By Tanja Zimmermann
Photo: semeyas from Pixabay
The European Central Bank (ECB) is venturing into the next chapter. After a nine-month trial phase, it is now getting more serious about the digital euro. On July 14, 2021, it announced that a two-year investigation period would be used to gather more concrete results and experience. A decision on the digital euro will not be made until after that. What will be tested in the two-year investigation period is the functional design, especially for users. It will be determined for which use cases a digital euro is best suited and can be used. It will examine how a digital euro could be designed and distributed to individuals and companies and what market impact it could bring. In doing so, the ECB is trying to meet the needs of people in the EU. Undesirable effects on financial stability and monetary policy as well as illegal activities should be able to be prevented by a digital euro. The project will also investigate whether legal changes would be necessary in the member states.
70 percent of the world's central banks are investigating the introduction of a digital currency
In addition, there is an international trend to conduct more digital transactions. Die Zeit reported in 2021 that in the U.S., only 32 percent of transactions are now conducted with a physical currency. In Sweden, for example, it is only 20 percent and in China it is 40 percent. China and the U.S. are also considering the introduction of digital currencies. According to a 2020 study by the Bank for International Settlements (BIS), around 70 percent of central banks worldwide are investigating the introduction of their own digital central bank currency (CBDC). The first central banks are already planning to introduce one in the next few years.
A digital euro is a digital central bank currency. It thus represents an additional type of money. In principle, a CBDC digitizes the cash issued by the central bank. Depending on the design, intermediaries such as banks may or may not be involved. A CBDC in the form of a digital euro could increase the efficiency of monetary policy, but also change the transmission mechanism depending on the design of a digital euro.
Efficiency, security, and sovereignty - the advantages of a digital euro
The advantages of a digital euro are higher security through central bank money, retention of ECB sovereignty, and higher efficiency through a digital means of payment. Higher financial resilience goes hand in hand with higher financial stability. At the operational level, a CBDC would increase the resilience of payment networks. Payment networks will be more diversified in this way. This will create a more secure digital payment system.
The current system could become more secure by using a distributed ledger technology (DLT). In this case, the corresponding data is stored in a decentralized manner on multiple servers, similar to blockchain technology. Due to multiple storage of the data, it can hardly be manipulated and is therefore less susceptible to cyberattacks.
Transactions could be made more efficient on a digital basis. In international payments, transaction costs and their duration are still high. For example, Handelsblatt reported in 2019 that foreign transfers could still take up to ten days in some cases, and fees of up to 7 percent can also be incurred in cross-border payments. A DLT-based system could reduce complexity in payment transactions. For example, clearing houses could be eliminated.
In the machine economy in particular, a digital euro could open entirely new possibilities. For example, self-driving cars could be equipped with a wallet. For pay-per-use transactions, CBDC could be transferred directly from wallet to wallet and used.
With a digital euro, the ECB is also trying to prevent its own monetary sovereignty from being undermined by citizens resorting to cryptocurrencies or other digital means of payment that are not under the control of the ECB but under the control of other states or companies. In addition, money laundering is to be countered.
A digital euro – changes in the banking sector
High transparency of money flows should be in line with privacy for the user. As before, certain paths are to remain anonymous. Only anti-money laundering provisions are to be considered. A digital euro could lead to changes in the banking sector. Central banks could become more like commercial banks. This would lead to changes in the transmission mechanism. This, of course, depends on the design of a digital currency.
The architecture – over 40,000 transactions per second
The initial test phase has already shown that the technical implementation will not be a hurdle. It was shown that both a settlement via blockchain and a settlement via TARGET Instant Payment Settlement (TIPS) of the Eurosystem enable over 40,000 transactions per second. In addition, a digital euro is designed to be environmentally friendly in energy consumption unlike cryptocurrencies, for example.
A digital euro that would be available to citizens and companies for payment as central bank money is likely just another step on the road to digitization. The two-year investigation period, starting in October 2021, is making great strides toward the digital euro.