A paper published by the European Central Bank (ECB) discusses various conditions for successful implementation of central bank digital currencies (CBDCs) such as the eurozone’s own digital euro. These projects can also be dangerous because of the possibility that the private sector will be displaced.
ECB: It is important that digital euros be used widely for payment, and not investments
A monetary authority must create the digital currency to be used widely as a means of exchange and payment. It should also have a sufficient store value function to ensure a success of the CBDC. This paper was released by the European Central Bank. At the same time, central banks need to ensure that currencies like the digital euro do not turn into a significant means of investment, crowd out private payment solutions, or undermine the banking sector’s intermediation role.
The document, which was published this week, is authored by three high-ranking ECB officials — Fabio Panetta, Ulrich Bindseil, and Ignacio Terol. These three high-ranking ECB officers have identified key success factors for CBDCs. They also offer expert advice on how to prevent the risks of digital fiat currency that many countries worldwide, including the major ones, are developing or exploring.
This paper lists three conditions that are necessary for the success of a CBDC. The first one is ‘merchant acceptance’ which has to be wide, meaning users should be able to pay digitally anywhere. Digital currency, unlike paper cash will have transaction fees and may need to be processed using dedicated equipment. Even though both types of money have legal tender status, there are still differences. The ECB gives more details:
While cash is impossible in ecommerce, CBDC legal tender might require merchants to make exceptions for those who don’t have the necessary device to take non-cash payment.
The second success factor has been defined as ‘efficient distribution.’ The ECB officials quote a Eurosystem report, according to which a digital euro should be distributed by supervised intermediaries such as banks and regulated payment providers. Incentives could be given to the supervised intermediaries in an effort to promote the circulation of the digital currency central bank. The document divides intermediary services into two categories: onboarding and funding services — which would include operations required to open, manage, and close a CBDC account — and payment services.
‘Demand from consumers’ is the third condition for success which refers to the ability to use the CBDC to “pay anywhere, pay safely, pay privately,” the paper emphasizes. Fabio Panetta (Executive Board member, ECB) and his team believe that the ability to use the digital currency in peer-to–peer (P2P), payments is a motivating factor for residents within the euro zone. These transactions are beyond what can be achieved with private solutions. They also believe privacy can motivate people, and that central banks may use privacy-enhancing technologies while adhering to anti-money laundering regulations. They insist, despite the protests that have been made against the digital currency in particular.
As public and independent institutions, central banks have no interest in monetising users’ payment data. These data would be processed only in the manner necessary to perform their duties and comply with all laws and public interests.
CBDC-Risk Prevention Measures: Paper Proposals
The paper by the ECB discusses other risks that central bank digital currencies pose, including excessive CBDC holdings. The paper suggests several measures that can be taken to limit the flow of excessive funds into central bank digital currencies, such as the implementation of limited conversions. This could stop the possible outflow of CBDC deposits from banks. A barrier to further restricting the flow of CBDC could also be created by setting per capita caps and placing a cap on the CBDC that each person can own.
In this document, we address concerns that issuing a CBDC may trigger bank disintermediation. This could crowd out private sector payments solutions. This negative effect must be avoided by ensuring that there is sufficient functional scope. The scope should be balanced between not being too large, which could limit the availability of private sector solutions. This could be а challenge for the financial sector, the ECB representatives warn.
While CBDCs are a good option and central banks should follow technology and payments trends to help citizens and business, the authors conclude that they need to answer many questions about the creation of digital currencies like the euro. They stress that the CBDC must have a functional range, a suitable business model, and appropriate controls to ensure its robust use.
Is it possible that the European Central Bank could issue a digital currency? Comment below to share your opinions.
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