Digitization does not stop at the monetary system. Since the advent of Bitcoin and other cryptocurrencies has proven the advantages of distributed ledger technology (DLT), central banks are also increasingly interested in their own digital currencies. The FED and the ECB are already developing their own Central Bank Digital Currencies (CBDCs). In this article we will go into the current status of the ECB's CBDC and look at the advantages and disadvantages of a central bank-controlled digital currency. Furthermore, the question to be clarified is which main features a digital euro must have in order to be a serious alternative to physical money?
What is a CBDC?
In today's world, commercial banks play a key role in the custody and distribution of physical notes and coins to the public. Central Bank Digital Currencies (CBDCs) are now designed to bridge the gap between the physical world and the digital world. The digital currencies of the central banks (e.g. the ECB) should fulfill the properties of cash, but as the name suggests, exist in digital form.
In concrete terms, the digital euro (e-euro) thus fulfills the vision of transferring the advantages of cash to the digital world. In addition, the money should be distributed directly to the general public and can be owned, held and used by them. In addition, the e-euro aims to provide users with instant and convenient peer-to-peer transactions with a level of privacy similar to that of physical cash.
The aim is for the ECB's CBDC to create a new public-private partnership that is not possible with banknotes and coins. With the introduction of a digital euro, the private sector should be able to develop innovative business models and promote public-private partnerships.
Effects of a CBDC on the financial system
According to the analysis, the introduction of a CBDC shows significant risks for the financial system. In order not to fall into financial instability, the digital euro must therefore meet many criteria. In particular, in several scenarios, policymakers should take into account the different levels of demand for the digital euro. In addition, the ECB needs to consider various restrictions that stakeholders are subject to when issuing, making available and using a CBDC. This could be specific security requirements or regulatory requirements.
Among other things, when assessing the impact of a digital euro, the ECB must pay particular attention to both the banking system, the financial system and the economy. These include bank profitability, the risk of disintermediation in times of bank runs, cash flow and bank liquidity risk.
Stress tests will play a key role in this. They are designed to meet the various design specifications set out in the European Union Treaties. Thus, time will tell if CBDCs are even able to exist in the central bank system.
What requirements does a CBDC have to meet?
In order for a Central Bank Digital Currency to be marketable at all, it must meet several requirements. On the one hand, the technological design of a digital euro applies here. It is also important to clarify the question of which payment-related aspects the ECB's CBDC should fulfil. In addition, legal considerations must be made about the digital euro.
The Digital Euro Association, among others, takes care of all these questions. In the recently published paper "Ahead of the digital euro: Public Digital Euro Working Group Recommendations" they go into the necessary requirements. They also clarify important questions about the CBDC of the ECB.
Advantages of a digital euro
While adopting a CBDC is proving difficult, it still offers some benefits. In this way, a digital euro can enable payments to be made in a matter of seconds. Furthermore, security can be guaranteed by the DLT technology. This ensures the privacy of the buyer when shopping, such as when paying with cash.
The current plan is for the digital euro to be stored in a kind of virtual wallet. This technology enables customers to pay directly from the wallet using an app or QR code. This is done both online and offline, using technical solutions such as Bluetooth. Overall, the process would be significantly simpler and faster than current SEPA transfers.
Danger – Does the e-euro make us dependent on the ECB?
CBDCs can offer many advantages in terms of technological advances. Despite all this, there are some critics. This is largely due to the conflicting properties that CBDCs are said to exhibit. Edward Snowden speaks of CBDCs as follows:
“Instead, a CBDC is more of a perversion of a cryptocurrency, or at least of its basic tenets and protocols – a crypto-fascist currency, an evil twin that invaded ledgers on the opposite day, expressly designed to deprive users of the fundamental ownership of their money and to put the state at the center as the intermediary of all transactions.”
He is by no means wrong with this statement. Because the term "peer-to-peer" alone, i.e. a transfer without a middleman, makes no sense under the influence of the ECB. However, if a CBDC were to be introduced under the influence of a central bank, there would be many risks for users. In this way, the central bank has complete control over money flows and can specifically determine who can participate in the market. Funds can easily be frozen or access blocked.
This power would certainly restrict people's freedom. For these reasons, it is of paramount importance that a digital currency or digital money is decentralized. Only if no one can influence it is it really suitable as a currency. Currently, only Bitcoin meets these requirements. Since decentralization is guaranteed by the Proof-of-Work consensus mechanism, Bitcoin is truly independent.
In conclusion, one can say that the introduction of a CBDC is hardly feasible under the required aspects. As soon as an instance has the ability to view transactions and, if necessary, influence them, a CBDC is hardly a step forward into a freer and more progressive future.
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