The digital euro – the next revolution in finance?

It would be an inconspicuous revolution: the digital euro could neither be seen nor touched. But for the first time, we would have non-physical money that could be used like notes and coins. We provide an overview of the advantages, concerns and the current status.

Is the digital euro coming? On 18 October 2023, the Governing Council of the European Central Bank gave the green light for the start of a two-year preliminary phase, after which a concept for digital cash in the eurozone should be ready for a decision.

The idea of digital currencies has so far been characterised primarily by cryptocurrencies such as Bitcoin, which was created in 2009. However, the digital euro is a fundamentally different project.

Digital euro - what is it?

“We see a digital euro as a digital form of cash that enables all digital payments free of charge and fulfils the highest data protection standards.” This is how ECB chief Christine Lagarde characterises the new means of payment.

The digital euro is not intended to replace conventional cash, but rather to supplement it for various uses. Just as the ECB, in cooperation with the national central banks, has issued money to date – printing notes, minting coins, granting loans to banks – in future it will also create money that only exists in digital form. This digital euro has the same value as the conventional euro and can be exchanged for conventional euros at any time. The technological basis of the digital euro has not yet been finalised in detail.

Just like conventional cash, banks will be able to obtain digital euros from the ECB and make them available to their customers. However, the handling of this digital money will differ from what we are used to.

How does the digital euro work?

To use the digital euro, you need a digital wallet. This is somewhat similar to the apps for the various smartphone payment systems that are currently available. In fact, the digital wallet can also be installed as an app on a smartphone or computer. Alternatively, however, it can also be used in the form of a payment card; this is then similar in function to a top-up cash card.

The digital euro is credited to the owner's digital wallet and can then be used from the app or from the payment card for electronic payment transactions – on the Internet, in shops, but also between private individuals.

The details of the functionality have yet to be developed. There will probably be a special app for the digital euro, but banks and other financial service providers could also integrate the function into their own apps.

The European Commission wants retailers to be obliged to accept digital euros and banks to offer digital euros to their customers.

What is the difference to today's ways of electronic payment?

The currently established forms of cashless payment only work if you are a customer of a bank or other financial service provider. The digital euro, on the other hand, can also be used without a bank account.

No data connection to the bank is required to pay with the app or payment card – neither for the buyer nor for the seller. The concept of the digital euro includes the requirement that transactions must always be possible offline as an option. Digital euros, which are only stored on the buyer's smartphone or payment card, are then transferred directly to the vendor's wallet in real time via an interface, without any financial company being involved or informed. The digital euro then actually works like cash – it's like a banknote travelling from wallet to wallet. The prerequisite is that there are enough digital euros in the wallet for the payment.

The online payment function, on the other hand, works in a similar way to today's cashless payment methods. It enables purchases to be made in situations where it is not possible to bring the smartphone and payment terminal into contact, such as in online shops. Here, a bank is usually entrusted with the technical handling of the transfer processes. However, it is not necessary to open an account with this bank.

Why should the digital euro be realised? The advantages

The ECB's monetary watchdogs have been concerned for a long time about Europe's increasing dependence on private financial service providers such as PayPal, which mainly originate from the USA. In addition, digital currencies are currently being considered in many countries. If they are introduced at some point and prove their worth in everyday life, there are fears that they will also be used in the eurozone and destabilise the euro if there is no European equivalent. The digital euro is therefore intended to secure the financial stability and financial sovereignty of the eurozone.

These are the political considerations. However, the digital euro could also bring very practical benefits:

• Digital currency for everyone
  Electronic payments are becoming increasingly important in everyday life. The digital euro gives everyone free access to digital financial services - in principle, you don't need a bank account, smartphone or internet access.
• Data protection
  The digital euro offers the possibility to pay anonymously. Banks and financial service providers do not have access to payment information if consumers do not want this. The European Commission has also stipulated that neither the ECB itself nor national central banks should be able to identify users of the digital euro.
• Simplification for consumers and retail
  In the long term, the digital euro can push commercial payment providers into niches. Merchants and shoppers will no longer have to struggle with half a dozen payment options, as the digital euro will always work as a means of payment. In any case, the negotiating position of vendors towards payment service providers such as credit card companies will be strengthened.
• Financial innovation
  The digital euro can trigger further financial innovations in the eurozone. So far, this has also failed due to the strong market position of US financial service providers. The digital euro will reshuffle the cards.
• Resilience
  The digital euro increases the financial system's resilience to cyber attacks and technical disruptions. The euros deposited in wallets continue to function even if, for example, the payment systems of banks are down.
• Speed
  Payments with digital euros are payments in real time.
• Expanded market opportunities for banks
  The digital euro will be distributed to industry and consumers via the banks in the eurozone. According to the European Commission's current plans, anyone wishing to use it outside the eurozone must have an account with a euro bank. This will make banks more attractive to international customers.
• More stable than crypto currencies
  Bitcoin & Co. are managed decentrally and anonymously. The disadvantage of this is that no one is really responsible for the stability of the currency. The digital euro is administered by the European Central Bank. It is committed to the common good; its management is accountable to society and its activities are critically monitored by politicians and the public.
   

The other side - concerns

No light without dark - there are also concerns about the possible introduction of the digital euro.

In principle, the banks' interest groups welcome the considerations regarding the digital euro. However, there are also concerns. What will happen to the banks' deposit business if customers perhaps prefer to hold digital euros in their own wallets in future instead of depositing them in a bank account? Based on these considerations, bank representatives are calling for an upper limit on the amount that private individuals may hold in their wallets.

Upper limits are also being discussed for another reason. In times of crisis, customers could flee to the digital euro and put their banks at great risk due to a sudden outflow of deposits. Converting the money in an account into digital euros and transferring it to a digital wallet will presumably be much easier than queuing in front of an ATM - the bank run at the click of a mouse could dramatically exacerbate the situation during a banking crisis. For this reason, there will probably indeed be an upper limit on the possession of digital euros.

Finally, acceptance by people will be of central importance. Above all, trust in the safety of the technology must be created.

Digital euro - status quo

The ECB concluded the preliminary investigation phase initiated in 2021 in October 2023 with a final report ("A Stocktake on the Digital Euro"). The European Commission had already presented its proposals for the legal framework for the introduction of the digital euro in June.

The ECB is now beginning a two-year preliminary phase during which the rules and regulations are to be finalised and the technological issues clarified. Providers who could develop and set up the technological infrastructure are also to be selected.

At the same time, the legal framework is being worked out in detail so that a final decision on the introduction of the digital euro can be made quickly after the two years.

Once the start signal has been given, the construction of the infrastructure can begin. A further two years are estimated for this phase. The digital euro could therefore be introduced in 2028 at the earliest. Even revolutions take their time.

Text: Thorsten Kleinschmidt