Digital Euro: To Be or Not To Be

The way to the digital age of money

Digital currencies have been the subject of increasing interest worldwide as the use of physical cash diminishes. The European Central Bank (ECB) has been exploring the introduction of a digital euro since October 2021. It is considering what the digital euro should be, how its distribution would work, and what impact it would have on the market. The ECB isn’t alone. As of 2023, approximately 130 countries are exploring Central Bank Digital Currencies, accounting for 98% of global GDP, according to Atlantic Council. Central banks across the globe are developing virtual versions of their currencies. The central bank of China started researching and developing the digital yuan in 2014. Pilot programs were subsequently launched in various cities across the country to test the digital currency in real-world scenarios.

Digital euro would be a central bank digital currency and, as such, an electronic equivalent to cash. It would coexist with banknotes and coins, providing people with an additional choice among various payment methods. It would be used for all digital payments, just like cash is used for physical payments, in all stores and with all merchants in the euro area that accept digital payments. With the digital euro, payments in the euro area would be free, as it is a public good, just like banknotes and coins.

The digital euro would not be one of the types of cryptocurrencies. Cryptocurrencies are not guaranteed or managed by any central institution, making them risky and unstable. In contrast, the same institution that guarantees cash, the European Central Bank, would guarantee the digital euro. Like cash, it would always be worth as much as its nominal value; one digital euro would always be worth exactly as much as a coin for €1.

Digital Euro in practice

Through their bank or another public institution, such as the post office, people would open a wallet for digital euros. They would load money into it through a linked bank account or by depositing cash. They could then start making payments with digital euros. When they received money in the form of digital euros, they would store it in their digital euro wallet, up to a certain maximum amount, or deposit it into their bank account. Paying with the digital euro would always be secure and instant – whether in physical stores, online shops, or between individuals.

A maximum limit for the amount of digital euros that a person or business could have in their digital euro wallet would be set. This would prevent excessive outflows of deposits from bank accounts, thus maintaining financial stability. Banks depend on deposits as a vital source of funding and could end up having to charge more on loans, slowing economic activity.

A digital euro might not look much different than viewing a bank account via your phone. The back-end process of paying, however, would be very different. In an electronic transfer today, the sender's bank transmits a message to a clearinghouse, asking it to shift money from its account to the recipient's bank. The clearing function has to verify the details, then arrange to debit the sender's bank's account at the ECB and credit the recipient's. Choreographing the moves can take as long as two days until the money settles in the recipient's account. A digital euro could in theory streamline the transaction at lower cost. The ECB could keep its own ledger, automatically tracking the owner of each digital cent. Or it could set rules for other ledger-keepers in a decentralized system, perhaps similar to the distributed ledger for Bitcoin, which records each transaction using blockchain technology.

The European Central Bank emphasizes the need for the digital Euro to be user-friendly, with features like offline payment capabilities and integration with existing banking applications. For offline payment user could turn on Bluetooth and send a token, a sort of electronic IOU (stands for “I owe you”), that would update the ledger when back online.

The digital euro would not bear interest. Similar to cash, the digital euro would be a retail means of payment and not an investment tool.

Challenges

Societal Impact

A key goal of the digital Euro is to enhance financial inclusion, especially for unbanked populations. This involves strategies to improve digital literacy and promote widespread adoption, considering the varying levels of digital infrastructure across member states.

Technological Infrastructure

The technological backbone of the digital Euro is expected to leverage advanced blockchain and cryptographic solutions. These technologies aim to ensure scalability, security, and interoperability, essential for a robust digital currency system.

Regulatory Landscape and Compliance

The digital Euro’s regulatory framework is being shaped by the European Commission's legislative proposals, which address critical aspects such as legal tender status, anti-money laundering (AML), counter-terrorism financing (CTF), and data protection (World Economic Forum, 2023). These regulations are essential in maintaining user privacy and ensuring a secure digital currency environment.

Economic Implications

The introduction of the digital Euro is poised to significantly impact monetary policy and the banking sector. It holds the potential to reshape monetary sovereignty, influence bank deposits, and alter lending practices. Additionally, the digital Euro could streamline cross-border transactions, potentially transforming international trade dynamics.

What Comes Next

Meanwhile, based on the findings of the research phase, the ECB's Governing Council has decided to move to the next phase of the digital euro project. The first stage of the preparatory phase, started in November 2023, will last for two years, during which the Eurosystem will focus on further testing and experimenting and will continue to consult with all stakeholders, including the public, to ensure that the digital euro meets the highest standards of quality, security, and usability. Possible subsequent steps would be decided by the Governing Council after two years based on the results of the first stage and developments in the legislative process.