In July this year the European Central Bank officially launched its digital euro project, marking the end of the ‘examination phase’ and the beginning of an ambitious two-year ‘investigation phase’, with the potential to launch in five years’ time. This takes the ECB one step further than the 86% of central banks said to be researching central bank digital currencies. While this may sound superficially slow, there are multiple wicked problems to solve.
Unlike the Federal Reserve, which remains sceptical that a digital dollar would solve any major problem confronting the US payments system, the ECB’s key motivations for considering a digital euro are to preserve citizens’ ability to use central bank money and to protect its monetary sovereignty.
The concerns stem from the use of cash decreasing to the point where it is no longer universally acceptable, removing individuals’ access to convert electronic retail money into central bank money. This could create significant instability during a financial crisis and remove a key pillar of the monetary system. There are also concerns of crowding out by foreign CBDCs or payments solutions by foreign companies, such as stablecoins, displacing the euro.
However, cash is only gradually declining in the region. It remains the most used instrument in the euro area for retail payments. In comparison, cash as a share of all payments has fallen below 50% in most nations in Asia (bar Japan), the US and UK.
While reducing dependence on private money is a key motivation, the ECB will be tasked with striking a fine balance between providing the digital euro as an option for consumers and not crowding out the private sector.
Last year, the ECB’s experimentation established two important points. First, the functional approach to design will not be restricted by technology, meaning that the choice of ledger and potential privacy requirements can be shaped entirely by policy objectives. Second, the ECB cannot offer unlimited CBDCs to consumers as it is incompatible with negative interest rate policy. A future CBDC will very likely have limits on holdings or tiered remuneration assigned to every wallet.
The investigation phase will need to develop a business model that is just successful enough to encourage both intermediaries in the retail payments industry to promote it and consumers to adopt it, while not being so successful that it stifles competition and innovation in the private sector.
Furthermore, unlike cash, where the state employs one operator for printing purposes, the Eurosystem will likely aim to balance ensuring they do not give undue preferences to certain providers with providing the best solution for consumers.
Beyond these trade-offs, the ECB’s High-Level Task Force on a digital euro will also begin exploring the legal requirements surrounding implementation. It remains to be seen whether this will involve using existing rules, amendments or an entirely new treatment. If the European Commission decides to change legislation, we can expect this to create delays to the five-year timeline given the amount of time legislative processes take. For the digital euro to be a reality in five years, intensive dialogue between legislators and the ECB will be paramount. The ECB also knows that social attitudes to digital identity and privacy will need to be incorporated into the design but balanced with regulatory requirements. Like law, this is a contingent issue for CBDC committees which extends beyond the – already growing – remit of a central bank.
The ECB intends to solve these challenges with extensive and early stakeholder engagement. The Digital Euro Market Advisory Group’s work will start this October. MAG is comprised of business practitioners acting in a personal capacity to determine the value a digital euro could add for different stakeholders (such as consumers, merchants and payment service providers). Views discussed in MAG will then be explored by the Euro Retail Payments Board, established in 2013, to promote institutional dialogue on retail payments.
It’s already clear that the ECB, like the Bank of England, will make a point of leaning against private-sector rent-seeking in this space and encourage a multi-party public-private system, and not for a while yet.
