Digital Euro Blurs the Lines Between Money and Politics
A central bank-backed digital currency would put the EU in the global vanguard when it comes to taking cash payments online. But missteps could put the entire banking systems at risk if the project streamlines finance too much at home or abroad.
The European Union is officially still weighing whether to introduce a digital euro, but most signs point to a “yes” in October 2023, when a two-year review wraps up. At its best, the project could usher in a cheaper, safer way to replace cash payments with electronic transactions. If it goes wrong, the entire banking system could teeter.
Central bank digital currencies, as such projects are formally known, are generally a welcome move to replace the Wild West of crypto assets with something that is more recognizable as money. “Central bank” is the key phrase—when a credible monetary authority is involved, any currency can join the big leagues. Without it, digital assets are no better than digital tulips.
A digital euro is thus in a completely different category than Bitcoin, Ethereum, or any other privately developed, computer code-based financial instrument. It would be easier on the environment too—instead of requiring astronomical amounts of computing power, a digital euro would have roughly the energy footprint of a credit card network. It still, however, comes with big questions surrounding privacy, fraud protection, and financial stability.
The European Central Bank decided the eurozone needed to get ahead of the official-sector crypto craze, given the speed with which similar projects are taking off in China and elsewhere. While the US Federal Reserve has so far taken a measured approach to assessing pros and cons, the EU has pushed ahead. Five companies, including Amazon and European payments provider Worldline, were chosen in September to prototype different ways a digital euro could be used, as the ECB’s technical work picks up steam. Particularly given the growth of stablecoins—crypto assets whose value is pegged to traditional currencies—and other attempts to bridge the divide between traditional central banks and private money, the ECB decided to take charge.
A Public Good
“Payments are a public good that is simply too important to be left to the market,” ECB President Christine Lagarde said in November 2022. “In the absence of a public anchor, the emergence of new kinds of digital assets could harbour instability and confusion among citizens about what is money and what is not.”
The key will be making sure the money stays in circulation and not under the digital mattress. This is not a new problem—the euro area discontinued €500 notes after finding they were more often used for money laundering than in daily life—but it is one that has particular salience as physical cash becomes more and more of a relic.
“Normal” digital transactions, which move money via a card network or automated clearinghouse system like SEPA, are wholly products of the banking system. Banks work by leveraging consumer deposits to make loans. If large swaths of the economy suddenly started paying themselves directly, credit conditions could try up overnight—especially in Europe, where banks provide the vast majority of corporate finance. National borders make this even more of a concern. Not only does the EU not have much of a cross-border capital markets union, it has relatively little cross-border banking due to the ring-fencing and risk management required under current EU rules. Furthermore, if a digital euro caught on in other jurisdictions, it could pull money out of banks in another country that could not even draw on EU institutions for help.
This kind of financial cannibalism is very much on policymakers’ minds. The ECB’s 2020 analysis focused on online payments made through financial-sector intermediaries, with peer-to-peer payments considered mainly for offline transactions. This would have the advantage of keeping banks in the loop—along with their systems of deposit insurance, reporting requirements, and other administration the central bank does not want to take on directly—and keeping the ECB at arm’s length from transaction data. Consumers have grown used to leaving a digital trail on their bank accounts, but the idea of sending purchase information straight to the government makes a lot of people uncomfortable. According to German Finance Minister Christian Lindner: “Digital cash will only be widely accepted as a supplement or equivalent substitute for notes and coins if privacy is protected. Personal and transaction data from everyday transactions must therefore not be stored.”
A Political Project
In general, the digital euro would be useful as a means of payment and a unit of account, but not a store of value. In November, ECB Executive Board Member Fabio Panetta floated a monthly limit of 1,000 transactions, possibly capped at €50 each, with a balance limit of €3,000 at a time. Policymakers do not want the digital euro to replace savings accounts or other kinds of investments. The ECB also is wary of allowing it to be used internationally, even though eurozone finance ministers have expressed interest in worldwide use as a way to preserve “monetary sovereignty” and help the euro catch up to the dollar.
Practically speaking, the digital euro is likely to be a political project rather than a technical innovation. The euro is already sturdy, widely used, and plenty online without the ECB taking on financial technology. But finance ministers and central bankers would like to lay claim to the world’s premier digital currency, which a digital euro could become, as well as the defensive advantage of making a digital euro just to ensure no one else tries to.
In terms of who would use it, the biggest advantages could come to the smallest parts of daily life. Tipping, in particular, could get a jumpstart if patrons could quickly and easily toss over a few euros from their phones where they previously would have offered physical coins. Digital euros also could help people who are too poor or too transient to maintain bank accounts and are currently shut out of many kinds of electronic transactions. By definition, the unbanked are some of society’s least well off, but a digital euro might help them catch up as long as they can manage to buy a smartphone.
The ECB’s choice of Amazon as one of its prototyping vendors has raised eyebrows but does not seem, at this point, to signal future preferential treatment. If there is a digital euro, consumers will want to be able to spend it, and it makes sense for a company that handles a whole lot of everyday transactions to look into how this would work practically. The retail giant has been chosen for e-commerce, no surprise, while other companies were picked to handle online and offline peer-to-peer transactions as well as different kinds of in-store or “point of sale” exchanges. The ECB says there are no plans to reuse the prototypes, only to see how they interface with the ECB’s nascent back-end systems. Since the companies are participating at their own expense it remains to be seen how they will follow up. The ECB also has not decided whether it will use distributed ledger or blockchain technology, or some more central system.
The ECB has said it could imagine the digital euro as a monetary policy transmission channel, not just an additional mode of making payments. Part of this justification may just be protective—if people who want digital currency use the ECB’s money instead of an alternative, there are more euros in circulation to work with. There are further prospects: digital euros could give the ECB a way to involve more non-banks in its monetary policy operations, and in theory the central bank could even set specific interest rates or reserve requirements to further its overall policy goals.
The European Commission plans to propose legislation on a digital euro in the first half of 2023, ahead of the ECB’s planned October decision on whether or not to move ahead with the project. Debates around this path will offer more opportunities to seek buy-in well in advance of an actual launch. There are off-ramps, but so far, no strong calls for an exit. Instead, the European Commission, the Eurogroup of eurozone finance ministers, and the European Parliament all have been taking the time to have their say and air their concerns. Privacy is the biggest one, in terms of the popular view. Practically speaking, financial stability and the role of banks will be even more important, as will consumer protection and anti-money laundering rules.
It is not at all clear that the eurozone needs a digital euro but it is becoming increasingly evident that the eurozone wants one. With that political decision-making in mind, stakeholders now need to make sure they design a product that works without dragging a blockchain of unintended consequences behind it.
Rebecca Christie is a non-resident fellow at Bruegel, the Brussels-based economic think tank, and the Brussels columnist for Reuters Breakingviews.