Talking today at Consensus Distributed, European Central Bank (ECB) board member Yves Mersch spoke about the potential for a central bank digital currency (CBDC). The message was that the bank is carefully exploring a digital euro, but there is no demand right now. There was an interesting question about whether the ECB has the exclusive right to issue a digital currency.
“The lack of an imminent, what I would call, business case for a central bank digital currency should, and indeed does not stop us from seriously exploring the optimal design of a central bank digital currency, so that we will be well prepared should we ever have to take a policy decision to issue a digital currency,” said Mersch.
He said that across Europe, 76% of retail transactions still use cash, but acknowledged there were exceptions in some countries where cash usage was declining. However, across Europe, the growth in demand for cash outstrips GDP growth. Any move to digital cash would have to be driven by citizen demand, and the ECB does not see it yet.
Earlier this year, the ECB set up a task force to explore CBDC in conjunction with national central banks within the euro system. He provided a preview of the deliberations.
The current focus is on a retail CBDC. From the ECB’s position, a wholesale CBDC would be similar to business as usual because it would involve the same financial institutions.
A key question is whether a CBDC would be legal tender. That would require it to be usable at any location and under any condition, including offline. [For the record, China’s CBDC will be legal tender and can be used offline]. If the digital euro were not legal tender, then its legal position would need to be clarified.
Another legal question (Mersch is a lawyer) is whether the ECB has the exclusive right to issue digital currency in the way it has with euro banknotes. “Should it, in my opinion, not be acknowledged, however, that the ECB’s exclusive right to authorize issuance in euro banknotes and coins should also be applicable to a digital issuance. It’s a legitimate question, but we would need to have legal certainty,” said Mersch.
He later clarified that the ECB has the exclusive right to issue banknotes, but bank coins can be issued at the national level. So the question is whether a CBDC is more like a physical banknote or a coin. Depending on the legal interpretation, that means that individual EU countries could potentially issue digital currencies.
That’s particularly relevant given the strain caused by COVID-19.
Two routes: token or account based
The two main routes being explored are to issue a digital token or to have it account based.
With a digital token, it would be decentralized with the intention to allow for anonymity, just like cash. Some argue anonymity cannot be guaranteed and it could be designed in an “intermediate way”, which could raise social, political and legal issues.
A legal question is whether the ECB is permitted to outsource public law tasks to private entities.
And is it appropriate to have intermediaries that are not subject to supervision, compared to the current banking system?
The alternative is a retail account-based CBDC, where instead of supporting 10,000 accounts for financial institutions, the ECB would provide accounts for 300-500 million people and organizations.
An account based approach introduces numerous issues. It could crowd out bank deposits and digital bank runs could happen extremely fast. Central banks would have to be consumer facing and take on the burden of regulatory compliance. And historically, central bank control has been very inefficient. In Mersch’s opinion, this level of disintermediation of the banking system would be untenable.
Mersch also considered the issue of interest rates. For example, in times of crisis, the central bank could offer very negative rates. But this would undermine confidence in the central bank and discourages the concept of savings. An alternative is to have a payments tier versus a store of value tier. But this needs careful investigation and there are parallels with multiple exchange rate regimes.
The ECB board member concluded that the exploration continues.
“The ECB respects technological neutrality. We do not serve technology. Rather technology serves us. We will only introduce a digital currency if we become firmly convinced that it is both necessary and proportionate to fulfill our tasks in ensuring the stability of our currency,” said Mersch.
He concluded: “CBDC design choices are not merely technical questions. They have policy and legal implications. This is why we are devoting so much attention to every detail. If and when the time comes, we want to be ready, and let me assure you, we will be ready.”
Update: Added the clarification from Mersch regarding the right of nation states to issue coins in the euro system. The title was changed.