Stepping up preparations for the launch of a digital euro
Many central banks across the world are considering the introduction of a central bank digital currency (CBDC)/digital euro, and some have already done so. Among the major central banks in the West, the ECB's preparations are the most advanced. In 2021 we wrote about the ECB’s likelihood of launching a digital euro. Back then, we anticipated that the final decision would materialize by end-2023 and held an overall positive consensus. Nonetheless, existing concerns and skepticism from CBDC critics should not be overlooked, particularly due to its role in understanding the potential risks of launching a digital euro. We therefore revisited our views on where things stand in favor of a digital euro, describe its likely features and the potential risks and benefits presented by the launch.
This month, we expect the ECB to launch a three-year "realization phase" to develop and test the technical solutions and business arrangements necessary for a "digital euro", in close co-ordination with technology providers, payment providers, and the financial sector. At the end of the realization phase (presumably late 2026 or 2027), the ECB could decide if they will in fact launch a digital euro a few years later – taking a step that would have major implications for the financial sector, payment services, and monetary policy. While we currently sense a good degree of enthusiasm vis-à-vis a digital euro at the ECB and the European Commission, we think the risks and challenges are not easily brushed aside. Consequently, we do not regard the eventual launch of a digital euro as a foregone conclusion. After the realization phase, one option for the ECB could be not to go ahead immediately, but regularly reassess the case for a digital euro every 2-3 years, and then perhaps give the green light in the more distant future.
Justification: Why is a digital euro needed?
One of the main motivations behind launching a digital euro is to offer consumers an alternative Europe-wide payment option. But what are the other objectives behind this concept?
We highlight the key arguments in favor of a digital euro below:
- Preserving access to public money amid declining cash usage in an increasingly digitalized world;
- Serving as an "anchor" of the financial system of the future, providing the choice of an alternative form of public money;
- Preserving "strategic autonomy" and monetary policy autonomy amid the growing influence of private payment providers;
- Providing a more user-friendly form of digital money compared to private digital money;
- Gaining optionality in terms of monetary policy implementation;
- Facilitating cross-border payments, particularly in making international payments cheaper and more efficient; and
- Promoting financial inclusion by ensuring that everyone has access to the digital euro (indirectly via banks or via digital euro payment cards), particularly benefitting those who have no access to bank accounts.
What the sceptics say: Uncertain benefits, big risks, large costs
The CBDC/digital euro sceptics worry about negative implications for credit conditions and financial stability. Overall, they find the cost-benefit ratio of a digital euro unconvincing.
We summarize some of the key counterarguments below:
- Challenges to banks, risks to financial stability, cyber risk whereby CBDCs could lead to deposit flight from banks;
- Skepticism over adoption and tangible benefits for Eurozone consumers, particularly regarding concerns over privacy;
- CBDCs not necessary to "anchor" the financial system, in that the true monetary anchor of the monetary system is the reserves held at the central bank;
- Limited risks from Bitcoin and other cryptocurrencies whereby the euro might be less threatened by cryptocurrencies than has often/previously been claimed;
- Uncertain benefits to monetary policy that may also be small in practice;
- Other unintended consequences for the international financial order, including the risk of rising volatility in capital flows and currency substitution and risks to the dominance of the US dollar and potentially greater scope for the circumvention of international sanctions; and
- Overall unattractive cost benefit due to substantial effort and resources required to launch a CBDC.
If the digital euro materializes, what would it look like?
While the preparations still have a long way to go, the key features of the digital euro have already taken shape and have been described in many ECB speeches and the ECB's four "progress reports" published between September 2022 and July 2023. To summarize, the digital euro would be public money for retail purchases of limited amounts ("retail CBDC"). It would complement cash, not replace it. The digital euro would have legal tender status, so all merchants would have to accept it. The supply of digital euros would involve division of labor between the ECB, which would control issuance and settlement, and commercial banks, which would perform all customer-facing tasks. To limit deposit losses for banks, the ECB would apply a 2-tier structure: basic amounts of digital euro (tier 1) would be limited to c.€3,000-3,500 and would be unremunerated (i.e. zero interest); higher amounts (tier 2) would incur negative rates. Digital euro transactions would be subject to privacy protection similar to private-sector digital payments, but – unlike cash – there would be no anonymity. The main user group would be Eurozone residents, but cross-currency functionalities could be added at a later stage.
