The digital euro project: we are not there yet!

Two years ago I wrote a blog about the plans of the European Central Bank (ECB) to introduce a digital euro. In that year the ECB decided to set up the Digital Euro project and started with the technical investigation phase, focussing initially on fundamental questions such as the technological functioning of the digital euro.  

Now we are two years later and the ECB already published its third insight report in April. In this blog I will go into the various issues described in the reports including the essential requirements, design and distribution options, use cases and look forward into the agenda for 2023 and further.

Why a digital euro?

It is the task of the ECB to take care of financial stability and being responsible for efficient, trustable, payment transactions that are accessible for everyone.

The rapid digitalization requires to complement cash with its evolution in the digital sphere. A digital euro would respond to this growing preference for digital payments by making public money available also in digital form.

But for being widespread accepted and broadly accessed the digital euro should above all have the characteristics of cash: i.e. exchangeable anytime, anywhere, accessible to everyone and easy to use.

A well thought technical design and a proper regulatory framework are key that the digital euro retains its key characteristics as a public good.

Essential requirements?

Widespread acceptance and broad access are necessary to ensuring the digital euro would be a public good that meets the expectations of consumers and merchants.

The Eurogroup, a Committee of Finance Ministers in the Euro-zone, that is responsible for the financial and economic policy, has discussed the various key issues regarding the digital euro and announced a number of essential requirements and pre-conditions for the digital euro to become successful.

According to the Group:

• The digital euro should be given legal tender status in order to ensure consistency with cash.   
• It should be easily accessible and convenient enabling Europeans to use their money whenever, wherever they need it throughout the euro area, free of charge.
• Banks and other payment service providers (PSPs) should be required to make the digital euro available to their customers, thereby generating opportunities for financial intermediaries.
• People should be able to pay and be paid in digital euro anywhere in the euro area, no matter which intermediary they are using to access the digital euro or which country they are in.
• The digital euro should be designed to support financial inclusion and generate opportunities for financial intermediaries.

To realise all these requirements a common set of rules and standards is urgently needed.

The digital euro project: Investigation phase

The launch of the digital euro project started in October 2021. This project set up by the European Central Bank aimed at facilitating the digital transformation of payments for Europeans, offer a digital alternative to traditional cash, and making transactions easier and more efficient.

The first steps was the investigation of the technical solutions into the possible issuance of a digital euro. The ECB launched the Investigation (study and planning) Phase of the digital euro project roughly two years ago, focusing initially on fundamental questions such as the technological functioning of the digital euro.

Insight reports

Since the launch of the Investigation Phase the ECB has published three insight reports covering various topics related to the building up of a digital euro. These reports were aimed to inform relevant parties on the development and progress of the technical process of various relevant topics.

The first report covered topics such as the transfer mechanism, privacy and tools to control the amount of digital euro in circulation.

The second report focused on the roles of intermediaries, a settlement model, funding and defunding and a distribution model for the digital euro.

Publishing a third insight report

Last April the ECB released its third Insight Report covering the Eurosystem’s views on access in the digital euro, holding, onboarding, distribution aspects and functionalities.

-          The report sets out the Eurosystem’s views on how people could access, hold and start to use the digital euro.

-          The ECB recently endorsed a third set of design and distribution options that would feed into the overall design of the digital euro and would meet the need of euro area citizens, firms and intermediaries like banks.

-          The report also examines how the digital euro could be distributed by intermediaries. The report thereby identified how the digital euro could be integrated with payment service providers’ existing systems across a range of use cases including the provision of core, optional and value-added services.

-          The ECB further revealed it is considering plans to develop a digital euro app that would enable to make contactless and QR code-based payments.

-          The report also lays out the next steps it plans to take during the investigative phase and set out a timeline for the digital euro rollout.

Design options

The Eurosystem is finalising their prototyping work and seek input from the market to get an overview of options for the technical design of possible digital euro components and services. In parallel, they  are reviewing all the proposed design options to bring them together in a high-level design for the digital euro in Spring. Aim is to design a digital euro with online and offline functionalities, that will allow it to serve different use cases and offer users different benefits.

Onboarding

The Eurosystem is still conducting its own study of digital euro distribution. Convenience is a priority for access. For that reason onboarding should use established procedures for opening a payment account as much as possible.

The Eurosystem believes digital euro users would be onboarded by payment service providers (PSPs), as defined in PSD2, would be the best place to distribute the digital euro. Supervised intermediaries could integrate the digital euro into their own platforms. These should be obliged to utilise available information as often as possible in banks’ standard KYC processes.

Access

The Eurosystem is also envisaging two options for conveniently using a digital euro.

End users could access and use the digital euro through existing online banking /payment apps and interfaces they are already familiar with. Supervised intermediaries, including banks, could simply integrate the digital euro within their existing apps.

The digital euro could also be made available through a digital euro app provided by the Eurosystem. The Eurosystem is considering the development of a separate digital euro app for citizens that could those offer an additional choice. The app, that would include only basic payments functionalities, would ensure that no matter where one travels in the euro area, the digital euro would always be recognised and onewould be able to pay with it.

QR code and NFC

For in-store payments both QR-code and NFC contactless payments are envisaged. While QR code-based payments could be more easily deployed and foster a new European infrastructure as an alternative to the existing card rails infrastructure, NFC technology provides a highly convenient end-user experience which consumers in the euro area are already familiar with

Furthermore, NFC is the only widespread technology which could facilitate the development of a convenient offline payment method by introducing a physical card for the digital euro, fostering financial inclusion

In terms of technological options for payment initiation, the ECB would prioritise the use of QR codes for all use cases (peer-to-peer, e-commerce and point-of-sale), “alias/proxy” functionality for peer-to-peer and e-commerce (including app-to-app redirection) and NFC (near-field communication) for the point of sale.

Focus group survey of digital wallets report

The ECB also released a report on a focus group survey of digital wallet features commissioned by the European Cloud Partnership (ECP).

Main findings of this report concerning people’s views on specific features of a potential digital wallet. These findings are relevant to the design features of a possible digital euro.

Person-to-person money transfers are considered an essential feature for a digital wallet. Offline payments which are considered not widely available are deemed a useful feature when for example someone has limited connectivity. Participants also valued budget management tools and conditional payments, including payment on delivery and pay-per- use.

Study participants however raised privacy issues

Services by intermediaries

By providing a single set of rules, standards and procedures, the scheme would ensure that citizens can always access certain core services, no matter which intermediary they have their account or wallet with. But on top of the basic services the scheme would further allow intermediaries to develop products and services built on a digital euro. People could choose to make use of any additional services offered by participating intermediaries on a voluntary basis.

Basic services

Supervised intermediaries would be required to provide a set of mandatory core services to end-users. These should be available both on- and offline.

Offline functionality where payer and payee are not connected to the internet and need to be in physical proximity to each other would give payments a level of privacy that is close to that of cash. It would allow holdings, balances and transaction amounts to remain unknown to anyone but the user. The Union legislator will be responsible for ensuring this is enabled in relevant legislation.

The scope of digital euro basic services is yet to be defined but should be similar in nature to the basic services that credit institutions are to provide under the Payment Accounts Directive (PAD). They could therefore include such features as the free opening of digital euro wallets/accounts, making payments between individuals as well as the funding and defunding of digital euro accounts/wallets.

Additional services

Supervised intermediaries could offer advanced services to improve end-user’s experience. These could include pre-authorisations, value-added services such as recurring services and the ability to split person-to-person payments among multiple parties or conditional payments, where people could decide to authorise an automatic payment where pre-defined conditions of their own choosing are met, such  as payment on delivery, pay-per-use services and automatic reimbursement as well as the potential provision of cross currency functionalities. These latter could be added after the digital euro’s launch in the Euro-zone.  

The Eurosystem can support the market-led development of these services via standards in the scheme rulebook and/or by providing necessary back-end functionalities that enable the provision of such services by intermediaries.

Compensation model

In a separate document the ECB also confirme that it is developing a possible  compensation model for the production and issuance of a digital euro. Economic incentives should be used to encourage the active distribution of the digital euro and to ensure that it is widely available.

The Eurosystem defined a number of key principles for such a model. It is envisaged that this model will offer network effects and generate economic incentives for acquirers, merchants, and issuers, to “ensure an effective distribution of a public good like the digital euro”. Aim is to minimise additional investment costs for the private sector

As the digital euro is aimed to be a public good, it would make sense for its basic day-to-day use to be free of charge for private individuals. This should cover all services necessary to enable persons to pay and be paid with digital euro in a convenient manner, such as person-to-person money transfers.

Intermediaries should be compensated for the services they provide. Legislative safeguards should prevent merchants from being overcharged by intermediaries if they are obliged to accept digital euro as legal tender. The Eurosystem would bear its own costs related to settlement, processing and scheme. The model could also cover issues such as transaction fees, interest rates, incentives and other mechanisms for compensating users

Work agenda for 2023

In the autumn the investigation phase will come to an end while the European Commission will present its legislative proposal. The European Commission announced it would come with a legislative proposal that should provide the legal basis for the digital euro at the end of June. The Commission pointed that in the proposal the essential policy options will be defined.

End investigation phase

The project is in the final stretch of the investigation phase, which will conclude in autumn. The central bank now plans to carry out further work on the details of the rollout approach with a view to presenting the implementation plan for the potential realisation phase of the digital euro to the bank’s governing council for decision.

The end of the investigation phase will include a holistic review, and the final findings, including advice on potential digital euro issuance, design, and implementation, that will be presented to the ECB’s Governing Council. Only at that point will the ECB Governing Council decide whether or to move to the net phase of the project, the realisation phase. The ECB aims to present the plan for the potential realisation phase of the digital euro to its governing council in Q3 2023. Moving to the realisation phase however does not mean issuing the digital euro.

Regulatory framework

The ECB technical investigation that is being developed in cooperation with the European Commission, is now running parallel with the European Commission’s preparations for undertaking the necessary legislative process.

The ECB is intensively discussing with governments and the European Parliament about a regulative framework for the digital euro. As soon as the Commission publishes its draft EU law proposal which would give the digital euro a legal underpinning  — which is expected to come soon — the co-legislation process will begin.

Legal tender status

The European Commission is expected to propose a draft law to ensure that the cash form of the euro is legal tender, in line with a ruling from the European Court of Justice in 2021. The court said legal tender means mandatory acceptance of the euro at full face value, along with power to discharge from payment obligations or release from debt. Giving the digital euro legal tender status may help to increase its adoption and use. If the EU decides to grant formal 'legal tender' status to a digital euro, the bloc would need to do likewise for the cash version of the single currency.

Privacy

The final design of the digital euro will depend on the level of privacy European legislators deem appropriate. They are aware of some people’s concerns that a digital euro could harm the confidentiality of their payment data.

To succeed, the digital euro will need to ensure and maintain users’ trust - and for this, privacy is both a key dimension and a fundamental right. The anonymity of paying with cash should also apply to the digital euro. The ECB has said it does not want to keep or have access to any personal data on its users. Information would only accessible to intermediaries

Officials involved in the preparatory regulatory work are presently looking to determine the appropriate degree of anonymity that strikes a balance between personal privacy and efforts to prevent crime such as money laundering, terrorism financing and other illegal activities. The ECB has been working on solutions that would preserve privacy “by default and by design”, thereby giving people control of their payment data. 

Realisation phase

In the autumn, the ECB Governing Council may decide to move to a “realization” phase. If so the Eurosystem would dedicate the next years to further prepare for a potential issuance of a digital euro

The next project phase expected to be launched later this year or early next year, including further development of integrated services and testing technical solutions and business arrangements necessary to eventually provide and distribute a digital euro to wider society, if and when decided in live pilots.

Throughout the next project phase,

-          any necessary adjustments to the design of the digital euro that may emerge from legislative deliberations will be accommodated

-         while the possible technical solutions and business arrangements necessary to provide a digital euro will be developed and tested.

The two potential realisation phases of the digital euro launch will run in parallel in order to “optimise the release path”, with each release preceded by a piloting exercise to prove design decisions.

Decision whether or not to issue the digital euro

The decision to move to the realisation phase, will be entirely separate from the decision whether or not a digital euro issuance. That would be taken at a later stage and only after the European Parliament and the European Council have adopted the legislative act. Ultimately it will fall on European legislators to decide.

Plans for staggered roll out/approach

Though the launch of the digital  euro is not expected before 2026, the European Central Bank (ECB) has already laid out plans for a staggered rollout of a digital euro. In practical terms, a staggered approach would contribute to ensuring a smooth end-user payment experience.

The initial releases would focus on the use of the digital euro just in the Euro zone, and would begin with the bank initially releasing the digital euro for use in person-to-person and ecommerce transactions. The digital euro would thereby be made available primarily to people, businesses and authorities located in the Euro-zone. Non-residents, including visitors, may also have access to the first releases of the digital euro, provided they have an account with a euro area-based PSP.

Further releases may enable access for individuals and businesses in the European Economic Area (EEA) and selected third-party countries. This will depend on accessibility rules to be set out in the legislative framework for a digital euro.

The third progress report also anticipates the potential provision of cross-currency functionalities. Initial cross-currency use cases could include P2P payments in Central Bank Digital Currencies (CBDCs) with foreign exchange conversion and digital users purchasing goods and services from an online merchant outside the euro area with currency conversion or in-store payments facilitating an omnichannel approach with currency conversion

We are not there yet!

According to a paper of the European Parliament titled “Digital Euro: When in doubt, abstain (but be prepared”, the risks of rolling out a digital euro currently outweigh the benefits. It should not be introduced unless “new elements” emerge strongly supporting such a decision.

The paper continued saying “unless new elements” emerge strongly supporting such a decision. Next to that, launching a digital euro would put the ECB in a new position: that off offering a new payment instrument in competition with banks and other payment services providers.

“It is not clear that there is a market niche for a PDE (potential Digital Euro), nor that a DPE would have a good chance of establishing itself in today’s highly diversified, competitive, innovative, and fast moving retail payment industry” according to the report.

We are not there yet!