Since we last reported on the ECB’s thinking about CBDCs1, multiple central banks have undertaken research in designing, operating and selling CBDCs. As of January, the Atlantic Council2 lists 103 central banks have research projects, 16 are at proof-of-concept stage, there are 14 pilots and 4 fully launched CBDCs3.
There is unanimity on some basic features; all schemes are mobile phone based. All reject internet dependency: users should be able to spend “offline” provided that a phone signal is available, even though later in the process online validation will take place. Beyond these basics, however, there is a vast divergence of design features including a split between centralised versions and decentralised, blockchain based schemes.
Objections to CBDCs raise concerns about privacy, state surveillance of spending, as well as fears that central banks might – by preventing cash withdrawals of bank deposits – set deeply negative interest rates and thereby tax savers via the back door. None of the project papers we have read contemplate the abolition of cash, but it is obvious from experience to date that CBDCs are unpopular, and without total cash abolition, huge incentives such mandating CBDCs for receipt of pensions and welfare will have to be imposed for usage to improve.
Despite this unpopularity, the ECB’s project is at an advanced stage, and it is no doubt assimilating all feedback from pilots and launches. This will doubtless inform its present thinking concerning the three main issues at the heart of the design of a future central bank digital euro (CBDE): i) technical structure, ii) private sector involvement, and iii) presentational aspects, how to sell CBDE.
We summarise below feedback from pilots and launched schemes on these three core issues, (but we ignore China and Zimbabwe – totalitarian regimes). Then we consider the ECB’s latest publications and consider how best it might move forward.
I. Technical Design
The most prominent design question is whether to decentralise record keeping and/ or transaction validation. The world’s sixth most populous country, Nigeria has a fully launched blockchain based CBDC as of September 2022. Despite substantial government promotion, take up is poor – only 6% of Nigerians had an e-Naira wallet and 98% of them had never been used by May 2023.
The Central Bank of Nigeria had previously banned cryptocurrencies, so it seemed inconsistent to issue a blockchain based e-Naira4. Sweden, Israel and a few other countries remain blockchain fans. Quite possibly some central banks believe that bitcoin is a successful alternative currency. This belief confuses bitcoin’s market value with its function. A 2023 book by Bob Seaman5, “The Coinmen” cites Federal Reserve data to show that as of early 2022 less than 0.3 per cent of all bitcoin transactions were purchases of goods and services; the overwhelming majority were simply trades from fiat or other crypto in or out of bitcoin. There is scant evidence that blockchain based cryptocurrency can function as a usable currency. The Bank of Israel perhaps recognises this and appears to be changing its mind, recently stating that continuing improvements in Israel’s digital banking payments system questions the necessity of a CBDC shekel.6
The overwhelming majority of projects and pilots are centralised, not blockchain based. The Bahamas is regarded as the CBDC pioneer of democratic countries, having launched its Sand Dollar in 2020. However, it has proved unpopular – the present volume of Sand Dollars is equivalent to about 0.2% of traditional cash in circulation. Financial inclusion, put differently offering a banking service for the unbanked, is a frequently cited motivation for CBDC projects. Whereas Bahamas is a heavily banked society, Jamaica is not. The Bank of Jamaica has a fully launched CBDC, JAM-DEX, as of summer 2022. And yet take up mirrors that of Bahamas at around 0.2% of cash, questioning whether CBDCs are really a solution still in search of a problem.
II. Private Sector Involvement
Unsurprisingly, none of the projects show any central bank appetite to interface directly with users. Every piloted and launched scheme involves multiple roles for the private sector. Uruguay’s e-Peso, piloted for 6 months from November 2017, employed IBM to manage the call centre/ customer service aspect, RedPagos, a local PayPal type entity, to manage the fiat to e-Peso interface, yet another different local company to implement and manage the core technology, and two further local companies for the two wallets – one wallet for the users’ mobile phone and a second ‘system’ wallet – designed to ensure pseudonymity – encrypted at the system level so that payments were not customer to customer, but took place within the central banking system to minimise the risk of counterparty traceability. In our view, the e-Peso was skilfully designed to allay as far as possible the ‘big brother’ objections to CBDCs. And yet it flopped and nothing significant has been announced since 2018.
III. Selling CBDCs to Citizens
At a recent event at think tank OMFIF7 in London, enthusiastic panellists adopted the technique of pretending that cash abolition is inevitable and making spurious claims that CBDCs fix shortcomings in existing payment systems8.
The ECB faces an uphill struggle in selling a CBDE to the governments and publics of 20 Eurozone member states. Further, no democratic country’s CBDC can be regarded as successful. There is trivial public appetite. A forthcoming paper by leading economist Kevin Dowd lists every supposed operational benefit of CBDCs but concludes they offer no benefits that cannot be achieved using existing tools.
The ECB’s Published Thoughts since 2021
a) Original Justification
The ECB’s project justifications were twofold; firstly the fear that cryptocurrencies and stablecoins might impair its powers. But this fear was shown to be grossly overstated. The fear was specifically about a project named Libra which had been principally led from its 2019 inception by Facebook (now Meta). The project fizzled out when the Federal Reserve indicated its hostility in June 2021, but the ECB was apparently still scared. Libra’s now total demise proves that established private sector companies’ ambitions towards currency competition can easily be quelled by central banks.
The second justification was that the declining use of cash might undermine public trust in the ECB as the controlling authority behind the euro. Different versions of this argument have been deployed by other central banks; it can be expressed more simply as their fear that their main public facing product, cash, is falling out of favour. But this fear is again misplaced; as all research shows, there is no public desire to abolish cash. Cards are obviously convenient and increasingly used, but the public are alarmed at restrictions on cash access and want to have the ability to withdraw all their bank balances in the event of any jitters about the safety of their deposits.
b) Current thinking
The ECB’s design thinking is well advanced, a CBDE would be fully centralised with the ECB and Eurosystem acting as issuer and settlor of online transactions. Banks and fintechs will provide a range of customer interfacing services. As expected, its copious annual CBDE project reports address in detail security matters such as KYC, money laundering and anti-terrorist financing.
However, the project has been dogged by objections from the EU’s privacy institution around privacy matters. The European Data Protection Board claims that the proposed design reveals too much user data to private sector intermediaries and breaches existing EU GDPR regulations. We await the next annual update in April with interest.
Conclusion
The ECB must be worried about low take up of CBDCs everywhere they have been trialled or launched. However, even worse for the ECB’s reputation would be a scandal. Imagine the reaction if, after three or four years of expensive research and development, a CBDE were to result in mass data breaches, account balances being lost in the ethernet, accounts emptied by fraudsters, or the elderly unable to spend.
Our somewhat perverse conclusion is that the ECB should perhaps launch a simply designed damp squib. Maximum holding limits could be small and transaction ceilings low. Acceptance by shops could still be mandatory, but usage so trivial that nobody would care. At least the ECB could subsequently report that it had established a functioning digital alternative to cash and satisfied its two project justifying arguments.
But of course, the ECB should discontinue this work and concentrate on the far larger problems on its plate. Inflation remains elevated and sticky. The US and China are throwing huge amounts of economic stimulus around and Europe is being severely squeezed by higher energy costs. These sorts of fiscal and supply factors complicate monetary policy and make inflation targeting all but impossible. CBDCs are of no help with any of that and merely drain ECB resources.
2 https://cbdctracker.org
3 The number is really 5, but China claims its project is still a pilot.
4 Nigeria’s eNaira CBDC: What Went Wrong? (cornell.edu)
5 The Coinmen (Bitcoin Exposed) by Bob Seeman | Goodreads
6 CBDC-a-privacy-eroding-pound-FINAL-1.pdf (bigbrotherwatch.org.uk) pp 26
7 Official Monetary and Financial Institutions Forum
8 Unlocking the potential of a CBDC ecosystem – OMFIF
Source: https://en.irefeurope.org/publications/iref-newsletter/article/cbdcs-the-hottest-topic-in-central-banking-what-form-of-central-bank-digital-euro-should-the-ecb-launch/
Nice balanced article by Gordon Kerr.
I wonder if anyone had heard about the other possible use of the new digital euro. As a replacement for the existing, heavily indebted, euro. Clive Thomas predicts that once digital euro is accepted , old euro will be phased out by rapid inflation and old euro debts defaulted on. He predicted the $3000 e- euro new account limit accurately two years ago. In other words , they hope the e- euro will be a backstop for their banking system.