What has been decided – and what has not?
On 14 July 2021, the Governing Council of the European Central Bank (ECB) approved a project to prepare for the potential issuance of a digital euro. Although the ECB stated the project does ‘not prejudge any future decision on the possible issuance of a digital euro’, this marks a significant step towards its launch.
Outside China, the ECB is now the only major central bank that has said it is seriously considering issuing a central bank digital currency (CBDC). The apparent aim is a ’retail CBDC’ that can be used by end users in form of ‘a riskless, accessible, and efficient form of digital central bank money.’
The responses to the ECB’s consultation suggest that the public are enthusiastic about the introduction of a digital euro, which should give the project plenty of impetus. However, given the many uncertainties around the design and functions of a digital euro, the unclear impact on the business model of credit institutions and the functioning of monetary policy, the rapid technical developments in this area and reliance on end-user acceptance, a cautious and iterative approach seems prudent.
Will a digital euro become a DLT-based CBDC?
Alongside its decision, the ECB published its key technical learnings from the earlier experimentation phase. Most importantly, the ECB confirmed that ‘there were no major technological restrictions for any of the topics assessed’, although it had assessed a broad range of design options.
This means that the ECB can select from a broad range of technical solutions for its digital euro. The ECB concluded that a digital euro could be developed on centralised technology and distributed ledger technology (DLT), or a combination of both.
For instance, the Eurosystem-operated and central ledger system TARGET Instant Payment Settlement (TIPS) could be extended to issue and distribute a digital euro. Alternatively, the ECB could issue value tokens called ‘digital bills’ via a DLT-only solution that would enable users to open wallet accounts with third-party service providers.
The ECB also tested combinations of DLT and central ledger design solutions that put more reliance on existing financial intermediaries in the issuance, distribution, and transfer of digital euros. These solutions are primarily account-based.
The alternative would be a bearer-instrument-based CBDC that permits offline peer-to-peer transactions. These bearer instruments may be understood as a true digital alternative for physical coins and bank notes, although also they would need to be synchronised with the online ledger at some point.
Further aspects that were tested concerned the interplay between anti-money-laundering requirements and privacy concerns, and how end-users could initiate transactions. The European Data Protection Board, which brings together the EU’s data protection authorities, recently emphasized the importance of such considerations and offered its support to ensure that user privacy and data would be protected ‘by design and default’.
Why should financial institutions take a closer look?
In its press release, the ECB mentions that it will define ‘a business model for supervised intermediaries within the digital euro ecosystem’ over the next two years. This clearly refers to the fact that the new CBDC may rely on financial intermediaries, such as credit institutions, payment institutions and wallet providers, for its issuance and related payment transactions. The ECB also emphasised that a digital euro would only be successful if it proved value for everybody involved, including financial intermediaries.
Whether institutions will actually benefit from a digital euro may depend on whether they are willing to adapt their business models to the changed payment infrastructure but also on the technical solution that will be implemented. Institutions should observe these developments closely to ensure that they have the technical capabilities to support a digital euro.
The ECB has established a new digital euro market advisory group (MAG), which will advise on the design and distribution of a potential digital euro from an industry perspective and complement the work of the Euro Retail Payments Board.
What are the next steps?
The ECB said that, in October, it will begin two years of further research and stakeholder engagement to determine the final design of the digital euro.
At the end of this period, the ECB aims to start developing a digital euro, which it expects will take another three years.
Therefore, a digital euro could be issued as early as at the end of 2026.
The wider EU and international context
Although it is being developed by the ECB, the digital euro very much fits into the European Commission’s broader strategic goals of economic, financial and technological sovereignty, as well as boosting the international role of the euro.
As set out in the Commission’s retail payments strategy, payments have become more strategically significant, especially since the onset of the COVID-19 pandemic. The drive towards instant payments (which we should hear more about later in Q3 2021) and the launch of the European payments initiative (EPI), a private-sector project that aims to offer a pan-EU payment solution (with Commission and ECB backing), are other elements of the Commission’s strategy to strengthen Europe’s strategic autonomy in the payments sector.
In addition, as part of its digital finance strategy, the Commission has recently proposed legislation to create a comprehensive legislative framework for cryptoassets, including stablecoins. In the Commission’s view, the proposed legislation, which is currently going through the EU’s legislative process, aims not to regulate out, but rather regulate in, private-sector solutions (and thus enable them to compete fairly with any European proposition).
However, there are many voices, including in the European Parliament, who argue that such private-sector initiatives ‘undermine monetary sovereignty’ and that a ‘digital euro is a necessity for Europe to achieve digital sovereignty… [and] the best answer to private initiatives’.
We understand that the Commission, as well as the Eurogroup (which has shown full support for the initiative), will support the ECB in this next phase, including to understand whether any amendments should be made to the EU’s existing financial services framework. As set out in a letter accompanying its announcement, the ECB will continue its close dialogue with the European Parliament, particularly as its support is needed for any legislative amendments.
Work on a digital euro will, of course, continue in parallel to discussions at an international level, with questions inevitably arising regarding its use/interoperability internationally, including when it comes to cross-border remittances.