The digital euro - an initial stocktaking

ECB and Eurosystem central banks are positioning themselves for the introduction of digital central bank money.

The digitalisation of payment transactions continues to progress. Therefore, the European Central Bank (ECB) and the national central banks in the Eurosystem, such as the Deutsche Bundesbank, are also working intensively on adapting central bank money to the digital age. In the Eurozone, this will be the digital euro.

Why do we need a digital euro at all?

From the central banks' point of view, two aspects play a decisive role in the question of why a digital euro is even necessary:

First, the role of central bank money as the anchor of the payment system must be preserved so that the different forms of money, i.e. central bank money and private forms of money such as bank deposits, credit cards and electronic payment solutions can easily continue to co-exist, be exchanged and complement each other. This is particularly important since the use of cash for payment transactions is decreasing continuously.

Second, a digital euro as a European payment solution would contribute to Europe's strategic autonomy and economic efficiency. At the same time, the aim is to ensure that Europe is not dependent on private providers such as Meta, which made a first - albeit failed - attempt to introduce a digital currency with Libra, or on other nations that are working on digital solutions. For example, Nigeria and the Bahamas have already introduced digital central bank money. China is also already in a comprehensive test phase with the E-Yuan.

Fit for payment transactions of the future

With a digital euro, people in Europe will be able to use central bank money anywhere in the euro area for digital payments, just like cash is used to pay for purchases in shops today.

To achieve the greatest possible acceptance among the population, the digital euro should, from the central banks' point of view, be secure, inexpensive and stable in value, and at the same time, help to minimise any shortcomings with cross-border payment transactions. To this end, the digital euro should also become legal tender, although this decision is up to the (European) legislator. This makes it clear that the digital euro is not only intended for interbank payments, but also as a digital means of payment for everyone.

The digital euro could provide easy and convenient access to a digital means of payment for all segments of the population, including those who have had limited access to digital payment methods to date. An offline functionality would also be useful from the central banks' point of view.

Representatives of the ECB and Deutsche Bundesbank have repeatedly confirmed that the Eurosystem will continue to offer cash in the future. The digital euro is intended to complement cash, not replace it. This aspect should not be underestimated, especially in countries like Germany where the use of cash is still very widespread.

Preserving financial stability

At the same time, the central banks want to avoid a large outflow of deposits from the banking sector and a shift to central bank money. This could be achieved by setting maximum amounts for holding digital euros or staggered interest rates.

Such quantitative limits for individual credit balances or a less attractive interest rate for larger credit balances are intended to prevent the digital euro from being used as a form of investment instead of exclusively as a means of payment. The ECB has proposed an (initial) cap of around EUR 3,000 to 4,000 per citizen in the euro area and an overall cap of EUR 1 to 1.5 trillion for the total digital euro holdings. This is to avoid negative effects for the financial system and monetary policy overall.

At the same time, it preserves the role of banks as financial intermediaries. They could play a particularly important role in spreading of the digital euro throughout the retail sector and bring in competences from the private sector, especially in areas such as consumer onboarding or anti-money laundering checks. From the central banks' point of view, the digital euro should result in the services and business opportunities for the private sector being expanded, not limited. This should bring relief to many financial market participants.

The digital euro is not expected before 2026

The legal framework for a digital euro will be prepared in a legislative proposal that the EU Commission intends to present by the beginning of next year. To this end, it has conducted a public consultation in recent months, which is now being evaluated. In autumn, a hearing of the EU Commission on the digital euro is planned in Brussels to discuss the results and further steps.

Since October 2021, Eurosystem experts have also been working on specific questions regarding the functional design of the digital euro in a two-year investigation phase. At the end of 2023, the Eurosystem will decide whether to enter the realisation phase. This phase is expected to take three years and will involve, in particular, developing and testing technical solutions and establishing the regulations required for the issuance of a digital euro. It is therefore not expected that a digital euro will be introduced before 2026.

Protection of privacy and technical implementation are only some of the unresolved issues

Despite the very lively communication on the digital euro currently by representatives of the central banks, many questions remain unanswered.

For example, the greatest possible protection of privacy is desired. This is likely to require, among other things, changes to the current regulatory framework for combating money laundering and terrorist financing. However, from the central banks' point of view, it does not seem possible to achieve complete anonymity in the use of the digital euro. A simplified due diligence and an exemption from the monitoring obligation are only being discussed for lower-risk payments, e.g. online transactions and contactless payments for small amounts.

The technical implementation and in particular the question of whether it should be done centrally or decentrally also remain unclear. In any case, "simplicity" is the guiding principle expressed by the central banks, i.e. a product that is easy to understand and use. Whether the digital euro can be designed to support programmable payments in a highly automated environment is also being discussed. However, such a function will probably not be implemented until a later point in time.

There is still a long way to go, but at the end of it we will (most likely) have a digital euro.

Even if there are still a lot of questions regarding its practical implementation, the enormous effort that is currently being made by the central banks already speaks for the fact that the digital euro will come. However, the complexity of such a project and the multitude of legal, technical and economic issues involved pose immense challenges for central banks. In this respect, the envisaged time frame which aims for implementation by 2026 seems quite ambitious, even if it may seem (too) long for some market participants. Hopefully the central banks will succeed in creating a means of payment that can cope with the digital age and that will gain the trust of citizens - as is the case with the physical euro today - and thus contribute to financial stability in the euro area.