A paper published by the European Central Bank (ECB) discusses various conditions for successful implementation of central bank digital currencies (CBDCs) such as the eurozone’s own digital euro. The authors also point to different risks that such projects entail, like the danger of crowding out the private sector.
ECB: Digital Euro Should Be Widely Used for Payments, Not Investment
In order to create a successful CBDC, a monetary authority needs to establish the digital currency as a widespread means of payment and exchange that also has a sufficient store of value function, according to the paper released by the European Central Bank. At the same time, central banks need to ensure that currencies like the digital euro do not turn into a significant means of investment, crowd out private payment solutions, or undermine the banking sector’s intermediation role.
The document, which was published this week, is authored by three high-ranking ECB officials — Fabio Panetta, Ulrich Bindseil, and Ignacio Terol. They list key success factors for CBDCs and offer their expert opinions on how to avoid risks associated with the digital versions of fiat currencies that dozens of countries around the world, including major economies, are currently exploring or developing.
The paper identifies three conditions for the successful implementation of a CBDC. The first one is ‘merchant acceptance’ which has to be wide, meaning users should be able to pay digitally anywhere. Unlike paper cash, a digital currency is likely to come with fees for each transaction and require dedicated devices to process the payments. There are other differences as well, despite both forms of money having legal tender status. The ECB elaborates:
Cash is impractical in e-commerce, while making CBDC legal tender may require exceptions for merchants who do not have the device needed to accept non-cash payments.
The second success factor has been defined as ‘efficient distribution.’ The ECB officials quote a Eurosystem report, according to which a digital euro should be distributed by supervised intermediaries such as banks and regulated payment providers. To encourage the distribution of the central bank digital currency, incentives may be paid to supervised intermediaries. The document divides intermediary services into two categories: onboarding and funding services — which would include operations required to open, manage, and close a CBDC account — and payment services.
‘Demand from consumers’ is the third condition for success which refers to the ability to use the CBDC to “pay anywhere, pay safely, pay privately,” the paper emphasizes. Member of the Executive Board of the ECB Fabio Panetta and his colleagues believe that residents of the euro area can be motivated by the option to use the digital euro in peer-to-peer (P2P) payments beyond the reach of existing private solutions. Privacy can be another motivating factor, they say, pointing out that central banks could use privacy-enhancing techniques while still complying with anti-money laundering regulations. Despite protests against the digital euro particularly in that regard, the three experts insist:
As public and independent institutions, central banks have no interest in monetising users’ payment data. They would only process such data to the extent necessary for performing their functions and in full compliance with public interest objectives and legislation.
Paper Proposes Measures to Prevent CBDC Risks
The ECB paper discusses some of the risks associated with central bank digital currencies as well, such as excessive CBDC holdings. It suggests a number of measures to prevent a permanent or temporary excessive flow of funds into a central bank digital currency, including the introduction of limited convertibility that could terminate the potential outflow of bank deposits into a CBDC. Setting per capita limits with a ceiling on the amount of CBDC each individual would be allowed to hold could serve as another barrier.
The document devotes attention to concerns that the issuing of a CBDC could trigger a process of bank disintermediation and crowd out payments solutions currently provided by the private sector. To avoid this negative effect, finding an adequate functional scope is crucial. It should neither be too broad, crowding out private sector solutions, nor too narrow, limiting the use of the central bank digital currency. This could be а challenge for the financial sector, the ECB representatives warn.
The authors of the paper conclude that while CBDCs have clear merits and central banks need to follow trends in payments and technology in order to continue to fulfill their task to serve both citizens and businesses, they still have to address many questions regarding the design of a currency like the digital euro. Besides the functional scope, appropriate business model and controls are required to meet demands and ensure robust use of the CBDC, they stress.
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