We are approaching the end of the year 2023 and we are on the verge of an unprecedented event that will certainly have a significant impact on the financial world. We are talking about the development of the digital Euro. This new asset generates many expectations and questions in this sector, not only for users who want to know how it will work, but also for the developers and regulators of the European Central Bank (ECB), who are still working to resolve all the doubts.
The world of digital payments is indeed striving to stay ahead of the curve, meet the needs of involved parties and provide different payment methods to keep up with the decentralized trend. In turn, central banks like the ECB also see the trend towards digitalization and want to go shoulder to shoulder with the market.
What is the Digital Euro?
Inevitably, we must start with the basics. That is to understand what this new digital Euro is all about. To begin with, this is a project in the research phase. Officially, like the current Euro, the digital Euro will be a regulated currency in an electronic format that will function as a medium of exchange for people in the euro area.
It is also known as central bank money or public money, because it is issued by a public entity, in this case, the ECB. In fact, at present, the only money issued by central banks are banknotes and coins. Many may be wondering at this point, how do the payments I make online, with credit or debit cards, or the transactions I make between accounts of different banks work? These types of transactions use private money created by commercial banks, which are regulated by a central bank.
It is important to emphasize this last point since this is the basis on which the official monetary system of each country is established. When you use an ATM to withdraw or deposit money into your account you are converting private money into public money and vice versa. You know that your private money in the commercial bank has a stable value because it is backed by a public entity.
In this sense, the digital Euro will be a means that will allow people to make transactions and payments without using cash, with the characteristic of being issued by the ECB, not by a commercial bank. In this way, the European entity will be the first in the world to issue regional currency in both formats, physical and electronic, a milestone for monetary and payment systems at national and international levels.
Key Features of the Digital Euro
As previously mentioned, the most important characteristic of the digital Euro is that it is issued by a public entity, which makes it public money, i.e., it is backed by an official entity that guarantees the stability of its value.
Thanks to its electronic nature, everyone in the euro area will be able to use it to make payments online or in physical establishments via cards and apps, just as they are used to doing with private money.
Due to these characteristics, this digital currency is particularly different from cryptocurrencies, since the digital Euro preserves the fundamental functions of money as it is:
- a reliable and stable medium of exchange;
- store of value;
- unit of account.
In some cases, the cryptocurrencies we know today fulfill these functions to a greater or lesser extent. Either way, this mitigating factor can be a disadvantage depending on the perspective. First of all, those that directly accept crypto payments are very few, really very few, particularly merchants in both the e-commerce and retail sectors. If you are going to shop in a virtual or physical store of a well-known brand of clothing, technology, among others, or simply dine in a restaurant you will need a common fiat currency, for example Euros or Dollars. This forces cryptocurrency holders to convert them to these fiat currencies in order to make a payment, so cryptocurrencies in most cases are not an appropriate medium of exchange.
Secondly, the value of cryptocurrencies inevitably depends on the trust generated by the private company issuing them as well as each crypto itself. Having no backing from a centralized institution, the value of a cryptoasset can rise or fall sharply from one minute to the next, depending on multiple conjunctural factors. Therefore, cryptocurrencies, especially the less popular and less reliable ones in the market, often do not satisfactorily fulfill their function of being a store of value; and, in relation to the first and second points described here, they are not stable and reliable as a unit of account, i.e., as a reference for other currencies.
Undoubtedly, this scenario of uncertainty and speculation gives a profit margin to many investors who wish to obtain a yield from cryptocurrencies, but it entails a great risk for all those who deal with them. Even stablecoins -cryptocurrencies with less volatile behavior than others, such as USDT- suffer from this same problem, as their value depends on trust in the issuing private company and they are not accepted in most stores when a direct payment is made.
Against this background, anyone in the euro area will have access to the digital Euro to make secure payments with it at any store, as merchants will have to accept it just as they do with the current Euro. Most likely, an application with high-security standards and most likely with the help of a QR code will be used for this purpose.
Benefits and Advantages
First of all, it is important to note that the digital Euro will have a major impact on the role of a central bank in the digital payment system. Although it may seem commonplace for users, who for many years have been familiarizing themselves with online payments, the use of apps -from commercial banks and e-wallets of other financial institutions- and decades with the use of credit and debit cards, for monetary regulators it will be an unprecedented experience that will allow them to play a more relevant role in the digital world. With the digital Euro, the ECB will be able to maintain its sovereignty as a money issuer and give a boost to the Euro as the anchor of the payment system in the digital spectrum.
The digital Euro also has the potential to reduce transaction costs for users, as well as the ecological footprint of the payment system in Europe. It would create a unified ecosystem that enables transactions that eliminate particularly the costs generated when making interbank transfers. In this scenario, payment service providers would have tools that would make their business more efficient and faster, which would also mean lower costs for both merchants and consumers using their payment platforms.
According to the Think Tank Bruegel, which specializes in economic policy, new payment technologies can reduce the transaction times of the current system from 3-5 days to 2-10 seconds. In addition, they can offer peer-to-peer transaction costs of around 1%, while the current system of payments with corresponding banks offers rates between 2% and 7%1.
In principle, it will be possible to make payments using a digital wallet even without an Internet connection. In relation to this, the Eurosystem assures that in the case of offline transactions it will not see the user's personal data or their payment patterns.
Moreover, by taking advantage of a digital space in the euro area, users will be able to make instant payments and cross-border transfers at very low cost with a single stable currency, which will contribute to meeting the Eurosystem's objectives in terms of price stability and financial integration.
Challenges and Concerns
According to a public consultation conducted by the ECB on the digital Euro, privacy, with 43%, is the feature most wanted by people2. In this respect, cryptocurrencies are preferred because they guarantee a very high degree of privacy with respect to even large transactions. This is because they are fully decentralized and unregulated assets. Although there is a possible space for anonymous offline transactions, it is still a concern for users what will happen in the case of online purchases and high-amount transactions.
Undoubtedly, this regulation-privacy relationship will be one of the most important challenges for the the digital asset market.
The security is on the second place in this poll, with a result of 18%. Being a regulated currency, the digital Euro must offer a secure ecosystem to perform online and offline transactions, with the potential to prevent fraud and guarantee a universal consumer protection service.
In third and fourth place are the absence of additional costs and offline use, with 9% and 8% respectively. As mentioned above, these two aspects are part of the ECB's considerations and will most likely be guaranteed by the regulator before starting to officially issue the digital Euro to the public, since without them the electronic format would not have the same conditions as the physical Euro, so the ECB would fail to comply with its commitment and the use of this digital currency would be unfeasible.
Of course, the development of this new Euro is expected to be simple and widely accessible enough that anyone, even with little knowledge of technology, can use it to make even the simplest everyday purchases. However, since Covid, states and the EU have started a new milestone of digitalization of users through local state and single European systems of user identification and provision of digital services. It is possible that the infrastructure formed will serve as a foundation for providing access to the digital euro to the population, which will simplify the user journey itself. Thus, automatic access to the digital euro and further settlements using NFC are possible, as soon as this technology will be widespread.
Precisely in this scenario of wide access and usability, a digital Euro generates great concern in the traditional banking sector. The popular concern on the market is that in a central bank digital currency system, commercial banks are likely to lose relevance. In this context, citizens would be able to use universal accounts at central banks, which would eliminate the intermediation of commercial banks, which would lose their customers' deposits as a fundamental source of money. However, these fears are not based on facts. Most probably, with the introduction of a digiatl euro, banks will preserve an important role. ECB will still use the financial system for the dissemination of the digital Euro. That is, this new Euro will reach the digital wallet of citizens through their direct relationship with their respective commercial bank. On the other hand, in the context of the digital euro, it is the neobanks that could come to the forefront as their business model differs from credit institutions such as traditional banks.
Despite the questions and concerns of citizens, commercial banks and central banks alike, expectations are positive. Nearly 120 different central banks are at some stage of developing a digital version of their national currencies, which speaks of a broad interest and significant investment in these projects to obtain a satisfactory result sooner or later3.
For the time being, the digital Euro is in the final part of the research phase, which started in October 2021 and was scheduled to be completed in October 2023. We are therefore awaiting the decision of the ECB Governing Council on this project. If the new phase is approved, this will lead to the realization of the digital Euro project with the development of integrated services and real tests. Of course, the next step is to adapt the ECB decision to the local regulation of all respective countries, the technical and legal framework should be harmonized.
Undoubtedly, if the development and implementation of the digital Euro is successful, it will serve as an example of innovation and financial integration for other countries, just as the physical Euro has been.
What is a digital Euro?
It is a project of public money issued in electronic format by the European Central Bank. It will have the objective of functioning as an official and regulated means of payment, with the same value and characteristics of the current Euro, but adapted to be used in digital transactions.
What are its main characteristics?
The stability of its value, the backing of a public entity, the low transaction costs and the speed of digital Euro transfers stand out. The ECB's objective is to ensure that the digital Euro fulfills the main functions of a traditional fiat currency, which should be a reliable and stable medium of exchange, a store of value and a unit of account.
What are the main challenges?
Within a broad scenario of challenges, the digital Euro must guarantee privacy, have high security standards, reduce transaction costs in the euro area and provide a mechanism to make online and offline payments.