In Lapland in Northern Finland on Wednesday the European Central Bank (ECB) governing council discussed the digital euro and how it can start to bring the public on board for what would be a fundamental shake-up in the way the financial system works. For consumers, the central bank digital currency (CBDC) would offer a new way to spend money – using an app on a smartphone, you could pay bills or transfer cash using digital euro issued directly by the ECB. This would be an alternative to paying cash, or using a smart card or phone to pay money via the bank.
But CBDCs are controversial – there are questions about what advantages they will give consumers and privacy concerns about what information central banks might hold. The technical challenge and the issues for the financial system are also really significant.
A digital currency, while in essence simple, could fundamentally change the world of banking and payments and the way people manage their day-to-day finances. The ECB seems to be going for a kind of hybrid version, with banks retaining a key role, but there is a long way to go in spelling out how this would work.
1. What is a digital euro?
It is digital currency issued directly by the central bank – and thus backed with its guarantee, as is the case with physical cash. It is thus a liability on the books on the central bank. Being backed by a central bank should ensure it is a lot more stable that crypto currency – which has swung hugely in value – and offers more guarantees than stablecoins which big tech companies could issue linked in value to an existing currency such as the US dollar (though Facebook’s project to launch a digital currency linked to its platform collapsed, showing that this is not a straightforward exercise). The power of central bank backing would be the key aspect of the digital euro.
2. How would the public use it?
Most likely via a smartphone where people would have digital “wallets” – these could be provided by existing banks, integrated with customers’ current banking, with a basic app provided directly on behalf of the ECB also likely to be part of the plan.
These could be used to pay for goods and services – as with smartcards and phone apps now – and also to transfer money “offline” to other users, as would happen with cash or some existing card services. People would be able to transfer money between their digital euro wallet and their existing bank accounts – or go into a financial institution and top up their wallet with cash. A key issue would be what limits are put on the amount of cash people can hold in their digital wallets and whether there are restrictions on the size and number of payments they could make with their wallet.
There would also be the ability to pay regular bills in digital euro, linking in with existing bank services, and plans for functionality to allow other payment services, for example online shopping. The digital euro wallet could be used anywhere in the euro zone; functionality for international payments and speed of money transactions would be important. And some kind of automatic payment functionality could be developed, allowing payments to be triggered when certain conditions are met - such as, for example, purchasing in some locations.
3. Why bother?
A good question. Consumers manage fairly well with the current mix of online services and cash, after all. The ECB argues that CBDCs would offer a safe, free and secure system backed by a public institution, be accessible to all – including less well-off people without links to a bank – and could in time lead to new functionality. They also argue that as more and more payments move online, a system backed by central banks would be more secure than one which private operators like big tech firms might offer, which could lead to confusion and instability.
“Payment is a public good that is simply too important to be left to the market,” ECB president Christine Lagarde said late last year.
This is all linked to the move online. Cash payments in the euro area have dropped from 72 per cent of total payments to 59 per cent. But in countries such as the Netherlands and Finland, cash is used in only one fifth of transactions. In the Republic, contactless payments account for around 60 per cent of transactions, as cash and cheque use fall, according to the latest figures from the Banking and Payments Federation of Ireland.
4. Are there other reasons?
Yes, and they’re mainly strategic and political. Europe’s politicians and the ECB want to ward off the threat of private companies taking control of monetary payments, and want to develop the euro as a leading currency. In the years ahead, there are fears that the ECB’s efficiency in managing Europe’s money and its monetary policy could be affected if a currency issued by a private company came into wide issue – and of course most of the likely candidates are US companies, with Chinese firms also strong in payments technology.
Strategic autonomy for Europe in this vital area is thus seen as important, particularly after Covid-19 and the Ukraine war. Meanwhile, most other central banks have pushed ahead with studies on this and China has launched a pilot project. The ECB may have some misgivings about the complexity of all this, but a two-year study to end next year is likely to give the green light – 2027 is touted as a possible launch date.
5. What are the concerns?
A key issue is privacy. Consumers are used to banks having access to information on how and where they spend money, but allowing the official system – as represented by central banks – to have this access could prove controversial. This has led to warnings from leading politicians, notably those in Germany where privacy is a particularly hot issue. Meanwhile, there have been warnings that giving central banks control of digital currency would, in time, allow them to control how money was spent.
ECB executive board member, Fabio Panetta, moved to try to allay these concerns when speaking in January to the Economic and Monetary Affairs committee of the European Parliament. He said that the digital euro would never be “programmable money” – meaning that the ECB would not set any limitations on where, when and to whom people can pay with a digital euro. He said the ECB was also proposing that it did not have access to personal data – much of which would continue to be held by banks. It would, he added, be up to legislators to decide how this would be squared with adequate measures to combat money laundering, the financing of terrorism, fighting tax evasion and ensuring sanctions – such as those currently on Russia – are complied with.
This balance looks set to be vital in the debate on setting up a digital euro. Panetta said, for example, that the ECB hoped to design a system allowing “offline” payments – between individuals – offering a level of privacy “close to that of cash”. What “close to” means will be important.
In a statement on the issue in January, the eurogroup of finance minister, chaired by Irish public spending minister Paschal Donohoe, said that maintaining users’ trust in relation to privacy was important, but that the design of the euro should also comply with other policy objectives such as fighting money laundering and tax evasion.
6. What about the financial system?
The digital euro has predictably raised concerns in the financial sector and plans will also be carefully assessed by bank regulators. Potentially, a digital euro could lead to significant upheaval in the sector. The ECB has sought to calm some nerves, indicating that the digital currency will work through existing banks who will be able to integrate the free payment service in their apps and still try to sell other services to customers. At a political level, the eurogroup statement also referred to the likely role of regulated financial intermediaries, though it said further work is needed on precisely who will do what.
Banks, however, will remain concerned about being cut out to an extent – disintermediated in the jargon – from people’s day-to-day transactions and about the implications of this for their relationship with customers and their profit margins.
The move to a digital currency also raises questions about the risk to bank deposits – a key source of funding for banks in raising cash to lend on to customers. Will the public prefer to hold cash in their digital euro wallets in favour of traditional bank accounts? Panetta said that it was not the ECB’s intention to compete for deposits, indicating there would be a limit on cash in digital wallets to ensure banks’ savings deposits were not undermined.
And if there are concerns about a bank’s financial health, is there a risk that customers could pull deposits out and into digital euro, leading to instability? Along with questions over implications for central banks and banking balance sheets, there are huge issues here to work through. And that is before the huge practical and technical issues, currently the subject of the ECB-sponsored study.
7. What next?
While the green light will not be given to move ahead until the end of next year, the wind does seem to be behind this project. The eurogroup gave the work its blessing earlier this year and will be a key political voice, while the European Commission is due to publish a legislative proposal on the digital euro before the summer, led by Irish commissioner Mairead McGuinness. Expect big efforts to try to sell the idea to the public and intense discussions around issues such as privacy and control, which have already led some to paint digital currencies in a malign light, as a way for “the system” to have details on where people spend and in time control of this. There is no reason to believe that this is the ECB’s intention. But this is not going to stop the debate on the digital euro – which is not even really underway yet – getting hot and heavy.