Why we need a digital euro

In their contribution, Jonas Groß, Manuel Klein and Prof. Dr. Philipp Sandner with the question of why CBDCs like the digital euro are needed.

This article first appeared in the April issue of Crypto compass, the magazine for everything to do with blockchain. Do you want to know more about it? Then click on this button:

The digitization of the monetary system

Cash has been losing importance as a means of payment for years. This trend is further intensified by the change in payment behavior in the wake of the corona pandemic towards digital payment methods. So cheated after representative surveys by the Bundesbank the share of cash turnover in 2014 was still 53%, but fell to 48% in 2017 and only around 32% in 2020. Since this trend will noticeably continue outside of Germany, central banks around the world are developing their own digital ones Currencies, so-called Central Bank Digital Currencies (CBDCs). According to current study by the Bank for International Settlements (BIS) around 86% of the central banks surveyed deal with CBDCs in theory or in first prototypes. The world’s first CBDC was introduced in the Bahamas in October 2020, and China is now also intensively testing the specially developed CBDC called DC / EP. The European Central Bank (ECB) is now also considering introducing a digital euro. In the middle of the year the ECB wants to decide whether a project around the digital euro should be started. ECB President Christine Lagarde expects a digital euro over the next five years should be introduced.

The private sector digital euro

In addition to the initiatives run by the public sector, the private sector is also working on promising solutions for the digitization of money. A major motivation for fintechs and banks is to leverage and realize the benefits of distributed ledger technology (DLT). Here, DZ Bank, LBBW, Commerzbank and the traditional bank von der Heydt are currently leading. With the “tokenization” of commercial bank money or e-money, new types of business models can arise on the basis of the distributed database. These business models use the advantages of DLT in payment transactions, such as the elimination of intermediaries such as clearing houses, and the resulting reduction in transaction costs. In addition, distributed transaction systems are typically available 24 hours a day, 7 days a week and payments can be programmed. In addition, micro-payments can also be carried out efficiently and machines and devices can be integrated into the monetary system. It can be expected that DLT will transform numerous industries and enable many new business models, both for the financial sector and for the manufacturing industry. As a newly created initiative, the Digital Euro Association would like to help shape the discussion about the digitization of money and work out possible applications of the digital euro and the resulting benefits.

Effects on the financial sector and the manufacturing industry

In the financial sector, DLT enables the transfer and processing of tokenized assets (digital assets) as well as the corresponding payments in euros via one and the same platform. Billing can take place almost simultaneously, which reduces counterparty risks, increases liquidity and enables so-called “Delivery vs. Payment” processes (DvP), i.e. the simultaneous exchange of assets and money on the same platform. These applications could above all be made possible by a so-called Wholesale CBDC of the central banks. This new type of digital central bank money would make central bank reserves, which already exist in digital form as means of payment for commercial banks, transferable as tokens via DLT. In addition, payments that were previously made and allocated manually, for example coupons or dividends within the asset lifecycle, can be allocated, automated and simplified significantly better through clear documentation of the owners of the digital securities. In addition to a wholesale CBDC solution, solutions from the private sector are also conceivable for this.

In the manufacturing industry, pay-per-use billing for machines is made possible, which represents new financing options for production systems through payment depending on the usage. A DLT-based digital euro from the private sector in the form of tokenized e-money or deposit money will enable micro-payments directly between machines (machine economy), which will be of particular relevance for the Internet of Things (IoT). In principle, programmable payments are made possible, which enable efficient and automated transactions through smart contracts.

Conclusion

Both the public and private sectors are currently working on a digital euro. These private and public initiatives cover a wide variety of use cases. While the digital euro of the ECB is supposed to be a type of digital cash that can be used as a general means of payment, the DLT-based digital euro of the private sector enables new, innovative business models and addresses limitations of the current monetary system, so that, for example, micro-payments are carried out and machines can be connected to the cash cycle. The first German financial institutions are now working on such solutions, which could have a positive effect on the competitiveness of the German economy. It is now important to bring such a solution onto the market – this is how Germany can position itself as a pioneer in everything to do with DLT-based payments.

About the authors

Jonas Groß is project manager at the Frankfurt School Blockchain Center and is doing a doctorate on digital currencies at the University of Bayreuth.

Manuel Klein works as a consultant for a leading business consultancy specializing in the application of distributed ledger technology in finance.

Prof. Dr. Philipp Sandner heads the Frankfurt School Blockchain Center (FSBC) at the Frankfurt School of Finance & Management, which was initiated in February 2017.