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How to overcome the digital euro challenge

Author: ICAEW Insights

Published: 15 Apr 2024

As the digital revolution continues apace, plans for a digital euro offer significant benefits for society. Meglena Grueva looks at the journey from theory to practice.

Plans for a digital euro are continuing to gather momentum, almost two-and-a-half years after the European Central Bank (ECB) launched an investigation into how a digital currency across the Eurozone might work in practice. 

Initial proposals for a digital euro were published by the European Parliament (EP) in June 2023. In October 2023, the ECB pushed the button on the preparation phase of the digital euro project, two years after the launch of its investigation phase. And in January, the ECB issued a call for tender applications to develop a digital euro platform. Meanwhile, the ECB is continuing to draft the digital euro rulebook and address societal and industry concerns. 

Digital euro objectives

As the digital revolution continues apace, the digital euro aims to modernise the Eurosystem’s currency by meeting societal needs while preserving features such as confidentiality. A digital euro would be a widely accepted means of electronic payment for retail goods, issued by the central bank and accessible to everyone in the euro area. 

The aim is for it to strengthen European digital financial autonomy without replacing cash. Designed as a universal service, the objective is for it to be free, accessible, and user-friendly to foster widespread adoption across the euro area. 

It promises to benefit the public by enhancing privacy in digital payments and bolstering the euro’s global standing, through improving cross-border payment efficiency and interoperability with other digital currencies. The initiative seeks to enhance the benefits of the euro and further integrate the Eurozone’s financial infrastructure.

The financial sector, including banks and payment service providers (PSPs), will play a crucial role in distributing the digital euro, and will use existing infrastructures to manage transactions and accounts. The plan is for the rollout to be gradual, starting with person-to-person and online payments before expanding to physical retail environments. It should facilitate smooth integration with existing payment systems while at the same time minimising risks. 

Industry stakeholder implications 

Given the broader implications of a retail digital euro, its introduction will require careful policy calibration among EU institutions and member states. 

In particular, geopolitical considerations underscore the need for European payment sovereignty, given the current dominance of non-EU providers. Private-sector initiatives such as the European Payments Initiative (EPI) aim to address this by offering EU-wide networks to facilitate access to the digital euro. However, the legal framework must also support the ECB’s mandate while enhancing the Eurozone’s digital competitiveness. Transparent communication to engage stakeholders, especially citizens, will be key. 

The introduction of technologies such as GPS, social media platforms and tablets demonstrate how initial scepticism can morph into mass adoption as the benefits emerge over time. However, whether the digital euro can mirror this success remains to be seen.

Technical challenges and risks

The introduction of a digital euro comes with challenges and risks, which could impact its development and implementation. For that reason, the Eurosystem plans to build a payment system that underscores the importance of interoperability with existing payment railways. 

A comprehensive evaluation of potential benefits and costs is essential. For example, how to leverage existing technologies and networks to integrate into the current payments landscape, without the need to develop a solely new pan-European network. Or how to ensure individuals with a lack of digital access are not excluded from greater adoption of digital payments and euro payment systems. 

The digital euro will be a centralised system, according to ECB publications; that also means it will be a single point of attack that will need to be protected against cyber risks and threats. The Eurosystem must learn to manage and safeguard a new infrastructure that will attract the attention of cyber criminals globally. 

A successful digital euro should provide clear benefits and ensure fair competition. Concerns about competition imply that any new system must comply with legislation and allow for fair pricing, paving the way for public-private partnerships. Given the ECB’s dual role as operator and supervisor, a clear separation must be enforced to maintain independence and avoid conflicts. 

Potential impact on commercial banks

While the legislative proposal touted by the European Commission in mid-2023 aimed to clarify the digital euro’s functions and limit the ECB’s discretion by involving other actors in the decision-making process, many critical aspects remain undefined. This ambiguity raises concerns about the potential impact on commercial banks, particularly regarding fee limitations, obliging costs and distribution requirements. 

Although the ECB will cover the cost of building this new payment system, there will be certain capital infrastructure outlays for the banks to support the distribution of a digital euro. The timeframe for these cost recoveries, if any, remains unknown.

In addition, the digital euro’s distribution through applications including via banks, PSPs, and the EU provided by the ECB could potentially lead to the ECB assuming the role of a payment service provider. This dynamic brings both the ECB and PSPs – including new FinTech companies – into competition with banks for payment service provision.

Stakeholder collaboration needed

Collaboration among all these stakeholders is crucial to identify value-adding use cases for the digital euro, such as offline micropayments and programmable payments, while ensuring it complements the evolving payment ecosystem without undermining existing infrastructures. Additionally, banks must adjust to new challenges and many of their payment solutions and processes will need updating. 

The EP proposal states that businesses will have a ‘zero holding limit’ for digital euros, meaning that they will need to have an established system in place to use the waterfall and reverse-waterfall funding mechanisms proposed by the ECB. It will take a strong value proposition to increase adoption among merchants and businesses.

Holding limit to mitigate risks

Like central bank reserves, the digital euro will not appear on the balance sheet of commercial banks. Concerns regarding its potential as an unlimited store of value, and that it might lead to a decline in bank deposits, highlight the need for mechanisms to restrict the amount held by users. To mitigate potential risks, the ECB has imposed a holding limit, preventing excessive shifts from bank deposits to digital euro, and opted against paying interest on the holdings of the digital euro. 

Nevertheless, banks remain apprehensive as the digital euro is expected to diminish deposit levels, prompting the need for new funding sources, and forcing banks to reassess their business models and adjust their liquidity management. The shift to a digital economy underscores the need for on-chain payment solutions and the digital euro to provide central bank currency for digital transactions. 

A digital euro can bridge a crucial gap in the current payment landscape. Further collaboration with stakeholders, alongside continued legislative wrangling by the European Commission, Parliament, and Council, should address concerns and ensure the digital euro project evolves in a way that makes it fit for the digital era.

Meglena Grueva, Head of Digital Assets Solutions Germany, Mazars

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