Most ordinary Europeans haven’t even heard of plans to issue a digital euro. Even in the mainstream financial sector, people are at best lukewarm about the idea.
A key trigger for central bank digital currencies – the growth of private cryptocurrencies, including stable coins – has lost its impact now, as the crypto winter looks like it might become an ice age.
Nevertheless, the digital euro project is gaining momentum. The debate is already shifting from whether the European Central Bank (ECB) should issue digital currency, to how it should best manage the risks of doing so.
Indeed, in a process that brings back memories of the advent of the single currency itself 23 years ago, the digital euro – which the ECB intends for retail as well as wholesale use – seems unstoppable.
The ECB unveiled its initial plans on key design elements this autumn. Large banks and payments companies are likely to play a central role in distributing the currency to consumers and in processing transactions.
It is not a race, but as a matter of fact the euro area is at a relatively advanced stage in exploring a central bank digital currency
Christine Lagarde, ECB. Photo: Reuters
The central bank has jettisoned peer-to-peer validation in retail for now, except for low-value offline transactions used by people standing next to each other. The digital euro will not allow anonymous users, again except for low-value transactions.
Most importantly, the ECB will impose limits to individual holdings of the digital euro, perhaps €3,000 per person – as well as low interest rates or fees on digital euro accounts. This is to prevent unpleasant disruption in the existing financial system: the role of private banks in extending credit, based on fractional reserves, will be safeguarded.
The ECB now needs to decide who should pay for services such as checking against money-laundering and fraud. It also needs to look at the extent to which the digital euro could be used outside the eurozone.
Officially, the central bank has not decided whether or not to go beyond what it calls an investigative phase launched in late 2021. Nevertheless, the European Commission is preparing relevant legislation for the European Parliament and member states so that the ECB could move a retail digital euro to the pilot stage in late 2023.
“We don’t have all the answers, but we know that we’re on a path towards a digital euro,” Mairead McGuinness, commissioner in charge of financial services, said at a conference in early November.
A step ahead
The ECB’s readiness to go ahead with the digital euro project might be surprising given the largely theoretical arguments for it in the first place. The eurozone is not always quick to reform its financial sector. Economic and political heterogeneity, and the need for buy-in by each member state, often stands in the way of pressing changes, such as the completion of the banking union.
However, on retail central bank digital currency (CBDC), the eurozone is widely seen as being ahead of other currency blocs, except China.
There is clearly less consensus about the need for a retail digital currency at the US Federal Reserve than the ECB. In November, the New York Federal Reserve announced a 12-week wholesale CBDC pilot involving commercial-bank digital money, using distributed-ledger technology. Yet a retail digital dollar is still much further off than its euro equivalent, according to US think tank the Atlantic Council.
A digital defence against the death of cash
Policymakers are naturally at pains to say the digital euro, in retail form, is more than a technocratic project.
European commissioner for trade Valdis Dombrovskis has said there should be “an open, democratic process” around the plan, although voices pushing back against the entire project are less intense today.
At a European Parliament hearing on the digital euro in September, for example, questions focused on the European Central Bank’s decision to award a prototyping mandate to Amazon – not on the worth of prototyping in the first place. Four other mandates went to European firms.
Meanwhile, the first official argument in favour of issuing a retail digital euro in Frankfurt and Brussels is that the decline of cash could eventually threaten the ECB’s monetary anchor.
A digital euro, in other words, would help ensure that central bank-issued money remains fully convertible with the money created by commercial banks through credit, preventing a decline of trust in the system. That is despite insistence by the ECB that it will continue to issue cash anyway, and an assurance from the European Commission that it will clarify the legal-tender status of euro cash and ensure access to it.
“For most people all this is a very geeky and not very important,” says Grégory Claeys, a research fellow at Brussels think tank Bruegel.
He suggests most people don’t understand or care about the difference between public and private-sector money as it exists today.
It is no surprise, then, that of the minority of people who have heard of the digital euro project (about a third, according to a recent Eurobarometer survey), most of them don’t understand what it means. Many people don’t know, and don’t care.
But if officials in Brussels and Frankfurt appear determined to issue a digital euro for retail use, that doesn’t mean they are blasé about its potential impact on the stability and integrity of the financial system.
“Issuing a digital currency will have profound and systemic consequences,” Dombrovskis has warned. “This is a momentous decision that we cannot afford to get wrong.”
Fed chair Jerome Powell said in June that a digital dollar could help stave off the threat to the dollar’s standing from the launch of China’s digital yuan pilot in 2020. But Fed board member Christopher Waller reiterated he was “highly sceptical” in a speech in mid October, saying stability and US debt securities market liquidity, not technology, ensure the dollar’s global supremacy.
The Atlantic Council consequently puts the US, along with the UK, at an earlier research phase on CBDCs – still just thinking about it, in other words – while the eurozone is in what it categorizes as the next, development stage.
In the UK, a House of Lords economic affairs committee report published in early 2022 reinforced the case against a digital pound.
“We have yet to hear a convincing case for why the UK needs a retail central bank digital currency,” the report concluded.
Although the Bank of England has opened its real-time gross settlement system (RTGS) to blockchain-based payments, there seems to be little push for cyber sterling – and not just because the country’s near-term economic challenges are so intense.
“Policymakers are asking what problem a digital pound would solve,” says a senior UK banking source. “It feels like the issue has settled down.”
Things in continental Europe are starkly different.
“It is not a race, but as a matter of fact the euro area is at a relatively advanced stage in exploring a central bank digital currency,” ECB president Christine Lagarde has said.
Support from Lagarde herself has clearly been vital.
When she was IMF managing director, Lagarde argued in favour of CBDCs in 2018, saying there were clear advantages for payments systems, and that central banks should keep up with technological development.
Around the same time, then ECB president Mario Draghi (along with then BoE governor Mark Carney) saw no need to issue digital currency, arguing there were other means of making digital payments more efficient.
Lagarde, a former finance minister of France, is better known than Draghi for corralling political support. If national politicians in Europe were to scupper the project at the legislative stage, it would probably be because of privacy concerns, above all in Germany where physical cash remains more popular than in other northern European countries.
A 2021 public consultation by the ECB revealed that 43% of people across the eurozone thought privacy was the most important thing a retail CBDC should offer – and that number was highest in Germany.
Nevertheless, Germany’s finance minister, Christian Lindner, who is also leader of the liberal Free Democratic Party, has come out in favour of the digital euro in principle, saying that a retail CBDC would be “an enormous opportunity” for innovation in the eurozone. Bundesbank president Joachim Nagel is on the pro side, too. He has publicly argued it could help protect privacy, as central banks have no commercial incentive to use the data, unlike private payment providers.
European payments
Like the euro itself, the digital euro’s backers have been able to call on a desire for European unity to garner support.
According to Lagarde, the digital euro is “a cross-policy and truly European initiative that has the potential to affect society as a whole”.
This is a message the head of the European Parliament’s economic and monetary affairs committee, Irene Tinagli, has also picked up on.
There is no pan-European retail payments infrastructure. If a digital euro could provide such a reach, it would be the perfect basis on which to innovate and bring value-added services to citizens
Evelien Witlox, ECB
“I think it’s a way of testing how cooperation can be or should be among European institutions, when we talk about the euro’s future and the European Union’s future,” she has said.
The commonly given arguments about securing European economic sovereignty aren’t just about the entry of US or eventually Chinese big tech firms in the payments arena. Regulators on both sides of the Atlantic have, in any case, put out the threat to fiat money that once appeared from Mark Zuckerberg’s 2019 stablecoin project, Diem.
Most European card payments, however, are already run by payments companies headquartered outside the EU, above all Visa and Mastercard.
The ECB provided moral backing to a recent private-sector attempt to build a challenger to the US firms’ international card-payments dominance in Europe, through the European Payments Initiative. That attempt fell apart a year ago after concern among German and Spanish banks in the consortium about the costs involved in the roll-out.
In late October, the European Commission unveiled new legislation to force banks to offer low-cost instant euro payments across the European Economic Area. This was part of its effort to boost competition in payments, especially cross-border. The argument from inside the ECB is that a digital euro would add to these efforts by providing a new and more harmonized continent-wide payments network.
“There is no pan-European retail payments infrastructure,” says Evelien Witlox, programme manager for the digital euro at the ECB, speaking to Euromoney at the recent Sibos conference. “If a digital euro could provide such a reach, it would be the perfect basis on which to innovate and bring value-added services to citizens, and it would also be more inclusive.”
But the eurozone is already highly banked, mitigating the urgency from a financial inclusion point of view. Banks will in any case have to make instant international payments cheap or free – using private digital euros, as they exist today – due to the new instant payment rules.
FOMO
Some suspect the biggest driver of a retail digital euro is the ECB’s fear of missing out, of falling behind other central banks, especially China.
In fact, that’s a good reason, according to Fabio Panetta, the ECB executive board member focused on the digital euro.
“Suppose that in the future a large country, which becomes more and more relevant not only economically but also financially in the global economy, decides to introduce its own digital currency,” he says. “Can we exclude that 20 or 30 years from now that digital currency might be widely adopted in other jurisdictions, including the euro area?”
But using a retail CBDC to promote the use of one’s sovereign currency is much more relevant today in highly dollarized frontier economies, not the eurozone, argues another public-sector expert in this area, speaking off the record.
Limits to privacy
Privacy is the main area in which politicians, as well as civil society, are challenging the European Central Bank on the digital euro.
The ECB has decided full anonymity is not viable because of the risk of exploitation by criminals and the need to enforce holding limits. Users would need to identify themselves to intermediaries during onboarding. It would therefore offer a level of privacy equivalent to digital payments as used today, except for low-value payments, including those made offline – Panetta has suggested a €50 limit, to a maximum of €1,000 a month.
Yet Germany’s finance minister, Christian Lindner, thinks people will not accept the digital euro unless it has a level of privacy for the most part equivalent to cash.
“We should introduce a digital euro that’s really acceptable by people and not only by policymakers,” he said.
According to Lindner, this means having a limit much higher than €50 for the central bank or its supervised intermediaries to be able to access personal and transaction data, because cash can be used for hundreds of euros of anonymous payments.
“We need a risk-based approach,” Lindner has argued. “We need limits, but realistic limits.”
The banks and payment firms who will on-board users and check transactions now warn, above all, about the costs involved, especially if a retail digital euro moves beyond the pilot stage. Bankers say the initial investment in adapting their payment systems could run into tens of millions of euros per bank – an amount relatively easily digestible by bigger banks, but less by small ones.
Even if this risk to economic sovereignty is remote for the eurozone, the rise of China and perhaps eventually its currency brings to mind the decline of sterling as a reserve currency after the First World War, Panetta argues.
“Given that the preparation takes years – not only because you need to adopt a legislative framework but also because the technical preparation is very complex – we want to be ready,” he has said.
That preparation for a digital currency may be particularly time-consuming in Europe because of the size and divergence of its banking and payments systems, together with the loose nature of its political system.
Canada, another frontrunner in CBDC, is already making sure it could issue a retail digital currency from a technical perspective, if the need arises.
Yet the eurozone seems unwilling to shelve the idea.
The ECB’s perspective is that the digital euro should be a means of payment, rather than a store of value that might undermine the role of commercial banks in taking retail deposits and lending. There is no intention to increase the holding limit over time, Witlox confirms.
For some campaigners, the digital euro project is shaping up to be a lost opportunity to radically reform the financial system by removing the moral hazard of implicit state support for private banks, including deposit guarantees.
“The main problem is that politicians aren’t taking the lead,” complains Martijn van der Linden, a Dutch economics professor.
He favours a stepped increase in holding limits, accompanied by banking liberalization, and chairs a foundation called Ons Geld to advocate such an approach. But he says politicians aren’t sufficiently challenging the ECB on this, partly because of fear of engaging too deeply on monetary issues.
The possibility that a CBDC would better transmit negative interest rates, discussed a couple of years ago, is less relevant now that high inflation has returned. But a more cautious digital euro, with holding limits, would also limit its power to be used in that way, notes Grégory Claeys, a research fellow at Brussels think tank Bruegel.
“Either a digital euro is unconstrained and dangerous, and brings structural change, or it’s constrained a lot and the benefits you get could be very small,” Claeys says.
We do not see a lot of needs for retail clients that are not met through the traditional digital currencies developed by the commercial banks
Alexandre Maymat, Societe Generale
Even those inside the project admit that inclusion cannot be the first objective, as it is in many emerging-market CBDC schemes, because of the eurozone’s relatively small unbanked population.
In emerging markets, there’s also less risk of disruption in terms of bank lending to the real economy (even though there may be better ways for the state or private sector to leverage technology – CBDC sceptics point to examples such as Kenya’s M-Pesa and India’s Unified Payment Interface).
According to Witlox, who was previously ING’s global director of payments, the digital euro’s objectives– supporting digitalization, as well as maintaining the monetary anchor and strategic autonomy – should be important to the banks.
“We should not look to the status quo and think that the status quo will stay as it is,” she says, when asked if the digital euro project is simply an attempt to keep up with other central banks. “The digital euro is a pre-emptive endeavour amid the developments we see happening.”
This is not just defensive.
“Innovation is happening, and with the digital euro we can give an extra impetus for this innovation,” Witlox points out.
Banks, however, say wholesale CBDCs – allowing interoperability with commercial bank-issued digital money – will bring the first opportunities for value-added innovation.
That is certainly the message from Ana Botín, Banco Santander executive chair, who is head of the European Banking Federation. She and Deutsche Bank chief financial officer James von Moltke have pointed to the potential for wholesale CBDCs to allow corporate clients to link payments with data on invoicing, supply chains and inventories.
Work by Societe Generale blockchain venture Forge is one example of commercial banks partnering with wholesale CBDC projects. It led an experiment with Goldman Sachs and the Banque de France last year using CBDC to settle digital bonds issued by the European Investment Bank (EIB) on the Ethereum blockchain – followed up in November 2022 with a second EIB digital bond issue, issued on a private blockchain and listed in Luxembourg.
On the retail side, there is potential for programmable CBDCs, perhaps allowing points systems, but this will depend on the sort of technology the digital euro might use in the future.
For now, consumer adoption of the digital euro will be gradual, rather than a big bang, according to Alexandre Maymat, head of global transaction and payment services at Societe Generale.
“We do not see a lot of needs for retail clients that are not met through the traditional digital currencies developed by the commercial banks,” he says.
