The coming of the digital Euro? Here are pros and cons

Original article published in Econopoly (Il Sole 24 Ore) in Italian on October 23, 2020

Historians will mark October 2, 2020 as a watershed date. It is the day when the European Central Bank (ECB) formally expressed its interest in a digital Euro, in this report by Christine Lagarde and Fabio Panetta.

Digital Euro. What is it?

Cash is already disappearing as we speak, constantly eroded by means such as credit cards, wire transfers and, for example in Italy, Postepay, Satispay, Hype.

So the digital euro is already a reality. FALSE.

The means mentioned above give the appearance of digital currency, without being one at all. In fact, these always rely on traditional systems that ultimately lead to the same entities: the banks. Without a bank account, it is impossible that credit cards, wire transfers and – generally speaking – all of today’s digital tools can work. Basically, cash is now dematerialized, but it remains in all respects deposited in the bank.

Instead, what the ECB now suggests is the creation and use of real cash, in digital form, kept directly by citizens and no longer by banks. Just as if the banknotes in our wallets were transformed into digital bits saved on our smartphone, smart card or computer. It is an epochal change.

Risks and benefits

The benefits of a true digital Euro are many and evident for citizens:

1. Cost. It is realistic to expect that transaction costs, which today are related to cards and wire transfers, will be greatly reduced. The ECB even considers scenarios in which these costs are zero. In short, the POS fees? A footnote in history books.

2. Financial stimulus. A digital Euro would make it easy to implement policies such as “helicopter money“, in which the state can immediately and automatically give money to citizens in need. No more “click days” for bonuses.

3. Financial inclusion. No longer required to have a bank account, anyone (even the so-called “unbanked“) will be able to access digital tools and, for example, make payments on e-commerce sites or directly receive international remittance.

4. Financial protection. As cash is no longer deposited in the bank, the citizen is no longer exposed to bank failures and possible blocking of the funds deposited therein.

5. Environmental impact. Cash in digital form (so, no longer physical) reduces the ecological footprint of monetary and payment systems.

6. Health. In times of Covid, less cash circulation in physical form helps to limit the contagion spread.

The risks of a true digital Euro are also several:

1. Privacy. Cash in physical form is effectively anonymous. Its digital counterpart, to be truly equal to cash, must also be anonymous. Yves Mersch (member of the ECB board) well expressed this concept last May saying “a digital Euro should guarantee complete anonymity; else it would inevitably raise social, political and legal issues“. However, this clashes with anti-money laundering regulations that do not tolerate anonymous transactions.

2. Loans. With a true digital euro, it is reasonable to expect a reduction in the amount of funds deposited in banks. This consequently leads to a decrease in the bank’s ability to lend money.

3. Revenues. The smaller amount of bank deposits leads to smaller numbers of “traditional” transactions via card / bank transfer. The final consequence is lower revenue for banks, institutions and payment systems.

4. Custody. Citizens are in total control of their digital money on their device (e.g., smartphone). However, if this is lost or broken, the digital money is going to be lost with it. A similar situation would occur in an inheritance, if the deceased did not previously leave the credentials to his/her heirs. However, this problem can be a huge opportunity for modern banks that know how to reinvent themselves and offer digital cash recovery systems in case of emergency.

Summing up, a citizen’s point of view is very different from that of a bank. For a citizen, the benefits of a true digital euro go far beyond the risks. On the other hand, for banks, the advantages of a true digital Euro are at first sight irrelevant when compared to the disadvantages that this would entail for their current revenue streams.

Why is ECB interested?

Great innovations are rarely pushed by those who have a vested interest in keeping stability and the status quo. Therefore, one might ask where this wind, in many ways revolutionary, of the ECB comes from. It is primarily a defensive move against digital currencies issued by private entities or foreign countries. The ECB report does not mention them explicitly, but it is clear that the attention is especially directed to Libra and China.

• Libra. The digital currency promoted by Facebook and announced in June 2019. In its original plans, a true transnational world digital currency that can be used from its launch by 3 billion people.
• China. It has long been working on DCEP, his national digital yuan 元, which can help the Chinese currency spread around the world and become a legitimate competitor against euro / dollar for international trade. Huge ambitions, also evidenced by the desire to take advantage of the 2022 Winter Olympics in Beijing as a stage to officially launch the Chinese digital currency.

“A terracotta pot, forced to travel together with many iron pots“, as the Italian writer Alessandro Manzoni wrote in “The Betrothed”. The ECB must have felt a bit like Don Abbondio, caught between the irreverent creativity of Silicon Valley (Libra) and the dynamic economic and technological rise of a totalitarian regime (China).

In all of this, we must admire the foresight of the ECB: both in having understood the extent of the upcoming tsunami and in describing in the report ways in which banks can participate in the creation of a digital Euro without suffering excessive repercussions.

What to expect

The ECB report of October 2 is still very generic. It indicates possible scenarios and potential solutions, without choosing or going into detail. On October 12, Fabio Panetta announced a public consultation on the digital Euro, inviting citizens, businesses, universities and associations to provide comments and suggestions.

In the public consultation, the ECB also asks which approach is to be preferred: the one without intermediaries and aimed at protecting privacy, or the one with intermediaries that can offer new added value. These are completely different paths, and they lead to very different scenarios.

It is therefore still early to say how the digital Euro will actually take shape. The only certain thing is that banks and financial institutions, not to mention the new paytech giant Nexi-SIA, must pay close attention to this phenomenon. Else, they are doomed to vanish into irrelevance in just a few years.