes the
themselves in central bank money, so the administration for the customer and
only way that the central bank provides charges the customer a fee for so doing.
money directly to the end user is when it That is awkward for the customer,
creates notes and coins – legal tender. because customers are having to pay for
Legal tender is always a very small part of a service that was previously free of
the payments world just because it is charge. Alternatively, the bank says to the
irritating and difficult to deal with, it has to customer: "We will effectively buy your
be stored, it has to be kept secure, it has CBDCs from you, so what you will own
to be transferred by physically moving it will not be CBDCs themselves, it will be a
around, and it is generally a nuisance.
CLIFFORD CHANCE 3
CENTRAL BANK DIGITAL CURRENCIES AND
THE THEORY OF MONEY
claim on us for those CBDCs." What that deemed for all purposes to be money, it
achieves is basically to reinstate deposit creates as many problems as it solves
banking as it exists today. From the because there are then currency and
bank's point of view it accepts the status money laundering requirements. "The
quo: it can take those CBDCs, lend them trouble with CBDCs is that they are like
out, make money out of the loan, use money, but in a number of respects they
that to subsidise the payment service and are not money and an answer 'this is
in that respect everything is as it was. money for all purposes' is every bit as
However, from the customer's point of unsatisfactory as the answer 'this is not
view, the question is 'What is the money for all purposes'. So, part of the
difference between owning a claim on a creation of CBDCs will have to be the
commercial bank for payment of sterling creation of a new legal architecture that
and owning a claim on a commercial deals with all these consequential
bank for payment of Bitcoin or questions," Gleeson says.
whatever'?" says Gleeson.
What's happening in
If the structure is a custody structure then
the UK?
there is a credit problem and customers
pay a lot more for the service than they In April 2021, the Bank of England and
are currently getting, and if there is a HM Treasury established a new CBDC
deposit structure then what was the point Taskforce to ensure a strategic approach
in creating the CBDC in the first place? "It is adopted between the UK authorities as
is that issue, the question of how these they continue to explore the possibility of
services will be provided, which will have developing a CBDC, with the creation of
the biggest impact on whether these new engagement and technology for
things are created at all and how they are broader stakeholder engagement.
actually used in practice," he says.
Alongside this, the Bank of England
Another question posed by Gleeson is published a discussion paper on new
what exactly are these things? "If I give forms of digital money and feedback to
you a CBDC, does that discharge a its March 2020 discussion paper,
payment obligation? If I go into a shop highlighting five core principles that will
and give the shop CBDCs in exchange guide the Bank of England's future
for a kettle, have I bought that kettle? It exploration of CBDC. These principles
sounds like a stupid question but actually point towards:
it has significant consequences because
the definition of a sale is the exchange of • Financial inclusion as a prominent
goods for a sum of money, called the consideration in the design of
price. I only have Sale of Goods Act any CBDC.
protection, or Consumer Act protection, if • A competitive CBDC ecosystem with
what I did was a sale. So, if the CBDCs the private sector taking a leading role
are money, I then have consumer in responding to end users' needs.
protection in respect of the kettle; if they
aren't, then I don't. How do you take • The need to assess whether non-
security over it? Can you not reasonably CBDC payment innovations could
claim that you can net a money claim deliver the same benefits.
against a different money claim? It's • The need to protect users' privacy
equally clear that you can't net a money (whilst complying with important legal
claim against an obligation to deliver a compliance requirements such as anti-
thing. So, if I owe you £100 and you are money laundering, countering the
obliged to deliver to me £100 in CBDCs, financing of terrorism and sanctions).
can I net or can I not?"
• Consideration of opportunities a CBDC
There is a whole array of questions of that might bring for monetary and financial
kind, all of which will need to be stability as well as for payments.
answered. If, for example, a CBDC is
4 CLIFFORD CHANCE
CENTRAL BANK DIGITAL CURRENCIES AND
THE THEORY OF MONEY
What's happening in area will have digital legal tender that can
be used in the digital space?
the Eurozone?
What is a digital euro? The report The ECB report identified several key
published by the European Central Bank principles: the digital euro should be
(ECB) on the digital euro1 states that the convertible at par; it should be a risk-free
digital euro will be, if it comes into force, a asset; it must permit equal access across
liability of the ECB and the euro system the Eurozone; and be based on a system
offered in digital form for use by citizens and technology that is secure and can
and businesses to make payments. The be trusted.
intention is that it would complement
cash and wholesale central bank money, One of the reasons cited for the issuance
but not replace them. "Interestingly, this is of digital euro partly concerns the
not synonymous with DLT or block chain, challenges to monetary sovereignty of the
and the intention of the report is to remain euro area from private challengers, such
technologically neutral even though, when as LIBRA/DIEM2, or potential currency
most people speak about central bank displacement when or if the digital yuan
digital currency, it is frequently in the or digital dollar become a reality and
context of block chain," says Jonathan becomes currently used in the digital
Lewis, a Clifford Chance Partner in the economy. "In order for the Euro area to
Financial Regulatory Group in Paris. preserve its financial and monetary
autonomy, it would be necessary to have
The Treaty on the Functioning of the something that's more user-friendly than
European Union, the Statute of the the current format of euro in the digital
European System of Central Banks and space. Clearly, there has been declining
the Regulation of 1998, which introduced use of cash and a need within the Euro
the euro, provides the legal basis for the area for a modern, robust payment
ECB and the euro system issuing notes system which facilitates and encourages
and coins which are legal tender in the innovation and the digital economy,"
Eurozone. The report recognises that, he says.
depending on what features and
functionality are adopted for the digital
What are the challenges
euro – and whether it is limited in purpose
or is to have the same legal status as a for a digital euro?
euro bank note, the legal basis to be There are significant policy issues of how
used under TFEU, the Statute and to reconcile a digital euro with financial
applicable regulations may differ. "Given stability, specifically how to reconcile a
political sensitivities on currency issues, digital euro with the traditional role of
the choice of legal basis is quite banks acting as intermediaries, which
important because as we saw in the euro transform retail and corporate deposits
crisis, there are often groups who take into loans and investments in the real
legal actions before the European Court economy both to industry and to
of Justice or domestic constitutional consumers. With this in mind the ECB's
courts, to challenge evolutions in the role report looked at differences in design,
of the ECB, the euro and monetary potential use of direct models, potential
policy," says Lewis. use of indirect models where the role of
intermediaries is preserved, account or
He adds that a parallel issue is, if the tokenised digital euro and issues of
digital euro becomes legal tender or its security, secrecy and privacy – today
equivalent , what happens in the cash is totally anonymous, but there is a
domestic commercial law of EU states as concern that digital euro should not be
to how one can validly discharge a debt; completely anonymous because of AML
in particular, would a person be entitled or concerns on the financing of terrorism
permitted to use stable coin or other and proceeds of crime.
digital currencies e.g. DIEM to repay a
debt, or will the use of those other digital
currencies be restricted because the euro
1 Report on a digital euro October 2020
2 The stable coin sponsored by Facebook.
CLIFFORD CHANCE 5
CENTRAL BANK DIGITAL CURRENCIES AND
THE THEORY OF MONEY
Within the context of combatting financial otherwise not regulated, and, in particular,
exclusion and facilitating full participation Stablecoin. There is also a forthcoming
in economic life the use of physical regulation to set up a pilot scheme for
devices eg digital wallets or encrypted DLT multilateral trading platforms and
mobile phones to facilitate offline use is central depositories.
also being explored. Partly with a view to
taking steps to preserve the traditional Christine Lagarde stated in the ECB
transformational role banks and partly to report that "we need to be ready to
explore the role of the digital euro as a introduce the digital euro should the need
tool of monetary policy some of the arise." The decision will be taken in the
discussions relate to whether there first half of 2021. "It looks as if we are
should be limitations on holdings of digital going in the direction of the digital euro
euro so they that do not completely being adopted and further work being
displace deposits as a source of stable done. With that in mind, the ECB and the
investment, and on issues of tiered Commission, in a joint statement in
renumeration, so that if you hold digital January 2021, said they were working on
euro beyond a certain level, either policy, legal and technical issues to
penalties are levied or you do not receive assess feasibility and the way forward,"
the same renumeration as someone with says Lewis.
a smaller holding.
The US perspective
A public consultation3 resulted in over
The US is behind other countries in terms
8,200 people responding (a fairly large
of how it sees CBDC development. It is
response): 94% were individuals, and only
very much in the planning and exploration
6% were professionals; most responses
stage, explains Megan Gordon, a partner
came from Germany, Italy and France.
in the Washington Litigation and Dispute
The issues identified were privacy
Resolution practice. Last year the Federal
concerns, security and trust in the
Reserve Chair, Jerome Powell, was
system, usability throughout the Eurozone
questioned by Congress about CBDCs.
and the ability to use offline. However,
At the time Powell said that he
one encouraging element of the
appreciated the importance of making
feedback, for those who want to preserve
quick progress and generally noted that
traditional banking, is the concerns
there were unanswered questions. In May
expressed to integrate the new system
2021, it was announced that the Federal
with existing systems and to potentially
Reserve will issue a research paper on
regulate intermediaries. Using
CBCDs this summer. While the Fed has
intermediaries as a gateway was
said consistently that it is under no rush
something that seemed to be envisaged
to introduce a CBDC, it is clear that there
by those responding to the survey, who
is increasing pressure to do so.
did not seem to consider the question of
"Congress is worried that the US will fall
direct access to the central bank.
behind its competitors – in particular
China – and there is concern that the US
On the wholesale side, there has been
Dollar will be replaced as a major
some interesting uses of digital euro by
international currency by another digital
the Banque de France. In March 2020,
currency that is easier to move
there was an issuance of covered bonds
internationally," says Gordon. Part of this
using Société General's FORGE system,
concern is based on the fact that 5.4% of
as well as, in early 2021, an issuance of a
Americans still do not have checking or
subscription of fund units using block
saving accounts. During the pandemic
chain and in April 2021 the issuance of
this meant that it was very hard to reach
an EIB bond using digital euro managed
a small, but significant, number of
through the Banque de France. This
Americans who were entitled to
activity needs to be put into the context
stimulus payments.
of the digital finance initiative; the new
Markets in Cryptoassets (MiCA) regulation
The Federal Reserve published a paper in
is intended to provide a context for the
February on five broad categories of what
regulation of cryptoassets that are
are seen as preconditions for CBDCs:
3 Report on the public consultation on digital euro April 2021.
6 CLIFFORD CHANCE
CENTRAL BANK DIGITAL CURRENCIES AND
THE THEORY OF MONEY
1. The first objective is in keeping with the 4. Robust technology and block chain.
guiding principle of the Central Bank, What technology is going to be used
which is to do no harm, but it also and who is going to design it? How do
wants to complement existing forms of we get to a technological environment
money and support innovation and that everyone can agree on? Block
efficiency. There are currently huge chains are also an issue given the
inefficiencies in some money transfers. amount of energy it takes to validate
transactions in a block chain. Some
2. Broad stakeholder support. "I think this
environmental groups are already
is going to be the hardest push for the
voicing concern about the energy
US, because it includes governmental
usage involved, and if very large block
bodies. The Fed has said that it will
chain systems are used to operate
require congressional approval to be
CBDCs then that problem will increase.
able to issue CBDCs and it's a pretty
big issue in the US to get that type 5. Market readiness and the appropriate
of consensus," Gordon says. It will timing for the introduction of CBDCs.
also require the buy-in of
"Are there end users that are willing to
financial institutions.
adopt it? Is there a demand for it? And is
3. A strong legal framework. There is a there an ecosystem to support it?," asks
general question in the US as to Gordon. "In other words, is it seen as
whether the issuance of CBDCs would solving a problem? There is a huge
be consistent with the Fed's mandate concern that the US will lose its
and whether it would require an prominence, and that the US dollar will
additional amendment to the Federal lose its prominence if China moves
Reserve Act in order to issue them. ahead. I think that is really what's driving
"I think that the general thought of the a lot of the US efforts in this regard," she
Fed is that it would, although there is says. That said, there is clearly a great
some disagreement on that. In the US, deal of caution about moving to a digital
legal tender means something different dollar. "I don't see the US as being at all
than it does in other countries. Federal the first mover on this, but the Fed has
law does not compel private said it will be a big year for CBCDs and
businesses to accept a currency or there will be more announcements in the
coin even if it is legal tender, and this coming months."
could make the rollout of CBDCs both
easier and harder. Easier because not China and CBCDs
every business has to actually support
China is pushing ahead with CBCDs.
it technically, but harder because many
There are some pilot programmes in
businesses could opt out and payment
place and many Chinese people are
systems, of course, need to have one
becoming increasingly aware of the
universal way to accept tender," she
concept. China's central bank, the
says. There is also an issue with anti-
People's Bank of China (PBOC), began
money laundering and sanctions. The
research into digital currencies as early as
US has a huge sanctions regime, which
2014, and has renamed the Institute for
plays a significant role in foreign policy
Printing Technology for Legal Tender as
– there are concerns about terrorist
the Digital Currency Research Institute.
financing, money laundering and
"This demonstrates an expectation by
privacy. There are also concerns about
China's central bank that printed legal
cost and liability – the cost of anti-
tender will be replaced by digital currency
money laundering systems and
at some point," says Kimi Liu, a counsel
sanctions controls are currently borne
in Clifford Chance's Beijing Banking and
primarily by the financial institutions, but
Finance Group.
in a system where the central bank
takes that over, who is responsible for
In April 2020, China formally announced
those costs and for consumer-facing
that it would test a digital currency called
issues, and who is liable to consumers?
Digital Currency Electronic Payment (DC/
EP) in some selected cities. "On the
CLIFFORD CHANCE 7
CENTRAL BANK DIGITAL CURRENCIES AND
THE THEORY OF MONEY
legislative and technology side, China is What's happening in Hong
making progress. Previously, there was a
Kong and Singapore?
lot of discussion as to whether China's
digital currency is for retail purposes only, The Hong Kong Monetary Authority
because all the testing is currently in retail (HKMA) has identified the inefficiencies of
situations – to buy coffee in Starbucks, cross-border payments, and has applied
for example, and to make other small technology to try and resolve those and
payments. However, in February 2021, make such payments more efficient, says
another initiative was announced focusing Rocky Mui, a partner Clifford Chance's
on wholesale," says Liu. Funds Practice, based in Hong Kong.
"They haven't created something
It is clear that China's central bank will completely new. They are not going to
adopt an intermediary model. The PBOC change the law, and it's not going to
will issue digital currencies to those create a new digital currency. It's really
intermediaries (China's major banks, and just building and upgrading the
third-party payment service providers infrastructure with block chain
such as TenPay and Alipay, in exchange technology," he says. In conjunction with
for the deposit of lawful currency with the the Bank of Thailand, it is developing a
central bank. Those intermediaries can pilot prototype of cross-border payments
offer digital currency wallets to end users settlement. "The idea is to get rid of the
and will undertake daily operations and corresponding bank because it's
transactions. "Given China's size, it will inefficient. Simply put, you have the local
be difficult for the Central Bank to build payment system in Hong Kong and
the infrastructure and a system to deal Thailand, and you then build a bridge
with individuals across the country, so it between them using a block chain. You
will rely on an intermediary for then can have a live feed in terms of
implementation," says Liu. The Chinese quotes, and execution and settlement
regulator is quite clear that it will be can be made in real time. That's the aim.
technology-neutral, so any technology It is a simple idea, so it's a lot easier to
that can satisfy security and reliability get all the stakeholders onboard. There is
requirements will be welcome. However, less concern about who has this control,
if DLT is used, it is likely to result in who is going to have the legal title and
enormous energy consumption which, privacy concerns," he says. Hong Kong's
with such a large population, will be approach is to move quickly. The next
problematic for the Chinese government. step is to bring in more central banks –
the UAE's, and the PBOC in China.
In terms of cross-border activity, China's
Digital Currency Research Institute has Singapore has been working on Project
announced that it will work together with Uban, a digital currency, for the past five
the UAE Central Bank, the Hong Kong years. It has tested a lot of elements,
Monetary Authority and the Bank of including cross-border settlement
Thailand, with support from the Bank for transfers, and has tried to tokenise
International Settlements Innovation Hub, bonds, loans and insurance. Now the
to develop a proof of concept prototype focus is on using the technology and the
to facilitate real time cross-border foreign digital currency concept to make the
exchange payments. "I think this is the settlement system more efficient.
start of China challenging the digital
currency concept on a wholesale and
cross-border basis, but it is still at a
preliminary stage," Liu says.
8 CLIFFORD CHANCE
CENTRAL BANK DIGITAL CURRENCIES AND
THE THEORY OF MONEYCONTACTS
Simon Gleeson Laura Douglas Megan Gordon
Partner Senior Associate Partner
London London Washington DC
T: +44 207006 4979 T: +44 207006 1113 T: +1 202 912 5021
E: simon.gleeson@ E: Laura.Douglas@ E: megan.gordon@
cliffordchance.com cliffordchance.com cliffordchance.com
Jonathan Lewis Kimi Liu Rocky Mui
Partner Counsel Partner
Paris Beijing Hong Kong
T: +33 1 4405 5281 T: +86 10 6535 2263 T: +852 2826 3481
E: jonathan.lewis@ E: kimi.liu@ E: rocky.mui@
cliffordchance.com cliffordchance.com cliffordchance.com
CLIFFORD CHANCE 9
CENTRAL BANK DIGITAL CURRENCIES AND
THE THEORY OF MONEYThis publication does not necessarily deal with every important
topic or cover every aspect of the topics with which it deals.
It is not designed to provide legal or other advice.
www.cliffordchance.com
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