Digital euro: how will it impact the payments and banking industry?
Sopra Banking Software hosted a LinkedIn Live session focusing on the European Central Bank’s (ECB) digital euro. During the session, host Anmol Sahib, Product Marketing Manager for Payments at Sopra Banking Software, and Guillaume Yribarren, Deputy Managing Director at payments specialist Galitt, explored the digital euro’s potential impact on the payments and banking industry.
Note: This discussion encompasses a wide range of topics subject to significant variation. However, it focuses on decisions that were made before April 2023.
Why is the ECB considering CBDCs?
Over the past decade, various private and decentralized initiatives have emerged in the financial sector, introducing alternative “currencies” independent of government institutions.
This has led to the emergence of decentralized currencies: the crypto-assets are mainly represented by Bitcoin. It is important to note that many of these crypto-assets do not have the characteristics of traditional currencies due to their inherent volatility. Nonetheless, they are gradually making their way into the payments market.
Secondly, private actors wanted to launch their own digital currencies. This was the case for Meta Platforms (with its Libra project, later renamed Diem) in 2019.
The emergence of these initiatives prompted governments to explore ways to safeguard the monetary stability of their respective countries or groups of countries. Initially, they responded defensively by enacting laws regulating or prohibiting digital assets. However, they have also taken an offensive operational approach by delving into Central Bank Digital Currencies (CBDCs) as a proactive measure.
According to BIS, over 90% of central banks worldwide have expressed their active involvement or future to embark on CBDC projects.
In Europe, the ECB started exploring the possibility of introducing a digital euro in July 2021 and is working with other central banks in the euro area in response to increasing consumer demand for trusted electronic payments and, therefore, a central bank digital payment instrument.
What is the digital euro?
In short, a CBDC is a digital currency issued by a central bank, a form of digital cash. The digital euro, if introduced, would serve as a risk-free digital currency issued and managed by the ECB, and it would function as a form of digital cash backed by the ECB.
It differs from stablecoins; indeed, both are digital, but a CBDC is not backed by a fiat currency and is, instead, a fiat currency.
Note: The exact impact of introducing the digital euro on the monetary supply remains unknown.
What are the motivations for a digital euro?
There are several drivers behind the development and introduction of a digital euro. These include:
- Financial inclusion: a digital euro can provide access to digital payment services for individuals currently underserved by traditional banking systems, promoting financial inclusion, and reducing the digital divide.
- Payment efficiency: a digital euro has the potential to streamline and accelerate payment processes, enabling faster and more efficient transactions for individuals and businesses, both domestically and across borders.
- Security and fraud prevention: by leveraging advanced technologies such as encryption and secure authentication methods, a digital euro can enhance the security of transactions, reducing the risks of fraud and counterfeiting.
- Monetary sovereignty: introducing a digital euro allows central banks to maintain control over their currency and monetary policies in the face of increasing digitalization and the emergence of private crypto assets / digital assets.
- Innovation and technological advancement: developing a digital euro encourages innovation in the financial sector, fostering the growth of new technologies and driving digital transformation.
- Competitiveness: the digital euro can enhance the competitiveness of the European Union by offering a modern, efficient, and secure payment method that aligns with the digital aspirations of individuals, businesses, and the broader economy.
Will it be based on DLT/blockchain technology?
That is a possibility, as the ECB says it’s still experimenting with different approaches and technologies regarding the digital euro. This includes centralized and decentralized solutions such as distributed ledger technology (DLT).
Blockchains’ primary challenge is facilitating collaboration among individuals who do not have a pre-existing relationship. However, in the case of the digital euro, this aspect of blockchain technology may not be applicable as the operation of the digital euro is designed to function within a centralized framework, involving trusted institutions such as the European Central Bank.
However, the blockchain infrastructure offers smart contract solutions and interoperability, meaning the latter has yet to be discounted entirely.
“As far as we know, the digital euro project is not planned to be based on blockchain, meaning that the European Central Bank and the euro system are preparing some rules, some infrastructure, and the framework to deploy it,” Guillaume said during the LinkedIn session.
How will the digital euro be distributed?
The digital euro will be distributed through the retail banking ecosystem, with commercial banks or PISPs acting as intermediaries in the same way they already manage their ATMS or cash machines.
The distributor will hold an account with the central bank on behalf of its customers and will handle all transactions for them. The central bank will oversee and operate the mechanism.
From an end customer’s perspective, the interface will resemble their everyday banking experience, but their bank will not hold the funds. Instead, the funds will be held by the central bank.
Note: The intermediaries will also be responsible for developing services related to the digital euro
What are the ways to use it?
An essential feature of the digital euro is its aim to be inclusive, ensuring accessibility for all individuals:
- It caters to those without access to financial services, eliminating the requirement for a traditional bank account.
- It accommodates individuals who lack digital access by facilitating tangible means of payment, ensuring participation regardless of technological limitations.
- The digital euro implementation does not require merchants to acquire new acceptance instruments or payment infrastructure.
- The introduction of the digital euro aims to streamline the deployment process for banks, making it simple.
To address the mentioned points and facilitate the use of the digital euro, the ECB has proposed several solutions:
- Account creation based on identity: The ECB suggests creating digital euro accounts for individuals based on their identity, allowing easy access and usage of the digital currency.
- Smart card utilization: Alongside digital euro wallets, the ECB proposes using smart cards to access and transact with the digital euro. This provides an additional physical option for individuals to utilize the currency.
- Compatibility with existing instruments: The acceptance of the digital euro will be designed to be compatible with existing payment instruments, ensuring seamless integration into current payment systems and infrastructure.
- Software Development Kit (SDK): The ECB plans to offer an SDK, enabling the development of digital euro functionalities within banking applications and wallets. This allows banks and developers to incorporate digital euro features into their existing platforms. Additionally, the ECB will provide a standalone digital euro wallet.
These solutions put forth by the ECB aim to provide accessible and practical options for individuals, merchants, and banks to utilize the digital euro effectively.
Will there be limits on how many digital euros you can store in your wallet?
Limits would have to be set on the value of digital euros stored in users’ wallets to prevent a flight in deposits and a banking crisis. Currently, a limit of about €1,000 is being considered by the ECB. If a threshold is not established, there are two potential risks to financial stability:
- The occurrence of a bank run potentially results in banks’ collapse.
- Difficulties in accessing credit due to commercial banks raising interest rates because of reduced deposits, leading to limitations in their ability to offer credit.
What about privacy when using the digital euro?
The subject of privacy is sensitive as it is a public expectation. Consequently, it is crucial to prioritize maintaining user privacy at all costs. However, it is equally essential that the digital euro does not become a tool for money laundering or terrorist financing.
Thus, it cannot offer complete anonymity (one option considered was implementing anonymous thresholds, with level 0 representing complete anonymity, but the ECB did not choose this approach). Presently, the plan entails each user having a single account tied to their identity, with the ECB not having access to transaction information or the identities of transaction participants.
“A digital euro would allow people to make payments without sharing their data with third parties, other than what is required to prevent illicit activities,” the ECB said on its website.
While the ECB will know how much digital money has been issued, it will not be possible to trace precisely an individual’s behavior, Guillaume said.
What are its benefits for all stakeholders?
To ensure the success of the digital euro, it needs to have a compelling value proposition for the public. Likewise, intermediaries involved in its distribution should find it financially rewarding. Here are the considerations for each stakeholder:
- Interchange fee: Transactions made with the digital euro may include an interchange fee, providing a financial incentive for the distributor.
- Additional services: Innovative services might incur charges.
- Enhanced features: The digital euro should offer features that differentiate it from other payment methods, such as conditional payment options and the ability to transact offline.
- Efficiency: The digital euro should prioritize security and speed, providing end customers with a seamless and reliable payment experience.
Does using the digital euro require an internet connection?
The digital euro will provide an offline functionality like cash, allowing usage without an internet connection. To enable this, the device will possess a self-contained wallet and ensure transaction security (addressing the double-spending issue).
Devices capable of offline operation will be required to incorporate a secure element with minimum security. Furthermore, periodic online reconciliations (frequency to be determined) will be conducted to mitigate money laundering and transaction tracking concerns.
When will it be introduced?
It is essential to point out that the ECB has yet to decide to go ahead with the digital euro and is still in the investigation stage of the project. The deadline to complete this stage has been set for October 2023.
The ECB’s Governing Council is then expected to decide whether or not to move to the next stage of the project, which would include testing and the possible live experimentation of the digital euro – which it says could take about three years.
Some live tests were conducted at the end of 2022, with the likes of Amazon selected to perform stress testing and proof of concept for the e-commerce use case.
“But we know that it will take years and years – presumably five years from now, we’ll maybe have a digital euro in our pockets,” Guillaume said.
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