Scholar evaluates ways to structure and regulate retail CBDCs to promote consumer protection.
Is the United States on its way to a cashless economy?
About 41 percent of Americans already report making all their regular weekly purchases without using cash. That number would likely only increase if the federal government were to follow several other countries that have started experimenting with central bank digital currencies (CBDC) as an alternative, intangible legal tender.
But in a recent article, Steven L. Schwarcz of Duke University School of Law argues that although CBDCs may be new, they raise many of the same considerations as traditional paper money. He proposes ways to structure these digital currencies in the United States to provide necessary consumer and privacy protections.
CBDCs are electronic currencies that are “sponsored by governmental central banks,” Schwarcz notes. He explains that wholesale payments, which are “payments among businesses and financial institutions,” are already rendered through digital transfers. Retail payments made by U.S. consumers have traditionally been made using cash, but with CBDCs, retail transactions could be rendered digitally as well.
Schwarcz claims that CBDCs are desirable because they provide an opportunity to “improve the speed and efficiency” of retail payments and to “broaden financial inclusion.” He emphasizes that if the United States is going to issue CBDCs efficiently, however, it should be structured in a way that uses existing commercial bank technologies.
CBDCs could be structured as a token-based or account-based system, Schwarcz explains. A token-based CBDC involves the central bank issuing currency represented through digital coins. Transfers of these tokens are then executed and recorded through smart contracts, or programs that run on a blockchain network. Transactions recorded on the blockchain are anonymous and could thus strengthen consumer privacy.
Unlike token-based CBDCs, account-based currencies are represented as electronic bank claims, and transactions are recorded through bank book entries.
Despite advantages that token-based currencies can promise to some users, Schwarcz argues that a retail CBDC in the United States should be structured as an account-based system instead. The decentralized nature of a token-based system is not conducive to CBDCs because it would limit the central bank’s ability to “maintain surveillance and control,” he claims.
Furthermore, Schwarcz contends that central and commercial bank infrastructures already operate using an account-based system for wholesale payments, so account-based CBDCs would be able to operate on technologies that commercial banks already use. In turn, this retail CBDC structure would be less disruptive to financial institutions, Schwarcz suggests.
In addition, an account-based structure would help mitigate security concerns, Schwarcz argues. Security issues are implicated by CBDCs because digital currencies provide governments with centralized monetary data. If a bank suffers a security flaw, for example, then citizens’ monetary data are vulnerable. By using commercial banks’ technology, however, an account-based structure ensures that monetary data are not completely centralized. The data will be distributed among the central bank and commercial banks, so a security flaw at one bank will not be detrimental to the data stored at other banks.
Furthermore, account-based retail CBDCs would use the same technology that commercial banks use to make wholesale payments, so account-based CBDCs would also be regulated under the framework governing wholesale transfers—Article 4A of the Uniform Commercial Code.
Article 4A governs digital funds transfers and outlines how to “allocate rights and obligations” between parties. Its requirements would be equally applicable to digital transfers in the retail context, Schwarcz claims. Wholesale payments are not made by consumers, however, so Article 4A does not take into account consumer protection.
A new regulatory framework for retail CBDCs thus should be created to implement legal safeguards for consumers using this new technology, Schwarcz contends.
Schwarcz argues in favor of a legal framework for retail CBDCs that would incorporate aspects from Article 4A and the Electronic Fund Transfer Act (ETFA), which controls “retail digital funds transfers.” Unlike Article 4A, which was written for businesses, the EFTA’s primary purpose is consumer protection. The EFTA carries out this purpose by requiring that banks “inform consumers of their rights” and “protects consumers from being charged excessive fees.”
The EFTA also limits consumer liability by providing safeguards for when consumers accidentally disclose information that leads to unauthorized transactions. Schwarcz explains that if consumers make such mistakes, they will only lose a maximum of $50 per mistake if they notify their banks of an unauthorized transaction in a timely manner.
Because of the technology and nature of the parties involved in retail transactions, retail CBDC regulation would best be served by employing guidelines from both Article 4A and the EFTA, Schwarcz concludes. As society becomes increasingly cashless, this approach would help ensure that consumers are sufficiently protected.