21 June 2023

SUERF's Niepelt: Digital Euro: An assessment of the first two progress reports

Some motivations for a digital euro remain vague, some fundamental tradeoffs receive limited attention. Most importantly, the reports lack an analysis of why digital euro holdings as stores of value are not desirable and whether strategies to limit such holdings cause collateral damage.

Against that backdrop some of the design choices backed by the Governing Council appear premature.

First Report

The first progress report motivates the case for a digital euro and lays out foundational design options endorsed by the ECB Governing Council. It characterises a digital euro as an electronic means of payment for retail users in the euro area but remains vague on what this means in practice. In terms of transfer mechanisms, the report anticipates an online option, validated by a third party; and offline option, peer-to-peer validated; and possibly cash-like features to enable greater privacy for low-value transactions.

Motivations

The report motivates the digital euro as an instrument to preserve the role of public money as anchor of the payment system in the digital age. But it does not explain why the trend decline in cash use for payment purposes endangers the anchor role of public money. Digitisation does not change the lender of last resort, bank regulation, or deposit insurance. Nor does it change interbank payment systems, in which banks settle by transferring central bank money (reserves). It does not, on its own, undermine the option to withdraw cash either, as long as the ECB ensures the availability of banknotes, as it intends to do. It is therefore unclear which specific risks the ECB foresees and how a digital euro would address them.

The report also motivates the digital euro as a contribution to Europe’s strategic autonomy. It remains unclear whether the authors have in mind national security considerations, independence from expensive overseas service providers, or monetary sovereignty (defence against “dollarisation”). Sovereignty could best be strengthened by developing attractive payment solutions for the most mobile user groups, including businesses. Against that background, a digital euro for business clients might be more promising than some of the use cases the project focuses on (see below)....

Second Report

The second progress report describes the anticipated division of tasks between the euro system and private intermediaries, the prospective settlement of digital euro transactions, and a “digital euro scheme”.

Role of Intermediaries

The report envisions the Eurosystem to be responsible for customer onboarding, supervision, and settlement of digital euro transactions, while private intermediaries would be responsible for the distribution of digital euros, all other customer-facing activities, and the provision of devices and interfaces.

The report does not address incentive compatibility. If the digital euro were a threat to the business model of banks, why would banks fully engage with rather than try to subvert the public-private partnership model?

Funding and Defunding

The report anticipates seamless conversion of cash and private money into digital euros, and vice versa. Liquidity in excess of a digital euro holding threshold would be pushed to linked private money accounts, and vice versa (“waterfall” and “reverse waterfall” model). The “waterfall functionality … would allow users to make or receive payments in digital euro in excess of any holding limit set by the central bank to limit the amount in circulation”....

 more at SUERF

© SUERF