The COVID-19 pandemic has accelerated the trend of contact-less payments, which has further decreased the role of cash as a payment instrument. As a result, there is a strong possibility of physical cash being substituted with its digital counterpart. Accordingly, on 2nd October, 2020, the European Central Bank (“ECB”) released a report titled “A Digital Euro for a Digital Era” (“Report”), highlighting the core principles and requirements needed for issuance of a Central Bank Digital Currency (“CBDC”) i.e. the digital euro in course of the idea that the future is for “international card schemes and solutions such as payment wallets and apps developed by large technology firms”.
In an era where central banks of many countries are researching on the issuance of a CBDC, this Report acts as a good start for the European continent. However, it does not provide clarity on many fundamental aspects. Firstly, it suggests that the legality of issuing a digital Euro lies under Article 128(1) of the Treaty on the Functioning of the European Union. Meaning the ECB has a right to issue this digital Euro, akin to banknotes, as legal tender, however, calling this digital currency as banknotes would be a slight exaggeration. This is because, although the report clearly mentions that the ECB has not committed itself to a particular design for issuing a digital euro, but by a cursory reading of Section 5 of the Report, one can clearly presume that the basic characteristics of physical cash might not be visible in a digital Euro.
Physical cash is the most secure form of payment. It is a token-based, interest-free, bearer instrument, and a transaction using the same, at least till a certain amount, is anonymous in nature. However, the digital Euro lacks all these qualities. It might be account-based, thereby, having less attractive interest rates or service fees (also called ‘Tiered Remuneration’) in order to limit its large-scale use. Furthermore, they also lack anonymity and it is unclear whether non-European Union citizens will have access to these CDBC. Hence, care should be taken that the digital Euro does not drift far apart from the characteristics of a traditional Euro banknote, or else, to cover the legality of the same, new regulations will have to be promulgated.
Another interesting feature discussed in the report is the offline usage of this digital currency. The technology to be used to facilitate offline usage is still not decided, but discussions suggest the issuance of a smart card might be a possibility. Offline usage with a smart card shall transform the digital Euro into a bearer instrument akin to physical cash. However, authentication of identities will be a huge challenge to overcome. This brings us to another major requirement when compared to physical cash - Privacy. There are possibilities of the existence of vulnerabilities in a digital system from cyber-attacks and other forms of digital tampering in the software. Surprisingly, this issue has not been reflected properly in the Report. This raises the question of whether privacy is considered a basic requirement under the Report or not.
Furthermore, since the digital Euro is a programmable unit of money, this means that certain design attributes could be built into its functioning, in order to increase its usability. The ECB can explore the area of a synthetic CDBC (“S-CDBC”). The S-CDBC is a form of private and public partnership, where the CBDC system is not entirely managed by a central bank and a wide range of tasks are outsourced to private companies, e.g. E-money institutes. In simpler terms, this is a digital currency issued by the aid of a private company but backed by the liabilities of a central bank i.e. the central bank money in the form of a central bank reserve. In this way, the central bank can provide its focus towards where it is most required - ensuring proper regulatory adherence. On the other hand, the private sector can handle functions such as customer management and technology design for the proper functioning of the CDBC. But when dealing with an S-CDBC, there needs to be an adequate differentiation of tasks that the public and private sector are required to follow, respectively.
Therefore, in essence, the ECB going digital is a remarkable step, but in the race of issuing a CBDC, it runs behind its Asian counterparts such as China and South Korea. Furthermore, in addition to the aforementioned points, it faces a novel set of challenges in the course of issuing a digital Euro, such as maneuvering the heterogeneity present in not only the economical set-up of different European countries of the European Union but also in their cultural trends and acceptance of digital currencies. Therefore, a proper consideration of all these challenges needs to be taken into account, and a digital Euro should be issued keeping in mind the characteristics of a Euro currency banknote and programmability of money as a concept.
The article is authored by Rishika Raghuwanshi, Co-Head, BlockSuits
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