Why the European Central Bank wants to digitize the euro

[Sum­ma­ry of an article from variances​.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”.