How the ECB Wants to Issue Its CBDC (#110 - 25 June 2022)



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The Future of Money with Henri Arslanian
How the ECB Wants to Issue Its CBDC (#110 - 25 June 2022)
By Henri Arslanian • Issue #99 • View online

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There have been many announcements and developments on a digital euro over the past three years that we have covered in this newsletter before. 
Recently the European Central Bank made public in a speech the direction that it has taken.
Some key takeaways from the address stand out: the CBDC approach, the maximum CBDC issuance, and the tiered interest rate.
Due to the potential impact of a CBDC, especially a euro CBDC, it is worth analyzing those takeaways.
The CBDC Approach
First, the digital euro will follow the two-tiered approach, meaning it will be issued by the ECB but distributed by banks and existing financial institutions.
This is not a surprise and an approach I expect from other central banks where privacy is an important consideration.
Source: The Book of Crypto, Henri Arslanian
Source: The Book of Crypto, Henri Arslanian
The above graph is taken from my latest book “The Book of Crypto” when I explain the various types of retail CBDC.
From the publicly available info, the ECB is taking a two-tiered approach, which means that it will use the existing financial institutions to distribute the CBDC and the ECB will only record wholesale payments (i.e. not have a copy of all the transactions that the public is making).
This is in contrast, for example, to what China is doing with its e-CNY, where the PBOC could hold a record of all retail e-CNY transaction. 
This approach is not a surprise to anyone who has been following this topic closely, as a recent survey from the ECB found that Europeans are really focused on privacy and happy to sacrifice convenience if it means that it affects their personal privacy.
For example, the majority of respondents to a recent ECB survey on the topic indicated that privacy in payments would be the most important feature of any digital euro. 
Source: European Central Bank
Source: European Central Bank
This preference was fairly uniform throughout the EU member countries but was particularly acute in the case of German respondents. 
Source: European Central Bank
Source: European Central Bank
When confronted with a specific choice between an offline digital euro focused on privacy, an online digital euro with innovative features and additional services, and a combination of the two, citizen respondents generally opted for an offline solution focused on privacy.
In addition, both citizens and professionals in the same sample generally agreed that the digital euro should be integrated into existing banking and payment solutions.
So it should not come a a surprise that the ECB is taking this two-tiered approach where the existing financial institutions are playing a role and where the ECB only sees wholesale payments and not specific data on retail transactions.
Maximum CBDC Issuance
Second, the ECB will establish personal limits on CBDC use, meaning an individual cannot hold more than a certain amount of CBDC.
Once again, this should not come as a surprise to anyone who has been following this space.
This idea was actually proposed by the Central Bank of the Netherlands in 2020, an idea we covered in an early version of this newsletter here
The ECB appears to be taking a similar approach.
For example, according to preliminary analyses from the ECB, maintaining a total digital euro reserve of between 1 trillion and 1.5 trillion would circumvent the negative effects that the CBDC could have on the broader financial system as well as monetary policies within the EU.
That amount would actually be comparable to the current holdings of paper banknotes in circulation throughout the Euro Area.
And given that the total population of Euro Area members is roughly 340 million, the ECB’s proposal would allow for holdings of between 3,000 to 4,000 digital euros per capita. 
The objective here for the ECB is to reduce any financial stability risks. This was the same rational the Dutch had in 2020.
The argument being that in the unlikely scenario that all citizens in the EU retain the maximum balance of CBDC allowed, it would result in a central bank footprint comparable to that of cash in 2019. Thus the impact would be manageable.
Tiered Interest Rate
The third aspect to consider when discussing the ECB’s plans to reduce any harmful consequences stemming from CBDC introduction involves tiered remuneration (a de facto interest rate), which would discourage the CBDC as a form of investment by applying disincentivizing remuneration above a specific threshold.
This would have the effect of subjecting large holdings of digital euro to notably less attractive rates. 
Once again, this should not come as a surprise to anyone who has been following this space.
This idea was again proposed by the Central Bank of the Netherlands in 2020, an idea we covered in an early version of this newsletter here
At the time, the Central Bank of the Netherlands actually proposed to lower the interest rate for CBDC holdings over a certain base amount. 
This is because if the interest rate on a CBDC is higher than the interest rate on commercial bank money, then most people would prefer to hold CBDC over commercial bank money.
But if the interest rate was significantly lower, there would probably be little demand for CBDC.
Consequently, the Dutch proposed that any interest rate over a certain base amount could be considerably lower to discourage any use over and above the base amount.
Based on the recent announcement, the ECB seems to be in agreement with this approach.
In addition, the ECB emphasised that the digital euro will be rolled out gradually, meaning the adoption process will take place over a period of several years.
A slow buildup means that it will be quite some time before a majority of citizens within the Euro Area begin holding and transacting with the digital euro. 
Ultimately, the ECB’s announcement on how they plan to design the digital euro is a very fascinating development and one worth following!
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Henri Arslanian
*Please note that this newsletter reflects Henri’s personal views and not those of any organisation he is involved with. This newsletter is for educational purposes only and none of its content should be construed as investment or financial advice of any kind.
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Henri Arslanian

Future of Finance and Money - PwC Global Crypto Leader, Best Selling Author, Keynote Speaker, University Professor, Host of Crypto Capsule™ - Views are my own

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