Understanding the Private Law Aspects of Token-Based Central Bank Digital Currencies

Central Bank Digital Currencies (CBDCs) are gaining significant attention worldwide, with many central banks exploring their potential. As of late 2023, 94% of 86 surveyed central banks are actively researching CBDCs, and three countries—The Bahamas, Nigeria, and Jamaica—have already issued their own CBDCs.

However, the legal foundations of CBDCs, particularly under private law, are often overlooked during the initial design stages. This blog delves into the private law aspects of token-based CBDCs, focusing on their legal nature, ownership rights, transfer mechanisms, and integration into the traditional banking system.

What is Token-Based CBDC?

Token-based CBDC is a form of digital currency issued by a central bank, where the monetary claim on the central bank is incorporated into a digital token. Unlike account-based CBDC, which relies on a current-account relationship with the central bank, token-based CBDC allows for the transfer of the token to equate to the transfer of the claim without direct interaction with the central bank. This form of CBDC is particularly novel and raises several complex legal issues, especially under private law.

Private Law and Token-Based CBDC

Private law governs the horizontal relationships between individuals or entities, as opposed to the vertical relationship between the state and its subjects, which is governed by public law. For token-based CBDC to circulate widely and be used daily by the public, it must interact seamlessly with private law mechanisms that underpin its circulation, such as transfer, collateralization, and custody.

Legal Nature of Token-Based CBDC

Determining the legal nature of token-based CBDC under property law is crucial. Legal systems traditionally classify property into categories such as movable versus immovable goods and tangible versus intangible goods. Token-based CBDC, being a digital asset, challenges these traditional classifications. It could be considered a hybrid asset, a novel sui generis category, or a pure intangible asset. Each classification has implications for how ownership rights are held, transferred, and protected.

Ownership Rights and Holding Structures

Ownership rights in token-based CBDC can be held and evidenced through registries/ledgers and wallets. The legal role of these technological tools is critical. For instance, should a registry/ledger be constitutive of ownership rights, or merely indicative? The answer depends on the legal nature of the CBDC and the design of its holding structure. Wallets, especially custodial wallets, play a significant role in holding and transferring CBDC, and their legal relationship with the holder must be clearly defined to ensure protection in case of insolvency.

Transfer of Token-Based CBDC

The transfer of token-based CBDC must be legally clear and final to support its use as a means of payment. The legal framework should specify when a transfer is considered complete, the impact of insolvency rules, and the application of the Nemo Dat rule, which states that no one can transfer more rights than they possess. Protecting good faith acquirers of CBDC is essential for its wide circulation.

Integration with the Banking System

For token-based CBDC to coexist with the traditional banking system, it must be possible to deposit, lend, and pledge it. The legal mechanisms for these transactions depend on the property law classification of the CBDC. For example, if CBDC is considered a hybrid asset, it could be subject to bailment under common law or deposit agreements under civil law. Pledging CBDC as collateral would require legal changes in many jurisdictions to accommodate the transfer of control over digital assets.

Private International Law and Cross-Border Circulation

Token-based CBDC requires appropriate private international law rules to support its cross-border circulation. The legal nature of CBDC affects which private international law rules apply, such as lex rei sitae for tangible assets or lex contractus for contractual claims. Determining the situs of a digital token held on distributed ledgers and through wallets is a complex challenge that may require legislative intervention.

Is Law Reform Needed?

While some private law challenges can be addressed through contractual freedom, comprehensive legislative intervention is likely necessary in many jurisdictions to provide a robust and predictable legal foundation for token-based CBDC. Countries must ensure the internal coherence of their legal frameworks and consider whether to anchor CBDC legislation within a broader framework for digital financial assets.

Token-based CBDC represents a new form of money with unique legal challenges under private law. Establishing a clear and adequate private law status is essential for its wide circulation and safe holding. Countries must carefully consider the legal nature of CBDC, the role of registries and wallets, transfer mechanisms, and integration with the banking system. International coordination and harmonization of private international law rules will also be crucial for the cross-border use of CBDC.

Key Questions for Developing a Private Law Framework for Token-Based CBDC

1. What is the legal nature of token-based CBDC under property law?
2. How are ownership rights in token-based CBDC held and evidenced?
3. When is a transfer of token-based CBDC considered final?
4. Does the payee of token-based CBDC enjoy good faith protection?
5. Can token-based CBDC be subject to legal arrangements for custody?
6. Are holders protected against the insolvency of their intermediary?
7. Can token-based CBDC be deposited with commercial banks?
8. Can token-based CBDC be used as cash collateral?
9. Is private international law fit for governing cross-border CBDC transactions?
10. What can the central bank do to shape adequate private law rules for token-based CBDC?

By addressing these questions, countries can develop a robust legal framework that supports the successful implementation and circulation of token-based CBDC.