The report on the digital euro is yet another effort by a central bank to demonstrate that they too are researching a Central Bank Digital Currency (CBDC). Many central bankers who had previously dismissed CBDC are reevaluating their strategy; sometimes to say that they have setup research and study groups or to justify their current roadmap that does not include CBDC.
Central banks are forced to reevaluate their digital strategy. Among the reasons are the advanced stage of the Chinese CBDC, the DCEP; the imminent launch of Libra stablecoin with its unparalleled network; the stubborn persistence of the unbanked; and the rapid migration of payments away from cash. The rise of such alternate and competitive payment and store of value systems also makes the transmission of monetary policy more difficult. For the smaller sovereigns, a focus on financial inclusion and their chance to leapfrog the larger economies are additional motivations for working on CBDCs.
The Euro is the second heavily used sovereign currency in the world. The euro is used for payments and quoting prices, two of the most important functions of money. The launch of a digital euro will have repercussions beyond the eurosystem.
Provision of an immediate and riskless payment system, available to all European citizens, a digital equivalent of cash, is the most prominent motivation for the creation of the retail digital euro.
Challenges to the European project are fueled by a variety of factors including heterogeneity of economic opportunities, challenges to the rules from some central European countries, cultural attitudes towards productivity, differing responsibilities for eurozone border controls and even heterogeneity of legal tender. The digital euro will definitely contribute to unifying the digital payment systems across the eurosystem countries and reduce the complete dominance of foreign payment systems.
A digital euro will function as an emblem of unification and integrate the European economies even further, it might even force the laggards in euro adoption into the fold of the euro. The EU has fallen behind in the digital race, without a digital euro they might fall further behind. The eurosystem does not apply to countries in the EU that have not adopted euro as legal tender. Of the 27, only 19 have done so and their national central banks’ issuance of the euro is controlled by the ECB.
In the study, a few principles for the design of a digital euro are stated. First, a digital euro would be still a euro, and therefore be fully convertible at par with other forms of the euro. This means full fungibility with bank notes, reserves and bank deposits. Second, a digital euro needs to be a liability of the Eurosystem, hence low risk central bank money. Three, it should be widely accessible across the euro area. Four, it should be market neutral, which is to say it should not smother private solutions. Five, it should be trusted by the citizens and end users.
A paper that is 55 pages in length, full of repetitions is not easy to wade through. Principles are stated and restated; this is well ploughed ground; most of these arguments and ideas have been encountered before. At this point, any paper on CBDC written as a survey of principles and operational precepts can be thought of as “CBDC theater”, especially if there are no new ideas or concrete plans. Luckily for the lazy, Appendix 1 neatly summarizes the principles and requirements,.
The paper suggests that the legality and the co-existence of the digital euro to be anchored on the Treaty on the Functioning of the European Union (TFEU) Article 128(1); giving the ECB the sole right to authorize the issue banknotes as legal tender. Although to call the digital euro a banknote would be stretch, banknotes and their attributes are a good starting point. If the digital euro drifts far from the euro banknote, a new rule may have to be promulgated to cover the legality of the digital euro.
The core principles exclude what is called a synthetic CBDC where regulated banks issue the digital euro backed by their reserves, as this would not be a liability of the ECB. On the issue of remuneration or interest, as cash has a zero lower bound (ZLB), it would be desirable for the digital euro to have a ZLB as well. Since the Eurosystem is currently in a negative interest rate policy, there might be a flight to the digital euro for investment purposes. As the digital euro is programmable money held in a user controlled device, a tiered system is certainly possible; a 3000 Euro holding, for example, could be subject to ZLB, whereas a higher holding would be subject to negative interest.
Two other requirements that come up in comparison to cash are privacy and offline usage. Both these can be addressed, with the a tiered system for privacy implemented in a wallet, whether hardware or software as well as offline usage supported by smart cards or other technologies. Although privacy does not shine through as a basic requirement in this paper.
The greater problem is the vulnerability of the core and edge of the system to cyberattack and other forms of digital tampering or bugs in the software. Such events can spread rapidly and cause a catastrophic loss of trust. Hence resilience and even a breaker needs to be inserted at design time.
Some of the questions come up always in the context of CBDCs. The implementation of the core system is often posed as a choice between a centralized database and a distributed ledger. The eurosystem is already decentralized in its operation, the structure of the core system should reflect that. The token versus account dichotomy always seems to pose the wrong question as well; maybe because of the communication gap between economists and technologists.
This paper opens a consultation period until mid 2021, when the ECB will consider whether to start a digital euro project and build a minimum viable product. Although the ECB calls for experimentation before that, there are no concrete steps outlined to create a lab or a sandbox.