Navigating challenges in the retail digital euro landscape

Last October, the European Central Bank (ECB) initiated the preparation phase of the Digital Euro project, following two years of investigation and a proposal on the establishment of a digital euro published by the European Parliament (EP) in June 2023. In January, the ECB began seeking potential providers to develop a digital euro platform and infrastructure through a call for tender applications. Simultaneously, the European supervisor continues drafting the digital euro rulebook and addressing societal and industry concerns.

We discuss in this article the context surrounding the digital euro and what needs to be considered when assessing the costs and benefits of the initiative. 

Why is the ECB working on a digital euro?

The digital euro aims to modernise the Eurosystem’s currency amidst the digital revolution, ensuring it meets societal needs while preserving features like confidentiality and acceptance. The goal is for it to facilitate all retail transactions, bolstering European digital financial autonomy without replacing cash. Designed as a universal service, it is intended to be free, accessible, and user-friendly, fostering widespread adoption across the euro area. The digital euro is viewed as a public good that could enhance privacy in digital payments and bolster the euro’s global standing by improving cross-border payment efficiency and interoperability with other digital currencies.

The financial sector, including banks and payment service providers (PSPs), will play a crucial role in distributing the digital euro, leveraging existing infrastructures to manage transactions and accounts. The rollout will be gradual, starting with person-to-person and online payments, before expanding to physical retail environments, aiming for smooth integration with existing payment systems while minimising risks. This initiative seeks to enhance the euro’s utility and further integrate the Eurozone’s financial infrastructure.

What are the implications for industry stakeholders?

Introducing a retail digital euro necessitates careful policy calibration among EU institutions and Member States due to potential broader implications for the financial sectors and society. As a result, geopolitical considerations emphasise the need for European payment sovereignty, given the dominance of non-EU providers. Private sector initiatives like the European Payments Initiative (EPI) aim to address this, offering EU-wide networks to facilitate access to the digital euro.

 To succeed, the EU legal framework will need to support the ECB mandate while enhancing the Eurozone’s digital competitiveness, with transparent communication being key for engaging stakeholders, especially citizens.  The digital euro will also need to offer choice and flexibility while leveraging existing technologies and networks to integrate into the current payments landscape, without solely depending on a new pan-European network.

More fundamentally, while it can be argued that the initative may not clearly address currently unmet needs among potential users, past examples like GPS technology, social media platforms and tablets all demonstrate how initial scepticism can lead to mass adoption since it is the market that can discover more benefits with time. However, whether a public sector currency like the digital euro can mirror this success remains to be seen.

What are the cost and benefits of such a payment system?

The Eurosystem plans to build a costly payment system, underscoring the importance of interoperability with existing payment railways. Technological challenges and risks also accompany the introduction of a digital euro, impacting its development and implementation. These will need to be considered carefully. A comprehensive evaluation of potential benefits and costs will therefore be essential. We discuss below some of these considerations.

“I still fail to understand what this will be useful for except that it is a way for the ECB to reaffirm its sovereignty over currency against private sector attempts to enter the market. It may facilitate interoperability and international transfers… still, banks are not convinced.”

Sylvie Matherat, Senior Global Advisor, Mazars

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

A successful digital euro should also provide clear benefits and ensure fair competition. Concerns about competition imply that any new system must comply with legislation and allow for fair pricing, emphasising the potential of 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.

Impacts on commercial banks

While the legislative proposal by the 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. The resultant 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 expenses related to building this new payment system, there will be certain capital infrastructure outlays for the banks supporting the distribution of a digital euro. The timeframe for these cost recoveries, if any, is yet to be seen.

Further, the digital euro’s distribution through applications including via banks, PSP’s, and the EU provided by the ECB presents the ECB with the potential 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. 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 require renovation.

The EP proposal references that businesses will have a ‘zero holding limit’ for digital euros, hence they will need to have a well-setup system in place to utilise the waterfall and reverse-waterfall funding mechanisms proposed by the ECB. Merchants and businesses will need to be approached with a strong value proposition to increase adoption.

The digital euro, constituting a claim towards the ECB, will not feature on the balance sheet of commercial banks. Concerns regarding its potential as an unlimited store of value highlight the need for mechanisms to restrict its use in this capacity. To mitigate potential risks, the ECB has imposed a holding limit, preventing excessive shifts from bank deposits to digital euro, and opted against remuneration for the token. Nevertheless, banks remain apprehensive as the digital euro is poised to diminish deposit levels, prompting the need for diversification in funding sources, reassessment of business models, and adjustments in liquidity management.

What’s next?

The shift to a digitally driven 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.

In the coming months, the Eurosystem’s collaborative approach with stakeholders may choose to refine the digital euro project and prepare a currency for the digital age. We trust that all points of concern will be addressed in the remainder of the preparation phase and time will show how this evolves.