The launch of the digital euro, a central bank digital currency (CBDC) for the Eurozone, is looking increasingly likely this decade. The European Central Bank (ECB) has announced it is to collaborate with five companies to develop and prototype potential user interfaces for the proposed coin.
The exercise is a critical stage in the two-year investigation phase of the digital euro, which is scheduled for completion by the end of Q1 2023. At that point, the ECB will publish its findings.
Unusually for a Eurozone project, American e-commerce and Web services giant Amazon is among the five companies chosen from a pool of 54 front-end prototype contenders, after a call was issued by the ECB in April.
Amazon will help test ecommerce payment use cases. The other four other companies are: EPI (point of sale payments initiated by the buyer); Nexi (PoS payments initiated by the payee); Worldline (P2P offline payments); and CaixaBank (peer-to-peer online payments).
According to a separate announcement from CaixaBank – the only European bank selected to take part in the programme – it has been chosen specifically to develop a mobile application for P2P digital euro payments.
However, the ECB has explained that the prototyping and testing phase should not be seen as a stepping stone to the direct involvement of any of these companies in the future. It said:
The aim of this prototyping exercise is to test how well the technology behind a digital euro integrates with prototypes developed by companies. Simulated transactions will be initiated using the front-end prototypes developed by the five companies and processed through the Eurosystem’s interface and back-end infrastructure.
There are no plans to re-use the prototypes in the subsequent phases of the digital euro project.
On the face of it, the digital euro project appears to be months in advance of discussions about the digital pound, aka the BritCoin.
The Bank of England kicked off its formal consultation on a retail CBDC this year, but sees the digital pound as “a major national infrastructure project”, according to former Treasury Minister John Glen. In other words, something the UK has a poor track record of undertaking swiftly, efficiently, and effectively.
Speaking last year, Glen said:
If there is a decision to proceed following the consultation, a development phase would include the publication, by the Bank of England, of a technical specification to explain the proposed conceptual architecture for a UK CBDC. This development phase could involve in-depth testing of the optimal design for, and feasibility of, a UK CBDC.
Following this, a decision would be taken on whether to move into a subsequent build and testing phase. Given the scale and national importance of such a project, this phase would likely take several years and could involve the development of large-scale prototypes and live pilots.
The most recent minutes from the Bank of England’s CBDC Forum suggest it is still discussing payment providers’ business models and how revenues could be generated from the project, at a time when the ECB has already moved onto prototyping and testing. In short, the signs are the UK is being left behind.
The future of finance?
So, what is the attraction of CBDCs? It is believed that tokenized currencies issued by central banks for everybody to use (as opposed to the digital reserves issued to banks and other institutions) could aid financial inclusion and speed up international currency transfers.
CBDCs would complement cash and other forms of payment and deposit, yet could also pose risks to traditional finance, including interoperability problems, inflation/deflation, and security. This is why many central banks are proceeding cautiously into the new world.
At present, 105 countries are thought to be at different stages of investigating CBDCs. To date, just 11 have launched them: Bahamas, Jamaica, Nigeria, and the Eastern Caribbean (a currency union of eight countries).
Others are piloting CBDCs, including Sweden, Ukraine, Saudi Arabia, United Arab Emirates, Kazakhstan, Thailand, Singapore, Malaysia, Russia, South Korea, Hong Kong, and – most significantly for the West, perhaps – China, which has rolled out limited quantities of the digital RNB yuan.
The message is clear: CBDCs’ center of gravity is moving towards Asia, and outside the traditional finance world dominated by the dollar. If China – or for that matter Russia – forces other nations to trade in their CBDCs long before the digital dollar, euro, or pound are launched, it could alter the balance of financial power.
However, nerves are also fraying internationally, given the recent problems associated with decentralized finance (DeFi) and cryptocurrencies, with the values of many tokens spiralling down amid empty promises, high-risk speculation, rows over energy usage, and reports on the criminal activities enabled by the crypto world. (Of course, nerves are fraying in traditional finance too, with soaring inflation, war in Europe, and a looming recession.)
Last week the Ethereum platform, on which the Ether coin is based, completed ‘The Merge’, switching from the proof-of-work system favoured by crypto purists to one based on proof of stake, saving an estimated 99.5% on energy usage. But although the switch was completed successfully, the value of Ether has since declined.
While CBDCs should not be confused with cryptocurrencies, having more in common with stablecoins (tokens linked to the value of a fiat currency or commodity), they may use similar blockchain or distributed ledger systems, and thus face at least some of the same risks. The rout in cryptocurrencies earlier this year saw some stablecoins lose their dollar pegs, in one case becoming almost valueless.
A briefing note from the US Federal Reserve explains:
While there are many potential options for designing and implementing a CBDC, one important consideration that spans all the approaches is security. Like cash and conventional electronic payment systems, security considerations for a CBDC include the prevention of counterfeiting, fraud, and double spending.
Given the likely importance of a CBDC to a jurisdiction's financial system and broader economy, other security considerations include anti-money laundering and countering the financing of terrorism, consumer protection, and financial stability.
A potential technology solution that is often discussed for a CBDC is distributed ledger technology (DLT). The use of a decentralised ledger replicated across a distributed network could offer enhanced availability and minimise single points of failure, and the use of cryptographic hashes ensures the integrity of transaction records.
[But] while DLT may offer benefits, its use is not without security risks. For example, many of the purported benefits are associated with permissionless designs, yet security incidents involving these same designs demonstrate the continued existence of vulnerabilities.
Europe is moving at speed, with the US playing catch-up from four years of the previous administration’s old-economy thinking. Meanwhile, the UK’s excessive caution and navel-gazing on CBDCs – though understandable and pragmatic – may turn out to be another historic mistake.