On October 2, 2020, the European Central Bank (ECB) released the “Report on a digital euro”. The report was prepared by the European Central Bank’s Digital Currency Advanced Working Group and is the first comprehensive report on the digital euro released by the European Central Bank.
The report sets out the core guiding principles for determining the design of the digital euro in accordance with the current euro system policy, and analyzes the reasons, impact, legal, functional and technical considerations of the issuance of the digital euro, and related follow-up work. The report pointed out that it is too early to work on the specific design of the digital euro, but any type of design must meet some of the principles and requirements identified in this report, while complying with relevant legislation. In addition, this report will serve as the basis for dialogue with citizens and other external stakeholders. This is the starting point for public consultation and everyone is encouraged to participate. At the same time, it is worth noting that the report emphasizes that the digital euro is not an encrypted asset or “stable currency” and mentions issues related to the mass application of distributed infrastructure.
1. Five core guiding principles for designing a digital euro
At present, there is still no conclusion on how to issue a digital euro in the future, but the report points out that any type of design in the future should follow the following five core guiding principles:
First, the digital euro is just another way to provide the euro, not a parallel currency. Therefore, it should be equally convertible with other forms of euro (such as banknotes, central bank reserves and commercial bank deposits).
Second, the digital euro will be a liability of the euro system, not an encrypted asset or “stable currency.” The issuance and circulation of digital euros should not bring unnecessary financial risks to the euro system, which means that the amount of central bank currency issued in the form of digital euros should always be under the control of the euro system.
Third, potential users in all euro zone countries should use the digital euro equally. Private intermediaries should use their expertise under supervision to participate in the provision of payment services.
Fourth, the central bank’s plan to issue a digital euro should not impede or restrict efficient private solutions in the field of digital retail payments.
Fifth, the digital euro must be trusted like any other form of euro.
2. Reasons for issuing digital euro: possible scenarios and potential demand
The report mentioned that the issuance of a digital euro may be a viable option for the euro system to achieve scenarios related to the core functions of the central bank and goals related to EU economic policies.
Scenario 1: Issuing digital currency can support the digitization and independence of the European economy. The digital euro that is open to the public will contribute to the digitization of the financial industry, thereby promoting the digitization of the entire economy. It can also reduce costs by improving the efficiency of payment service providers’ business processes and supporting new business models.
Requirement 1: Enhance digital efficiency. The digital euro should always keep pace with the most advanced technology in order to best meet market needs.
Scenario 2: The role of cash as a means of payment has declined significantly. The report pointed out that the preliminary results of the Euro System Payment Research conducted in 2019 indicate that the share of electronic payments in total payments is increasing. At the same time, the differences in the use of cash payments among countries are still significant. The report also mentioned that although it is not yet possible to draw a clear conclusion on the impact of the COVID-19 crisis on the use of cash, it may accelerate changes in payment habits and increase the use of electronic payments.
Requirement 2: Features similar to cash. Allow offline payment, facilitate the use of vulnerable groups, free use, and protect privacy.
Scenario 3: Currency form denominated in euros (i) central bank currency (ii) commercial bank deposits (iii) electronic money becomes a credible substitute, as a medium of exchange, and may become a store of value in the euro zone. The report pointed out that many foreign central banks are evaluating the possibility of issuing CBDCs in their own countries, such as providing them to European citizens, which may lead to currency substitution and increased foreign exchange risks. Second, and secondly, private institutions are developing non-euro-denominated payment solutions (such as global “stable coins”) that can realize global business and are widely used in European retail payments. These developments will promote innovation, but they may also threaten the financial, economic and political sovereignty of Europe. Therefore, the euro system can consider issuing a digital euro to ensure that payments in the euro area meet the highest standards and are conducted under its control. In addition, by providing digital payments, the euro system can ensure that European citizens have access to cutting-edge payment services. Especially when other foreign central banks continue to promote the issuance of CBDC, this will safeguard the global reputation of the euro
Requirement 3: Competitive characteristics. Technology frontier.
Scenario 4: If the euro system draws conclusions in the future, from the perspective of monetary policy, the issuance of a digital euro is necessary or beneficial. For example, the introduction of CBDC may strengthen the transmission of monetary policy, allowing the central bank to set the rate of return of the digital euro, which will directly affect the consumption and investment choices of the non-financial sector.
Requirement 4: Monetary policy options. If the digital euro is considered a tool to improve the transmission of monetary policy, the digital euro should be compensated by the floating interest rate of the central bank.
Scenario 5: Reduce the possibility of network incidents, natural disasters, epidemics or other extreme events hindering the provision of payment services.
Requirement 5: Backup system. Improve the overall flexibility of the payment system.
In addition, the report also mentioned in the reasons for the issuance of the digital euro the assumptions related to the broader objectives of the EU, including the more important role of the euro internationally and the euro system will actively support the improvement of the overall cost and ecological footprint of the currency and payment system. To accomplish the two goals, it is necessary to meet the requirements of international use, cost saving and environmental friendliness.
3. The potential impact of the digital euro
The report pointed out that by examining the impact of the issuance of the digital euro on the balance sheet and the core functions and functions of the euro system, the requirements that the digital euro should meet no matter what the future circumstances are.
Impact 1: Impact on the banking industry, monetary policy and financial stability. The issuance of a digital euro may affect the transmission of monetary policy, thereby negatively affecting financial stability. For example, by affecting the risk-free interest rate, to challenge the bank’s business capabilities. Given the key role of the banking industry in financial intermediation, the massive demand for the digital euro may also have a negative impact on financial stability. In a crisis situation, when depositors’ confidence in the entire banking industry declines, if the operational barriers to withdrawals in the form of digital euros are lower than the barriers to cash withdrawals, liquid assets may be quickly transferred from commercial bank deposits to digital euros. This may increase the likelihood and severity of bank runs and weaken financial stability.
Requirement 1: The number of digital euros in circulation is controllable. The report pointed out that the digital euro should be an attractive means of payment, but it should be designed to avoid using it as an investment method and avoid the risks associated with a large transfer from private currencies to the digital euro.
Impact 2: Impact on the central bank’s profitability and risk tolerance. The report pointed out that the issuance of digital currency will change the composition and scale of the euro system’s balance sheet, thereby affecting its profitability and risk exposure. In addition, the euro system may also face financial liabilities due to operating a retail payment system. For example, the failure of the IT facilities of the digital euro may cause losses to individual users.
Impact 3: Reputation and other risks. According to the report, the issuance of the digital euro and its functions will affect the image of the central bank. In the context of the euro system, if the operability of the digital euro is different in the eurozone countries, reputation problems may arise.
Requirement 2: Cooperate with market participants. The best practice path is that the digital euro should be provided to all euro countries through intermediaries, and they can use their existing services to avoid costly repetitive processes.
Requirement 3: Compliance with the regulatory framework.
Impact 4: Impact on the security and efficiency of the retail payment field. According to the report, the retail digital euro will inevitably affect the operation of the payment system, so its design should not hinder but should improve the smooth operation of the payment system.
Requirement 4: Safely and effectively achieve the goals of the euro system. The project and business costs should be estimated and compared with the expected benefits, while considering alternatives.
Requirement 5: Easy to use in the Eurozone. The digital euro needs to coexist with cash.
Impact 5: Impact on the cross-border use of the euro. In general, the widespread circulation of the digital euro outside the euro zone may have an impact on capital flows and the euro exchange rate, and may have a knock-on effect on the monetary policy of the euro system. Another related risk is that a significant shift in global investment portfolios to the digital euro may strengthen the exchange rate of the euro and damage the competitiveness of euro area companies. In addition, if the cross-border circulation of the digital euro is not properly controlled, it may promote international criminal activities. Finally, the supply of digital euros may result in the substitution of currencies of third countries, especially those countries with weak economic fundamentals. It may promote digital “euroization” so that the currencies of these countries will be replaced in whole or in part by the digital euro for local payments, as a savings tool, and eventually become the unit of account. This will seriously damage the monetary policy sovereignty of the affected economies.
Requirement 6: Conditional use by non-euro area residents. The design of the digital euro should include specific conditions for access and use by non-euro area residents to ensure that it does not cause excessive capital flows or exchange rate fluctuations.
Impact six: cyber risks. The digital euro may attract cyberattacks, which may have potential financial and commercial impacts on monetary policy, financial stability, financial risks, and the security and efficiency of the payment system.
Requirement 7: Network resilience. The report pointed out that digital euro services need to be highly resilient to cyber threats and have the ability to provide a high level of protection for the financial ecosystem. In the case of a successful attack, the recovery time should be short and the integrity of the data should be protected.
4. Legal considerations
According to the report, the specific design of the digital euro will determine the legal basis for its issuance. The main law of the European Union does not exclude the possibility of issuing the digital euro as legal tender, which will require the payee to accept it as a means of payment. In principle, the distribution and use of the digital euro can be outsourced, but it needs to be subject to strict supervision of the euro system.
Fifth, the possibility of digital euro functional design
According to the report, based on the possible characteristics of the digital euro, two types of digital euros that meet the required characteristics have been identified: offline and online. These types are compatible with each other and can be provided at the same time.
The digital euro used offline can be used without the intervention of a third party, so it can only be provided through specific equipment, which should be distributed or funded through intermediaries, and is very safe, and will not be hacked or by non-designated personnel use. In principle, offline digital euro transactions will be anonymous and can only be paid with a fixed non-negative interest rate. The digital euro used online calculates remuneration at a floating interest rate. It does not require any specific equipment. All online digital euro services are under the control of the relevant responsible parties (central banks and regulated private intermediaries) at all times. However, the real name of the online digital euro is used.
ØFollow -up work
According to the report, by the middle of 2021, the European Central Bank Management Committee will consider whether to launch the digital euro project, which will begin at the investigation stage. The purpose of the investigation is to determine at least one viable product that can meet the requirements described in this report.
