The European Central Bank (ECB) is exploring a digital euro. Early October 2020, the ECB Governing Council released a whitepaper discussing its initial research on such a project. One of the ECB’s clearest and most repeated messages is that a digital euro will not replace cash, but complement it. A digital euro is meant to facilitate electronic payments, while cash would remain a valid form of payment and the primary form of value storage.
The European Central Bank’s Exploration of a Digital Euro
This exploratory paper comes as a direct result of a digitalized economy whose momentum is ever growing because of new technologies, legislation meant to increase the competitiveness of digital competitors, and traction that digital currency projects are gaining around the world. Despite the changing world, and the changing needs and expectations of individuals, businesses, and other economic actors, a digital euro is not meant to upend the current monetary system. The paper is a painstakingly methodical exploration of how-to architect, legislate, and standardize a digital euro to maintain financial stability and preserve the ECB’s capacity to influence monetary policy.
The paper itself is a proactive effort from the ECB, dedicating time and resources towards determining the opportunities, risks, and costs of adopting a digital euro. This is also apparent in the scenarios that would motivate the ECB to pursue a digital euro project, the majority of them being a proactive step to maintaining competitiveness, improving efficiencies, and increase the stability of the monetary system.
|
Scenario |
Proactive |
Reactive |
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A digital euro would foster the digitalization of the European economy |
x |
|
|
Decline of cash payments |
|
x |
|
A different form of money – digital currencies issued by other central banks, decentralized organizations, or private companies – becomes a credible alternative to the euro |
|
x |
|
A digital euro would be necessary or beneficial to strengthen European monetary policy |
x |
|
|
If a digital euro would mitigate the negative effects that a cyber incident, natural disaster, or other extreme event would have on payment services |
x |
|
|
Adopting a digital euro causes the euro to gain international relevance |
x |
|
|
Adopting a digital euro improves overall costs and ecological footprint of monetary and payment systems |
x |
|
This is a charitable view of the ECB, whose digital euro project is still in the proof-of-concept stage with the decision whether to formally launch it being made earliest in mid-2021. This means that in the time it will take to methodically prepare a digital euro project – as it should, this is not a project to leap into lightly – the ECB may fall into a reactive position, as cash payments continue to decline and other currency options become more prominent and potentially challenge the euro.
The New Way to Exchange Value
The ECB whitepaper explores the possible architectures that a digital euro could be built on, letting the decision be shaped by solution requirements such as privacy, user access to the digital currency, or protecting its use for payments rather than investment. The architecture question will be the focus of the ECB’s future research, though we can predict that it will likely follow a centralized infrastructure with access facilitated by supervised intermediary banks. Decentralized architectures are part of the conversation, but options such as distributed ledger technologies (DLTs) are relatively untested to the scale that the ECB would require and pose higher risks to the stability and security of the Eurosystem. The overall risk-adverse tone of the report and self-determined requirements that the back-end infrastructure of any digital euro project should be controlled by the central bank indicates a preference for known and/or centralized solutions, though many of the active central bank digital currency (CBDC) projects around the world are working with DLTs.
The interest the ECB is showing for alternative payment methods indicates two things: that the ECB has a desire to be a leader in shaping the future of payments, and that their decision whether or not to pursue a digital euro will have a strong influence on the emerging use cases for the digital exchange of value between parties. This is not simply a digital payment, but the digital exchange of a request accompanied by trusted identity, resulting in the receipt of value. For example, the user of a carsharing service unlocks the car door with a one-time key issued to their mobile app. Or a hotel booking automatically issues room keys and admission to the building upon payment. Or the owner of an electric vehicle agrees to sell back reserve power to the grid. These are use cases where a digital transaction does not end with the successful transfer of money, but where payment is the trigger for the exchange of value, making the transaction a two-way process.
Decentralized: How and Why?
The next months will be an interesting time of research and inquiry: Which of the global CBDC projects will succeed, and will it become the standard architecture of digital currencies? Will CBDCs be able to fulfill the future of two-way digital transactions to exchange value? Or is it only possible if they operate on a decentralized architecture? And how will the ECB’s goal of preserving the intermediary roles of banks in monetary system interplay decentralized payment systems, whose major outcome is to disintermediate?
We believe the future of payments and the exchange of value will be use-case driven. Grassroots solutions will emerge for particular use cases like carsharing to fill the time until major institutions develop their proposals and standards. There will be stiff competition to establish the platforms, architectures, and methods that gather a critical mass. And we will continually be surprised at the new use cases for the digital exchange of value.
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