Central Bank Digital Currencies (CBDCs) have been in consideration for years as cash transactions become less common. While research shows 60% of people would like to continue to have the option of using cash, an increasing number of people choose to pay digitally, using cards and applications issued by banks and other digital and financial firms.
These new digital currencies would be legally equivalent to physical money, with the full backing of a central bank. As a result, they could enable more ubiquitous access than crypto tokens or other digital payments as legal tender. In addition, they could help improve financial access and open the door to a lot of innovation in the FinTech space.
On June 28, 2023, the European Commission published a legislative proposal on a digital euro as part of an investigation phase concluding in October 2023. After regulators look at how a digital euro could be designed and distributed, as well as the impact on the markets, they will decide whether to start the development process.
In this article, we’ll look at the digital euro, how it might work, and how it could impact the broader crypto space.
What is the Digital Euro?
The digital euro will be a digital version of euro notes and coins. In addition to having the same value, most merchants across the euro area would be required to accept the digital euro. While it wouldn’t replace cash, it would provide a safe, secure, instant, and convenient alternative to paper notes and coins, bringing the European Union into the digital era.
The digital euro also addresses limitations of existing digital solutions. For instance, consumers could use digital euros across the euro area and make payments without a bank account or internet access. You could also make payments without having to use a specific application or vendor, such as PayPal or a specific credit card company.
The digital euro would also be free of charge for consumers, providing a cheaper alternative to many other forms of digital payments that impose fees. For example, many apps charge transaction fees of 3% or more to send or receive money in exchange for goods and services, resulting in higher costs for consumers and merchants.
Many proponents of a digital euro also hope it will promote innovation in FinTech. Today, Visa, Mastercard, PayPal, and other U.S. firms dominate the space and handle most digital transactions across the EU. The digital euro would help the EU maintain sovereignty – particularly if more CBDCs come out or with the rise of crypto stablecoins.
How Will the Digital Euro Work?
The European Union is still experimenting with different approaches and technologies to support a digital euro. These technologies include centralized and decentralized solutions, including distributed ledger technologies like blockchains. However, regulators are still finalizing their decision and may not opt to use a blockchain at all.
Besides technical aspects, regulators must also develop the right rules and processes to support innovation. A comprehensive rulebook is in development that addresses everything from risk management requirements (e.g., how to prevent a bank run if transactions are instantaneous) to governance and change management.
A digital euro could also introduce systemic financial risks if regulators aren’t careful. For instance, an interest-bearing digital euro wallet could pit the government against commercial banks, potentially causing liquidity issues in lending markets. Or, the ability to quickly transfer funds could exacerbate bank runs when rumors start about certain banks.
Unlike cryptocurrencies, the digital euro and other CBDCs would be fully controlled by a central bank. These centralized authorities could increase or decrease token supply to meet their monetary policy objectives (e.g., stability). Moreover, CBDCs will likely leverage proprietary technologies and require consumers to use proprietary wallets to access them. And, of course, CBDCs would be legal currencies rather than property.
These characteristics involve a lot of trade-offs. For example, CBDCs can be spent anywhere and aren’t subject to capital gains taxes, making them a lot more useful as a currency than many crypto tokens. On the other hand, CBDCs are proprietary digital tokens controlled by a centralized entity, which introduces a lot of privacy and security concerns. And CBDCs aren’t necessarily spendable everywhere like popular stablecoins.
Impact on the Crypto Space
Crypto enthusiasts generally look forward to a digital euro, but some concerns exist. After surveying the public, privacy ended up being the most important feature for both citizens and professionals. A digital currency would give the issuer unprecedented real-time insights into how tokens change hands, creating a potential privacy nightmare.
Fortunately, the EU and ECB have little interest in mass surveillance programs. Moreover, the ECB has clarified that it would distribute digital euros via intermediaries like normal euros. Banks would have the only access to personal data when paying online or when withdrawing digital euros from an ATM machine (or via an app into a wallet).
Ultimately, a digital euro could instead become a reliable “stablecoin” within the crypto ecosystem. Rather than using questionable reserve methods, the euro “stablecoin” would be backed by the central bank, providing a much more stable source of value. But developers could still incorporate it into the crypto ecosystem like other stablecoins today.
Despite their limitations, Stablecoins won’t be going away anytime soon. Their decentralized and open nature align better with crypto values, while making them easier to integrate into the ecosystem. And with proof-of-reserves and other techniques, many stablecoin projects aim to provide more reassurances to their customer base., despite their limitations.
That said, it could be several years before anyone sees a digital euro in their account. After the EC’s proposal, the European Parliament and Council will debate the proposal before sending final recommendations to the European Central Bank for their final decision in late-2023. And, for its part, the ECB has specified an implementation date of around 2024.
In the meantime, crypto enthusiasts should continue following the digital euro’s progress to better understand how it might fit into and reshape the future digital economy.
The Bottom Line
The launch of a digital euro would be a tipping point in the development of Central Bank Digital Currencies (CBDCs). With the EC’s legislative proposal and the ECB’s support, the digital euro appears well-positioned to become a reality over the coming years. However, many questions still remain about the technical and practical implementation.
Beyond the crypto world, the digital euro could have a profound impact on financial markets. Foreign investors could use it disproportionately and increase exchange rate volatility, while consumers could quickly transfer funds out of a bank, making bank runs easier. Regulators must evaluate all of these considerations before coming up with a final plan.
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