This article sheds light on the latest development concerning the digital euro. The article briefly introduces the role of the eurosystem and the changing payment landscape. The European Central bank ECB vision of the digital euro as revealed by Christine Lagarde, ECB President, and Fabio Panetta, ECB Executive Board Member, is presented. Following this introduction, the article focuses on the objective and key characteristics of the digital euro, the digital euro design requirements, the legal considerations surrounding the issuance of the digital euro, the digital euro technical implementation, the digital euro infrastructure, and hardware and software end-user access. A comparison between digital euro and crypto currency and stablecoin is established. The digital Euro institutional framework is depicted and the German Bundesbank perspective of the digital euro is highlighted. The article concludes with lessons learned and road ahead for Arab banks to develop their central bank digital currency.
Role of Eurosystem
The Eurosystem provides safe money and reliable means of payments to households, businesses and the broader financial system in the euro area. By pursuing its tasks of maintaining monetary and financial stability and the smooth operation of payment systems, the Eurosystem ensures that money and payments serve European society.
A key part of the Eurosystem’s mission is to provide citizens with riskless money for their payments. the Eurosystem has been providing euro banknotes for nearly two decades.
Changing payment landscape
While cash is still the dominant means of payment, new technologies and the increasing demand for immediacy from consumers are changing the way European citizens pay. This is evident in the expanding role of fast electronic payments.
The speed of innovation is accelerating and people around the world are showing an increasing preference for digital payments. Against this background, the Governing Council of the European Central Bank (ECB) established a High-Level Task Force in January 2020 in order to advance work on central bank digital currencies (CBDC) in the euro area.
DIGITAL EURO FROM ECB PERSPECTIVE
According to Christine Lagarde, ECB President, and Fabio Panetta, ECB Executive Board Member and Chair of the Eurosystem High-Level Task Force on Central Bank Digital Currency (HLTF-CBDC), The European Central Bank ECB is always committed to maintaining confidence in euro currency, and adapting the form of money and payment services to the changing ways in which people spend, save and invest.
To ensure that consumers continue to have access to central bank money in a way that meets their needs in the digital age, the ECB’s Governing Council decided to advance work on the possible issuance of a digital euro as an electronic form of central bank money accessible to all citizens and firms. A digital euro would be introduced alongside cash, it would not replace it.
OBJECTIVE OF DIGITAL EURO
A digital euro would create synergies with private payment solutions and contribute to a more innovative, competitive and resilient European payment system. By serving as a unifying force in Europe’s digital economies, a digital euro would also be an emblem of the ongoing process of European integration.
DIGIRAL EURO key characteristics
The European Central Bank Report on digital Euro describes the key characteristics of the digital Euro as follows:
Form. The digital euro would be a central bank liability offered in digital form for use by citizens and businesses for their retail payments. It would complement the current offering of cash and wholesale central bank deposits.
Advantages. A digital euro could support the Eurosystem’s objectives by providing citizens with access to a safe form of money in the fast-changing digital world. This would support Europe’s drive towards continued innovation. It would also contribute to its strategic autonomy by providing an alternative to foreign payment providers for fast and efficient payments in Europe and beyond.
Need. A digital euro may become essential when cash decline significantly and/or when other electronic payment methods become unavailable owing to extreme events.
Design. The digital euro is designed in such a way as to avoid possible undesirable implications for the fulfilment of its mandate, for the financial industry and for the broader economy.
Economic Policy. A digital euro could support the general economic policies of the European Union (EU). It could satisfy the emerging payment needs of a modern economy by offering, alongside cash, a safe digital asset with advanced functionalities.
DIGITAL EURO DESIGN REQUIREMENTS
Until now there is no specific commitment to a specific design of a digital euro. But it is clear that any type of design must fulfil a number of principles and requirements identified including accessibility, robustness, safety, efficiency and privacy while complying with relevant legislation. As identified in the ECB report , Digital euro design consideration and requirements include:
- P1: Convertibility at par: Not a parallel currency
- P2: Liability of the Eurosystem: A digital euro is central bank money and its issuance is controlled by the Eurosystem
- P3: European solution: Widely accessible on equal terms in all euro area countries through supervised service providers
- P4: Market neutrality: Not to crowd out private solutions
- P5: Trusted by end users: Trusted solution from the start and over time
- R1: Enhanced digital efficiency: The digital euro should keep pace with state-of-the-art technology at all times in order to best address the needs of the market as regards, among other attributes, usability, convenience, speed, cost efficiency and programmability. It should be made available through standard interoperable front-end solutions throughout the entire euro area and should be interoperable with private payment solutions.
- R2: Cash-like features to tackle a decline in the acceptance of cash: To match the key distinctive features of cash, a digital euro aiming to tackle a decline in the acceptance of cash should permit offline payments. Moreover, a digital euro should be easy for vulnerable groups to use, free of charge for basic use by payers and should protect privacy. It should have a strong European branding.
- R3: Competitive features to limit the uptake of forms of money that are not denominated in euro and/or not appropriately supervised: The digital euro should have features which are at the technological frontier. It should offer the basis for providing functionalities that are at least as attractive as those of the payment solutions available in foreign currencies or through unregulated entities.
- R4: Monetary policy option: The digital euro should be remunerated at interest rates that the central bank can modify over time.
- R5: Back-up system: If aiming to improve the overall resilience of the payment system, the digital euro should be widely available and transacted via resilient channels that are separate from those of other payment services and can withstand extreme events.
- R6: International use to increase the international role of the euro: The digital euro should be potentially accessible outside the euro area in a way that is consistent with the objectives of the Eurosystem and convenient to non-euro area residents.
- R7: Cost saving: The design of the digital euro should achieve cost efficiency, as such reducing the cost of the current payment ecosystem.
- R8: Environmentally friendly: The design of the digital euro should be based on technological solutions that minimise its ecological footprint and improve that of the current payment ecosystem.
- GR1: Ability to control the amount of digital euro in circulation: The digital euro should be an attractive means of payment, but should be designed so as to avoid its use as a form of investment and the associated risk of large shifts from private money (for example bank deposits) to digital euro.
- GR2: Cooperation with market participants: A project to introduce a digital euro should be carried out in line with best practices in Information Technology IT project management. The digital euro should then be made available on an equal basis in all euro countries through supervised intermediaries, which could leverage their existing customer-facing services and avoid the costly duplication of processes.
- GR3: Compliance with the regulatory framework: Although central bank liabilities are not subject to regulation and oversight, in issuing the digital euro the Eurosystem should still aim at complying with regulatory standards, including in the area of payments.
- GR4: Safety and efficiency in the fulfilment of the Eurosystem’s goals: The digital euro should be designed in a safe and efficient way. Its project and operating costs should be estimated and compared with the expected benefits, considering alternative solutions in any future scenario. The provision of non-core services should be left to supervised private entities.
- GR5: Easy accessibility throughout the euro area. The digital euro should be made available through standardised front-end solutions throughout the entire euro area and should be interoperable with private payment solutions. It should be easily accessible by anyone, including citizens who currently do not participate in the financial system (for example, those who do not have an account at a commercial bank), and should be easy to use. The digital euro would need to co-exist with cash.
DIGITAL EURO LEGAL CONSIDERATIONS
The legal considerations surrounding the issuance of the digital euro by the European Central Bank include:
Legal basis. The concrete design choices for the digital euro would determine the legal basis for the issuance of the digital euro.
Eurosystem competence. EU primary law does not exclude the possibility of issuing digital euro as legal tender, which would consequently require payees to accept it for payments.
Private law issues. Depending on the design of the digital euro and on the purpose for which it is issued by the Eurosystem, different private law issues would arise. For instance, in an account-based model, the digital euro would constitute a claim on or a representation of a claim on the relevant national central bank (NCB) or the ECB for convertibility at par with another representation of the sovereign currency. Accordingly, the private law rules governing bank deposits would apply.
DIGITAL EURO TECHNICAL IMPLEMENTATION
Digital euro technical implementation considerations include:
Users could access the digital euro either directly or through supervised intermediaries. If users have direct access, the central bank would need to provide end user-facing services, such as customer identification and support. This would not be necessary if users access the digital euro indirectly, i.e. through intermediaries responsible for the provision of such services.
Users’ privacy can be protected to various degrees, depending on the preferred balance between individual rights and public interest. Means of payments in current use already provide varying degrees of privacy, ranging from anonymous cash transactions to transactions requiring documentary verification or monitoring via bank accounts.
Use of a digital euro as an investment
The amount of digital euro that individual users could hold would be kept within a range such that the overall value of the digital euro in circulation would remain below an aggregate threshold deemed reasonable.
Demand for a digital euro could also be controlled through incentive schemes under which less attractive interest rates or service fees are applied when individual holdings exceed a threshold.
Restrictions on access to digital euro services
The Eurosystem may restrict the scope of individuals/entities that can access digital euro services. However, a digital euro without access restrictions would allow international use.
A digital euro could be provided either through an account-based system or as a bearer instrument.
A digital euro could be provided as a web-based service and/or through dedicated physical devices such as smart cards. Whereas in the first case a broad range of devices could be used (for example, computers, mobile phones and wearable devices) and an internet connection would be necessary, the second case would require payer and payee to have specific compatible devices that could also enable offline use.
Availability and usability offline
An electronic payment that is not confirmed online – either through the network of users or in a central register – can still be considered final by relying on trusted hardware modules. Offline functionality avoids the sharing of transaction details with parties other than the payer and payee, enabling the digital euro to become a complement to cash and providing a back-up payment solution that is available in extreme situations.
A digital euro may be remunerated for monetary policy reasons, and also for financial stability and structural reasons, such as to lower demand for digital euro for investment purposes and to prevent the Eurosystem becoming a large investment intermediary. Remuneration could also be considered an attractive feature for users, which would preserve the role of the euro in retail payments in a digital environment with alternative digital currencies.
Legal tender status would be a desirable feature of the digital euro. Without this status, the drivers of acceptance would be more similar to those of other electronic payment solutions.
A digital euro based on infrastructures existing in parallel to those of other payment solutions could help to withstand extreme events such as cyber incidents and attacks, natural disasters, and pandemics. Parallel infrastructures for private payment solutions could provide this but would be costly.
Possible coexistence of types of digital euro
Based on the description of the possible features of a digital euro, it is possible to identify two types of digital euro:
- The first type is mutually compatible digital euro offered to satisfy the core principles and scenario-specific requirements and general requirements.
- The second type of digital euro can be used online and remunerated at a rate that varies over time. Remuneration would be a powerful tool for monetary policy applications and also to limit shifts from private money into the digital euro.
DIGITAL EURO INFRASTRUCTURE
According to the European Central Bank, issuance of a digital euro should remain under the control of the Eurosystem. Supervised intermediaries should be involved at least for the identification and onboarding of entitled users and possibly for the routing of transactions to the central bank infrastructure; they could build new businesses on digital euro-related services.
Two approaches are considered for the back-end infrastructure: centralised and decentralised. In the first approach, digital euro transactions are recorded in the Eurosystem’s ledger. In the decentralised approach, the Eurosystem sets rules and
design options in which private entities would act as custodians of digital euro holdings, thereby leaving users with a claim on the intermediary rather than on the Eurosystem
End users could hold their accounts in a centralised digital euro infrastructure provided by the Eurosystem. Such accounts would allow users to deposit and withdraw digital euro by means of electronic transfers from/to other forms of money and to make payments in digital euro.
Two types of user access are identified in the centralised infrastructure
- Direct access by end users to central bank accounts
- Intermediated access by end users to central bank accounts
The main difference between a direct and intermediated model is the role of the private sector. While in a direct model, supervised intermediaries are mere gatekeepers, in an intermediated model they would play a more prominent role, including that of settlement agents. In both cases, the private sector would be able to build new businesses based on digital euro-related services.
An infrastructure with some decentralisation could be used to provide a bearer digital euro, where either end users, or supervised intermediaries acting on their behalf, would verify any payment. This could be achieved through one of the following two models, which could also be combined:
- Direct end-user access to the bearer digital euro: A decentralised infrastructure could allow end users to transfer holdings of the bearer digital euro among them with no need to mandate a third party to play any role in the transaction. This approach could be implemented in two ways: either via distributed ledger technology (DLT) protocols or by means of local storage (e.g. using prepaid cards and mobile phone functionality, including offline payments).
- Hybrid bearer digital euro and account-based infrastructure: A hybrid decentralised infrastructure could be implemented to enable the use of a bearer digital euro at the level of supervised intermediaries, who could act as settlement agents on behalf of their clients for retail transactions in digital euro and also use the same infrastructure for their wholesale payments.
HARDWARE AND SOFTWARE END-USER ACCESS
Access solutions link end users to the back-end infrastructure. The Eurosystem would need to ensure integration of different end-user access solutions to make digital euro services universally accessible and allow their interoperability with the financial market ecosystem.
Solutions for end-user access to a digital euro infrastructure could either be hardware or software-based, or a combination of both types of solutions. In any case, front-end access solutions need strong customer authentication and identification.
End-user solutions and any private systems involved in the provision of digital euro services should interface with the back-end infrastructure of the central bank in a way that ensures the highest protection against the risk of unwarranted creation of digital euro units without authorisation from the central bank.
Hardware solutions for using digital euro services include devices possessed by end users, merchants’ acceptance devices and ATMs. These would be hardware elements in mobile phones, computers, smart cards, wearables or tokens that an end user can use as a gateway to access digital euro services via mobile and web-based banking applications
Software solutions for end-user access to payment services include applications, web interfaces, digital wallets and virtual cards. Mobile and web-based banking applications that use mobile and desktop devices for user identification are widely used in e-commerce and peer-to-peer P2P payments.
digital euro vs crypto and stablecoin
Digital euro. According to the European Central Bank, the digital euro would be a risk-free form of central bank money (i.e. a digital representation of cash), which means that it is issued by the central bank and remains its liability at all times. The Eurosystem is accountable to the European citizens for ensuring that the value of the instruments it issues is unchanged over time (i.e. one euro today is worth one euro tomorrow, be it in the form of cash or digital euro) and the amount of goods and services they can buy with such instruments (i.e. the purchasing power of money issued by the central bank) does not fluctuate beyond a predefined threshold.
Commercial bank money and electronic money. In contrast to the digital euro, commercial bank money and electronic money are liabilities of supervised private entities. Private money issuance needs to comply with the regulations and the issuing private institution is subject to supervision or oversight by public authorities. While such entities might in theory default and become unable to satisfy the claims of their customers to convert their holdings into central bank money, their customers are protected by a legally binding regulatory framework that obliges the supervised private issuer to take measures to protect the value of their liabilities. The central bank, beside its supervisory function, acts as a lender of last resort to avoid default by the commercial banks in exceptional situations. Moreover, deposits with commercial banks are protected in the euro area by deposit insurance schemes.
Crypto-assets. In contrast, crypto-assets are not a liability of any entity, thus there is no reliable framework to sustain their value and to protect their direct holders. These assets are mostly unregulated, which poses high risks to the users. Their price is highly volatile because crypto-assets lack any intrinsic value, which means that they trade like a speculative commodity. These characteristics limit the use of crypto-assets to only a limited set of investors and make their market illiquid; this in turn implies that users might fail to convert their crypto-asset holdings back into the amount of euro they initially invested. Regardless of the technology used for a digital euro, its nature (a risk-free liability of the central bank) makes it fundamentally different from crypto-assets.
Stablecoins. Blockchain technology is used for the issuance and trading of various asset types. Stablecoins are recorded by means of distributed ledger technology. Their characteristics differ according to the type of claim they represent, which could make them similar to commercial bank money, electronic money, investment funds or crypto-assets. All forms of stablecoins, aim at keeping their value stable over time, but this can only be guaranteed by a digital euro.
DIGITAL EURO Institutional framework
The digital euro will involve various European institutions and authorities. Institutions involved in European Union (EU) legislation, such as the European Parliament, the EU Council and the EU Commission, will have a fundamental role to play.
Other institutions, such as the European Banking Authority, the European Securities and Markets Authority, and the European Systemic Risk Board, will also be involved in order to further explore the potential risks of digital euro and ways to address or mitigate them.
The international implications of the issuance of Central Bank Digital Currencies CBDCs requires open dialogue with other central banks and international organisations. The international central bank group established by the Bank of Canada, the Bank of England, the European Central Bank ECB, the Bank of Japan, Sveriges Riksbank and the Swiss National Bank, together with the Bank for International Settlements are usually involved in assessing the potential use cases for Central Bank Digital Currency CBDC and its international dimension. Other important international institutions, such as the Financial Stability Board, the Financial Action Task Force, the Committee on Payments and Market Infrastructures, and the International Monetary Fund are also involved.
Joachim Nagel describes Germany Bundesbank perspective of the various opportunities and risks of a digital Euro. According to Joachim Nagel, the digital euro offers a whole range of opportunities. However, its introduction entails potential economic risks.
There are two main risks to the financial system:
- The first risk is bank runs. In the future, the digital euro would enable citizens, in the event of tensions in the financial system, to convert their overnight bank deposits into central bank money in seconds with a few mouse clicks or touches. In extreme cases, this could bring many banks to their knees if they encounter liquidity problems due to rapid outflows of deposits. Depending on the design of the digital euro, these risks can be managed.
- The second risk is structural disintermediation. bank customers could shift a significant proportion of their bank deposits from their current or other deposit accounts to Central Bank Digital Currency CBDC. For commercial banks, this would mean losing a cheap and stable source of funding. If commercial banks lose a significant portion of these deposits because citizens are using the digital euro as a store of value, banks’ credit supply could fall and financing conditions for the real economy could deteriorate.
- Further risks cannot be ruled out if the complex monetary system is expanded. It is necessary to design the digital euro in way to keep the potential risks manageable.
Digital Euro advantages can be seen from two perspectives:
- From a monetary and foreign exchange policy perspective, the introduction of a digital euro will be a measure that would safeguard the anchoring function of central bank money, even in an increasingly digitalised world.
- The second perspective concerns payment transactions in Europe. The introduction of a digital euro could support progress in the area of payments and increase Europe’s sovereignty. There is currently no single cross-border solution for e-commerce or card payments for the euro area that is based on European infrastructure.
With a digital euro, future digital payments in the euro area could be carried out independently of non-European payment infrastructures. This would reduce risks and dependencies in payment transactions, which would also be beneficial to financial stability. A digital euro could also contribute to the protection of payment data.
The introduction of a digital euro would be particularly beneficial for consumers if it would allow digital payments to be processed easily, quickly and cost-effectively, whilst protecting payment privacy. People would then have access to the digital euro in addition to cash.
The digital euro infrastructure could open up the prospect of serving as a platform for innovation. In particular, this could apply to automated payment transactions, which are likely to become increasingly popular as digitalisation increases.
A wholesale version of the digital euro could make progress possible, especially for large-value payments, which are common amongst Eurosystem banks and counterparties.
There are two approaches to making central bank digital currency CBDC usable for cross-border payments:
- A unilateral approach: This involves issuing digital currency according to one’s own rules. A unilateral approach would certainly be less complex, but entails economic risks. If a foreign central bank digital currency became widespread domestically, this could impair the effectiveness of monetary policy. A similar phenomenon is known as informal currency substitution or dollarization.
- A multilateral approach: This involves cooperation between the issuing central banks to make CBDC directly exchangeable and interoperable. This approach does not provide for large quantities of digital money to be held in foreign currency, thereby potentially limiting the economic risks for the participating currency areas. Varying degrees of interoperability can be aimed for.
The interoperability of central bank digital currency poses great economic, technical, legal and political challenges. Once these can be overcome, the shortcomings of cross-border payments will decline significantly.
Digital euro status
The digital euro did not appear yet. It is still an ongoing project. The initial focus is on using the digital euro within the euro area. It is intended to enable simple payments in everyday life, just like cash, but in digital form. It should therefore be usable in both retail outlets and when making purchases online. Equally, it should be possible to use the digital euro for cashless payments from person to person or payments made between individuals and public authorities.
The next steps undertaken by the European Central bank are conceptual analysis, practical experimentation and public consultation.
LESSONS LEARNED AND Road ahead for ARAB BANKS
Issuing a central bank digital currency, like the digital Euro, should take into accounts several considerations including:
- Design requirement
- Legal framework
- Technical implementation
- End user access
- Institutional framework
Risks and opportunities of a central bank digital currency should be weighted, and Arab banks should make sure that commercial banks will not be adversely impacted from issuing a central bank digital currency.
Two approaches for Arab banks could be adopted in issuing a central bank digital currency:
- A unilateral approach: each central bank in an Arab country will issue its own central bank digital currency.
- A multilateral approach. Central banks in various Arab countries can collaborate together to issue a strong unified digital central bank currency.
The unilateral approach may be easier for Arab banks, but a multilateral approach may be more powerful and would strengthen the global role and position of Arab banks and give them greater competitive advantages.
In all cases, it is obvious for Arab banks and authorities, that a Central Bank Digital Currency is a must take endeavour that should be approached carefully with local and international vision.
Issuing a unified central bank digital currency backed by various central banks in the Arab region would enhance the competitiveness of the Arab banking and financial system and empowers its global outreach and widen its scope in settling international payments.