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The Digital Euro First Generation

A big step in the smallest possible way. Functioning and the interests behind it

System architecture of the digital euro

111 out of 131 countries are currently working on a Central Bank Digital Currency (CBDC). Of these, 11 have launched a first CBDC version, 21 are running pilots, and 33 are conceptualising a CBDC.[1] As far as the digital euro is concerned, operational and legal planning is now well underway.[2] The system structure and mode of operation are basically set. The digital euro is circulated within the existing two-tier banking system, basically analogous to cash, but digitally ('digital cash'). See diagram. According to the official view of the ECB, the digital euro is not intended to compete with today's system-dominating bankmoney, let alone replace it, but merely supplement it. 

The digital euro is created by the ECB and issued to the banks by conventional channels such as open market repos and regular refinancing transactions; or the banks change CB reser­ves into digital euros, as with cash. ('CB' stands for 'Central Bank').

The banks pass on the digital euros according to demand to their non-bank customers, in exchange for a current account balance, similar to withdrawing cash. To this end, the banks must have digital euros available, like in vault or in an ATM. So banks have to finance the digital euro at 100%. In other words, as far as the digital euro is concerned, there is no fractional reserve banking. In addition to the ECB as the primary source, banks can obtain digital euros already in circulation by borrowing them from custo­mers or on the interbank money market.

On the ECB's balance sheet, the digital euro is registered as a liability, like CB notes in public use, and CB reserves used among banks only. For banks and users, on the other hand, the digital euro, again like cash, is always an asset – in contrast to the banks' deposit money, which is a liability of the banks to their customers.

Accounting for CB money as a liability has long been outdated, especially since national currencies have become pure fiat money, i.e. uncovered money, backed neither by gold nor silver, but solely by sufficient trust in a respective state, its CB and govern­ment, to maintain the currency's validity, value, permanence, and to defend it in the event of crises. When a CB lends to a bank and pays out in cash or reserves, then the CB as creditor does not actually have a liability to the bank, but just a claim, whereas the bank as debtor does have a liability to the CB. None­theless, modernised approa­ches to account for CB fiat money in a consistent way continue to be ignored.[3]

The digital euro balances and payment transactions between CBs, banks and users could basically be of a conventional nature (transfer of book money), but the digital euro is expected to come as a digital token. Ownership and transfer of digital euro tokens will be based on a non-public access-authorized database. The latter will not be a blockchain, nor will digital euro tokens be cryptocoins.

Users have access to their digital euro payment account via an app called e-wallet (electronic wallet). This is issued to customers by banks and other payment service providers (PSP). The term e-wallet is somewhat metaphorical. A digital euro wallet does not 'contain' money like a purse or a cash box, but is a kind of passport or key. This provides access to specific information about an address (a digital euro account) in the system data­base.[4]

The digital euro wallet allows the owner to check the balance in a relevant euro payment account and make real-time payments directly from payer to payee (P2P payment). This is done without monetary intermediation by banks/PSP. Bankmoney and CB reserves are not involved here. Banks/PSP act as technical payment interface providers within the digital euro payment system. Payments in digital euros will generally be made online, but can also be made offline using near-field communication (NFC) similar to prepaid cards.

Sovereign-money design principles for the digital euro

The digital euro is a new third type of CB fiat money, in addition to CB notes and CB account balances (reserves). The digital euro thus is sovereign money with the status of basically unrestricted legal tender under the sole control of the ECB. Today, CB money serves as base money for bankmoney at the second level, and further money surrogates at the third level, such as, for example, e-money, money market fund shares, and stablecoins.

Since the digital euro represents sovereign money, its introduction can be seen as a first step of structural change in money and banking towards a sovereign money sys­tem – not yet by now, but in a long-term perspective. From this per­spec­tive, a number of CBDC design principles can be formulated:[5]  

— Unrestricted legal tender.
The digital euro should be a universal means of payment like cash once was and bankmoney de facto is today. The use of the digital euro should not be subject to arbitrary quantity limits or restrictions with regard to user groups and purposes (private and public households, companies, financial institutions).

— Issuance of digital euros according to demand.
Digital euros are to be put into circulation by the ECB according to user demand. 

— Unrestricted convertibility of digital euros.
In the public money circuit, mutual exchange­ability between digital euros, bank­money and cash should be warranted at all times.

— Dual use of central bank reserves and digital euros.
In the interbank circuit, CB reserves and digital euros should be convertible into each other or substitutable for each other, respect­ively.

— Extension of the CB liquidity guarantee to digital euros.  
The de facto liquidity guarantee of CBs to provide banks with necessitated amounts of reserves should extend to digital euros. In times of business-as-usual this won't really matter, for under such conditions there is no particular reason for a landslide from bankmoney to digital euros. However, in the event of balance-sheet troubles in an individual bank, or an impending systemic banking crisis, such a liquidity guaran­tee will effectively help prevent a run on bankmoney.

— Gradual expansion of the use of digital euros by public institutions.
In view of the share of public expenditure, this can contribute significantly to the spread of the digital euro, even if the amount of individual payments in digital euros were limited.  

— Gradual reduction of CB guarantees and government warranties for bankmoney.
Today, there are far-reaching state warranties for 'systemically relevant' large banks and their private bankmoney. For one thing there is the CBs' de facto liquidity guarantee for the banks (CB as 'lender of last resort'). For another thing, govern­ments stand bail for high amounts of bankmoney (the government as 'bankmoney guarantor of last instance') and stand by to recapitalise banks in trouble (the government as 'bank recapitaliser of last instance').[6] To the extent the digital euro gains ground, the CB and government guarantees for private bankmoney can be gradually removed.

— Putting digital euros into circulation not only via banks and perhaps other financial institutions,
but also via the Treasury, for example by directly purchasing government bonds, rather than only indirectly by way of open market pur­chases, as well as by issuing a fair share of new CB money as debt-free genuine seigniorage.

— The digital euro should not be interest-bearing,
just as cash does not bear interest. Interest is paid on credit (lending or investing), not however on the money as the means of payment in which credit is disbursed.
Accordingly, the Bundesbank in its day refused to pay 'deposit' interest on banks' CB reserve balances. CB reserves, after all, are not a cash loan from the banks to the CB; instead, CB reserves are the best high-powered base money available so far.

In contrast, the currently prevailing view of the identity of money and credit is a false identity. It creates confusion and causes the inherent instability and proneness to crisis of the money and banking system by making money part of the financial economy and its risks, rather than building the financial economy on a money supply of safe stock.

— The digital euro must protect financial privacy,
i.e. confidentiality, pseudonymity and even partial anonymity within the bounds of what is legally justifiable. Absolute anonymity cannot and should not exist. Even with today's improperly idealised cash, anonymity exists only to a limited extent. In the legitimate interest of all parties involved, payments must be traceable and verifiable. Illicit money holdings and payment transactions must be detectable.    

— The digital euro should be programmable by users.
The combination of digital money and smart contracts promises to be a useful tool in private business management and public administration. However, the usage of digital euros by users must not be pre-programmable by the ECB or the banks/PSP.

The digital euro as currently set out by the ECB and the EU parliament

According to current, already quite defined plans, the first-generation digital euro will fulfil the aforementioned design principles only partially and to a very limited extent. The following can be said in detail.

— Unrestricted legal tender.
Legal tender, Yes; unrestricted, No. The digital euro is legal tender and accessible to all non-bank user groups (retail banking). However: the digital euro will not be an unrestricted means of payment, but only be avai­lable and usable to a very limited extent. The ECB has not yet made a final public statement on this literally decisive point. According to what is being reported undisputedly, individual payments are to be limited to 1,000 digital euros, and the permissible amount of digital euro holdings to 3,000. If that limit is exceeded, a 'waterfall mechanism' automatically converts the 'excess' digital euros back into bank­money (sight deposits). Conversely, if a digital euro balance falls below 3,000, customers can arrange for an amount up to the permitted limit to be automatically converted from their current account balance into digital euros ('reverse waterfall').
These restrictions effectively exclude the use of digital euros in payment transactions by companies and public bodies (B2B) to a large extent.

The restricted usability of the digital euro makes it clear that the ECB is not giving the first-generation digital euro a greater role than the cash that is still in use. This is clearly in the interest of the existing bankmoney regime. The provision of digital euro apps by banks, the unilateral distribution of digital euros by withdrawing them from a bank current account, the quantitative limitation of the digital euro's usability, the compulsory re-exchange of 'surplus' digital euros back into a bank current account – all of this ties the digital euro to a bank current account, thereby integrating the digital euro as a subordinate marginal ele­ment into the bankmoney regime. It is a banking-protectionist arrangement which artificially mini­mises the potential of the digital euro instead of leaving the scope of digital euro usage to the public market demand of money users.

Things are similar in other currency areas. In China, there have been over 260 million e-yuan apps since 2022. Their further growth seems to have stalled since then. One reason is that the Chinese central bank does not pay interest on holdings of e-yuans, whereas normal book-money balances at banks and payment services earn deposit interest. Another reason is the cap on the use of e-yuans of 5,000 e-yuan per day (USD ~690, € ~640) and only 50,000 e-yuan per year (USD ~6,900, € ~6,400). The Swedish e-krona is to be restricted in the same way as cash is currently restricted there (no more large bills, only small cash payments). Most EU countries now have legal limits on cash payments. Formerly, one used to say 'cash is king'. Today it's obviously 'bankmoney is king', while the digital euro is to be neither 'king's rival' nor 'heir to the throne'. So one really wonders why the digital euro is being introduced at such great effort in the first place. 

— Issuance of digital euros according to demand.
Yes, but... Euro tokens shall indeed be issued according to customer demand at banks, and the banks' demand at the ECB. Although: only within the limits of the above tight restrictions.

— Unrestricted convertibility of digital euros.
Convertibility, Yes; unlimited, No. In the public circuit (retail banking), the mutual convertibility of bankmoney, cash and digital euros is basically granted, but again only within the limits of the above-mentioned waterfall mechanism.

— Dual use of central bank reserves and digital euro.
No. The exchange of CB reserves into digital euros for public use is of course necessary and possible. To what extent, however, is determined by the restrictions on use. In the interbank circuit (wholesale banking), the use of digital euros in addition to or instead of CB reserves (dual use) is not even an issue. Fractional reserve banking and the de facto unlimited ability of banks to create their own money in the longer term remain unaffected – although digital money, as the technologically more advanced type of money compared to conventional book money, could easily supplement or even replace CB reserves.

This would not incur additional costs for the banks, as they anyway have to fully finance CB reserves as much as digital euros. However, the banks do not earn interest on holdings of digital euros, whereas, for some unknown reason, they do on CB reserves. As if the CB owes the banks anything in monetary terms, when in actual fact, conversely, the banks owe the CB interest and repayment on CB loans.

— Extension of the CB liquidity guarantee to digital euros.
No. This was not taken into account, presumably because the dual use of CB reserves and digital euros is not considered. 

— Gradual expansion of the use of digital euros by public institutions.
No. Not an issue so far.

— Gradual reduction of CB guarantees and government warranties for bankmoney.
No. Not an issue so far.

— Putting digital euros into circulation not only via banks and perhaps other financial insti­tutions, but also by directly purchasing government bonds as well as through debt-free genuine seigniorage.
No, not an issue so far. The first-generation digital euro is designed to retain, not to challenge the existing bankmoney regime. If the state needs money above tax revenues, it must continue to borrow exclusively from banks and other institutional investors first. The ECB, for its part, is required by EU law to issue new money – whether book money, cash or digital tokens – only by way of credit and exclusively via banks, while the ECB remains prohibited from borrowing sovereign bonds directly from the government (as is customary in Canada on a pro rata basis) or even granting the government a bridging loan on CB account (ana­lo­gous to British or Indian ways and means advances).   

— The digital euro should not be interest-bearing.
Yes, the ECB will not pay any 'deposit' interest on holdings of digital euros. It's not known whether this was decided in analogy with cash, or even for the deeper reason that a loan is not identical with the money (the means of payment) that comes into circulation by paying out the loan. Either way, the digital euro not bearing interest means a competitive advantage for bankmoney to the extent that banks pay deposit interest on account balances. Under normal conditions, and continued state guarantees for private banking risks, many customers will prefer the deposit interest on bankmoney to the safety of the digital euro.

— The digital euro must protect financial privacy.
Yes. Contrary to widespread fears, and in some cases deliberate disinformation, the first-generation digital euro respects financial privacy; operationally and legally in a similar way and to the same extent as is currently the case with both book money and cash. Analogous to cash, the ECB knows how many euro tokens it has put into circulation, but does not know who is holding them and what they are being used for. On the other hand, the operators of digital euro apps (banks/PSP) must be able to trace payments within the framework of what is legally required, as has already been the case with bankmoney and CB reserves (for example, in cases of technical error, contentious issues, know-your-customer rules, detecting black money and money laundering, or other illicit transactions).

The digital euro also offers pseu­do­nymity in the form of a user identifier, or user app identifier, respectively. That iden­tifier is automatically generated when a digital euro app is opened (on-boarding) and remains secret during regular operation.[7]      

— Digital euro programmable by users for their own purposes, not however usage-prescriptively by the ECB or banks/PSP
No and Yes. The ECB has decided that the first-generation digital euro will not be pro­gram­mable at all, neither for end users nor for banks/PSP or the ECB itself. Per­haps this decision was taken against the backdrop of the paranoia rife in certain circles that digital money would open the floodgates to an Orwellian surveillance state. It may also be that the potentials of programmability, the linkability of digital money tokens with smart contracts, and possible con­se­quences for money circu­la­tion, are not yet sufficiently clear and that unpleasant surprises should be avoided. However, this may also have given away for the time being an advantage of digital money. In larger organisations and in the internet of things, programmability of digital tokens can be useful and enhance efficiency. So far, only the Bank of England has considered making the digital pound programmable for end users in agreement with payment interface providers.[8]  

What conclusions can now be drawn regarding the matches and differences between the upcoming digital euro and the above-mentioned CBDC design principles? There are only two close matches, one relating to the protection of financial privacy, the other to the non-interest-bearing nature of the digital euro. On all other points, there is a 'No' or a 'Yes, but', with the 'but' being the more important. The most important and deci­sive component is the severely restricted usability of the digital euro and its sub­ordi­nate integration into the bankmoney regime which is shielded from currency compe­tition, in particular – and strangely enough – from having to compete with the state's own sovereign money.

By introducing the digital euro the ECB is certainly taking a big step, but in the smallest possible way. The monetary policy potential of a growing share of digital euros in the money supply for achieving monetary stability, sound finances and beneficial real-economic development is rather being ignored. The notorious instability and crisis proneness of the existing bankmoney regime as well as the CBs' involvement in it remains the grotesque elephant in the room, while supposed risks of the digital euro are over-dimensionally blown up (bank run, 'disintermediation').

Some may be disappointed. On the face of it, what was to be expected was confir­med.[9] The vested interests of the banking sector prevailed in the design of the first-genera­tion digital euro.  The ECB is settling for the bare minimum. Apparently, like other central banks, the ECB continues to see itself primarily as the 'bank of the banks'. CBs are more inclined than ever to make themselves and the public believe they hold the lead in the monetary system by setting base rates on CB reserves, when is appa­rent that the banks are pro-actively leading the system by deci­ding on the quantities of monetarily dominant bankmoney, while state central CBs have become a re-active auxiliary body of the private banking sector. In doing so, CBs and governments have conferred a para-sovereign status on what is actually private bankmoney.

The crucial point of CBDC: money substitution

So far, CBDC has mainly been justified by the CBs in advanced countries with the fact that cash has gradually been disappearing as a result of cashless bankmoney trans­actions and, most recently, as a result of the incipient digitisation of money. So they want to compensate for the disappearance of cash by offering a modern digital type of CB money. In systemic terms, CBDC is thus ascribed a subordinate marginal role as cash has played for decades. This suggests maintaining the status quo and a quasi 'peaceful coexistence' of CBDC side by side with bankmoney. Apparently this applies to the minimalist, first-generation digital euro, which has been trimmed down to the measure of today's residual cash. Never­theless, it's misleading. As a type of money, as a non-cash means of payment, CBDC competes with bank­money. Rather than peaceful coexistence, the longer-term future bodes for com­pe­tition and political rivalry bet­ween CBDC/the digital euro and bankmoney.

This highlights the real crux of the matter: money substitution in the sense of CBDC crowding out bankmoney in the long run. This reverses the previous historical money sub­stitution, through which CB cash was supplanted by non-cash bankmoney. The more CBDC there will be, the lower the share of bankmoney and its systemic dys­func­tions, the lower the instability and crisis proneness of the bankmoney regime to the benefit of the entire financial and real economy.

In the CBDC discourse to date, the question of money substitution has in fact played an important role, but was never clearly ­spoken out. Instead, there has been much guess­work about alleged problems coming with CBDC, especially 'disintermediation', bank runs, and hoarding of CBDC/digital euros.

— Disintermediation is a fictitious problem. It refers to the fear that banks could face difficulties financing their business because of the digital euro. Such worries assume banks to be financial intermediaries like non-monetary financial institutions, or shadow banks respectively, that is, credit institutions that take up bankmoney upstream to lend or invest it downstream.

Banks, however, can only do this in the interbank circuit when using central bank reserves among each other. Banks cannot do this with the bankmoney of their cus­to­mers; or only in the one special case where a bank poaches customer account balances from other banks, as a result of which the poaching bank receives the respective amount in central bank reserves. Otherwise, however, banks as monetary financial institutions, i.e. money-creating institutions, are not intermediaries of their own bank­money, but always its creators. Savings and term deposits held at a bank are not used by anyone. They represent temporarily deactivated bankmoney. They cannot be used for a bank's proprietary transactions. For these, banks need CB reserves and residually some cash, to a small fraction of the large amounts of bankmoney they create.

The digital euro in no way restricts fractional reserve banking and the ability of banks to create their own bankmoney in doing business with non-banks. Equally, the CB's anytime fractional refinancing of banks is in no way in question. As far as customers replace cash with digital euros, it makes no difference for the banks, as they have always had to finance cash 100%, just as they will have to finance the digital euro in the future. Only when the digital euro spreads beyond the tight restrictions currently envisaged will banks gradually have to finance more digital euros. Only then will the financing privi­lege banks have today – the bankmoney privilege – gradually diminish. Anyway, there will not be a financing problem for the banks as long as the CBs habi­tually accom­mo­date the banks' demand for base money, be it CB reserves, cash or CBDC/digital euros.

— Bank run is a problem indeed, not however a problem of CBDC, but the primordial problem of fractional-reserve bankmoney since it has existed. Expecting the digital euro to trigger a landslide run on bankmoney is unfounded. (Rather, the expectation unintentionally betrays worries about the vulnerability of bankmoney). Under normal conditions, you don't change your habits that quickly. 'Old habits die hard', including when it comes to money and making payments. Such changes tend to happen over time and in the suc­cession of generations. Moreover, from the users' point of view the advantages of the digital euro over bankmoney will exist to a degree, but not be immediately over­whel­ming (online banking, electronic payment transactions, ease of use, speed of payment, cost benefits).

Even the superior safety and security of the digital euro compared to bankmoney remains relative as long as CBs and governments guarantee bankmoney on a large scale. Only in a banking crisis is a flight from bankmoney to be expected, whether into cash or foreign exchange (US dollars, Swiss francs) as hitherto, or into digital euros in the future. Any such run will once again be due to the instability of bankmoney, not the digital euro. Thanks to the stock-safety of CB money, the stability of the monetary system can only gain, not lose, with the spread of digital euros. The ECB can defuse the bank run problem by pre-emptively guaranteeing to make any necessary digital euros available to the banks, either by converting existing CB reserves or by granting addi­tio­nal credit in digital euros.

— Hoarding of CBDC is one of the most recent fears that have been improperly raised. Strictly speaking, hoarding was a problem in the Middle Ages and the Early Modern Age, when money consisted of coins made of copper, silver and gold. In today's era of freely created fiat money, the problem of hoarding, which inhibits money circulation, trade and production, has become irrelevant. In today's bankmoney regime, savings and term deposits are 'hoarded' in enormous amounts. Who cares. In contrast, once digital euros circulate beyond tight restrictions, and some of these digital euros are put into savings and time accounts, that money is not 'hoarded' (i.e. deactivated), but in fact used as a means of financing and thus kept in active circulation. If, however, in a crisis or for other reasons, people prefer to keep their money with them rather than spend it or invest it, this is not specifically attributable to CBDC or bank­money or any other type of money, but, as Keynes put, to the liquidity preference of households and companies. The extent to which interventions are legitimate in this case, and which ones are actually useful, is another question.

Money substitution past and present

Mark Twain is credited with the statement History doesn't repeat itself, but it often rhymes. In the modern history of money, the 'rhyme' is that a recomposition of the money supply and associated changes in the monetary system occur when
1. the dominant type of money causes chronic problems that cannot be solved within   the existing framework, and
2. a new type of money emerges or is already latently present, that can contribute to solving the problem and may come with further advantages.

The table below summarises the relevant monetary turning points, types of money, issuers, and functional problems.

Money substitution: Monetary turning points in the composition of the money supply

The last money substitution took place in the course of the 20th century, in that bank book money increasingly replaced cash. In the public circuit, Treasury coins and CB notes (in the US also Treasury notes) were marginalised by cashless payment with bank­money. In the vast majority of payment transactions, cash cannot compete with bankmoney. As a result, bankmoney has become the system-defining dominant type of money. In the interbank circuit, this was reflected in the fact that cash was no longer used at all, apart from transport to meet customer demand.

Interbank transactions have always been carried out primarily by clearing claims and liabilities between banks. In the course of the 20th century, this was replaced by the interbank transfer of CB reserves, most recently by means of the CBs' RTGS payment systems (Real-Time Gross Settlement). In conjunction with the massive concentration process in the banking sector, this has meant that the amount of CB reserves neces­si­ta­ted by the banks has become ever smaller in relation to the much larger amounts of bankmoney. (Exception: large over­hangs of CB reserves as a result of CBs' Quantitative Easing policies in the aftermath the 2008 banking crisis).

In advanced countries, the substitution of bankmoney for cash, presently at 90–97%, is likely to have reached its peak at this state of affairs. Substitutable cash is no longer present in systemically relevant quantities. The functional problems of the bankmoney regime – in terms of monetary system instability, not technically – cannot be solved within that frame­work and have become more entrenched. At the same time, a new type of money – tokenised digital money – has begun to re­place traditional book money.

In a sense, this can be seen as an analogy to the 18th and early 19th centuries, when the overshoot of unregulated paper money from too many private and princely issuers was overcome by the note monopoly of the then new national CBs. Seen in such historical dimensions, there is today a comparable necessity and oppor­tu­nity to substitute CBDC for inherently unstable bankmoney, including new third-level money surrogates and also the spread of private crypto­cur­rencies. The severe restrictions likely to be im­posed on the use of first-generation CBDC/digital euro are designed to prevent such structural change. Beyond such conservative protectionism, bank­money will be increasingly exposed to competition from CBDC/the digital euro.    

In terms of efficiency and thus costs, bank money does not yet seem well equipped to compete with CBDC/the digital euro. See table. Another competitive advan­tage of CBDC is of a monetary and economic nature and consists in CBDC's stock-safety. CB money is backed by a state's powers as a guarantor, compared to which even very large financial cor­po­ra­tions normally look small. In fact, bankmoney would have dis­appeared long ago if CBs and governments had not repeatedly rescued it with massive interventions from one crisis to the next. State CBs and governments as guarantors of last instance for private bankmoney are certainly not an example of productive public-private partnership, but rather an absurdity in view of state monetary sovereignty as a prerogative of constitutional importance.

The interests of the public and politics. Special case USA

It helps understand the current situation taking a closer look at the interests of the various groups involved – the money-using public, politicians, banks and shadow banks, not least the central banks.

For the majority of the public, the upcoming digital euro is still a long way off. In the nations that have already introduced CBDC, adoption is slow. CBDC is not yet a big hit. As surveys show, the public is hesitant due to concerns about the security of digital money and the protection of financial privacy (oddly enough, irrespec­tive of the easily possible monitoring of individual money holdings and payment transactions in today's book money system with bank accounts). 

At the same time, there is a growing group of mostly young and middle-aged people with a pronounced affinity to IT. Quite a few of them already use mobile payment apps, possibly via a smartwatch, and may have already traded in cryptocurrencies. These groups will hardly hesitate for long to use CBDC (unless they are libertarian ultras who see salvation in private money and the devil himself in state CBs).

As far as politics is concerned, the basic attitude towards CBDC tends to be rather positive. Technologically, politicians and officials want their country or area of responsibility to be among the more advanced; and today this involves digitisation, including the digi­tisation of the monetary and financial system. Of course, various details of the matter tend to be controversial.

A polarisation pro and contra CBDC has so far only emerged in US politics, along the current lines of dissent between Republicans and Democrats. Many Republicans, and a few Democrats, are suspecting the spread of digital curren­cies to weaken the Ameri­can banking and financial system and threaten the inter­national hegemony of the US dollar (USD). The USD-based banking and financial system dominates inter­natio­nal payments and capital flows to a considerable extent and also serves as a sanction instrument for US foreign policy. The concerns relate to private crypto­curren­cies as well as a digital dollar from the US Federal Reserve.

To be sure, such concerns do not 'rhyme' in this case. Apparently, these politicians intend to shield US banks from the challenge of private cryptocurrencies and CBDC, thereby supposedly also maintaining the USD's international position. However, such pro­tec­t­io­nism fails to recognise that the dollar hegemony is not based on the national currency unit as such, and not solely on the political-economic and military supremacy of the United States. The dollar hege­mony is also based on the types of money in which the USD is denominated. With USD notes alone, without the highly developed IT book money system of the dollarised financial world, there would be no dollar hegemony. According to this interrelation, without a digital dollar there would be no more dollar hegemony and no globally leading US financial system in the future. With their oppo­sition to a digital dollar, the conservative politicians in question are about to score a major own goal. In the long term, they would relinquish America's monetary and financial leadership. Whether another currency, or two or three, would take the USD's place, and which these might be, is left open.

The banking interests

Around 2014, at the beginning of the discussion about CBDC, bankers did not seem to be worried. Treasury coins and CB notes have traditionally been part of the banking business, and 'digital cash' would probably be something similar. Only towards 2020 one seems to have realised that 'digital cash' is an illustration of something much more far-reaching than is conventional cash of limited practical use. It was realised that CBDC is potentially a strong competitor to bankmoney, and that in the long run the introduction of CBDC/digital euro may prove to be the beginning of the end of the dominance of bankmoney. This would be all the more so if state guarantees for bank­money were gradually removed (liquidity guarantee for the banking sector by the CB as lender of last resort, and the government as bankmoney guarantor and bank recapitaliser of last resort). Even if bankmoney is currently still shielded from having to compete with digital euros, the adoption of the digital euro is likely to progress over time. The public interest in the digital euro on the part of CBs, governments, non-bank financial institutions and other users is on a collision course with private interests in bankmoney and other private money surrogates.

Recognising the weak position of bankmoney in real competition with CBDC, the banking community has for some years now begun to talk CBDC down, also with the help of banking-friendly think tanks, experts, politicians and journalists. The main line of argument reads that CBDC is 'a solution in search of a problem'. There was no need for digital euros, as bankmoney offers customers everything they need. This is a text­book-classical argument typical of placeholders against ground-breaking innovations.

As if to prove it, banks have recently rushed to offer near-instant payments in bank­money, albeit at a higher price. In the USA, the service is called FedNow, in the euro area SEPA Inst (Single Euro Payment Area Instant Payment Service). This still involves fractional reserve banking with inherently unstable bank liabilities, not however P2P instant payment with stock-safe digital euros fully owned by the users. Banks are now also offering deposit interest on account balances again, while digital euros will not be interest-bearing. In return, according to current plans, the use of digital euros for basic everyday purposes shall cost users nothing.[10] How this is defined and delineated from other purposes is still left open.

The argument that the public in countries with a highly developed banking system is well served by bankmoney and does not need CBDC refers to the direct customer bene­­fit, that is, aspects such as convenient handling of money, secure and fast pay­ment while maintaining financial privacy, not least the costs of account manage­ment and transfers. As things currently stand, the digital euro is somewhat superior to bank­money in each of these respects. Perhaps the banks can still catch up in terms of ease of use, security and speed through advanced technology and operating processes. Whether they can also achieve parity in cost competition remains to be seen.

Whatever the prognosis, what is omitted is that customers will continue to have to make do with crisis-prone, unsecure bankmoney, money that will fall into the bank­ruptcy estate of a bank unless CB and government come to its rescue; instead of giving customers access to safe and stable CB money (sovereign base money), which does not fall into the bankruptcy estate and remains in the possession of its users, no matter what problems banks, capital and financial markets may be entangled in.

The customer benefit of CBDC versus bankmoney is not the sole and not the syste­mi­cally decisive reason in favour of CBDC. Rather, the even more important purpose of the matter is to regain control of the monetary system through effective quantity and base-rate policies by CBs for achieving a stable monetary foundation of the financial and real economy.

The fixation on customer benefits is a deliberate distraction from the actual problems and dysfunctions of the bankmoney regime:
-    the inherent instability and crisis-proneness of fractional-reserve bankmoney and the banking sector
-    its recurring liquidity and run problems
-    the recurring scandalous constraint for CBs and governments to rescue systemically relevant banks to save everyone's bankmoney, as this is held hostage to the banks' balance sheets,
-    today's allocation bias of bankmoney creation in favour of non-GDP finance as compared to real-economic financing
-    the de-facto constraint for central banks to accommodate the banks' demand for refinancing, and the weak effectiveness of monetary policy in the existing bank­money regime.

It is often overlooked that non-monetary financial institutions such as money market funds, investment trusts, private equity investment agencies, building societies, insu­rance companies, etc. are exposed to the functional problems of the bank­money regime basically like everyone else. They cannot create 'deposit' money themselves. Most of the money they use is bankmoney from non-banks, the rest directly taken up from banks. So non-monetary financial institutions operate on bankmoney and thus have an interest in digital euros.

This is why, for example, during the banking crisis after 2008 the insurance company Talanx tried to obtain a reserve transaction account at the ECB/Bundesbank in court. Unsuccessfully. But the divergent interests between banks and non-bank financial institutions on this point persist. The bankmoney privilege is a factually resulting but unfair competitive disadvantage for non-monetary financial institutions. They thus have a considerable interest in using digital euros, and doing so on a large scale.

The ambivalent interests of central banks: the core problem of the whole story

The ECB is currently envisaging the introduction of the digital euro for 2026–28. The many years of development process and recurrent contradictory announcements from various CBs leave the impression that the CBs are not in a hurry with introducing CBDC. At the Swedish Riksbank and the Bank of England, the development of a CBDC was already underway since 2016, with the aim of launching it two to three years later. However, despite conceptual progress and some piloting, this has not yet happened.

The hesitancy and the stop-and-go of central banks when it comes to introducing CBDC may be due in part to the perhaps underestimated technological and operational com­ple­xity of the matter. More likely, however, the reasons stem from political dis­agree­ment. The central banks are caught in a role conflict here, put more pronouncedly, they themselves are the centre of the conflict pro and con CBDC. The internal differen­ces of opinion run between the progressive protagonists of CBDC and the con­ser­va­tive defenders of the status quo.

The progressive protagonists of CBDC see the need to introduce digital money and pay­­ment technologies in order not to be left behind by international private develop­ments in this field. There is also a need for some systemic change to enable more effec­tive monetary policy and to strengthen monetary control (of money, not of credit and finance) and the role of national CBs as 'guardians of the currency'. Such goals can­not possibly be achieved by base-rate policy alone in the context of a money supply proactively determined entirely by bankmoney. Instead, what is needed is control over a sufficiently large, ultimately dominant CB money supply in the public circuit, today in the form of CBDC/digital euros.

In Europe, the CBDC protagonists initially included the CBs of Sweden and the UK, now the ECB; in Asia, the CBs and governments of China and India; and from the outset the Basel Bank for International Settlements and the International Monetary Fund.

In contrast, conservative defenders of the status quo continue to see the role of CBs in acting as 'bank of banks' in the sense of retaining the private bankmoney regime and, if need be, acting as an auxiliary state body and guarantor of the banking sector. They are basically not opposed to digitising and otherwise modernising money and finance, but they are Banking-School conservative in terms of monetary theory and policy, hesi­tant or even hostile to CBDC, thus delaying the development and intro­duc­tion of CBDC. They are committed to the bankmoney regime, which they still believe to be CB-led, and thus see themselves as the natural guarantors of bankmoney. Even if they cannot completely prevent CBDC, they insist on a restrictive, minimised design of CBDC/the digital euro, which is subordinately integrated into the bankmoney regime. The exis­t­ing system is thus largely protected from real structural change for the time being.

The different opinions of monetarily progressive and conservative central bankers reflect the ambivalent role of CBs. Central banks are supposed to be the national 'guardians of the currency'. This includes issuing CB money in sufficient quantities and keep­ing the overall money supply under control to ensure monetary stability as far as the domestic purchasing power and the foreign exchange rate de­pend on monetary quantities and base rates. Over time, however, CBs have manoeuv­red themselves into the role of a state support agency for the private banking sector, at all times reactively complying with the facts the banks proactively create. This role is now even ascribed to the CBs as a matter of course in textbooks.

Now, however, as issuers of CBDC, the most modern form of money, CBs are histo­ri­cally entering into yet another competition with the banks as creators of money. Whether intentional or not, the introduction of CBDC will in fact call into question the current, monetarily privileged position of the banking sector, and thus also the para-sovereign status which CBs and governments actually grant to bankmoney today.

There's the saying You can't have your cake and eat it. With regard to the conflicting intentions inside CBs, this means that it is not possible for them to introduce CBDC without this having an impact on the bankmoney regime and the CBs' current role in it. Over time, CBDC will inevi­tab­ly lead to a more or less extensive substitution of bank­money. CBs need to introduce CBDC in order to better fulfil their factual role of being the national or supranational monetary authority, especially as issuers of CB money in general public use. Because this – a dominant amount of CB money in the public circuit – is the actual basis for monetary policy transmission and effectiveness.



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References

Atlantic Council CBDC Tracker, Central Bank Digital Currency Tracker - Atlantic Council    

Bank of England / HM Treasury. 2023. The Digital Pound – a new form of money for households and businesses? Consultation Paper, Feb 2023.

Desan, Christine. 2022. How To Spend a Trillion Dollars: Our Monetary Hardwiring, Why It Matters, and What We Should Do About It, Working Paper 3/12/22, Harvard Law School.

European Central Bank. 2023. A stocktake on the digital euro, 18 Oct 2023, A stocktake on the digital euro - Summary report on the investigation phase and outlook on the next phase (europa.eu)

European Central Bank. 2024. Update on the work of the digital euro scheme’s Rulebook Development Group, 3 Jan 2024. Update on the work of the digital euro scheme’s Rulebook Development Group (europa.eu).

European Commission. 2023. Proposal for a Regulation of the European Parliament and the Council on the establishment of the digital euro, Brussels, June 2023.

European Commission. 2023b. Digital Euro Package, 28 June 2023. Digital euro package - European Commission.

Hess, Simon. 2020. Regulating Central Bank Digital Currencies: Towards a Conceptual Framework, SSRN, https://ssrn.com/abstract=3582501 

Huber, Joseph. 2017. How to account for sovereign central-bank currency, sovereign money website, How to Account for Sovereign Central-Bank Money — sovereign money.

Huber, Joseph. 2023. The Monetary Turning Point. From Bankmoney to Central Bank Digital Currency (CBDC), palgrave macmillan.

Huber, Joseph. 2024. Digital currency and financial privacy: Abusus non tollit usum, Digital Currency and Financial Privacy — sovereign money.

Kumhof, Michael / Noone, Clare. 2018. Central bank digital currencies – design principles and balance sheet implications, Staff Working Paper No. 725, May 2018, London: Bank of England.

Kumhof, Michael / Allen, Jason / Bateman, Will / Lastra, Rosa /Gleeson, Simon / Omarova, Saule. 2020. Central Bank Money: Liability, Asset, or Equity of the Nation? Cornell Law School research paper, No. 20–46, 5 August 2020. 

Mayer, Thomas. 2023. Der digitale Euro: Eine (wahrscheinlich) vertane Chance, Flossbach von Storch Research Institute, 12 Sep 2023. Der digitale Euro: Eine (wahrscheinlich) vertane Chance - Flossbach von Storch (flossbachvonstorch-researchinstitute.com)

Monnet, Cyril /  Niepelt Dirk. 2023. Why the digital euro might be dead on arrival, Vox/CEPR, 10 Aug 2023. Why the digital euro might be dead on arrival | CEPR.

Omarova, Saule T. 2021. The People's Ledger: How to democratize money and finance the economy, Vanderbilt Law Review, Oct 2021, Vol. 74, No. 5, 1231–1300.

Positive Money Europe / Veblen Institute for Economic Reforms. 2023/24. A Digital euro for the People. A digital euro for the people: position paper (positivemoney.eu).

Endnotes

1 Atlantic Council CBDC Tracker, March 2024.

[2] European Commission 2023, 2023b, European Central Bank 2023, 2024.

[3] Kumhof et al. 2020, Omarova 2021, Desan 2022, Huber 2017 167–70, 2023 174–79.

[4] This also applies analogously to conventional prepaid cards or value cards. They do not store the amount of money concerned, but just relevant information about an account balance (like an interactive bank statement). The liquid deposit balances in question are actually located elsewhere, usually in a separate bank omnibus account for those cards.

[5] Kumhof/Noone 2018, Kumhof et al 2020, Hess 2020, Positive Money Europe/Veblen Institute 2023/24 ch. 2, Huber 2023 117–149.

[6] In addition, there is now 'bail-in' of bank customers, that is, the forced conversion of customer deposits into bank equity – temporarily when things are going well, lost when going badly.

[7] On the issue of financial privacy relating to CBDC/the digital euro, see Huber 2024.

[8] Bank of England 2023, pp. 32, 45, 53.

[9] Cf. Monnet/Niepelt 2023, Mayer 2023, PM Europe/Veblen Institute 2023/24 ch. 1. 

[10]  European Commission 2023, Art. 41–46.