Between a rock and a hard place - the implementation of the Digital Euro

Even if the term Bitcoin has been minted a while ago, it has been only in the last 2 years that cryptocurrencies have become well-known for the public in general. As wider acceptance as means of payment and a steady news barrage on cryptocurrencies (ex. as with Tesla), their valuations have rallied, and their names and technicalities have become water-cooler (or Reddit) conversation topics.   

However, even if the focus of recent months has been mostly on cryptocurrencies and their recent volatility, one should be really paying attention to the latest concoctions of the largest Central Banks in the realm of digital currencies.

With the looming threat of cryptocurrencies displacing traditional hard currencies in their most relevant functions, Central Banks have been trying to envision how could the technologies and systems used by those newcomers be put to their own use, allowing thus monetary authorities to occupy a more central spot in the undergoing digital revolution. The wide acceptance of alternative means of payment is viewed by the Central Banks as clear threats to their current role.

The European Central Bank (ECB) has been recently venturing into this field, allocating effort and brainpower into thinking CBDCs (Central Bank Digital Currencies) and their role in the world economy. Fully embarking on this quest, the ECB has created several transnational workgroups and been publishing White Papers aiming to address the different issues and challenges impacting on the creation and utilization of the Digital Euro.

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However, the discussions around these issues, rather than focusing on the technological challenges, tend to be clearly around issues such as the impact on monetary policymaking and banking regulation.  The true obstacles to the implementation of the Digital Euro are clearly not coming from the bits and the bytes, they are coming from three major areas in which the ECB, as the orchestrator of the banking system in Europe, will have a hard time letting go:

  • The control over how money is exchanged between economic agents, namely through stringent “Know Your Client” and “Anti-Money Laundering” regulations;

  • The control over monetary policy levers, namely those impacting inflation, interest rates and foreign exchange rates, over which the ECB has almost full authority within the Euro area;

  • The control over the participants on the banking system, curbing new entrants, which ultimately will ensure a certain degree of stability of the financial industry as whole;

These three major concerns have been the real obstacles in designing a truly Digital Euro as an alternative or even as a significant add-on to the current Euro. All the questions being raised on how it should work, reflect the attempt to balance between openness and one or several of these concerns.

Out of the many ongoing discussions within the ECB, these are the most relevant:

  • Will EU citizens allowed to entirely bypass current banking systems making use of the Digital Euro without possessing a bank account?

  • Even if citizens can bypass banks, will they be forced to use financial intermediaries to acquire Digital Euros?

  • Can Digital Euro transactions remain anonymous (as with current bank notes)?

  • Will there be limits for large-value transactions in Digital Euros?

  • Will it be possible for non-EU entities to use Digital Euros?

  • Will there be limits for how much value and for how long can one keep a Digital Euro account?  

  • Will the ECB (or commercial banks) be able to remunerate holdings of Digital Euros?  

One may be tempted to believe that the ECB would have by now provided clear guidelines on how it wants to move forward on many of these issues. However, it is rather the opposite – all these questions raise the control issues previously identified, hence requiring a strong degree of consensus from European institutions and governments to answer.

We all know through experience that this type of consensus is, in practical terms, impossible to achieve in Europe.

Once one starts viewing these issues from a more conservative standpoint, the answers become quite clear: the Digital Euro will be a surrogate of the current Euro and will have functions and use cases quite similar to the ones that the current system is already able to perform.

The endgame of this endeavor will likely be a proxy of the current Euro, built upon the same architecture (and its limitations) that, even if it presents a few technological advancements, will not revolutionize the financial system.

However, consumers will not be willing to accept this easily, namely if other free and convenient options remain available.

The only option left for European governments to stop cryptocurrencies (or other more open CBDCs) from displacing the Euro is to render them outright illegal. The game is rigged to create the legal framework limiting economic transactions within Europe and even possessing value in those digital currencies, except if done through a bona-fide (ECB regulated) financial institution.

In the end, the EU will have lost an opportunity to redesign the financial system architecture, trim down the inefficiencies of its players and provide more value to consumers and companies. We will have to patiently wait for the next financial crisis to see some changes. Perhaps longer.  

Ricardo