The European Central Bank has officially launched its digital euro project. But there is still a long way to go before digital euros start to appear in our digital wallets. In this post we look at the rationale, timeline and implications for the project.

What is a CBDC?

Central Bank Digital Currencies are an electronic form of central bank money, potentially accessible to all citizens and companies as an alternative to, and introduced alongside, cash.

Several countries are picking up speed on developing CBDCs, notably the US and China. But CBDCs raise fundamental questions about financial stability and monetary policy, as well as societal questions such as the ongoing role of cash and private banks.

The ECB’s digital euro project sets out its stall for how the EU will answer those questions.

Rationale for the digital euro: Potential benefits

The ECB has identified the below scenarios in which a digital euro could benefit the EU and its citizens. One of the key themes is the desire to improve the autonomy of the Eurosystem.

1. The digitalisation and independence of the European economy could benefit from a digital form of central bank money available to citizens.
2. It could provide a more sustainable option for central bank digital currency in the face of declining use of cash as a means of payment. An increasing dependence on private forms of money and private payment solutions could endanger the sustainability of the cash infrastructure and hamper the provision of adequate cash services.
3. A form of money other than euro-denominated (i) central bank money, (ii) commercial bank deposits, or (iii) electronic money could become a credible alternative as a medium of exchange and, potentially, as a store of value in the euro area. Here, solutions with a global reach developed by private actors such as big technology providers, possibly outside EU supervision, could threaten European financial, economic and political sovereignty. A digital euro offering the same functionality as such a private form of money would seek to counter this threat.
4. If the Eurosystem were to conclude in the future that the issuance of a digital euro is necessary or beneficial from a monetary policy perspective. The central bank could use a digital euro as a direct transmission channel and, for example, set the renumeration rate on the digital euro as they deem necessary for the overall economy.
5. The need to mitigate the probability that a cyber incident, natural disaster, pandemic or other extreme events could hinder the provision of other forms of payment services. In this scenario, a digital euro, together with cash, could constitute a possible contingency mechanism to make sure that payment services are still available.
6. The international role of the euro could become a Eurosystem objective which would be enhanced if issued as a digital euro, especially if it were designed as an interoperable way to offer cross-currency payments.
7. If the Eurosystem decides to proactively support improvements in the overall costs and ecological footprint of the monetary and payment systems. A digital euro would not need to be physically produced, nor would the infrastructure need cash distribution centres, branches and ATMs. The power consumption of a digital euro core settlement system would be low; in its tests, only a few kilowatts were needed to run thousands of transactions per second.

What has happened so far and what happens next?

The ECB emphasises that no final decision has yet been made on whether a digital euro will actually be adopted. The issues surrounding CBDCs and the many options available in their development are complex and require careful thinking, so it is no big surprise that the EU plans to take five years to work it through.

The Digital Euro Report October 2020

The launch of the digital euro project was preceded by a report on a digital euro published in October 2020. This examined the issuance of a digital euro from the perspective of the Eurosystem: defining scenarios and implied consequences which could induce the Eurosystem to issue a digital euro. It also identified a number of principles for such a digital euro, explored its potential effects and design possibilities, and considered technical and organisational approaches. 

Further experimental work

Following the October 2020 report, the Eurosystem’s High-Level Task Force on CBDC conducted further experimental work to address key design options left open by the report.

Digital euro project phases 

• Investigation phase: As no major technical obstacles were identified during the preliminary experimentation phase, the Eurosystem has proceeded to launching the digital euro project with an investigation phase projected to last 24 months.
• Experimentation phase: This investigation phase will be accompanied by an intensified experimentation phase which focuses on the technical aspects of a digital euro.
• Determination: At the end of the digital investigation phase, the ECB will decide whether or not to start work on the actual development of a digital euro. 

Timeframe

Assuming a positive decision, overall, we expect the timeframe to be at least 4-5 years from now.

What will happen during the investigation phase?

The goal of the project is to develop a riskless, accessible and efficient form of digital central bank money. In the investigation phase the ECB will further develop the functional design of a digital euro based on the user's needs which are key to this goal.

While further diving into the technical side of things, the legal framework will also be assessed to identify any changes that might be required to issue the digital euro.

Lastly, the ECB will focus on the possible impact of a digital euro on the market, privacy concerns and, maybe most difficult of all, assess the meaning for supervised intermediaries with the goal to define business models with the digital euro ecosystem.

Here, the ECB has already identified a broad array of design options and significant implications in its October 2020 report. While the ECB aims for a balanced outcome, the stakes are high. For example:

• Role of banks: The future roles of banks could be significantly affected if the Eurosystem were to grant its end users the ability to directly access and operate accounts on its infrastructure, potentially ending the need for private banks.
• Role of intermediaries: The Eurosystem could continue to interact directly only with supervised intermediaries which would, for example, act as settlement agents instructing transactions on behalf of their customers as of today. Alternatively, a decentralised infrastructure could allow end users to transfer holdings of bearer digital euro among them with no need third party involvement (such as the Eurosystem or supervised intermediaries).

Will a digital euro be DLT-based?

No decisions made yet on design features

Up until now, the ECB has only identified general principles and goals, shaping a general outline of key characteristics. No decisions have yet been made on final design features, such as the underlying technology.

While the ECB recognises the possibility of using DLT protocols, it also emphasises that there is no need to use DLT. In its experiments so far, ECB has focused on how to combine a centralised ledger and a decentralised ledger as well as focusing on the issue of scalability and how to determine digital identity.

TIPS system

Even though there were no major technical restrictions identified for all technologies tested to date, experiments conducted on the TARGET Instant Payment Settlement (TIPS) System showed a slightly higher scalability as compared to blockchain based models. According to some press coverage, the ECB currently seems to lean towards the use of TIPS as a potential technological basis for a digital euro.

What to look out for

While other countries’ CBDC projects pick up steam, and while the euro area becomes increasingly dependent on non-European payment networks, the pressure to enhance European based payment solutions is likely to build. As a result, there is the possibility that other initiatives with similar objectives might gather political support over the digital euro.

This is already the case for the European Payments Initiative (EPI), which aims to provide a system for real-time payments between consumers based on the SEPA instant credit transfer scheme. Given the increasing pressure from consumers for this kind of solution, we expect growing support for this initiative.

In any case, central banks are aware of the many difficult and open questions around CBDCs, especially in connection with the significant impacts a CBDC could have on the financial system. They will tread carefully and are most likely to move forward incrementally considering carefully the design options and functionality. 

Note that players in the payments industry will have the chance to input their thoughts on the digital euro in market advisory group (MAG) which will be established. We will keep you updated on developments. 

Learn more about global trends in payments, including CBDCs, by catching up on the payments session in our Regulating the Digital Economy Series.