Digital euro — Status and perspectives
The euro is going digital. Not tomorrow, but the day after tomorrow. We will see that the ECB has made the decision and is working on it. The digitization of the second world currency is not a small challenge, as it is used in 19 countries, from Cyprus and Malta to Finland, France and Germany, which have very different economic profiles. Considering money, the central pillar of any economy, is a very interesting exercise that raises the question of what functions it must fulfill within its territory but also beyond. Let’s find out in this article.
How far is the ECB?
The physical euro, which has just celebrated its 20th anniversary, has established itself as the second reference currency behind the US dollar, which is logical given the size of the eurozone economy. The twenty countries in the eurozone are, as a reminder, Germany, Austria, Croatia, Belgium, Cyprus, Spain, Estonia, Finland, France, Greece, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, the Netherlands, Portugal, Slovakia and Slovenia. While China and Sweden have been working specifically on a CBDC (Central Bank Digital Currency) since 2014 and 2017 respectively, the ECB only publicly announced a potential one after the publication of research work in 2019 and its Digital Euro Report in 2020 voiced digital euros. Finally, in July 2021, the ECB announced the launch of a digital euro project.
As part of a two-year investigation phase, which is therefore still ongoing, analyzes of the fundamental aspects of the digital euro will be carried out as a first step. The focus in the preliminary investigation phase is on identifying use cases for the digital euro. Further tests will be carried out to determine the technological basis to be used, in this case a decentralized or a centralized digital register, possibly a system combining both. In addition, the role of commercial banks in such a system is also examined; this is an important topic.
The digital euro will not be available until 2026 at the earliest, according to the personal assessment of ECB President Christine Lagarde and statements by the ECB at the beginning of the project (Siedenbiedel, 2021; ECB, 2021b). This time horizon is comparable to other similar projects worldwide. China started to work on its digital yuan in 2014 and rolled it out in four test cities in April 2020. However, it is imperative to equip the European economy with one or more digital currencies in order for the digital economy described in the following chapter to develop. This is exactly what has been happening in China for the past two years without much media coverage. This puts China one step ahead of all other countries in monetary terms. It’s like we’re still paying with checks and cash while China is already using credit/debit cards. Not striving for a digital currency or, better yet, for digital currencies would be like ignoring the Internet in the mid-1990s: nonsense. We will explain this further in the next chapters.
In terms of means of payment, the ECB’s mission is to provide the euro area’s 350 million inhabitants with the right tools, to ensure their security and to adapt to changes in customs, technology and the economy. The ECB is therefore closely monitoring these three variables and is of course aware of the development of cryptocurrencies, the adoption of Bitcoin by El Salvador and the Central African Republic, advances in China, etc.
It is important to understand that a programmable euro — a euro-denominated means of payment that enables programmable payments — is not a new currency: it is still the euro that we already know and use today. What is new is that this euro is managed in a digital register on which other operations take place, allowing the digital economy to emerge. If a decentralized digital registry is used, the programmable euro would not be registered in a central database as is currently the case, but would be based on a blockchain that would be accessible via private keys maintained in wallets of organisations, machines and individuals. This sets a programmable euro apart from cryptocurrencies, which were designed from the outset as independent and disruptive payment instruments at the edge of the system. The energy consumption of a blockchain-based euro would be significantly lower than Bitcoin because it would use either a centralized digital register or a partially decentralized register designed not to incur a particularly large amount of electricity since PoW only makes sense in fully decentralized systems. Only certain well-identified participants will be able to validate the transactions, so they don’t have to compete with energy consumption to get that right.
Now, let’s quote the ECB’s website to learn a little more about their progress: “With the increasing use of digital and mobile technologies, everyday payments are also undergoing a profound transformation. As people increasingly switch to digital payment methods, access to central bank money must be guaranteed all the time, for everyone. Because central bank money is the cornerstone of our common currency, the euro, its development is key to strengthening the euro area’s strategic autonomy and efficiency of payments. Central bank money is currently only available to the public in the form of cash. In a digital world, it could therefore be supplanted as a means of payment. A digital euro would be a central bank-issued electronic currency that would be accessible to everyone in the euro area. This would maintain the stabilizing effect of central bank money in payment transactions.”
“Even a digital euro would be a euro — just like banknotes, but digital. It would be issued as money in electronic form by the Eurosystem (the ECB and the national central banks of the euro area) and could be used by individuals and businesses alike. It would not replace cash, but supplement it. It would make paying easier, contributing to accessibility and inclusion. With a digital euro, everyday payments could be made quickly, easily and securely. One of the main objectives of a digital euro issued by the Eurosystem is to provide a monetary anchor and thus a public good in the digital age. It could boost financial innovation and improve the overall efficiency of payments. The success of the digital euro will depend on whether people in Europe use it on a daily basis. The decisive factor will therefore be how it will be designed. It must offer added value compared to existing solutions. Eurosystem experts have defined some basic requirements for a digital euro. For example, it should be easily accessible, robust, secure and efficient, data protection should be protected and applicable law should be observed. We will use these cornerstones as a guide when designing the digital euro. For many years, central banks have provided the monetary base (e.g. cash) and the private sector has provided payment solutions (e.g. credit cards) to customers. As a digital euro would ultimately be backed by the ECB, this combined model could remain in place. Citizens could exchange private money (i.e. commercial bank money) for public money (i.e. central bank money) at any time and pay with central bank money.”
The ECB’s website reads as follows (as of 1 August 2022): “Discussions are currently taking place as part of the investigation phase on what a digital euro could look like. This investigation phase started in October 2021. It will last around two years and will therefore be completed in October 2023. We are examining what a digital euro could look like and how it could be made accessible to retailers and individuals. We also examine what impact it would have on the market and to what extent European legislation may need to be changed. Once the investigation phase is complete, we will decide whether to start developing a digital euro.”
The conclusion of the speech on June 15, 2022 in Brussels by Fabio Panetta, Member of the ECB Executive Board and Head of the Digital Euro Project, helps us to understand how the ECB wants to shape the digital euro: “We are designing a digital euro that enables central bank money to be used for digital payments. We are giving people in Europe a digital means of payment to do their everyday shopping anywhere in the euro area, supporting Europe’s societal goals. Digital money issued by the central bank and available to all would be an anchor of stability for the payments market. Central bank money and private money would continue to co-exist. Financial intermediaries will play a key role in the delivery of the digital euro. We are working to counteract at an early stage any possible undesirable consequences that the issuance of a digital euro could have on monetary policy, financial stability and the allocation of credit to the real economy. As a legislator, you will play an important role in ensuring that the necessary regulatory framework for both public and private forms of money is in place in the digital age. For my part, I will update you at regular intervals on the progress of our investigation phase.” In summary, the ECB wants to create a currency with the digital euro that combines three fundamental advantages: the protection of privacy and the universal availability of cash, the security of a central bank currency and the many innovations that a purely digital currency offers. It can be assumed that it will take a long time before cash disappears completely, if at all, but that the digital euro will bring so many advantages that a growing part of the population and organisations will adopt it voluntarily.
The future role of commercial banks
The ECB has so far pointed out in their publications that intermediaries, such as commercial banks, have to play a key role in the upcoming digital euro. First, it will be possible for online banking services and applications to use this digital euro. Banks can also take over the distribution of the digital euro, teach individuals and companies how it works, fight money laundering and carry out identity checks. Commercial banks have been performing these tasks for many years and have extensive expertise and data that the ECB would like to have access to. They could also issue their own digital euro, which would be equivalent to, and of course compatible with, the ECB’s digital euro, with the risk that consumers could turn away from it and prefer the original, or that “digital bank runs” could occur if commercial banks fail. The benefits of letting commercial banks issue their digital euro, which will be collateral-based, are that it would take some of the pressure off the ECB’s network, especially if it were centralized, that the disintermediation of commercial banks would be avoided, and that it would be a form of digital euro ahead of the time that the digital economy so desperately needs, as commercial banks would issue an “unofficial” digital Euro before the ECB’s one.
These are fictitious offers.
Eurozone citizens and organizations are therefore likely to have a choice between the safe and official euro of the ECB and that of commercial banks and other financial institutions powered by the digital euro. In order to make their euro more attractive compared to the official euro of the ECB, commercial banks may pay a small interest rate to the holders, as can be seen in the above table.
The potential benefits of a digital euro for the ECB and the European economy
The digital euro could be created for the following reasons:
⦁ to promote the digitization of the European economy and the strategic independence of the EU
⦁ in response to a sharp decline in cash use
⦁ to avoid the widespread use of foreign central bank digital currencies or private digital payment services in the euro area
⦁ as a new transmission channel for monetary policy
⦁ to mitigate risks to the normal provision of payment services
⦁ to strengthen the international role of the euro
⦁ to reduce the overall cost and environmental footprint of money and payment systems.
Let’s go through these points in detail.
Promoting the digitization of the European economy and the strategic independence of the EU
This point is obviously fundamental. In terms of strategic independence, it is important for us Europeans to become less dependent on PayPal, Apple and Google Pay, Visa, Mastercard and American Express, since they are all American companies.
The sharp decline in the use of cash
One of the reasons why the ECB is considering launching a central bank digital currency is the declining importance of cash as a means of payment in the Eurozone and the concomitant declining influence of the ECB on payments as it manufactures the coins and banknotes and provides them to companies and commercial banks. The proportion of cash transactions is declining both in the EU (74% in 2017, 60% in 2020; Pietrowiak et al., 2021) and in Germany (79% in 2016, 73% in 2019; ECB, 2020c.). It’s important to mention Germany when it comes to cash payments, not only because it’s Europe’s largest economy, but also because Germans are still disproportionately attached to cash. There are lots of small businesses in Germany which still only take cash mostly because they are not willing to pay high Visa or Mastercard fees to accept these means of payment. However, the pandemic has accelerated the downward trend in cash payments as online commerce has gained prominence after the closure of a significant portion of physical stores and cash has also been shunned as a potential vector of the virus. So the overall use of cash is declining and this trend is sometimes encouraged by companies and/or States in Europe and other areas.
Monetary sovereignty
The use of private sector payment methods such as mobile phone and credit card payments has increased significantly, and these are often non-European services. The proportion of credit card transactions in Germany rose by 14% between 2018 and 2019, a revolution in a very cash-bound country (Statista, 2021). The establishment of a central bank digital currency should therefore primarily serve as a complement to cash and strengthen the role of the ECB vis-à-vis the private sector, since we cannot allow stablecoins, bitcoin, or other fiat currencies in digital form to replace the euro.
The new transmission channel of monetary policy
The ECB’s monetary policy could run through the digital euro. Technically, it could be programmed in the digital euro. This could be an opportunity to question the centralization of European monetary policy and be inspired by new models, as we will see in the Marshall Islands SOV.
Mitigating the risks to the normal delivery of payment services
Cash can be forged and payment services hacked, which could be avoided if we design the future digital euro well and decentralize it a bit. In general, digital money obviously does not need to be transported, manually counted, secured, etc., eliminating many costs and steps where errors or hacks can occur.
Strengthening the international role of the euro
What if the future digital euro served as a payment infrastructure for exchanging money outside the eurozone? Indeed, it is designed to be inexpensive, efficient and practical to use. Instead of exchanging tugrik (the currency of Mongolia) for rubles or baht for ringgit (the respective currencies of Thailand and Malaysia), companies, NGOs or even States could use the future digital euro to transfer value between two different currency groups. Some cryptocurrencies like Ripple offer that, so why not the ECB? This would make the euro a tool for international monetary power. If the ECB doesn’t do this, the US Federal Bank or the People’s Bank of China could make their currency available as a stablecoin for payments outside their territory. We could then witness a clash of CBDCs serving as a means of payment outside of their “normal territory” and thus as a tool of influence for the issuing countries.
Reduce the overall cost and environmental footprint of money and payment systems
A digital euro would be less resource-intensive than the creation of coins and banknotes and would make it possible to create a computer system using current technologies, optimized in terms of energy consumption. It would be a centralized or partially decentralized, highly scalable and secure system that would obviously not be based on proof-of-work.
The ECB also mentions the environmental aspect, the scalability and the insufficient performance of the blockchain in this area: “Both the processing of TARGET Instant Payments (TIPS) of the Eurosystem and other solutions, such as the blockchain, have proven to be suitable to process over 40,000 transactions per second. Tests also indicated that architectures combining centralized and decentralized elements are possible. According to these experiments, a basic infrastructure for the digital euro would be environmentally friendly: in the tested architectures, the power consumption for carrying out tens of thousands of transactions per second is negligible compared to the energy consumption of crypto assets such as Bitcoin.”
Major players in the business world, such as accounting firms, are preparing themselves and their clients for the launch of a digital euro and are trying to figure out what benefits this could bring to their clients, as seen in this presentation by Ernst and Young Germany.
Source: EY Germany
What will happen to cash in the euro area?
Cash is a fundamental tool for democratizing the central pillar of our economies: money. It is important to remember that many people, even in developed countries, otherwise have no access to their money because they do not have a bank account or a bank account with very limited functions.
Cash has advantages that make it very valuable and difficult to replace, in descending order of importance:
⦁ Financial inclusion: by definition, cash can be used by anyone without having to identify themselves.
⦁ Protection of privacy: cash is obviously the ultimate anonymous form of money, not just in Hollywood movies.
⦁ Stability over time: if there is one form of money that has always existed, it is cash.
⦁ Sentimental attachment: cash is the only tangible money that exhibits all of the above properties such that it still evokes a sentimental or ideological attachment in a significant portion of the population.
⦁ The physical incarnation, which brings with it a certain security.
Cash, therefore, has a bright future ahead mainly thanks to the first two features on this list: financial inclusion and privacy. Can these properties be transferred to the digital world? This is one of the biggest challenges in implementing the digital euro. It will of course be accessible to everyone, but users still need to own a smartphone and know how to use the system. Of course, the digital euro will respect everyone’s privacy, although this cannot be guaranteed as everything that happens online can be tracked per se. Note that the ECB is talking about a digital euro that can also be used offline, as China has done with its digital yuan, and that inclusion, security and privacy are at the heart of the reflections and work currently being carried out by the ECB.
What could a digital euro look like before that of the ECB?
If we accept the idea that the digital euro is essential for the emergence of the digital economy and that we cannot afford to wait too long, then we can look at the solutions already exist or could come by 2026. Let’s look at three offers in chronological order of availability:
⦁ Stablecoins, i.e. cryptocurrencies, are already available. Most are pegged to the dollar, but the Eurocoin (EUROC) from Circle and Silvergate Bank, two American firms, was launched in July 2022 and could be the first serious stablecoin denominated in euros. The concern with stablecoins is that sometimes it is not known who is issuing them and whether an amount equal to their market capitalization is deposited somewhere as collateral. For example, 124 million Stasis Euros are currently in circulation, another Euro stablecoin. We don’t know if they are backed by an equivalent collateral, even in bitcoins. It is therefore unlikely that a central bank will accept them as legal tender as things stand. It would be a loss of sovereignty and reckless risk-taking. The ECB has taken a clear position on this: “Unsecured crypto assets, for example, cannot offer the same functions as money because they are neither stable nor scalable. Transactions are slow and expensive. And in some forms, they pose a threat to the environment and other societal goals. Stablecoins, however, are vulnerable to onslaughts, as we saw recently with algorithmic stablecoins. In this context, it is extremely important to close the regulatory gaps that still exist in the area of crypto assets.” Fabio Panetta, Brussels, June 15, 2022.
⦁ The systems for the digital economy described in the following chapter could already be developed on digital registers without digital currency, but would have to be linked to traditional payment systems, which would have the advantage that interactions between autonomous and intelligent machines could already take place. On the other hand, the disadvantage would be that the payments would not be made in real time and in the same system. A token could be introduced that would have no direct monetary value but would represent debts and receivables and trigger payments through the SEPA system.
⦁ A digital euro issued by companies specialized in issuing digital currencies and accredited by the ECB: those managing stablecoins today, or commercial banks. Then a decision would have to be made on the coverage of this digital euro to be requested from these companies and entities: one fiat euro for one digital euro, or less?
We can imagine that in the first few years the digital euro will exist alongside the cash euro we know, also in physical form, and that the ECB and commercial banks will be able to move citizens to the digital euro by providing them with a small interest and by highlighting its advantages: among others, the fact that it is programmable, which could allow users to benefit from automatic refunds or dividends, for example. Whatever form the digital euro takes, its various forms must be compatible with each other, regulators must make it a legal payment instrument, any digital euro not issued by the ECB must be backed by strictly regulated collateral and the new role of commercial banks must be clarified. We all need to engage in dialogue to lay the technical and regulatory foundations of the digital economy: governments and regulators, central and commercial banks, corporations and consumer organizations. The digital euro is a major challenge for the European economy to become more efficient, independent and competitive and, as we shall see, to become fairer, more transparent and more sustainable.
