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Why the European Central Bank wants to digitize the euro

Marc Olivier Strauss-Kahn
Marc-Olivier Strauss-Kahn
Director General of Banque de France (BDF)

[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. 

BIS pyra­mid scheme: con­sumer pref­er­ences (left) cor­re­spond to as many choic­es to be made by the cen­tral bank (right) 2

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”. 

1https://​www​.law​.ox​.ac​.uk/​b​u​s​i​n​e​s​s​-​l​a​w​-​b​l​o​g​/​b​l​o​g​/​2​0​2​0​/​1​1​/​m​a​r​k​e​t​s​-​c​r​y​p​t​o​-​a​s​s​e​t​s​-​r​e​g​u​l​a​t​i​o​n​-​m​i​c​a​-​a​n​d​-​e​u​-​d​i​g​i​t​a​l​-​f​i​n​a​n​c​e​-​s​t​r​ategy
2https://​www​.bis​.org/​p​u​b​l​/​q​t​r​p​d​f​/​r​_​q​t​2​0​0​3​j.htm

Contributors

Marc Olivier Strauss-Kahn

Marc-Olivier Strauss-Kahn

Director General of Banque de France (BDF)

Marc-Olivier Strauss-Kahn is Honorary Director General of the Banque de France (BDF), Senior Fellow at the Atlantic Council, teacher and member of private and associative boards, including that of Citéco, Europe's leading economic education museum. In 2001-08 and 2012-17, he was Chief Economist and member of the BDF's Executive Committee, French representative in bodies such as the G20 or the BIS, the OECD and the IMF. He also worked at the latter three institutions, the FED and the IDB. He is a graduate of ESSEC, Sciences Po Paris, and the Universities of the Sorbonne, Nanterre and Chicago.