Summary of the webinar on legal aspects of digital currencies
Held virtually on 26 January 2021, Bank for International Settlements (BIS), Basel, Switzerland.
Introduction
On 26 January 2021, the BIS Innovation Hub and the Financial Stability Institute (FSI), BIS with the support of the Committee on Payments and Market Infrastructures (CPMI), hosted a webinar on the legal aspects of digital currencies. The webinar was organised by Mr Ross Leckow, Senior Adviser Fintech – Strategy and Legal, BIS Innovation Hub; Mr Rastko Vrbaski, Senior Advisor, FSI, BIS; and Mr Takeshi Shirakami, Deputy Head of CPMI Secretariat.1
The programme included welcoming remarks from the Head of the Innovation Hub, Mr Benoît Coeuré and Mr Fernando Restoy, Chair of the FSI, BIS followed by a series of fireside chats with leading legal practitioners and academics in this area: Mr Klaus Löber, Chair of the CCP Supervisory Committee at ESMA, Mr David Fox, Professor of Common Law at University of Edinburgh, Mr Simon Gleeson, Partner at Clifford Chance and Ms Corinne Zellweger-Gutknecht, Professor of Private Law and Economic Law at University of Basel. The organisers are grateful to Ms Eva Huepkes, Head of Regulatory and Supervisory Policies at Financial Stability Board (FSB), and Mr Diego Devos, General Counsel, Legal Service at the BIS for their role in chairing sessions. The webinar was attended by 274 people from 79 countries around the world representing central banks, international financial institutions, academia and legal practitioners from the private sector.
This note summarises the conference themes and highlights the issues discussed.
Background
Digital currencies, including central bank digital currencies (CBDCs), are at the heart of innovation in financial technology. Since the advent of bitcoin, a growing variety of digital currencies have been identified as holding the potential to facilitate faster and cheaper payments and a more efficient financial sector. Work in this area is progressing quickly in academia, central banks, international institutions, and the private sector. The BIS has been at the forefront of these developments with conceptual work done in the Monetary and Economic Department (MED), the FSI, the hosted committees and associations, and most recently the BIS Innovation Hub.
Despite the opportunities that digital currencies may present, challenges remain. Their potential can only be realised if they are supported by a legal framework that guards against risk and provides certainty to market participants with respect to the legal status of digital currencies and the legal consequences of their use. Jurisdictions around the world are stepping up efforts to ensure that their legal frameworks meet these challenges. In the spirit of fostering international collaboration, the webinar examined the progress that has been made and what remains to be done.
What are digital currencies?
There has been a proliferation of different types of "digital currencies" or "digital money" over the past decade with the emergence of cryptocurrencies like bitcoin and Ether, stablecoins, and CBDCs. At the same time, discussions of their implications have been hampered by the absence of an agreed taxonomy of the relevant concepts. There are no universally accepted definitions of these terms or even of "currency" or "money" more generally.
There is no universally accepted legal definition of "currency" nor "money". But generally, lawyers often identify "currency" with payment media issued under the authority of the state and in physical form – that is, banknotes and coins with legal tender status. They make up only a small proportion of the money in circulation. "Money" is often considered to be a broader concept. It refers to currency but also to any other means of payment denominated in a unit of account (such as bank money).
The ideas of "digital currency" and "digital money" cut across these traditional legal understandings. Bank deposits exist in digital form and are a form of "digital money." But they do not feature prominently in discussions about digital currency or money today. These discussions focus on cryptocurrencies, stablecoins and CBDCs where the terms "digital currencies" and "digital money" are used almost interchangeably. Not all of the instruments meet a general definition of currency or money. For example, "cryptocurrencies" cannot, as a legal matter, be considered "currencies" as they exist only in digital form and are issued by the private sector (ie not by the state) under terms that are not underpinned by established legislation or legal doctrine. Some instruments do not possess all of the attributes of money from an economic perspective: a means of payment, store of value and unit of account. For the purposes of the discussion in the workshop, the terms "digital currencies" and "digital money" were used interchangeably and focused on payments instruments that are: (i) issued in digital form only; (ii) managed under a system that relies on cryptography; (iii) recorded on a ledger that may be in decentralised form; (iv) issued by entities in either the private or public sector; and (v) used as a means of payment. They include cryptocurrencies, stablecoins and CBDCs.
The current landscape
Lawyers and policy makers are grappling with a host of legal challenges related to digital currencies. In many jurisdictions, digital currencies remain the subject of legal uncertainty and complexity. Challenges relate to the heterogeneity of digital currencies, and the interaction between regulatory regimes and contractual arrangements. Issues related to the legal foundation for holding and transferring digital currencies, the allocation of liability among relevant parties, cyber-risk, data and consumer protection contribute to these legal challenges.
Different jurisdictions are taking different approaches to the resolution of these issues. These range from doctrinal interpretations (eg the United Kingdom) to creating new legal categories to deal with digital currencies (eg France and Liechtenstein). Many other jurisdictions are still studying the issues before deciding how to proceed. Legislative reform in the area of cryptoassets more generally has focused to some degree on "security tokens" (ie tokens the replicate the features of securities) rather than digital currencies that are intended to be payments instruments.
Work is being done at the international level to resolve these issues. International organisations and standard-setting bodies such as the FSB, the Financial Action Task Force (FATF), the CPMI, the International Organisation of Securities Commissions (IOSCO) and the Basel Committee on Banking Supervision (BCBS) are all examining different aspects of the legal framework for digital currencies. Some progress has been made. For example, in the field of anti-money laundering and combatting the financing of terrorism (AML/CFT), FATF has amended its international standard to address the specific features of "virtual assets." The FSB has issued a report setting out principles to guide the regulation of stablecoins. Most of the work in international bodies has focused on "public law" (eg the law of regulation). Efforts to examine private law issues and harmonise substantive law between jurisdictions remain less advanced.
Key legal issues related to digital currencies
A private law analysis of a particular cryptocurrency, stablecoin or CBDC will depend on the specific features of the instrument in question rather than the label attached to it. These features will be particularly relevant as to whether the holder of a particular instrument is a "creditor" or an "owner."
Can digital currencies be owned?
Although digital currencies are products of unique legal and technological engineering, a common feature is that each unit of currency is a distinct item of data that participants in the system treat as a transferable representation of value. It is intended to be a liquid asset whose essence and primary function is to be spent, like other kinds of money.
Depending on their design, digital currencies may, as a legal matter, differ from conventional forms of money, such as deposits in bank accounts. While both are incorporeal and may be manifested in digital form, the resemblance breaks down once we understand the legal nature of deposits in bank accounts and the role of the digital representation in this context. A digital ledger may record the balance of a person's holdings of bank money in an account but the "money in the account" is a legal right to enforce payment of a debt owed by the bank to the account holder. The digital record of the account is only secondary evidence of some other separate thing, which is the customer's right against the bank. With certain types of digital currencies, however, the item of digital data is the very thing itself. Evidence and entity are combined in the one thing. This is one reason why it can be difficult to fit them into conventional private law categories of thing or right.
Different systems of private law may take different views as to whether a digital currency can be owned. All depends on how the system recognises kinds of intangible property other than rights to enforce debts or obligations owed by another person. This differs across jurisdictions: some jurisdictions take a functional approach to ownership and may extend the concept of ownership to incorporeal assets that do not represent a debtor-creditor relationship, while other systems may limit the concept of ownership to corporeal/tangible things. Where digital currencies can be recognised as a form of property, possession of a private key granting access to the currency on a distributed ledger is an important indicator of ownership.
These distinctions do not hold up in all cases. Some digital currencies – for example, certain types of stablecoins - may be analysed as transferable kinds of debt (ie claim, not property): the holder of a stablecoin who is entitled to redeem the coin for a set amount of fiat currency may be considered a kind of creditor against the issuer of the stablecoin. Other instruments like bitcoin do not reflect a debtor-creditor relationship, and the data unit is the very asset itself. If the holder owns anything, it is a legally privileged power to "spend" the data by entering into transactions that will be recognised as valid according to the system rules and the law.
How do you transfer a digital currency?
When one holder transfers a digital currency to a new holder, the value represented by the currency flows between them. However, depending on the system's design, it may not be correct to say that the holder's ownership right is "transferred" with the flow of value. In such cases, when the "transfer" takes place, the data entry representing the transferor's currency is extinguished, and a new data entry representing the transferee's currency is made.
The data entries representing the value at each holder's public key are distinct entities. A new data entry represents the value at the transferee's public key. Whatever right the transferee has to the value at his or her public key may be newly created. What we call "transfer" of a digital currency may actually be a system for original, rather than derivative, means of acquiring rights in the asset. Depending on the rules governing the system, the recorded state of the ledger may be definitive about the legal effect of any "transfers" recorded on it. Private keys are necessary to exercise ownership rights: typically, once the private key is lost, all practical capabilities to transact with that unit of data are lost and to a certain extent the asset ceases to exist.
The legal consequences of such a system have to be carefully considered and may vary between jurisdictions. Under one approach, a person who the ledger recorded as the holder of the currency would have a secure legal title to it. The holder's title would not be subject to hidden, off-ledger defects (eg theft) which might affect its exchange value. This kind of ownership analysis would ensure that every unit of the currency was equivalent in exchange to every other. The currency would be fungible in its exchange value as well as its nominal value.
When is a payment in digital currency final?
There are system-based and legal dimensions to the way in which payments with digital currency may be explained.
For a payment in digital currency to be considered final, the changes in the ledger that record the transferee as a new holder of the currency need to be complete so that the transferee, as a practical matter, is in a position to make a new transaction with the digital currency without the risk of the previous transaction being reversed. Identifying this moment on a distributed ledger that relies on a consensus-based validation process may not be easy as it may take time for consensus amongst the nodes in the system to be reached. This issue is distinct from the legal question in some jurisdictions whether a payment between two parties needs to be accepted by the recipient in order to become final, and what constitutes such acceptance. It should not be necessary to insist on specific acceptance as a separate legal requirement for payments of digital currency to be final through a ledger system. The payee's participation in the system should be enough to signal his or her acceptance of digital currency that it transferred to his or her public key. There is an analogy here with the operation of automated bank payment systems. Payment can be considered final and a debt of the payer discharged even before the payee realises that the credit has been made to his account.
Financial stability aspects
The financial stability issues associated with digital currencies require closer examination by lawyers and policy makers, particularly in the areas of insolvency and deposit insurance.
As a matter of legal design, digital currencies could either be held in wallets maintained by various types of service providers or in the form of deposits held with banks. The legal consequences of these two models differ considerably. In the first case, the customer continues to own the coin while in the latter the ownership is transferred to the deposit taker. In a wallet-based model, the customer, as owner, is not exposed to insolvency risk but possibly to the risk of fraud by the wallet provider. In contrast, a depositor with a bank is a creditor to the bank exposed to the risk of its insolvency.
If the two arrangements were to exist side by side, deposits would generally be less expensive, and consequently more common, than wallet provision because they would allow deposit takers to employ deposited funds for other purposes, such as lending, whose profits could be used to cross-subsidise deposit-taking. The co-existence of both models could however create the preconditions for bank runs on deposit-takers. This raises the issue of whether the maintenance of stability of deposit takers of digital currencies would require extending deposit insurance coverage to deposits of digital currencies. On the other hand, the extension of insurance to wallet structures would raise a number of fundamental concerns, since the insurance would be covering both the fraud risk of the wallet provider and the stability risk of the digital currency issuer.
Extending deposit insurance to deposits of digital currencies would also be necessary if digital currencies – particularly, stablecoins – were to become so widespread that they de facto circulate as a universal unit of account and medium of exchange. If stablecoins were to become such an important feature of a domestic monetary system, policy makers would need to monitor their growth and, when appropriate, subject the respective issuers and operators to regulation. These entities could be required to contribute to the funding of any applicable insurance scheme.
The most appropriate solution to these questions will ultimately depend on the risk appetite of policy makers and private firms. Private firms are likely to be more inclined than policy makers to take on risks whose consequences may require the commitment of public resources.
In assessing the magnitude of the systemic risks that may flow from cases in which a cryptocurrency such as bitcoin becomes widely adopted in a jurisdiction's financial system, it is important to distinguish between two separate potential functions of the asset: as a store of value and as a means of payment.
An analysis of a global stablecoin's legal structure raises design questions that are important for financial stability: in particular, the right of coin holders to enforce a claim against the reserve in the event of the issuer's insolvency. The answer to this question depends on the design of the stablecoin itself.
Digital currencies and legal tender
An important question related to the emergence of digital currencies concerns the circumstances in which they may or should be treated as legal tender under national law.
There is no universally accepted definition of legal tender but the concept typically includes the following core properties: (i) a legal tender of currency that is accepted in payment by a creditor has the effect of discharging the financial obligation for which it is made; (ii) a creditor that refuses to accept a legal tender of currency will, at the very least, be precluded from exercising all or part of his or her rights to enforce payment (eg no action in court, no default penalties, etc); and (iii) the discharge takes effect in the unit of account provided for in the law and at nominal value of the amount paid. Throughout history, legal tender status has typically been accorded only to tangible monetary objects – that is, banknotes and coins issued by the state. However, some jurisdictions have taken a more expansive approach and, subject to certain conditions, have extended legal tender status to certain types of money in non-physical form (eg in Switzerland where central bank reserves are one form of legal tender).
The conferral of legal tender status on a particular monetary object, by definition, requires a legal act – typically, the enactment of legislation. Historically, different approaches have been taken in the design of legal tender legislation. At times, jurisdictions have taken a "repressive" approach that penalises parties who do not use or who refuse to accept a legal tender of currency. Other jurisdictions, under the "exclusive" approach, require the use of monetary objects that possess legal tender status and preclude parties from agreeing to other forms of payment but do not impose penalties for the failure to do so. Under the "indicative" approach, jurisdictions grant legal tender status to particular monetary objects but allow parties to contractually agree to other forms of payment. Finally, some jurisdictions take the "privileging" approach that does not grant legal tender status to particular monetary objects but creates incentives in legislation to promote their use. History shows that the higher the intrinsic quality and stability of a jurisdiction's monetary framework and public finances, the lesser the need to resort to repressive legal tender legislation.
In principle, it would be open to a jurisdiction to accord legal tender status to digital currencies that are either issued by the state or by private parties. There are already jurisdictions that, under certain circumstances, grant legal status to deposits held with the central bank (for settlements between commercial banks) or deposits held in commercial banks. But there are limitations that should be kept in mind in considering the conferral of legal tender status on digital currencies. In particular, legal tender status may not be appropriate for monetary objects that are not issued by the state and, accordingly, bear credit risk – eg stablecoins or a cryptocurrencies. Moreover, it may not be appropriate to grant legal tender status to any form of digital currency – whether public or private – whose use requires access to technology that may not be universally available in the relevant jurisdiction.
In any event, the conferral of legal tender status on a digital currency such as a CBDC does not necessarily guarantee wide adoption by the general public. Features such as convenience and inclusion could make CBDC more attractive for the user compared to commercial bank money and thus acquire the status of quasi legal tender. In addition to legal tender status, legal issues such as privacy and price stability are important.
Conclusion
Jurisdictions are devoting a great deal of attention to their legal frameworks to address the specific features of different types of digital currencies. While progress is being made, there is more work to be done. The legal design choices that can be made in response to the issues highlighted in the webinar would have consequences for the way in which digital currencies are treated in relevant jurisdictions. In charting the course ahead, an active dialogue between lawyers and policy makers is essential.
1 Mr Helio Vale, Adviser, BIS Innovation Hub, and Ms Dung Tran, Administrative Secretary, FSI, BIS provided invaluable support in organising the webinar. This summary document was prepared by Ms Codruta Boar, Adviser, BIS Innovation Hub.