ECB paper highlights success factors for CBDCs, Digital Euro – Finance

A paper published by the European Central Bank (ECB) discusses various conditions for the successful launch of central bank digital currencies (CBDCs) such as the Eurozone's own digital euro. The authors also point out various risks that such projects entail, such as the risk of crowding out the private sector.

ECB: Digital Euro should be widely used for payments, not investments

To have a successful one CBDC, a monetary authority must establish digital currency as a widely used means of payment and exchange with sufficient store of value function, according to the European Central Bank paper. At the same time, central banks must ensure that currencies like the digital euro not become a significant means of investment, displace private payment solutions or undermine the intermediary role of the banking sector.

The document, published this week, was written by three senior ECB officials - Fabio Panetta, Ulrich Bindseil and Ignacio Terol. They list the 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 is “merchant adoption,” which needs to be broad, meaning users should be able to pay digitally anywhere. Unlike paper money, a digital currency is likely to incur fees for each transaction and requires dedicated equipment to process the payments. There are also other differences, although both forms of money have legal tender status. The ECB states:

Cash is impractical in e-commerce, while adopting CBDC as legal tender may require exceptions for merchants that do not have the necessary equipment to accept cashless payments.

The second success factor was defined as “efficient distribution”. The ECB officials cite a Eurosystem Report that a digital euro will be distributed by supervised intermediaries such as banks and regulated payment providers. In order to promote the distribution of the central bank digital currency, incentives can be paid to supervised intermediaries. The document divides intermediation services into two categories: onboarding and funding services – including the operations required to open, manage and close a CBDC account – and payment services.

“Consumer demand” is the third success condition, which refers to the ability to use the CBDC to “pay anywhere, securely and privately,” the paper emphasizes. ECB Executive Board member Fabio Panetta and his colleagues believe that euro area residents can be motivated by the option to use the digital euro for peer-to-peer (P2P) payments outside the reach of existing private solutions. Privacy may be another motivating factor, they say, noting that central banks could adopt privacy-enhancing techniques while continuing to comply with anti-money laundering regulations. Despite protests against the digital euro in this regard, the three experts insist:

As public and independent institutions, central banks have no interest in monetizing users' payment data. They would only process this data to the extent necessary to carry out their tasks and in full accordance with public interest objectives and legal requirements.

Paper suggests measures to avoid CBDC risks

The ECB paper also discusses some of the risks associated with central bank digital currencies, such as excessive CBDC holdings. It proposes 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 end the potential outflow of bank deposits into a CBDC. Another obstacle could be the setting of per capita limits with an upper limit on the amount of CBDC that each individual can own.

The document addresses concerns that the issuance of a CBDC could trigger a process of bank disintermediation and displace payment solutions currently offered by the private sector. In order to avoid this negative effect, it is crucial to find a sufficient range of functions. It should neither be too broad as to displace private sector solutions nor too narrow as to limit the use of central bank digital currency. This could pose a challenge for the financial sector, ECB officials warn.

The paper's authors conclude that while CBDCs have clear merits and central banks need to follow trends in payments and technology to continue fulfilling their mission of serving both citizens and businesses, there are still many questions about the design of a currency like the digital euro. In addition to the range of functions, a suitable business model and appropriate controls are required to meet the requirements and ensure robust use of the CBDC, they emphasize.

Do you think the European Central Bank will issue a successful digital euro? Share your thoughts on this topic in the comments below.

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