Last week, the European Central Bank (ECB) announced that a proposed digital euro will be tested over the next two years. By stating that this “aims to ensure that in the digital age, citizens and firms continue to have access to the safest form of money, central bank money,” ECB President Christine Lagarde positioned the digital euro as an alternative to cryptocurrencies such as Bitcoin. The attractiveness of these private peer-to-peer initiatives of “stateless” money will be influenced by the new Central Bank Digital Currency (CBDC). The two forms of money, which can simultaneously compete and complement one another, will always be interrelated.
But first, a note on digitization versus digitalization: while digitization is the act of getting material into zeros and ones, digitalization is about creating native digital assets. So, whereas an e-book is a digitized book, Wikipedia is a digitalized (or digital) encyclopedia. The process by which Wikipedia came to be is unfathomable in a physical world. If you had to reprint Wikipedia every time someone made an edit, you would very quickly run out of paper.
Although people may think of money as already being fully digital, it is merely electronic. Digitized, not digitalized. Crypto is digital by design. For legal tender, the digitalization is more complex. Commercial banks can already turn your banknotes and coins into dematerialized euros when they are deposited in your bank account. Furthermore, wire transfer and bankcard systems are popular tools to carry transactions with these digitized forms of money. In fact, most of the money issued by central banks has already been digitized for decades. But those are not digital assets, they are merely old assets that have been transformed into zeros and ones.
What is all the fuss about a digital euro?
The current central bank-digitized euro is only limited to wholesale credit operations with eligible financial counterparties. The game-changer is the extension of the central bank deposits to all citizens and commercial firms. This redefinition of the scope of the parties eligible to access central bank digital euros allows the full digitalization of the system. The digital euro is more than digitized coins and banknotes, it opens up a new era of natively digital functions following the footsteps of Bitcoin. This implies major differences in terms of democracy, policy, control, and privacy for everyone involved. Each one of these paradigm shifts deserves its own dedicated article.
To its credit, the ECB was perfectly clear about its goals in the announcement: “a digital euro must be able to meet the needs of Europeans while at the same time helping to prevent illicit activities and avoiding any undesirable impact on financial stability and monetary policy”. And it is important to spot the intruder: if the last two points are traditional central bank prerogatives, the anti-money laundering (AML) objectives have traditionally been assigned to specific financial watchdogs, not the Central Bank.
However, AML objectives have already been conveniently invoked in the past by the ECB to justify controversial monetary policy decisions. For instance, in 2016, the Governing Council referred to concerns that the €500 banknote could facilitate illicit activities when it announced that it decided to discontinue its production and issuance. Knowing that the digital euro is meant to ‘prevent illicit activities’ tells us a lot about the kind of arbitrage which prevails when determining the future of “cash”.
What is the appeal for individuals?
The biggest advantage for people will be the ability to access central bank money without bank intermediaries. On top of opening a new field of opportunities for fintech, it gives more control to citizens by allowing them to keep part of their money under their digital mattress as well as carry peer-to-peer online transactions in euros. Since the Central Bank can never go bankrupt, it means that the money is 100% safe, and since all payments are made in one ledger (big book), they will all be near-instantaneous. So, it appears to be ultra-safe instant money. What’s not to like?
The digital euro provides the underlying technology for the European Payments Initiative which aims to get rid of traditional banking cards and mobile payment solutions with a unified card and digital wallet that can be used across Europe. In the very first paragraph of its report on a digital euro, the ECB confirms that it has already started adapting its underlying infrastructure for such use cases, hence the reference to the creation of TIPS, the TARGET Instant Payment Settlement service for instantaneous electronic payments in euros.
For now, the ECB has been consistently reminding us that the digital euro will be used complementary to cash and deposits. This message was reiterated last month when we debated the issue with the ECB at the BC4E Summit. In principle, having more options is always a good thing. At a time when a growing share of commerce takes place online, having a means of payment designed to serve this new economy may seem like a smart move.
Is everything truly better?
Although it is promising that the ECB kicked off this initiative with a public consultation on a digital euro, it is worrying that the results were skewed to the opinion of German millennials working in the tech sector. As a matter of fact, the public hasn’t yet demonstrated a strong interest in the digital euro, despite the potential for life-changing consequences. The adoption or defiance will likely begin when the use cases become more tangible.
Thanks to the new direct connection with citizens that the digital euro allows, the central bank will also gain more control over the supply and usage of money. Giving central bankers more power for monetary policy transmission and AML enforcement also increases the risk of citizens’ subjugation. With the possibility to monitor every transaction, the ECB could be tempted to discourage cash conversion to subdue criminal liquidities, to charge negative interests to encourage spending, etc.
With this in mind, political activists, like criminals, are likely to stick with good old cash, as it cannot be easily frozen, seized, tracked, or devalued by authorities. The broader public has also demonstrated similar behavior in certain situations over the recent years. In 2015, many Greeks began to withdraw cash from their bank accounts fearing the imposition of capital controls. Similarly, Venezuelans started turning to cryptocurrencies as the Bolivar became subject to growing defiance.
In the meantime, digital euro holdings will be subjected to hard limits (currently being discussed is a maximum cap of 3000€) or soft ones (e.g. disincentives beyond a threshold) for financial stability purposes. Because if all the money is being held by the central bank, the commercial banks relying on deposits to make loans will have a harder time doing their jobs. Therefore in the short term, any form of a digital euro will have to avoid being too attractive in order to prevent large shifts from bank deposits. For anyone with interests vested in the traditional financial system, the adoption of a digital euro should be approached with caution. Collaboration with private banks could become rocky at times.
Is it good for crypto?
By facilitating peer-to-peer monetary transactions, a digital euro should facilitate crypto-to-euro transactions. And if the digital euro has smart contract capabilities like the digital yuan should, then bridges could even be built between “government chains” and decentralized chains. In addition, using similar types of underlying technologies (blockchain, decentralized wallets, etc.) for legal tender should further facilitate the normalization of crypto assets in the mainstream financial sector and popular culture. Rather than positioning itself as an alternative to Bitcoin, digital euros could become its latest new companion.
The proliferation of digital assets designed for multiple emerging use cases and launched at different points in time is likely to continue. The ECB is facilitating the smooth integration with these solutions while fighting dollar predominance in the crypto world. In less than five years, there has been a real colonization of cryptocurrencies by the US dollar, with several stable coins tied to it. It created dependence on the US, and the Federal Reserve’s monetary policy, and gives them a kind of exterritorial power on transactions taking place in Europe, which makes it harder for the ECB to execute its own financial stability mandate.
I don’t expect a single payment solution for the European decentralized economy. The ECB will be unable to launch a solution that satisfies everyone for such a wide range of new use cases. Especially given that most of them remain to be discovered. Moreover, getting rid of central banking constraints was a clear motivating factor for the introduction of Bitcoin in the aftermath of the 2008 financial crisis. The more the ECB will strengthen its power, the more some people will be keen to stick with alternatives.
That being said, all the crypto players in Europe should welcome a digital euro with a certain level of optimism as decentralized and centralized digital currencies are meant to grow together: the progress of one should simply reinforce the appeal of the other. However, the fact that they have an inherent desire to replace or even neutralise one another guarantees the potential for a lot of new tension for years to come.
