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The Digital Euro - Big Step Fallen Short.
A Non-Starter?
The idea of a digital euro – referred to hereafter as 'd-euro' – is basically a good one. If designed appropriately, as a new type of safe and secure central-bank money in public circulation, available for everyone and usable for everything, easy to use for anyone who can handle a mobile phone or laptop, a d-euro can address both the advanced decline in traditional cash as well as the rapid growth of stablecoins and other cryptocurrencies. To the extent that a d-euro becomes widespread, it enhances the effectiveness of monetary policy and generates greater seigniorage revenue for the central bank, to the benefit of the public purse – revenue which, until now, is primarily benefitting the banks through their privileged private creation of bank deposit money, bankmoney for short. Today, bankmoney is in an almost unique position as the general means of payment in the public circuit, with remaining cash accounting for only 3–10 per cent of the public money supply (M1).
Private bankmoney has also acquired quasi-sovereign status, with central banks as anytime liquidity providers for the banks, and governments as ultimate guarantors of too-big-to-fail banks and their bankmoney. For this reason, and also against the background of the growing prevalence of cryptocurrencies and stablecoins, it would be only logical, in the interest of central banks’ monetary sovereignty, to effectively increase the proportion of central-bank money in public circulation once again.
How the d-euro is supposed to work. Not particularly digital, nor akin to cash
The d-euro will be issued by the Eurosystem, which comprises the European Central Bank (ECB) and the National Central Banks (NCBs). The Eurosystem will operate a central platform for processing d-euro transactions. In this context, the banks act as payment service providers. They open, manage and close d-euro accounts for their customers who wish to use the d-euro. However, d-euro accounts are not part of the banks' balance sheet as is the case with bankmoney; instead, d-euros constitute a liability of the respective NCB or the ECB. To enable customers to use their d-euro accounts, banks provide them with a d-euro app, including a d-euro wallet. Furthermore, the banks facilitate the conversion between bank balances and d-euro balances.
When a customer converts a bank deposit into d-euro deposit, this results in a balance sheet contraction of the respective bank: on the liabilities side, the customer’s bank deposit is closed out; on the assets side, a reserve balance of the same amount is returned to the central bank. The respective amount of d-euros will be credited to the customer’s d-euro account. For a customer, this results in an asset swap (bank balances swapped into d-euro balances). For the central bank, it results in a liability swap (reserve liability to the bank swapped into d-euro liability to the customer).
The d-euro is no crypto token, the digital-euro platform no blockchain or similar ledger. Rather, the d-euro is an additional new category of central-bank deposit money. Even so, cryptographic methods are reported to be used in the processing of transactions on the d-euro platform, for example in connection with fraud prevention and the security of digital-euro holdings and payments, user authentication, or the use of pseudonymity to safeguard financial privacy. The d-euro is expected to be used online as a rule, but can also be transferred offline in near-field communication. This requires sufficient amounts pre-provided via the app/wallet, similar as with prepaid cards. Offline transfers are subsequently recorded via the digital-euro accounts and the central processing and settlement platform.
Given a system architecture of this kind, describing the d-euro as 'digital cash' appears somewhat misleading. The d-euro is neither particularly digital (cryptographically tokenised) nor does it resemble cash. Digital-euro balances are transferred from one digital-euro account to another; not from one digital-euro wallet to another, as cash is passed from hand to hand. The wallets are not 'money stores', but rather re-present balances in digital-euro accounts and enable payment instructions. Transactions are processed on the Eurosystem’s central digital-euro processing platform, with banks acting as payment service providers managing the digital-euro accounts.[1]
The structure of the two-tier banking and money system is thus maintained. Central banks deal with banks only (with the exception of some transaction accounts – not credit accounts – held by public authorities). Central banks have no dealings with the general money-using public (nonbanks). The latter conduct their financial transactions with banks and other payment and financial services providers. Nonbanks do not have direct access to central-bank money. Even so, it remains true that the d-euro will make a new category of central-bank deposit money available to nonbank users, as a supplement to or substitute for cash, as well, at least in principle, as an alternative to bankmoney and cryptocurrencies.
On the current plan for the digital euro. A 'big step' fallen short
As said at the start, the d-euro could be a good thing. However, according to the plans drawn up by the ECB and EU authorities, the d-euro will only be implemented to a very limited extent. The plan imposes limits on the ownership and use of the d-euro. The figures under discussion are a maximum holding of 3,000 euros and a maximum of 1,000 euros per single payment.
If a d-euro account balance exceeds a total of 3,000 euros, the excess amount is to be automatically converted into a demand deposit on a related bank account. This automatism is called 'waterfall', its counterpart 'reverse waterfall'. In the latter case, any shortfall in the amount of a d-euro transfer is automatically made up by a conversion of bankmoney from a payer’s related bank current account – subject to the 1,000 euro limit and provided that sufficient funds are available in the account.
These restrictions on ownership and amount of payment significantly preclude the use of the d-euro in payment transactions involving companies and organisations. With 1,000 euros, not even half of all tenants can pay their monthly rent. Even payments made by small businesses will frequently exceed 1,000 euros. So they are unlikely to adopt the new type of money, not wanting to make things more complicated by having to deal with two types of cashless payment – using bankmoney for major payments, and the central bank’s d-euro for small change. The ECB wants to see the d-euro used only for 'day-to-day payments' such as buying food or clothes, or filling up petrol, or eating out at a restaurant. Perhaps this will create some competition to credit cards and debit cards. But in this way alone, the d-euro will not become widely used, much less gain any systemic importance, so as to lend credibility to the aim of preserving or regaining monetary sovereignty. You cannot achieve monetary sovereignty with small change.
By imposing said restrictions, the ECB is shielding bankmoney from having to compete with the d-euro. This largely prevents the d-euro from substituting bankmoney as a means of payment. In doing so, the Eurosystem is positioning the d-euro as a monetary weakling; even though the d-euro was meant to help retain, or regain, respectively, the Eurosystem's monetary sovereignty – vis-à-vis cryptocurrencies, particularly stablecoins, and in fact also vis-à-vis bankmoney.[2]
For a means of payment to become widely accepted as money, a large number of actors as payers and payees must use it. Self-sustaining network effects will only emerge with a large number of users making frequent and substantial payments. It will therefore come as no surprise if, due to the aforementioned restrictions, the d-euro remains a non-starter. This would thwart the Eurosystem's intention to create an innovative means of payment capable of competing with bankmoney and cryptocurrencies. The banks will be pleased, as will the issuers of US dollar-denominated stablecoins. For the latter, the network threshold problem does not appear to be an issue; globally, the annual volume of stablecoin transfers has reached levels close to those of MasterCard and VISA.
As far as the d-euro is concerned, the preliminary conclusion is that, for the banks, essentially everything will remain the same. By managing the d-euro accounts, providing the d-euro app/wallet, and converting between d-euros and bankmoney, the d-euro is integrated into the bankmoney regime. The system-defining dominance of pro-actively created bankmoney as well as the central banks' re-active role as bodies ever ready to accommodate and support the banks remain unaffected.
Compulsory acceptance countering lack of acceptance/adoption?
In 45 countries pilot schemes involving Central Bank Digital Currency (CBDC) are being, or have been, carried out.[3] In all places it has proved difficult to reach sufficiently large numbers of private and business users making payments frequently enough. From a technological and operational point of view, all CBDC pilots appear to have worked well so far. However, adoption rates of digital wallets remained too low, and the even bigger problem is the usage rate. Registered wallets, where they exist, are used only rarely and only for making small payments.
Reasons for this are not only the aforementioned limits on holdings and single payments, which in a similar way apply to most pilot schemes, particularly in China and India, the largest pilots with millions of participants. Another reason is the slow uptake by business users. What is more, black labour, money laundering, the underground economy in general, have a preference for cash-in-hand payments. By contrast, online payments in d-euro can, if necessary, be traced on d-euro accounts and the Eurosystem platform, similar to tracing transfers of bankmoney. D-euro offline payments too – which are the closest thing to cash payment – cannot erase their electronic trail.
Another reason for the lack of acceptance of the forthcoming d-euro will be that the Eurosystem does not pay interest on d-euro balances; whereas banks normally pay deposit interest on their customers’ current account balances, just as the NCBs pay interest to banks on their reserve balances.
As long as banks pay interest on account balances whilst the d-euro remains non-interest-bearing, most actors who accept the d-euro at all will, of their own accord, immediately convert it into bank deposits. This is one of the reasons why the uptake of the digital yuan in China and the digital rupee in India began to stagnate after a while. As a result, the People’s Bank of China has now decided to pay interest on holdings of digital yuan.
By being legal tender, the d-euro is subject to a legal obligation to accept it, just as has been the case with cash to date. It’s just that nobody cares. Not even the tax office accepts tax payment in cash. It is true that some small shops only accept cash. Other small shops now refuse to accept cash and demand cashless payment. They find cash too cumbersome and more hassle than cashless payments. Regulation is one thing, enforcement deficit is another.
The current plans for the d-euro envisage obliging certain businesses to accept payments in d-euro, particularly those that already routinely accept card or online payments, such as retail outlets, restaurants and hotels, online retailers and other vendors. It remains to be seen to what extent those businesses will actually get on board.
Required: Unrestricted use and interest-bearing status of the d-euro
For the d-euro to be a success, there are two key requirements. First, the use of the d-euro – which is, after all, intended to be 'unrestricted legal tender' – should not be arbitrarily restricted. Instead, the use of the d-euro should be left to public demand and market acceptance.
Second, if banks pay deposit interest on current account balances, the ECB should pay the same rate of interest on d-euro balances. True, monetarily and financially that doesn’t make sense. It is the loan that earns interest, not the means of payment. Coins and central-bank notes have never paid interest. By contrast, bank deposits may earn interest because they represent an implicit cash loan from customers to their bank. Savings and term deposits earn interest in order to prevent an expensive outflow of reserves or generate a cheap inflow of reserves. Why, however, the ECB pays banks interest on reserve balances is a mystery, as reserve balances stem from a loan from the Eurosystem to the banks, not the other way round. The favour of paying a phoney interest on reserve balances is not justified on commercial banking grounds, but constitutes a bank subsidy. If one feels compelled to do the banks such a favour, then, for pragmatic reasons, one can and should make the d-euro interest-bearing as well, so as to promote its use among the general public in the face of the existing quasi-monopoly of bankmoney.
Footnotes
[1] Details on how the d-euro is supposed to work (often not entirely clear from a technical and operational point of view) can be found on the ECB’s website FAQs on the d-euro.
[2] It is true that within the interbank circuit the means of payment are exclusively central-bank reserves (banks’ account balances with the central bank). However, the volume of these reserves results from the banks’ fractional refinancing requirements arising from their pro-active creation of bankmoney. Central banks seek to exert influence on this through the base rate they set. This certainly has an impact on demand for credit at banks and, consequently, on their creation of bankmoney. However, the extent of this influence and its precise effects remain unclear and controversial. All in all, it is the banks’ pro-active dealings that the central banks in fact are compelled to follow and accommodate re-actively, not the other way round.
[3] Central Bank Digital Currency (CBDC) Tracker.