The idea of issuing a central bank digital currency (CBDC) is too attractive to ignore, a postdoctoral researcher from the University of Luxembourg wrote in a study. The research was shared by the Oxford Business Law Blog on Friday, Feb. 22.

Hossein Nabilou, a postdoctoral researcher at the Faculty of Law, Economics, and Finance of the University of Luxembourg, presented his findings in a study entitled “Central Bank Digital Currencies: Preliminary Legal Observations.” The report focused on potential challenges that launching a CBDC might cause for the European Central Bank (ECB).

According to Nabilou, cryptocurrencies have significantly impacted the banking sector. He writes how their functionality, similar to money issued by a central bank, first drew banks’ attention. Banks were also preoccupied with the idea that cryptocurrencies could ruin their monopoly on controlling the circulation of money and influence the stability of existing financial systems, Nabilou believes.

Thus, CBDCs can be treated as a policy response to the growing popularity of cryptocurrencies, he continues. Despite the prevailing scepticism towards crypto and several failed attempts to launch a state-backed coin, such as the Venezuelan Petro, central banks are actively studying the technology behind digital currencies. Some of them even have the possibility of launching a CBDC in their agenda, the researcher writes.

However, if the ECB launches a digital currency, it might lead to banking disintermediation, Nabilou continues. Customers will get direct access to the central bank’s balance sheets, and consequently there will be no reason for them to hold balances within a commercial bank, which might lead to overall banking sector instability.

Moreover, such a move would centralize the credit allocation and undermine the principle of an open market economy with free competition, violating the constitutional constraints set by the EU. For those reasons, the ECB is unlikely to issue a CBDC unless the appropriate regulations are introduced, Nabilou concludes.

Venezuela was one of the first countries to launch a state-backed coin in 2018. Despite the efforts taken by the government, the Petro has seemingly failed to help bail out the country’s economy. Several banks in Iran have also supported a gold-backed digital currency dubbed PayMon, while Egypt is still considering a possibility of launching a CBDC.

Some central bank officials have publicly shared Nabilou’s view on CBDCs. For instance, South Korea’s central bank has recently issued a warning over CBDCs, stating that they would result in mass withdrawals of funds from private institutions, squeezing liquidity and pushing up interest rates.