Flawed Design Risks Digital Euro

The Centre for Economic Policy Research (CEPR) has published a paper questioning whether the design of the digital euro could already be undermining its chances of success ¹.

The paper argues that the design appears to support an unstated objective of protecting banks and their business models, thereby risking missing out on key social benefits. The rationale for a digital euro outlined by the European Central Bank (ECB) is to preserve European strategic autonomy, reduce rent extraction by payment service providers, and serve as a robust monetary anchor when cash transactions decline.

The CEPR suggests that to avoid instability to the financial system, banking as usual must be safeguarded. To stop the digital euro being too attractive, risking disintermediation, the thinking is that holdings of digital euros must be limited and negative interest rates will be applied during periods of financial stress.

The need to promote a digital euro to drive adoption clashes with such design decisions. Without widespread adoption and use, key benefits may not materialise, such as fostering competition in the payment sector, reducing the social costs of liquidity provision, substantially scaling down too-big-to-fail problems and the associated bank regulation, and increasing transparency around the costs and benefits of liquidity creation.

Perhaps opting for the status quo risks missing a significant opportunity for reform.

ECB perspective

Coincidently, the ECB has published a paper that explains why it is pursuing the financial stability related design choices for the digital euro ².

To understand the risks of disintermediation and other flows of funds in the event of a digital euro, the ECB built a constraint optimisation model allowing individual banks to choose how to respond to outflows of deposits, based on cost considerations and subject to the availability of reserves and collateral, within the individual banks and system wide, and for a given level of liquidity risk tolerance.

The ECB used the model to simulate the impact of a fictitious digital euro introduction in the third quarter of 2021, based on data from over 2,000 euro area banks. It found that the impact depends on the: 

• Number of deposits withdrawn and the speed at which this occurs

• Liquidity available within the banking system at the time of the digital euro introduction

• Liquidity risk preferences of the markets and supervisors

• Bank’s business model

• Functioning of the interbank market.

The ECB found that a €3,000 digital euro holding limit per person, as has been suggested, would have been successful in containing the impact on bank liquidity risks and funding structures and on the Eurosystem balance sheet, even in extremely pessimistic scenarios.

Modelling acceptance

In a separate development, the IU Internationale Hochschule has looked at the possible acceptance of a future digital euro in Germany.

The paper considers the theoretical background of CBDCs and the core information known about a digital euro. To assess to what extent a digital euro has the potential to be accepted and actually used, prototypes of designs are presented and assessed using the Technology Acceptance Model (TAM) and the Model of Consumer Acceptance of Electronic Commerce.

The results of the study show that acceptance by the German population can be assumed. However, there are significant differences depending on the final design choices.

1 - Why the digital euro might be dead on arrival | CEPR

2 - Know your (holding) limits: CBDC, financial stability and central bank reliance (europa.eu)