The recent report of the European Central Bank on a digital euro: How should you interpret it?
Authors: Alexander Bechtel, Jonas Gross, Philipp Sandner
The European Central Bank (ECB) has recently published a report on the digital euro. The report defines scenarios under which a digital euro will be introduced and specifies principles and requirements a digital euro would have to comply with. In this article, we evaluate the ECB’s report and discuss its three most important aspects that should help with the interpretation of the report.
Summary of the report
On October 2, 2020, the European Central Bank (ECB) published its long-awaited report on the digital euro, a central bank digital currency (CBDC) for the euro area. The ECB addresses the topic against the background of its mandate. Therefore, it intends to create a digital form of cash for European citizens rather than a programmable form of money for the European industry. We argue, however, that in its current form outlined in the report, the ECB’s digital euro lacks core features of physical cash such as being token-based, not remunerated, and anonymous.
In its report, the ECB stresses that it has not yet decided whether to launch a digital euro but that “we need to be ready to introduce a digital euro, shall the need arise” (p. 2). The report defines principles and requirements that need to be fulfilled if a digital euro will be introduced one day. The ECB notes that a digital euro could support the euro area in achieving the following objectives: providing citizens access to a modern form of money, driving innovation and digitization, and offering an alternative to foreign payment providers.
The ECB defines the following scenarios, from which the need for a digital euro might arise: First, the digitalization of the European economy should be supported. Second, a digital euro could be a response to a significant decline in the use of cash as a means of payment. Third, a digital euro could be required if there is a significant potential for foreign CBDCs or private digital payments to become widely used in the euro area and, therefore, to partly replace the euro as a means of payment (e.g., the Libra payment infrastructure, China’s DC/EP system, a CBDC for the US dollar). Fourth, a digital euro could provide a new transmission channel for monetary policy. Fifth, a digital euro could mitigate the risks that a cyber incident, natural disaster, pandemic, or other extreme events hinder the provision of payment services. Ultimately, a digital euro could improve overall costs and the ecological footprint of monetary and payment systems.
Besides, defining scenarios for a digital euro, the ECB also discusses risks that could emerge from a digital euro, e.g., related to financial stability, regulation, IT security, capital flows, the euro exchange rate, and currency substitution in developing economies. The ECB stresses that such risks have to be prevented and defines key design dimensions a digital euro has to fulfill to prevent such risks.
Three aspects how to interpret the ECB’s report on the digital euro
1. The ECB’s digital euro does not mimic digital cash
The ECB’s report states that a digital euro should constitute a digital form of cash. Therefore, one would expect that the ECB’s digital euro mimics physical cash as closely as possible. However, this is not the case. The key dimensions of the digital euro discussed in the ECB report vary substantially from the basic features of cash.
First, cash is a bearer instrument and a token-based form of money. Second, cash is not remunerated, i.e., it carries no interest. Third, cash enables transacting anonymously, at least up to a certain threshold (for instance, 10,000 euro in Germany). The ECB does not commit to any of these three properties. Instead, it leaves room for the ECB’s digital euro being account-based, interest-bearing, and without anonymity features.
2. The ECB neglects programmability features for the digital euro, which makes it less useful for the industry and for targeted fiscal and monetary policy
In the past months, programmability of money has caught a lot of attention. The “digital programmable euro” that could be based on or strongly interlinked with a DLT is a term that is widely used to indicate the usability of the euro for DLT-based business processes and targeted fiscal and monetary policy (see here for a clear definition of the programmability of money and payments). For instance, the DLT-based euro could be used to pay for tokenized assets without any friction or delay, allowing seamless delivery vs. payment. Many industry participants desire a digital programmable euro to provide these capabilities. Moreover, the programmable euro could be used to implement targeted aid payments during crises such as the current COVID-19 pandemic.
However, the ECB does not put any emphasis on programmability or the use of DLT. It has not made any decision about whether the digital euro should be issued on a DLT or whether it could or should be programmable. The fact that the term “programmability” is mentioned only twice in the whole report shows that this topic has no priority in the ECB’s current discussions.
While it is unfortunate that the ECB does invest more efforts into analyzing potential advantages of offering a programmable euro, the private sector might be able to step in. For example, individual financial institutions or consortia of banks or of non-financial private companies (such as the Libra Association) could decide to issue money on DLT networks that is pegged to or even backed by the euro from the ECB (i.e., central bank money). Such a private digital programmable euro could potentially be launched earlier than the digital euro of the ECB, which — according to experts — would most likely not be launched before 2026. This, however, might be too late to satisfy the demand from the industry, which is likely going to increase in the coming months and years.
3. Intermediaries would continue to play an important role after the introduction of the ECB’s digital euro
Even if the ECB remains vague about a concrete design of a digital euro, first tendencies about the setup were revealed. The ECB does not intend to crowd out commercial bank money and take over the deposits and payments business from the banking sector. Instead, it aims for a public-private partnership in the form of a two-tiered CBDC system so that a setup for a ECB’s digital euro would benefit from the comparative advantages of both the private and the public sectors.
The private sector (i.e., banks or other regulated intermediaries) is responsible for innovating and building intelligent solutions for end users. This includes the selection of a proper technology, data management, regulatory compliance as well as customer onboarding, management, screening, and monitoring (including KYC and AML/CFT processes). The public sector (i.e., the central bank) focuses on regulation, supervision, and financial stability. In other words, the central bank seeks to support innovation and it makes sure that it happens within the borders of a regulated environment.
In order to enable this partnership, the ECB might have to restrict access or disincentivize the use of the digital euro. Otherwise, introducing a CBDC (a risk-free means of payment and store of value) might lead to large shifts of deposits from banks into the digital euro. This could lead to a disintermediation of the banking sector. Particularly in times of crises, the option to store wealth in a risk-free and liquid asset with a central bank’s asset might lead to “digital bank runs”. Against this background, the ECB considers implementing restrictions for the use of the digital euro, either through a cap for CBDC holdings or a tiering of interest rates.
It is understandable that the ECB starts from its mandate when thinking about design dimensions of the digital euro. However, only looking at the mandate neglects the view of the end users, i.e., the hundreds of millions citizens and dozens of millions organizations in the euro area. The question arises, who is supposed to use the ECB’s digital euro and for what reasons? In its current form, the ECB’s digital euro might neither cater to the needs of European citizens nor to the needs of the European industry. The former needs true digital cash in the form of a non-interest-bearing digital bearer instrument with anonymity features. The latter needs programmable payments. It is not necessary that the ECB’s digital euro solves all use cases at once, but the ECB should at least have one clear use case in mind when discussing design considerations.
While the report lacks a clear orientation on this regard, the ECB is at least aware of this: The report states that “[c]ommunication with prospective end users and with the supervised intermediaries that could be involved in the provision of services is crucial to assess the actual business case for issuance” (p.45). It is crucial to have the end users in mind who should in several years use the digital euro. Until mid-2021, the ECB will be conducting a consultation process to gather feedback from prospective users, regulators, and policy makers. Only then, the ECB will announce whether a digital euro will be introduced.
Alexander Bechtel is a research and teaching assistant at the Swiss Institute of Banking and Finance at the University of St. Gallen. His research focuses on monetary policy, safe assets, and digital currencies. Alexander publishes one of the leading German podcasts about digital currencies, called “Bitcoin, Fiat & Rock’n’Roll”. You can find more information including contact details and social media profiles at https://alexanderbechtel.com/.
Jonas Gross is a research assistant at the University of Bayreuth and project manager at the Frankfurt School Blockchain Center. His research focuses primarily on central bank digital currencies (CBDCs) and stablecoin projects such as Libra. You can contact Jonas by mail (email@example.com), LinkedIn, and Twitter (@Jonas__Gross).
Prof. Dr. Philipp Sandner has founded the Frankfurt School Blockchain Center (FSBC). In 2018 and in 2019, he was ranked as one of the “top 30” economists by the Frankfurter Allgemeine Zeitung (FAZ), a major newspaper in Germany. Further, he belonged to the “Top 40 under 40” — a ranking by the German business magazine Capital. Since 2017, he is member of the FinTech Council of the Federal Ministry of Finance in Germany. The expertise of Prof. Sandner includes blockchain technology in general, crypto assets such as Bitcoin and Ethereum, the digital programmable euro, tokenization of assets and rights and digital identity. You can contact him via mail (firstname.lastname@example.org) via LinkedIn or follow him on Twitter (@philippsandner).