Why the European Central Bank wants to digitize the euro

[Sum­mary of an art­icle from vari​ances​.eu.]

In mid-2021, the European Cent­ral Bank (ECB) is expec­ted to announce a pro­ject for a digit­al euro to be imple­men­ted with­in the next 5 years. The United States could fol­low with their “digit­al dol­lar”, but this will be later. There is already a lot of talk about this Cent­ral Bank Digit­al Cur­rency pro­ject. In simple terms: what will this digit­al euro be, why is the ECB inter­ested in it and how will it be implemented?

What is a Cent­ral Bank Digit­al Cur­rency (CBDC)?

As a remind­er, only phys­ic­al cash – coins and bank­notes –, called “fidu­ciary” money, are issued by the sov­er­eign author­ity and are leg­al tender in a coun­try mean­ing they can­not be refused in pay­ment. So-called “scrip­tur­al” money (partly made up of bank depos­its) is cre­ated by super­vised and reg­u­lated banks and can be trans­ferred elec­tron­ic­ally. These two forms – fidu­ciary and non-cash – togeth­er per­form the three func­tions of money: unit of account, means of pay­ment and store of value (provided that infla­tion remains low).

As such, a CBDC com­bines the advant­ages of these two forms of money. (1) It rep­res­ents a claim on the cent­ral bank that is as secure as a bank­note (and there­fore more secure than a bank depos­it); (2) It is access­ible to every­one, like a bank­note (where­as cur­rently only banks have an account with the cent­ral bank); (3) But it is elec­tron­ic and can be used remotely (unlike a bank­note). It is thus at the heart of the dia­gram below.

How would the digit­al euro dif­fer from Diem or Bitcoin?

CBDC should not be con­fused with “stable­coins”, elec­tron­ic assets that are start­ing to be pro­duced by the private sec­tor but are indexed to exist­ing cur­ren­cies. The best-known example of these stable­coins remains the Diem, ini­tially named Libra by Face­book as early as 2019, but still in the pipeline. Stable­coins, issued by unsu­per­vised entit­ies, pose risks to mon­et­ary and fin­an­cial sta­bil­ity (data pro­tec­tion, poten­tial glob­al oli­go­pol­ies, etc.).

CBDC also dif­fers from crypto-assets (mis­takenly called “crypto­cur­ren­cies”), whose value is not based on any exist­ing cur­rency. The value of Bit­coin, the most fam­ous example, is extraordin­ar­ily volat­ile because it is based on its announced scarcity (at most 21 mil­lion units) and its increas­ing eco­nom­ic and envir­on­ment­al pro­duc­tion costs. Thus, one Bit­coin trans­ac­tion cur­rently con­sumes the energy needed for half a mil­lion trans­ac­tions per card. This also lim­its its scalab­il­ity, which is essen­tial for a cur­rency. Nev­er­the­less, crypto-assets are in demand as spec­u­lat­ive assets, which need to be reg­u­lated ¹.

Why digit­ize money?

On the one hand, to main­tain pub­lic con­trol over money cre­ation in the face of private com­pet­i­tion. The CBDC provides a com­ple­ment to bank­notes, whose use for trans­ac­tions is decreas­ing (in volume and in value) but whose issued stock is increas­ing (hoard­ing). It is a ques­tion of pro­pos­ing a mon­et­ary asset guar­an­teed by the State in an uncer­tain digit­ized world. Money is a pub­lic good, and the cent­ral bank must offer a risk-free altern­at­ive to digit­ized assets issued by unsu­per­vised private entit­ies. There is also a geo­pol­it­ic­al dimen­sion: for­eign digit­al cur­ren­cies (pub­lic or private) risk destabil­iz­ing, if not crowding out, nation­al cur­ren­cies, as in the case of the « dol­lar­iz­a­tion » of devel­op­ing economies. 

How to design a digit­al currency?

Between now and the actu­al digit­iz­a­tion of the euro, vari­ous choices still need to be made, not­ably con­cern­ing the scope of the pub­lic-private part­ner­ship, the bal­ance between con­fid­en­ti­al­ity and com­pli­ance, and the leg­al frame­work. Trust in the cur­rency is at stake. 

The ECB will prob­ably opt for a hybrid archi­tec­ture (red base of the pyr­am­id): it will not fully del­eg­ate the man­age­ment of the digit­ized euro to the private sec­tor but will not dir­ectly man­age it either. In its 2020 report, it thus explains that “super­vised private inter­me­di­ar­ies would be best placed to provide ancil­lary ser­vices” and that “a mod­el in which access to the digit­al euro is inter­me­di­ated by the private sec­tor is there­fore preferable”.

The ECB must also decide on the issue of the tech­nic­al infra­struc­ture (yel­low level). This could be cent­ral­ized on a single plat­form or use a dis­trib­uted ledger via a decent­ral­ized net­work of com­puters, which may pose a scalab­il­ity problem. 

The green level cor­res­ponds, in par­tic­u­lar, to the trade-off between pri­vacy pro­tec­tion, favoured by the choice of a token (like a bear­er bill), and reg­u­lat­ory com­pli­ance; the lat­ter could require an account to trace trans­ac­tions, in par­tic­u­lar to avoid money laun­der­ing or ter­ror­ist financing.

The tip (blue) of the pyr­am­id refers to inter­op­er­ab­il­ity, i.e. the abil­ity of the CBDC to link whole­sale and retail mar­kets by being con­nec­ted to nation­al and cross-bor­der pay­ment sys­tems. Thus, the bank­notes are spe­cif­ic to each cur­rency zone, but respect glob­al stand­ards allow­ing them to be exchanged.

Finally, and in addi­tion to vari­ous tech­nic­al aspects (cyber risks, off­line trans­ac­tions, etc.), leg­al con­sid­er­a­tions need to be cla­ri­fied. These include: the leg­al basis for digit­al issu­ance, the leg­al implic­a­tions of dif­fer­ent formats, and the applic­ab­il­ity of cur­rency zone laws to the cent­ral bank as issuer. Without going into detail, a com­bin­a­tion of art­icles in the Treaty on the Func­tion­ing of the European Uni­on and the Stat­ute of the European Sys­tem of Cent­ral Banks should make this pos­sible, accord­ing to the ECB 2020 Report.

Innov­a­tions have marked the his­tory of cur­ren­cies. An MNBC will be anoth­er great step in the “Cash Odys­sey”. The need for cent­ral banks to accel­er­ate the ongo­ing pro­cess is clear, espe­cially in part­ner­ship with the private sec­tor. From crypto-assets or stable­coins to MNBC pro­jects like the digit­al euro, a gen­er­al prin­ciple always seems to apply: “the private ini­ti­ates, the state reg­u­lates or appropriates”.