It is well known that the ECB is currently in the two-year investigation phase of the digital euro. At the moment, several details about the possible design of the digital euro have already been defined. According to the current timeline, the investigation phase will be completed by the end of September 2023. The Governing Council will then decide if and in what form a digital euro will be introduced. Already now, some important conclusions can be drawn. This article is intended to summarize the findings to date and explain to what extent banks should already be dealing with the digital euro.
Author: Eduard Grigorjan
See German version here.
One of the most important decisions concerning the digital euro has already been made: If a digital euro is issued by the ECB, it will most likely be a retail CBDC, targeting private individuals in particular. It is analogous to cash and intended as an additional payment option. Questions remain about the many design options for the digital euro: Will there be a holding limit and how high will it be? What technology will it be based on? How will user data be protected? Will it be programmable? Based on two progress reports on the progress of the investigation phase to date, published in September[1] and December[2] 2022, conclusions can be drawn (see Figure 1 for a timeline).
Use cases and roles
First and foremost, three relevant use cases have already been agreed upon, which are also based on two political objectives — in particular: Harmonizing the European payments landscape and strengthening the strategic autonomy of the euro area.
The use cases include:
1. Direct payments between individuals (Peer-to-peer payments)
2. Consumer-initiated payments to businesses offline at the point-of-sale or online in e-commerce for the purchase of products and services
3. Payments from and to the government by citizens
The selection of five companies (Amazon, CaixaBank, EPI, Nexi, Worldline) to develop prototypes for the interface of the aforementioned use cases and corresponding variations highlights this focus.
In addition, the roles have been defined more precisely, thus creating the clearest possible division of responsibilities between the Eurosystem, the so-called intermediaries and end users.
The Eurosystem comprises the ECB and the national central banks and is responsible for issuing and redeeming the digital euro, settling transactions, and onboarding and managing intermediaries.
Intermediaries are defined as credit institutions, payment institutions, or e-money institutions and are supposed to act between the Eurosystem and end users. The main responsibility of intermediaries is to manage any interaction between end users and the digital euro. This mainly includes end-user, liquidity, and transaction management.
End users of the digital euro can be individuals, companies or public institutions. The digital euro is made available to them and they can act as payers or payees.
Confirmed design options
Furthermore, the first design options for the digital euro have already been defined; others are to follow in the coming months.
One of these options is the transfer mechanism for validating payments. For offline payments, the validation process is to take place peer-to-peer, although the technical feasibility is still unclear. Online payments will be validated as usual with the help of a third party. For experimental reasons and with lower priority, the possibility of peer-to-peer validated online payments is still being examined.
Another very important design option is data privacy. According to a baseline scenario, this should provide “at least a level of data protection equivalent to that of current private sector digital solutions.” Full anonymity of user data is ruled out for the time being. During initial onboarding to use the digital euro, identities will be verified one time by a third party, and payments are to undergo standard checks only with respect to AML/CFT purposes thereafter. Beyond the baseline scenario, options are being explored to ensure higher data privacy for low-value/low-risk payments and offline payments.
Offline availability is intended to enable end users to make final and irrevocable payments without a network connection. In this case, both the verification and the recording of the payment are carried out exclusively by the two end-user devices that are interacting with each other in close proximity at the time of the transaction. It is quite likely that there will be restrictions on the number of transactions as well as the frequency.
In accordance with the distribution model, mechanisms for controlling the amount in circulation as well as the distribution of the digital euro, are to be arranged. In particular, certain holding limits on an individual basis are being considered for this purpose. This is intended to prevent the digital euro from being used for investment purposes, but rather only as a means of payment. The former would potentially result in large amounts of bank deposits being withdrawn and ‘invested’ in a risk-free digital euro. The overarching objective for this is to maintain financial market stability and continue to ensure an effective monetary policy.
The Eurosystem will be responsible for the settlement of transactions. Since end users’ possession of the digital euro entails a direct claim on the ECB, the latter is required to record the digital euro in its own balance sheet. As part of the settlement process, transactions will be checked for correctness and recorded in the accounts.
In addition, the role of intermediaries is described in more detail. As already explained, intermediaries act as direct contacts for end users, but they are also distributors of the digital euro. Within this role, they are responsible in particular for account management and onboarding (end-user management), liquidity management (see funding and defunding) and all conventional transaction-related processes, such as payment initiation, authorization, AML/CFT checks, etc. (transaction management).
The funding and defunding option involves converting cash or commercial bank money into digital euros and vice versa. A special feature is an optional automated funding or defunding mechanism, which enables end users to receive payments even though they exceed a possible holding limit in the account balance and, conversely, to make a payment even though the amount exceeds the balance in the digital euro account.
The remaining design options to be confirmed are expected in the third and final progress report by the end of the first quarter of 2023 at the latest.
Implications for financial institutions
Based on the use cases already approved and their design options, it can be derived that a new means of payment is likely to be introduced with the digital euro. In principle, various issues arise for banks with regard to regulation, its future functional role and typical requirements around procedural, structural and technical integration.
From a regulatory perspective, the European Commission will present a proposal on the introduction and objectives of the digital euro in the first quarter of 2023. In particular, adjustments may arise with respect to privacy and AML/CFT regulations, as well as possible integration with existing regulations.
Regarding the future role of banks and any integration issues, more clarity can be expected through the creation of a Digital Euro Scheme Rulebook. To this end, the development of a scheme rulebook has already been initiated, which sets out the rules for payments with the digital euro.[3] The role of the intermediaries in the form of credit, payment or e-money institutions and their responsibilities already indicate that banks will be faced with a great amount of work. Accordingly, an intensive examination of the digital euro is required.
Conclusion
Many questions about the digital euro remain unanswered, and without any news from the ECB, one can only speculate at this stage. Nevertheless, some fundamental decisions have already been made regarding the specific use cases and design options. Furthermore, the next steps and important milestones have been clearly communicated. On this basis, financial institutions can carry out initial planning, make preparations and take the first steps to address the topic of the digital euro.
About intas.tech
intas.tech is a consulting firm for financial institutions and asset managers focusing on the strategic assessment of blockchain use cases as well as the integration of digital assets into existing business models and IT infrastructures. As a joint venture of the Frankfurt School and Plutoneo Consulting, intas.tech combines blockchain know-how and expertise in the traditional financial sector.
Eduard Grigorjan is a Senior Consultant at intas.tech and responsible for topics related to digital money and blockchain-based payments. He brings more than two years of professional experience in consulting financial institutions and has, among other things, built up broad payments expertise in the context of one of the largest payments projects across Europe. You can contact him via mail or LinkedIn.
[1] https://www.ecb.europa.eu/paym/digital_euro/investigation/governance/shared/files/ecb.degov220929.en.pdf
[2] https://www.ecb.europa.eu/paym/digital_euro/investigation/governance/shared/files/ecb.degov221221_Progress.en.pdf?f91e0b8ff8cbd6654d7e6b071a8f7071
[3] https://www.ecb.europa.eu/paym/intro/news/html/ecb.mipnews221205.en.html
