Introduction
In recent years, the domain of digital finance has experienced a significant transformation with the introduction of Central Bank Digital Currencies (CBDCs). Unlike decentralized cryptocurrencies such as Bitcoin and Ethereum, which work independently of a central authority, CBDCs are digital versions of a nation's fiat currency, issued and managed by the central bank. This new type of currency combines the efficiency of digital transactions with the reliability of traditional money, though it still has some risks that will be discussed later.
As central banks across the globe explore or actively create their own digital currencies, CBDCs are expected to profoundly change the global financial framework. The reasons behind this transition are many, such as improving financial inclusion, upgrading payment systems, addressing the rise of private cryptocurrencies, and supporting monetary sovereignty in the digital era. The emergence of stablecoins has also accelerated this change. For instance, in May 2022, the algorithmic stablecoin TerraUSD (UST), valued at $18.7 billion, and its associated token Luna, worth $20 billion, collapsed almost immediately, with their values dropping from $1 and $80, respectively, to nearly zero.1 This incident clearly showed the weaknesses of some stablecoins and emphasized the need for a more secure, government-backed digital currency.
This article provides a brief overview of CBDCs, exploring their legal and regulatory implications and the potential challenges they present. It concludes with a discussion on the role of artificial intelligence, aiming to contribute to the ongoing debate on the future of digital currencies in an increasingly dynamic economic environment.
What is a Central Bank Digital Currency
A central bank digital currency (CBDC), also known as digital fiat currency or digital base money, is a digital currency issued directly by a central bank rather than by a commercial bank. Like physical banknotes and coins, a CBDC is a liability of the central bank and is denominated in the sovereign currency. There are primarily two categories of CBDCs: retail CBDCs (rCBDCs) and wholesale CBDCs (wCBDCs). Retail CBDCs aim to give the public a safe digital payment option for everyday use, while wholesale CBDCs are designed for financial institutions, functioning like central bank reserves but with enhanced features due to tokenization.2
Legal frameworks governing CBDCs
The regulation of Central Bank Digital Currencies differs significantly among the different jurisdictions, showing unique legal traditions, economic objectives, and levels of technological advancement.
Let's dig into some of the most important examples:
Digital Yuan (E-CNY) - China:
E-CNY is a fiat currency issued and governed by the central bank and designed to complement the existing cash system. The technical details of how it works are not public, but People's Bank of China (PBOC) officials have stated that it does not run on a blockchain. Additionally, the value of E-CNY is influenced by policymakers and economic shifts, but is ultimately supported and partially controlled by the state.
To trace the evolution of the E-CNY, People's Bank of China
began researching digital currency in 2014 under Governor Zhou
Xiaochuan.3 In 2016, PBOC Deputy
Governor Fan Yifei suggested that central banks should oversee
private digital currencies and create their own digital money.4 In 2017, the State
Council approved the development of the Digital Yuan in partnership
with major Chinese tech firms and commercial banks.5
Testing began in April 2020 across four cities, later expanding to multiple regions. The currency was used in retail settings and online platforms and by 2021, over 261 million users participated in the trial, with 13.8 billion US$ in transactions.6
Throughout 2022, testing extended to additional regions, and during the 2022 Winter Olympics, China evaluated the appeal of E-CNY by providing E-CNY's mobile application and payment cards or wristbands to visiting foreigners. As of 2024, the Digital Yuan has been introduced in 29 cities across China and is being widely used as part of the central bank's monetary tracking system. Anyway, we need to consider that adoption has been slow, and the digital currency is struggling to compete with established payment platforms like Alipay and WeChat Pay.7
On October 23 2020, to outline the legal framework for the E-CNY, the PBOC published a draft law proposing to officially recognize China's central bank digital currency. This draft law marked the beginning of public consultation and included provisions for other financial matters. Particularly, Article 19 of the draft states, "The basic unit of Renminbi is Yuan and the units of fractional currency of Renminbi are Jiao and Fen. Renminbi may be in physical form and digital form" thus providing a legal basis for the issuance of digital currency.8 This draft law is the first to officially recognize the E-CNY as legal tender, paving the way for its broader use.
The PBOC has the exclusive authority to issue RMB, both in physical and digital forms, making sure that the E-CNY is fully part of the country's monetary system and legal framework.
Digital Euro - EU:
The Digital Euro represents a project of the European Central Bank, which started in July 2021 to develop a digital currency for central bank purposes with the aim of having a fast and secured electronic payment system that would complement the traditional currency of the euro. It can be used for both cash and bank accounts. This digital currency will be issued by the European central bank system all over the Eurozone. It offers contemporary payment solutions for both individuals and companies.9
Charting the legal framework of the Digital Euro, it was the
European Data Protection Board (EDPB) and European Data Protection
Supervisor (EDPS) who first tried to establish a legislative
proposal for the recognition and regulation of CBDCs. This proposal
was elaborated in a joint opinion document titled "Joint
Opinion 02/2023 on the Proposal for Regulation of the European
Parliament and the Council on the Establishment of the Digital
Euro" which was adopted on October 17 2023. Chapter III
of this document explains the legal tender status of the Digital
Euro.10
The distribution of the Digital Euro shall be supervised by private service providers that will be authorized to deliver Digital Euro payment services, in compliance with Directive 2015/2366 and applicable national regulations.
Additionally, the ECB made a decision on October 18 2023, to enter the preparatory phase, which is scheduled to start in November 2023. This phase will include finalizing the regulations and choosing providers in order to establish the platform and infrastructure, preparing for the future launch of the Digital Euro.
Digital Dollar - US:
The U.S. House of Representatives recently voted to block the Federal Reserve from issuing a CBDC.11
The CBDC Anti-Surveillance State Act, introduced by Majority Whip Tom Emmer (R-Minn.), seeks to stop the creation of a digital dollar.
Additionally, the H.R.804 - Chinese CBDC Prohibition Act of 2023, prohibits money services businesses, such as currency exchange providers or money order issuers, from engaging in transactions involving a CBDC issued by China 12. This marks the U.S. as the first country to propose a ban on CBDCs.
Sand Dollar - The Bahamas:
In late 2020, the Bahamas became the first country to formally launch its very own Central Bank Digital Currency, the Sand Dollar, with an ultimate goal of promoting financial inclusion for its people spread across islands.
- Bahamian Dollar Digital Currency Regulations 2021: this legislation officially recognizes the "Bahamian Dollar Digital Currency" (BDDC).
- Bahamian Dollar Digital Currency (Holding and Transactional Limits) Notice, 2022: This regulation sets limits to holding and transactions using the Sand Dollar.
Looking ahead, the Bahamas intends to have rules finalized within the next two years, that will make it compulsory for commercial banks to support the Sand Dollar and place its position into the country's financial system.13
Challenges and considerations
There are various arguments in favor of introducing a CBDC. For
instance, a CBDC could help maintain the role of central bank money
as a monetary anchor in the payment system, offering a stable base
for transactions. It could also expand payment options by offering
an alternative form of central bank money to cash and commercial
bank deposits, hence increasing availability and financial
inclusion. Lastly, it could play a significant role in fighting tax
evasion.
However, the introduction of a CBDC also presents significant
challenges, particularly concerning financial privacy, individual
freedom, financial stability, and cybersecurity.
The Human Rights Foundation has joined the fight against CBDCs, showing concerns about mass surveillance, as CBDCs could give governments direct access to all financial transactions, eroding privacy and exposing citizens' personal details, including relationships, beliefs, and political views. This would also make it easier for governments to freeze funds, as seen in recent protests in China and Canada, potentially cutting off financial access for those who dissent.14
Moreover, the Wall Street Journal reported that commentators argue the digital currency could provide the Chinese government with a new way to monitor its citizens and track financial transactions.15
Christine Lagarde, President of the European Central Bank, has publicly addressed some of these risks, but critics believe that her responses have been insufficient, pointing always to the digital Renminbi as an example, noting its use of restrictive features like geo-fencing, geo-tracking, transaction limits, and time restrictions, which have raised concerns about the potential for abuse of power.
Artificial intelligence and CBDCs
The integration of Artificial Intelligence (AI) has the potential to greatly improve the development of Central Bank Digital Currencies, supporting central banks by delivering current research on innovations, risks, and regulatory challenges associated with CBDCs. The data analytics capabilities of AI could help monitor transactions in real-time, enabling the identification of trends and the evaluation of risks such as bank disintermediation, which is crucial for informed regulatory decision-making.16
Furthermore, AI can be essential for detecting fraud and managing risks by identifying suspicious activities and issuing compliance alerts.
It could also improve customer service by offering immediate assistance, which enhances user experiences with CBDCs. These are just some of the potential benefits.17
Conclusion
CBDCs have the potential to completely change the global financial environment by increasing efficiency, financial inclusion and stability. Central banks are now exploring different methods to integrate digital currencies into their systems, as seen in initiatives such as China's Digital Yuan and the Digital Euro. Although CBDCs offer important advantages, they also present many challenges, as we noticed previously. The application of artificial intelligence has the potential to mitigate some of these concerns, however, it requires careful regulation to prevent possible misuse.
In conclusion, as the development of CBDCs continues, finding the right balance between innovation and caution will be essential. How these digital currencies are implemented and regulated will shape their effectiveness and impact on the future of finance.
Footnotes
1 Gleb Kurovskiy and Natalia Rostova, "How Algorithmic Stablecoins Fail", April 2023.
2 Bank for International Settlements. "Annual Economic Report June 2021," Pages 70-73.
3 Areddy, James T. "China Creates Its Own
Digital Currency, a First for Major Economy." Wall Street
Journal, April 5, 2021. ISSN 0099-9660.
4 Yifei, Fan. "On Digital Currencies,
Central Banks Should Lead." Bloomberg, September 1, 2016.
Retrieved January 5, 2017.
5 Wu, Yu. "别误读了！目前数字人民币试点仍是'4+1'." Xinhua, August 15, 2020. Archived from the original on January 26, 2021. Retrieved May 2, 2021.
6 Feng, Coco. "China's Digital Currency: e-CNY Wallet Nearly Doubles User Base in Two Months to 261 Million Ahead of Winter Olympics." South China Morning Post, January 19, 2022. Retrieved February 13, 2022.
7 Forbes. "A 2024 Overview of the e-CNY: China's Digital Yuan." Forbes, July 15, 2024. Available at: https://www.forbes.com/sites/digital-assets/2024/07/15/a-2024-overview-of-the-e-cny-chinas-digital-yuan/
8 Zhonghua Remin Gongheguo Zhongguo Remin Yinhang Fa (Xiuding Caoan Zhengqiu Yijiangao) (中华人民 共和国中国人民银行法(修订草案征求意见稿)) Law of the People's Republic of China on the People's Bank of China [(Amendment Draft for Consultation)] (drafted by the Nat'l People's Cong., Oct. 23, 2022), art 51. http://www.gov.cn/zhengce/zhengceku/2020-10/24/content_5553847.htm
9 European Central Bank. "The Digital Euro." European Central Bank. Available at: https://www.ecb.europa.eu/euro/digital_euro/html/index.en.html.
10 European Data Protection Board and European Data Protection Supervisor. "Joint Opinion 02/2023 on the Proposal for Regulation of the European Parliament and the Council on the Establishment of the Digital Euro." European Data Protection Board and European Data Protection Supervisor. Available at: https://www.edps.europa.eu/system/files/2023-10/edpb_edps_jointopinion_digitaleuro_en_0.pdf.
11 Forbes. "The House Bans the Fed from Building a CBDC Like the Digital Yuan." Forbes, May 23, 2024. Available at: https://www.forbes.com/sites/digital-assets/2024/05/23/the-house-bans-the-fed-from-building-a-cbdc-like-the-digital-yuan/
12 U.S. Congress. H.R.804 - Chinese CBDC Prohibition Act of 2023. 118th Congress, 2023. Available at: https://www.congress.gov/bill/118th-congress/house-bill/804
13 Ledger Insights. "Bahamas to Mandate Banks to Offer Sand Dollar CBDC: Report." Available at: https://www.ledgerinsights.com/bahamas-to-mandate-banks-to-offer-sand-dollar-cbdc-report/
14 Human Rights Foundation. "CBDC 101." Available at: https://cbdctracker.hrf.org/cbdc-101
15 Areddy, James T. (April 5, 2021). "China Creates Its Own Digital Currency, a First for Major Economy." Wall Street Journal. ISSN 0099-9660. Retrieved April 6, 2021.
16 Ozili, Peterson K. (July 19, 2024). "Artificial Intelligence and Central Bank Digital Currency." Available at SSRN: https://ssrn.com/abstract=4906289.
17 ibid.
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