Contribution by Fabio Panetta, Member of the Executive Board of the ECB, to a panel discussion on central bank digital currencies at the US Monetary Policy Forum
New York, 18 February 2022
It is a great pleasure to take part in this panel on central bank digital currencies (CBDCs).
Throughout history, money and payments have been constantly evolving. And this also holds true in the digital age. As we increasingly pay digitally and shop online, we rely less on cash. Our wallets are gradually moving from our pockets to smartphones and other electronic devices.
These changes have profound implications for the nature of money itself, raising the question of whether central banks should issue digital currencies for retail use.
Today I will argue that in a digital world CBDCs are necessary to preserve the role of central bank money as a stabilising force at the heart of the payments system and to safeguard monetary sovereignty.
But CBDCs will need to be carefully designed. To be successful, they will need to add value for users, support competition rather than crowd out private innovation, and avoid risks to financial intermediation.
Why we need central bank digital money
Our monetary system is based on the complementarity of private money with public money – which is available for retail payments in the form of banknotes.[1]
Confidence in private means of payment is determined by our ability to convert private money into safe public money. This is because central bank money is a risk-free form of money that is guaranteed by the State: by its strength, its credibility, its authority.
Other types of money are liabilities of private issuers: their value is based on the soundness of the issuer and is underpinned by the promise of one-to-one convertibility with central bank money.[2] Our readiness to hold private money such as bank deposits reflects the confidence that we can always go to a branch or a cash machine and convert our deposits into cash. The fact that we can do this tells us that our deposits are safe. It reassures us that we will be able to convert them into risk-free central bank money in the future, too.
Bank runs and financial crises start when confidence in the convertibility of private money evaporates.[3] Without the anchor of sovereign money, people would constantly have to monitor the soundness of private issuers in order to assess the value of each form of private money. This would undermine confidence in the singleness of money and impair the functioning of the payments system.[4]
History provides examples for this. In times when various forms of private money coexisted in the absence of sovereign money – such as the free banking era of the 19th century – the notes issued by banks often traded at variable prices[5] and instability risks[6] required dominant banks and clearinghouses to act as quasi-central banks[7].
The consensus among central banks on the coexistence between public and private money was summarised 20 years ago as follows: “The composite of central and commercial bank money, convertible at par, is essential to the safety and efficiency of the financial system and should remain the basis of the singleness of the currency. In other words, central banks would accept neither an outcome in which central bank money crowds out private initiative, nor an outcome in which central bank money is phased out by a market mechanism.”[8]
In the digital age, however, banknotes could lose their role as a reference value in payments, undermining the integrity of the monetary system.[9] Central banks must therefore consider how to ensure that their money can remain a payments anchor in a digital world.
Some have suggested that innovative private payment solutions such as stablecoins could, if properly regulated, make CBDCs superfluous.[10] However, confidence in stablecoins would also depend on the ability to convert them into central bank money,[11] unless stablecoin issuers were allowed to invest the reserve assets in risk-free deposits at the central bank. But this would be tantamount to outsourcing the provision of central bank money, which would endanger monetary sovereignty.[12] Moreover, in the absence of public money, stablecoins could exacerbate the “winner-takes-all” dynamics inherent in payment markets, with adverse consequences for the functioning of the payments system.[13] And stablecoins’ potentially large investments in safe assets could affect the availability of these assets.[14] This could in turn have an impact on market functioning and real interest rates, with undesirable implications from a monetary policy perspective.[15]
Other threats to monetary sovereignty could emerge in the absence of a domestic digital currency.
If a foreign CBDC were to be widely adopted, this could lead to digital currency substitution[16]. This risk would be higher for small countries with unstable currencies and weak fundamentals, especially if the CBDC were issued in a major economy.[17] But it could eventually also affect leading currencies.[18]
Such risks are not imminent, but they should not be underestimated. Just as the US dollar overtook the pound sterling as the leading reserve currency within only a decade of the end of the First World War,[19] digital innovation may give rise to powerful new foreign contenders, with disruptive consequences for those markets that are not prepared to face the digital challenge.
The widespread adoption of a foreign CBDC would increase the risk of financial transactions being based on technologies managed and supervised elsewhere, with limited oversight by domestic authorities. A system of this kind may not have sufficient safeguards against external threats, including cyber threats. It could put the confidential data of people, businesses, and states at greater risk of being misused. And it could make the information needed to counter criminal activities harder to trace.
The scenario I am describing is not one of science fiction. It is already the case in the market for crypto-assets, which are widely used for criminal activities.[20] A similar situation might affect other digital asset markets in the future. So the regulatory framework needs to be adjusted, and this will make a big difference.[21] But it may not be sufficient.
The main benefits of CBDCs
A CBDC would preserve the coexistence of sovereign and private money in a digital world. This is not an abstract benefit – it is the basis for financial and monetary stability, ensuring competition and efficiency in payment markets.
But a CBDC could generate even more benefits for users.
It could improve the confidentiality of digital payments. The information contained in electronic transactions can be monetised by private companies[22], posing a threat to privacy. This risk is further compounded by big techs starting to offer financial services and by the rapid development of artificial intelligence. Data protection regulation aims to prevent misuse, but cannot always keep pace with technological innovation, as we have seen in past cases of data breaches and misuse by tech companies.[23]
If a digital currency were offered by an independent public institution such as the central bank – which has no interest in exploiting individual payment data for any purpose – it could enhance, not reduce, the confidentiality of electronic payments. Potential users clearly want this: when we consulted the public on the topic, privacy was identified as the most important aspect of a digital euro.[24] Sound governance arrangements that comply with data protection regulations would ensure that payment information is only accessed for permitted purposes, such as countering illegal activities. We are cooperating with the relevant European authorities on this issue.
A digital euro would also increase choice and reduce costs, contributing to a level playing field in payments.[25] Key segments of the euro area payments market, such as cards and e-payments, are dominated by a handful of players, which strengthens their pricing power. Some estimates suggest that Europeans pay about 1.4% of GDP for payments services. In the United States, the costs are higher.[26]
One might argue that private service providers are already well equipped to offer low-cost digital payment solutions. However, the limited evidence available suggests that low-income households use digital payments less than high-income households. This is consistent with the hypothesis that digital payments remain expensive for many users.[27] And even in advanced financial systems, many citizens are “unbanked” or “underbanked”.[28] Although financial inclusion depends on several factors, such as financial and digital literacy, the cost of financial services is likely to play a role.
Our digital euro project comes with a commitment that all – including vulnerable population groups – will have access to safe public money in the digital era.
Designing a successful digital euro
The fact that CBDCs are necessary to guarantee the smooth functioning of the payments market does not mean that their success should be taken for granted. Users may lack incentives to fully appreciate such benefit and – given the vast supply of private digital monies – could show limited interest in CBDCs.
Indeed, we face two opposite risks: being “too successful” and crowding out private payment solutions and financial intermediation, or being “not successful enough” and generating insufficient demand. We take both risks seriously.
To avoid interfering with the functioning of the financial system, we are considering how to make the digital euro a convenient medium of exchange but not an attractive form of investment. We are examining the pros and cons of introducing a quantitative cap on digital euro holdings[29] or a tiered remuneration that would disincentivise excessive holdings.[30] We are analysing the potential impact on monetary policy.
To ensure that our digital currency would be a convenient means of payment, we are working to make it available within private payment solutions, so that people would be able to use it easily wherever they can pay digitally. We aim to level the playing field by allowing intermediaries – including small ones – to offer innovative solutions to their customers. And we are considering how a digital euro could improve financial inclusion.
We are interviewing focus groups to identify the characteristics of a digital euro that would add value for users. And we are working on the technical options to reconcile different objectives such as the right of individuals to confidentiality versus the public interest in guaranteeing the transparency required to counter illegal activities; or the benefits of allowing the digital euro to be widely used versus the need to safeguard financial intermediation.
We have launched several work streams: on the design choices that can guarantee confidentiality, on the prioritisation of different use cases,[31] and on the business options for intermediaries[32]. We will cover areas such as cyber security and operational resilience.
We are interacting with all relevant stakeholders, from intermediaries to consumers, merchants and authorities. We are cooperating with the European Parliament, the European Commission and the finance ministers of the euro area countries. To get technical advice and collect a broad range of views on possible solutions, we have set up a Market Advisory Group[33] and are regularly discussing the project with the Euro Retail Payments Board[34], academics and think tanks. Bearing in mind the international implications of CBDCs,[35] we are cooperating with other major central banks.
In October 2021 we launched a two-year investigation phase to define the design features of the digital currency. At the end of 2023 we could decide to start a realisation phase to develop and test the appropriate technical solutions and business arrangements necessary to provide a digital euro, which could take three years. Only thereafter will we decide whether to actually issue a digital euro.
Conclusion
Let me conclude.
For decades, the complementarity of public money and private money has guaranteed stability, competition and innovation.
The digitalisation of payments cannot be ignored by central banks, which have so far provided their money only in physical form. Central banks cannot escape these transformations, nor should they underestimate the potential for far-reaching shifts that may occur.
To ensure that public money maintains its fundamental role in the digital age, the ECB has launched an investigation into the possible issuance of a digital euro alongside cash.
The digital euro is an ambitious and complex project that can improve the efficiency of the economic and financial system. We want to make it a driver of stability and inclusive progress, capable of strengthening ties between economies and financial systems around the world.
Our experience may provide useful insights for other central banks. And likewise, we are keen to learn from them. I am therefore pleased to exchange views with US experts, and I am now looking forward to our discussion.
