The digital euro in the pipeline
Slowly but surely, the development timeline of the digital euro is progressing. After the end of the public consultation round in January 2021, the ECB launched the investigation phase in July 2021. The ECB is scheduled to decide on launching the realisation phase in Autumn 2023. In that realisation phase, the ECB will develop and test the technical infrastructure and business agreements needed to issue the digital euro. The ECB will decide on a possible issuance only later, after the adoption of the necessary legislation by the European Parliament and by the EU Council. The precise design of a digital euro will have to balance the central bank’s own objectives (such as robustness and efficiency of the payment system, financial stability and monetary policy autonomy) with the needs of potential users (such as privacy, security and the pan-European nature of the currency). Along with opportunities, there are also pitfalls, such as the potential impact on the financial intermediation of the banking system and on the relationship of competing digital central bank currencies in the battle for the status of a global transaction and reserve currency.
In December 2022, the ECB published the results of the second edition of the SPACE study (“Study on the payment attitudes of consumers in the euro area”). The results confirm that the payment behavior of the European population has changed rapidly over the past three years. Compared to the first edition of the survey in 2019, the share of cash payments decreased from 72% to 59%. As a mirror image, digital payments (especially with cards) became significantly more popular. According to ECB Governor Panetta, this confirms that a digital version of the euro would meet Europeans’ growing preference for electronic payments.
A genuine digital currency
A fully-fledged digital currency (Central Bank Digital Currency or CBDC) is the digital equivalent of cash, in other words, a direct debt instrument vis-à-vis the central bank. In this sense, a digital currency is completely risk-free. In principle, it can also earn interest, which can even be negative if necessary or calculated on a tiered system depending on the amount held.
Private ‘currencies’ like Bitcoin, on the other hand, are not full-fledged coins. Bitcoin is not a debt claim against anyone, and is not backed by a central bank or any other body that watches over its value. In contrast, a CBDC, like its physical counterpart cash, does have intrinsic value in an indirect way due to its status as legal tender. At the very least, the user has the assurance that he or she can use it to pay the tax debt to the government.
The latest 2021 edition (published May 2022) of the Bank for International Settlements (BIS) survey, confirms the main reasons why currently 9 out of 10 central banks are exploring the concept of a digital currency. Both the experience of the pandemic and the phenomenon of so-called “stablecoins” and other “crypto-currencies” have accelerated central banks’ work on the development of CBDC, according to the BIS.
A primary motivation is to ensure the security and robustness of the payment system. A digital currency can help provide assured access to central bank money in the event of force majeure, such as natural disasters.
Second, a digital currency can promote the efficiency of the domestic and international payment system by making full use of new technology, and by responding to the gradually decreasing use of physical cash for payments. Moreover, a digital currency can promote the financial inclusion of populations that currently do not have access to the traditional payment system. This plays a role especially, but not exclusively, in emerging economies.
The third major motivation emerging from the BIS survey is financial stability in the broad sense. First and foremost, it is about protecting the autonomy and sovereignty of monetary policy within one’s own economy, against the backdrop of alternatives that may become readily available in digital ways. These digital alternatives can be of a private nature, such as Bitcoin, but also, for example, CBDC issued by foreign central banks. This defensive motivation thus goes beyond just the payment system itself. It also takes into account the possible consequences if deposits, and possibly credits, can also be held or issued in an alternative digital currency. Until further notice, it is true that all central banks involved exclude CBDC deposits as a savings or investment instrument. However, nothing guarantees that will always remain the case.
Moreover, the loss of control over the domestic money supply could lead to dangers to financial stability. For example, it is not clear who will assume (or want to assume) the role of ‘Lender of Last Resort’ if liquidity problems arise in connection with deposits in foreign CBDC.
A complement, not a replacement for cash
Regardless of practical design, a digital euro could have some important economic implications. For example, the question arises whether a CBDC will remain a complement to cash, or eventually replace cash at least de facto. Indeed, via the economies of scale in payments (the ‘network effects’), such a development could be rapid. Moreover, the government has an incentive to support such a trend in the context of fighting fraud and money laundering operations. A positive side effect for monetary policy of a complete disappearance of physical cash in favour of CBDCs would be that the effective lower bound of the policy interest rate would become less stringent. The interest rate paid on the digital euro, whether in a tiered system or independent of the amount, plays a crucial role here.
The advent of a completely risk-free digital euro could also encourage bank disintermediation. Deposit taking, and related lending, could therefore be compromised for commercial banks. In their plans for a CBDC, however, all central banks indicate that the digital currency would be intended only as a means of payment and not as a form of savings or investment. This could be done, for example, through an upper limit on the holding of digital euros, or through a discouragingly low interest rate compared to deposits in the banking sector. Moreover, according to the BIS survey, most central banks are considering designing the technical infrastructure of CBDCs in cooperation with the private sector, with the latter acting as an intermediary agent providing, for example, a payment interface for retail users or creating synergies with existing payment channels.
Finally, the possible advent of CBDCs also has potential implications for the international monetary system. It cannot be ruled out that digital currencies from different currency zones will compete for the dominant role in global digital financial markets in the future. Certainly central banks that are already openly promoting a greater international role for their currencies may go down that path. A world digital monetary order will therefore have to clarify the mutual role of different currencies (cooperative or competitive). At stake are the benefits of issuing the leading international transaction and reserve currency (the so-called “international seignorage”). For the US dollar, the stakes are highest.