A Central Bank Digital Currency comes down to putting the cart before the horse

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BrusselsReport.eu
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By Leonardas Marcinkevičius of the Lithuanian Free Market Institute

With the declining use of cash, there is a growing concern among some Europeans about the ability to use it to pay for everyday goods and services. In response, EU policymakers have set about creating a digital euro. The European Central Bank (ECB) is expected to finalise its preparations for introducing a digital alternative to cash, known as the central bank digital currency (CBDC), by October 2025.

By that time, monetary policymakers are likely to offer more clarity on several important questions that remain unanswered: the cost of a digital euro, its features, and how it would function. They are also set to announce whether they will move forward with the next step – the actual introduction of the CBDC.

Although the ECB’s deadline is still a year away, EU policymakers have already taken legislative steps. As early as 2023, the European Commission (EC) presented two related parallel proposals: regulating the digital euro and strengthening the concept of legal tender. This autumn, the European Parliament (EP) commenced the debates on both projects. While politicians concede that the decision on the introduction of the CBDC should be taken by the Central Bank, it is also noted that it “requires the adoption of a regulation establishing the legal basis for the digital euro”. The question is whether attempting to legislate on an instrument the operating principles of which have yet to be decided by its creators is putting the cart before the horse.

In this article, I will discuss the legal initiative itself, its details, and the potential risks and issues involved in such a proposal in more depth in other articles.

Strengthening the concept of legal tender

The European Commission proposes that the digital euro be recognised as legal tender. The proposal would not, however, prevent merchants from refusing to accept payments in such a form. Thus, the EC has put forward a parallel proposal to make it mandatory to accept payments in all legal forms recognised in the euro area, including not only cash but also the digital euro.

Until now, the mandatory acceptance of cash in the euro area has only been regulated by the European Commission Recommendation published in 2010. It advised against cash payments only in exceptional cases, such as when the seller had no change. However, ignoring this document did not result in any legal consequences.

EU policymakers are proposing to replace the Recommendation with an obligation: “The legal tender status of euro banknotes and coins means that they must be accepted at full face value, ensuring that the payment obligation can be met,” reads the Regulation. It implies that euro cash would have to be accepted by merchants in all cases.

As a result, the change to the current Regulation, which would make the digital euro legal tender, would require merchants to accept CBDC in all retail payments, regardless of whether one is buying a cup of coffee or a truckload of firewood.

Reducing the role of commercial banks

The aforementioned EU documents impose obligations not only on merchants but also on commercial banks and electronic money institutions, which would compel them to provide digital euro account services to natural persons free of charge. To use the CBDC, users would have to apply to their bank and open a central bank digital currency account. The financial institution would have an obligation to do so at no additional cost. Thus, commercial banks would only act as intermediaries between the central bank and the consumer in the process without any remuneration for their services.

In the current financial system, there are two forms of money: cash, which is money issued by the central bank, and electronic money, which is money created by commercial banks through loans and deposits. The initials ECB on banknotes indicate that the central bank is liable for them. When making cash payments, we simply pass on such a written guarantee to someone else and receive goods or services in return. However, the vast majority of the money currently used in the euro area is electronic, which means it is the liability of commercial banks.

However, the introduction of the digital euro would fundamentally change the system. The central bank would become directly responsible not only for cash but also for electronic money. Such a shift would result in the removal of commercial banks as intermediaries from the electronic money system.

Limits on savings are already on the table

Central bank involvement in the electronic money system would undoubtedly pose challenges. With a significant proportion of consumers withdrawing their commercial bank deposits and transferring them to their CBDC account, there would be more central bank money and less private money circulating in the financial system. As a result, not only payment services but also lending opportunities to individuals and businesses would decline. The risk of bankruptcy for private financial market participants would also increase.

EU policymakers have therefore envisaged that the ECB should have the option of limiting the functions of the digital euro as a store of value. For example, monetary policymakers could set a limit on the maximum amount of funds that each customer could hold in a central bank account. Although no concrete amounts have been specified by the authorities at this stage, discussions suggest amounts ranging from €500 to €3000. Customers would not be able to earn interest on these funds. Without these safeguards, they argue, there would be a risk of customers fleeing private banks. Yet what is underestimated is that such restrictions would significantly reduce the attractiveness of the digital euro itself to consumers. The central bank would, therefore, have to constantly balance the popularity of the CBDC against the stability of the financial system as a whole.

The idea of a digital euro is a prime example of something that happens very often in politics: putting the cart before the horse. Neither the idea itself nor the objectives that it seeks to achieve are entirely clear. Yet new rules for the market and for consumers are already under way and will undoubtedly have to be adapted to. Merchants are already facing an obligation to accept digital euro payments, while consumers who have not yet started using the instrument are already anticipating restrictions. Thus, it may be very challenging to navigate the road ahead.

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