The first test phase of the digital euro was launched on 1 November for a period of 2 years. It will provide an opportunity to study the design of the future digital currency and the rules that will govern its issue and management. A number of challenges need to be met to maximise the chances of this digital euro finding its audience, both end users and the banks responsible for its distribution.
The countries that have today finalised the large-scale adoption of central bank digital currency - MNBC - are few and far between: the Bahamas and Nigeria, whose main objective is social inclusion, an objective that seems to have been achieved. The case of China is different. The e-Yuan is not yet deployed on a large scale, but its implementation is less 'problematic' insofar as it is consistent with the use of social rating, which would find its full expression with programmable payment.
The ECB's discourse is resolutely optimistic and sees the digital Euro as a modernisation of central bank money to bring it into the digital world. At a time when many are surprised by this enthusiasm in the absence of clear use cases - the digitalisation of payments has been carried out by the private sector - it is difficult to identify what the digital Euro will be able to offer in addition.
Given these questions, it is interesting to look back at the Swedish experience. Indeed, Sweden was a pioneer in MNBC - it looked into the issue back in 2017. Yet it has still not launched E-krona despite publishing the phase 3 test report last April.
Sweden pioneering the subject?
Sweden has been a pioneer on the issue of developing an MNBC given the drastic decline in the use of cash in transactions since 2010: the percentage of transactions carried out in cash has fallen to less than 1% of GDP whereas it is still 10% in the Eurozone.
According to the Bank of Sweden (see below), only 9% of Swedes carry out transactions in cash compared with 39% in 2010. Given the low use of physical currency, central bank money (the Swedish krona) has essentially become an electronic interbank currency. Most users pay by credit/debit card or app.
Figure 4. Percentage of Swedes who made their last purchase in cash
Source Riksbank
We might wonder why there is such a gap between Sweden and the Eurozone countries. The strong adoption of digital technology by Swedes in their daily lives combined with a highly developed internet network no doubt explains this, not forgetting low levels of tax evasion.
Today, payments in Sweden are largely outside the control of the central bank and remain managed by the private sector with new players in addition to the traditional banking players. This development has contributed to a decline in seigniorage income collected on currency issuance; seigniorage income represents the difference between the value of the banknote and its production cost - essentially printing costs plus the costs of combating counterfeiting.
Given the high degree of privatisation in the payments market, the central bank questioned whether its legitimacy was being called into question and naturally raised the issue of developing a digital version of its currency.
The Riksbank initiated its work in 2017 - well before all the other central banks, particularly those in developed countries, which only seriously considered the issue after the announcement of the Libra (Facebook) project in June 2019, a real wake-up call . They then realised that privatising payment innovation could jeopardise their monetary sovereignty.
Sweden continues to test
Yet while Sweden has been way ahead of its time, the decision to issue an MNBC has still not been taken. The project has just completed phase 3 of testing.
First of all, it is interesting to understand the contributions of the two previous test phases: these looked at how to distribute E-kronas to users via participants authorised by the central bank, ensure offline E-krona transactions to guarantee untraceability for payments and how to ensure integration of the E-krona network into point-of-sale payment terminals.
The key issues analysed in this phase 3 are as follows:
1- Which digital currency model: DLT or account-based?1- Which digital currency model: based on Distributed Ledger Technology (Token-based) or account-based, the difference being that in the case of a DLT it is the validity of the object (token) that is verified whereas otherwise it is the identity of the accounts that is verified. We can use the analogy of a banknote, where authentication is required to make a payment (authenticity of the object), whereas for a credit card it will be verification of the identity of the accounts.
👉 What model of cooperation between the participants (banks, payment players) and the central bank?
👉 What level of governance exercised by the central bank?
These various questions are considered so that the central bank can decide which model could best guarantee the integrity of the E-krona brand while encouraging innovation.
By asking itself these questions, the Riksbank is setting itself apart from central banks that are now more advanced on the subject, such as the Central Bank of the Bahamas with the Sand, the Central Bank of Nigeria - and the Bank of China with the E-Yuan.
These projects do not attach the same importance to innovation through competition, because they are targeting other objectives such as financial inclusion in the Bahamas and Nigeria, and social rating in China.
Opting for an MNBC based on a DLT - named Corda in its phase 3 - undoubtedly allows us to enter the future and be more open to innovation by allowing the integration of smart contract to move towards the programmability of payments.
Warning, however, that the programmability of payments for the Riksbank does not mean the conditionality of the nature or indeed the recipients of the payments. In fact, according to the Riksbank, such a definition of the programmability of payments would be contrary to the universal nature of money.
Programmability is defined here in relation to the making of the payment. In this test phase, the Riksbank has experimented with payment for a car made during a sale between a private individual and a dealer as soon as the car has been registered. The question then arises as to the level of governance envisaged if the DLT model is chosen.
Innovation would be all the more stimulated if the level of governance exercised by the central bank were low. It would leave it up to the various participants approved by the central bank - banks but also payment players - to develop their own interface and services - in a similar way to bankcards today with the risk that end users would no longer know what an E-krona is.
The idea of having a single brand that is recognisable by everyone, as coins and banknotes symbolise so well, would no longer be feasible. To some extent, this is a throwback - salutary after all - to the days when banks issued their own notes with the exception that they issued them in return for a single object: gold.
The intermediate solution would be to give specifications so that E-krona is identifiable as a brand without having a single interface - a single app - and single services but rather apps with minimum services as well as a charter of rights and obligations.
If such an option is chosen, the terms of collaboration between the central bank and the authorised participants in terms of costs and revenues will also need to be studied. Terms and conditions must be established that provide sufficient incentives for authorised participants to offer E-krona to their customers. Indeed, it is reasonable to wonder how motivated banks will be to participate in the network given that the distribution of E-krona will be at the expense of their deposit-taking business.
In comparison with the current situation where payments in Sweden are massively dematerialised, banks would be the big losers since the digitalisation of payments now puts bank accounts at the centre of the system. How can they be encouraged to offer their customers the use of E-krona? Undoubtedly by allowing pure payment players who do not have this conflict of interest to come and compete with them.
But the outcome will depend heavily on the definition of the costs and revenues that fall to the participants. This is perhaps why the E-krona project is still in the exploratory phase and the decision to launch it has still not been taken. It is difficult to determine with any certainty the conditions for success if the aim is to offer an open MNBC model fuelled by innovation.
No wonder that at the same time the Riksbank is experimenting with an international payment system in cooperation with Norges Bank (Denmark's Central Bank), Israel's central bank and the Bank for International Settlements in order to make international payments faster, cheaper and executed at the most advantageous exchange rate for the customer!
Given the Swedish experience and the fact that Europe does not want to embrace the Chinese route, the Digital Euro project is still in its infancy. There are many challenges to be met, starting with the need for a consensus on the vision of the Digital Euro shared by all the member countries... This is far from being a foregone conclusion!
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