The Digital, Programmable Euro: Statement by the FinTech Council of the German Federal Ministry of Finance (Unofficial Translation)

On July 23, 2020, the FinTech Council of the German Federal Ministry of Finance (German: FinTechRat des Bundesministerium der Finanzen) published a statement about the digital, programmable Euro. With this article, we provide an unofficial translation of the German version of the paper with the goal to make the content also available to non-German speaking readers. More information can be found on the website of the German Federal Ministry of Finance. The PDF document can be found here. — Authors of the unofficial translation: Philipp Sandner, Jonas Gross

Abstract

The purpose of this document is first to define the term ‘digital, programmable Euro’. Due to the increasing demand for a programmable Euro, we explain the reasons why the programmable Euro is beneficial e.g. for the industry and end users. The main benefits are increasing efficiency in cross-border payments, automation, integration of delivery versus payment in one platform, and enabling micropayments. The use of the programmable Euro is particularly beneficial in the context of the machine economy — the next stage of the digital transformation — especially for Germany (keywords: autonomous driving, Industry 4.0, Internet of Things). In the following, different approaches are presented how the digital, programmable Euro could be issued and implemented. Here, variants of central bank digital currencies (CBDCs) play a role as well as the programmable Euro issued by private institutions, such as commercial banks, e-money institutes, or unregulated entities.

We further explain that China is currently leading the way in the development of an own digital currency and that, despite the importance of this topic for the domestic industry in Germany and Europe, the progress is currently too slow. A necessary step is to initiate a roundtable with industrial companies, retailers, associations, commercial banks, the German Bundesbank, and the European Central Bank (ECB). These players will use the programmable Euro later on and have so far only been partially involved in the discussions. Furthermore, a European legal framework for the digital, programmable Euro has to be established. The implementation and introduction of a digital, programmable Euro have to be approached with similar ambitions in terms of scope and speed of implementation as the Libra project initiated by Facebook to give the programmable Euro the appropriate significance. In this respect, efforts around the programmable Euro and its application in Germany and Europe must be intensified considerably.

Preamble

This document explains the reasons for the introduction of a digital, programmable Euro based on blockchain technology. Furthermore, various concepts will be presented and discussed on how such a blockchain-based digital, programmable Euro can be issued, accessed, and used. In the following, it is assumed that blockchain technology is the appropriate technological basis for the digital, programmable Euro. Therefore, this document does not compare existing (i.e., centralized) systems with decentralized blockchain systems. Although this assumption may be challenged, the following three aspects show that this assumption is plausible:

• Firstly, numerous studies analyze the advantages of blockchain-based systems over existing centralized systems in detail. Examples are publications by the Bank of England (2020), Consensys (2020), Riksbank (2020), ECB (2019a), OMFIF, and IBM (2019), Committee on Payments and Market Infrastructure (2017) and Deloitte and Monetary Authority of Singapore (2017).
• Secondly, the world’s most prominent projects addressing the digitization of money have also mainly chosen blockchain technology as their underlying technology. These projects include the already well-progressed central bank digital currency (CBDC) efforts of the Swedish and Chinese central banks and the Facebook-initiated Libra project. These initiatives aim to bring existing fiat currencies on blockchain systems and might go live within the next few years. Less progressed, for example, are projects by the Banque de France, the Deutsche Bundesbank, and the European Central Bank (ECB). However, also, these institutions conducted initial pilot tests or are in the process of setting up prototypes based on blockchain technology.
• Thirdly, Chapter 2 explains in detail why blockchain technology is a suitable technological basis for the digital, programmable Euro.

Based on these reasons, it is plausible to assume that blockchain technology is a suitable choice for the infrastructure of the digital, programmable Euro, and thus for the payment system of the future.

1. Introduction

1.1 Cash and electronic money

Today, the Euro exists in the form of cash and as electronic money deposited at financial organizations, such as banks and central banks. In the following, we use the term ‘electronic money’ explicitly for today’s electronic forms of the Euro to clearly distinguish electronic money from so-called ‘digital money’. As one form of digital money, the digital Euro, which is more and more demanded in Germany and Europe, mostly refers to the Euro based on a blockchain system. In concrete terms, this means that distributed ledger technology (DLT) would be used as a platform to organize ownership of Euro amounts. DLT is a family of innovative, decentralized technologies, of which blockchain technology is the most prominent one. Blockchain technology, in a narrow sense, is the technological basis of the crypto assets Bitcoin and Ether. For the sake of simplicity, we will speak of ‘blockchain technology’ in the following, but we refer to the entire technology family of DLTs, i.e., blockchain technology in a broader sense.

1.2 The digital Euro and the programmable Euro

In addition to the digital Euro, some experts also demand the programmable Euro. Although the two terms are often used synonymously, there is a significant difference. The digital Euro refers to the mere management of ownership of Euro amounts, analogous to a bank account with a money transfer function. Accordingly, today’s business transactions consist of the delivery of a good or a service and a separate payment process. Both sub-processes have so far been managed in different IT systems so that business transactions based on today’s system architecture are relatively slow and error-prone compared to a blockchain system.

Using blockchain technology, money will become ‘programmable’ and enables the integration of delivery processes and payment transactions in one single platform. Therefore, payment transactions can follow a certain logic and can also be executed automatically. Today, there are already automatic processes that manage money flows in conventional database systems, for example, standing orders and interest payments. However, the use of blockchain technology leads to significant efficiency gains, since even complex business processes can be implemented relatively easily via smart contracts — partly only with a few lines of code. Furthermore, a higher degree of automation can be reached, and the efficiency of existing processes can be improved considerably by enabling real-time payments and by the integration of delivery and payment.

Smart contracts enable the correct and automated execution of contractual agreements. Payment processes are often associated with the fulfillment of these agreements. The Euro is required in a programmable form to fully automate these agreements, regardless of the underlying Euro amount.

2. Reasons for the programmable Euro

There are numerous reasons for the introduction of a blockchain-based digital, programmable Euro. The main reasons are shown in Figure 1. Note that existing systems may partly perform at least as well as blockchain systems in terms of some aspects (e.g., real-time payments). However, only blockchain-based systems unite all the benefits described below. Existing payment systems are not able to fulfill these aspects simultaneously.

Figure 1: Reasons for the programmable Euro

2.1 Cross-border payments and trade finance

Within the SEPA area, money transfers can sometimes be executed within one day, and sometimes even within a few hours. Cross-border payments (SWIFT Global Payments Initiative, correspondent banking system), however, sometimes take several days to process and settle — not necessarily between banks but between end customers. This inefficiency applies in particular to remittances to another currency area or payments related to trade finance.

The blockchain-based programmable Euro could be transferred between two transaction partners within seconds to any country. In a globalized world, fast money transfers and low transaction costs — especially for cross-border payment transactions — are an important prerequisite for ensuring the international competitiveness of European companies. This competitiveness is of particular importance for the German economy with its strong export focus. Moreover, this applies not only to transactions related to the export business but also to all other money transfers between foreigners and nationals.

2.2 Automation

Companies seek to optimize all kinds of business processes. Nowadays, as soon as a business process triggers a payment — or complex processes need to be synchronized — “system breaks” typically occur. One example is a securities transaction, where a fax machine is still used frequently. Another example is a contract with a payment obligation, where the account number often still has to be inserted manually. Although this is often due to a lack of integration into ERP/TMS systems, these inefficiencies can also be eliminated by using blockchain technology (see Chapter 2.3).

Finally, an industrial example: In international supply networks, components are often produced in China and shipped to Germany within one day (delivery). The Euro payment, in return, often takes several days or even a few weeks (payment). This also applied to the entire fields of supply chain management, logistics, and also to the production of the future (Industry 4.0).

A programmable Euro enables automating all these processes with inherent system breaks. This applies not only to “pure” Euro payments but also to more complex financial processes: Factoring, leasing, sales financing, loans, as well as interest payments can be processed automatically by “programming” the payment flows via smart contracts.

2.3 Integration of delivery versus payment (DvP) and digital representation of assets and rights

In Germany, the Euro is almost always the medium of exchange for a service, a good or an asset. Inefficiencies and risks arise as soon as delivery and payment are not processed at the same time. This can be illustrated by the following example: When securities are bought, these securities have to be transferred as part of the business process (delivery). At the same time, a Euro amount must be transferred as the respective payment. This shows that the ownership of securities must be matched with the ownership of Euros “across domains”. For securities, these processes today take several days until the legally binding and risk-free finality is achieved. In the case of the transfer of GmbH shares or real estates, the respective transaction is often completed after several weeks in the sense of absolute finality.

Another argument in favor of using blockchain technology in the context of a digital Euro is that delivery versus payment, e.g., for a good or service, can be organized on integrated platforms. With today’s technologies, the time required for securities settlement, including the payment (delivery-versus-payment, DvP) can only be reduced to a minimum of two days. Blockchain technology allows an instant settlement, e.g., of securities.

2.4 Micropayments and ‘streaming money’

Value units represented on a blockchain are, by definition, divisible in infinitely small units. This so-called fractionalization affects all types of blockchain-based assets, i.e., money, such as the Euro, securities, and property rights. Of course, even if this possibility exists technically, regulations may prevent its application (e.g., divisibility of a single security into smaller parts may not be legally permitted).

Today, one Euro can only be divided into cents. Blockchain technology enables the transfer of even smaller amounts of money efficiently. Such small amounts will be necessary in the future, for example, if an electric car consumes a fraction of a kWh after a few minutes of charging. Even if sensors could, in the future, sell their data directly as autonomous agents, money in the sub-cent range will have to be transferred efficiently for single data points. Due to the practically infinite divisibility of a blockchain-based Euro unit, the choice of blockchain technology seems reasonable. These advantages also apply to the concept of ‘streaming money’ that refers to the steady flow of money throughout the whole time period, e.g., while a service is used.

2.5 Other reasons

Blockchain technology can also increase the security of payment systems by storing transaction data simultaneously on a large number of different computers. This would make the system more resistant to hacker attacks, as there would no longer be a single point of failure. In addition, blockchain technology ensures that transaction data cannot be manipulated or changed afterward.

3. Use cases for the programmable Euro

3.1 Cross-border payments and trade finance

The efficiency of cross-border payments, which are particularly important for Germany due to its high export and import activities, would benefit considerably from the introduction of the programmable Euro. Cross-border payments are currently mostly inefficient. According to the World Bank, transaction fees for cross-border payments, on average, amount to 7% of the transaction volume (World Bank, 2018); transaction execution often takes up to ten days. By using blockchain technology, payment processing would be quicker and cheaper as counterparty risk could be eliminated, and intermediaries would no longer be required for direct money transfers.

The international market for trade finance is expected to grow to around 50 billion US dollars by 2022 (from approximately 42 billion US dollars today). Germany is the second-largest market in the EMEA area and is expected to grow to a market volume of 3.6 billion US dollars by 2022 (from today’s approx. 3 billion US dollars). Digitization and product innovations play an increasingly important role in trade finance, as current processes in international trade finance are anachronistic. Often more than 20 actors are involved in an import/export transaction and the corresponding processes. Contracts often comprise more than 100 pages and have 10–20 documents that have to be duplicated and transmitted several times in analog form. So far, digitization has hardly taken place in this field. Companies are, therefore, actively looking for innovative solutions, such as blockchain-based transaction platforms, to realize — on average — an efficiency potential of 50% (Deloitte, 2018). However, the need for the programmable Euro is difficult to estimate due to lack of concrete numbers as this topic is too new, and only a few quantitative analyses have been carried out so far. Therefore, government institutions need to provide forecasts for the demand for and impact of the programmable Euro.

However, the following heuristics provide a first tendency about the potential impact and, thus, the importance of a programmable Euro for cross-border payments. In 2018, retail payment systems in the whole EU processed 34 trillion Euros (IT Finanzmagazin, 2019). Assuming that every money transfer took one day to reach finality, the cost of capital, at an interest rate of 3%, amount to 2.8 billion Euros that could be saved by real-time payments.

Another example focuses on Germany’s foreign trade. In 2019, Germany exported goods and services in a volume of 1.3 trillion Euros and imported goods and services in a volume of 1.1 trillion Euros (Statistisches Bundesamt, 2020). Assuming that — on average — payment processing abroad took three days, capital costs of almost 600 million Euros could have been saved at an interest rate of 3%. These figures only capture savings in the cost of capital. Further savings, for example, through automation, have to be added. Note that these figures only provide a first indication of the significance and magnitude of the potential of the programmable Euro.

3.2 Industry 4.0, Machine Economy, Internet of Things, Logistics 4.0

IoT Analytics estimates that by 2025 more than 20 billion devices will be connected to the Internet — three times as many devices as people are living on earth today (IoT Analytics, 2018). Within the field of Internet of Things (IoT), data will be generated, exchanged, and processed between machine and machine (M2M) and between machine and person (M2P). Some of these devices will also participate in payment systems to process machine-related sales and costs. In a few years, streaming money referring to the steady flow of money throughout the whole time period is likely to become relevant as well.

Logistics, supply chain management, and trade finance will merge and become one ecosystem: Under the term ‘Logistics 4.0’, companies will soon be able to realize an automated supply chain that offers customers and partners significant added value through self-monitoring and adaptive logistics. Technologically, such a system will be implemented using a mix of complementary technologies, such as GPS, barcode, and radio frequency identification, on-site and cloud architecture and software. This next era of supply chain digitization optimizes edge computing and IoT to provide automated real-time feedback mechanisms.

The potential for using blockchain technology as a security layer for logistics is also immense. For the use in Artificial Intelligence (AI) driven networks, the application is scalable, transparent, highly secure, and can improve efficiency throughout the entire value chain from storage to delivery and payment. The production sector (Industry 4.0) will be transformed by these technologies and will be connected to payment networks.

3.3 Financial sector and capital markets

In the field of capital markets, there are extensive efforts to directly issue a security in digital form (i.e., to abolish the mandatory obligation of certification (‘Urkundenpflicht’) and to digitize already issued securities. Such efforts demand the programmable Euro to map and process the associated payment flows digitally. This covers stock reconciliation as well as all payments to clients, such as coupons and dividends that become due during this period. Funding and financing activities, such as repo transactions, would also benefit from the programmable Euro.

Another potential field of application for the programmable Euro is foreign exchange trading. Here, currency pairs could be exchanged between trading parties in digital form in real-time. There are also efficiency gains in the settlement of forward transactions (derivatives) if due payments (margin) between different parties can be settled directly and immediately with a digital form of money. Thus, the programmable Euro is also beneficial to increase automation and process efficiency in the field of capital markets, while at the same shortening the settlement cycle.

4. Issuance of the programmable Euro

There are different ways to issue a programmable Euro. The different options are shown in Figure 2. A digital, programmable Euro can be issued either by a central bank or by a private organization, such as a bank, an e-money institution, or an unregulated organization.

If issued by the central bank under the term ‘central bank digital currency (CBDC)’, the programmable Euro would be digital legal tender. This digital currency could either be made available exclusively to specific players, such as banks (wholesale CBDC), or all end users (retail CBDC) — i.e., private users, companies, or the public sector. A retail CBDC could be issued directly by the central bank to the end customer (direct model) or distributed to the end customer via banks. The latter option could be realized as a claim (i) against the bank (indirect model) or (ii) against the central bank (hybrid model). In the future, a ‘machine CBDC’ is also imaginable as a third form of CBDC. In this case, machines would be granted direct access to a programmable Euro issued by the central bank.

Figure 2: Taxonomy for programmable money

4.1 Central bank issues the programmable Euro

The most prominent option is that the central bank issues the programmable Euro. The owner of a digital Euro amount would have a claim on the central bank. In this case, the risk of default would be the lowest since the central bank cannot, by definition, become bankrupt.

Over the past years, central banks have been examining both theoretically and practically the advantages, disadvantages, and the technical feasibility of programmable currencies. A survey conducted by the Bank for International Settlements (BIS) shows that more than 80% of 66 central banks surveyed are taking decisive action on CBDCs (Boar, Holden, Wadsworth, 2020). A (blockchain-based) central bank digital currency in the form of the digital Euro is also discussed in the context of the Euro area (ECB, 2019a; Bindseil, 2020).

A central bank digital currency would provide numerous advantages. For example, it could generate strong efficiency gains and thus cost savings along the value chain. These cost savings include both a reduction of IT and transaction costs in an interbank context and a reduction in the cost of providing central bank money in the form of banknotes and coins to the general public. Further benefits of a programmable CBDC have already been discussed in Chapter 2.

Besides these advantages, there are also several disadvantages. A CBDC can impact the structure, stability, and efficiency of the entire financial sector. It could transform the existing monetary system into a sovereign-money-similar system, whose consequences are difficult to assess. Such a system would emerge if almost all payment transactions were conducted in CBDC. In this case, credit financing would only be possible through the refinancing of banks via capital markets and no longer through money creation. Such a system would impact the flexibility of lending activities and could lead both to an increase in the cost of loans and to a decline in lending activities. Moreover, a CBDC introduction could yield a disintermediation of the financial sector. Note that all these aspects require further analysis.

The following examples of forms of CBDCs serve as a first orientation. However, their implications must be analyzed thoroughly in order to maintain the stability of the current financial system.

4.1.1 Wholesale CBDC: the programmable Euro for interbank and securities trading

The central bank would issue a programmable Euro for interbank and securities trading (wholesale CBDC) to regulated institutions — primarily commercial and retail banks. The central bank would thus provide financial institutions with the appropriate infrastructure and channels for transactions with the programmable Euro. The main advantages of a wholesale CBDC are the reduction of settlement and default risk, potentially optimized (cross-border) payments between financial institutions, and optimized settlement of securities transactions (WEF, 2020; BIS, 2018). Initial pilot projects of wholesale CBDCs have already been tested. For example, the ECB and the Bank of Japan have jointly piloted a blockchain-based application for the settlement of ‘atomic swaps that enable simultaneous and final settlement of trading transactions (ECB, 2019b). In the case of a wholesale CBDC, end customers have no opportunity to hold or use the programmable Euro.

4.1.2 Retail CBDC: the programmable Euro for the general public

In the case of a retail CBDC, access to digital central bank money is extended to customer groups outside the financial sector, mainly to private users and businesses. It should be noted that a retail CBDC will be even more beneficial and efficient if identities are also digitally mapped on a blockchain system (i.e., reporting and commercial register on a blockchain basis). By introducing a retail CBDC, central banks could thus issue a new digital means of payment that would circulate in parallel (as a complement or substitute) to bank money and physical cash and could be used as a means of payment. Unlike bank money, a retail CBDC would not be a claim on a legal tender but would — like cash — be legal tender itself. A retail CBDC could be either interest-bearing or non-interest-bearing.

For a retail CBDC, three distribution models can be differentiated. The CBDC units could be either deposited directly with the central bank or indirectly with an intermediary. If the CBDC units are deposited at the central bank, it could be accessed either directly or indirectly (hybrid model) via digital payment service providers (BIS, 2020).

4.1.2.1 The direct model of a retail CBDC

The first model is the “pure form” of a CBDC. Here, money is deposited directly with the central bank and the central bank manages the accounts The responsibility for client onboarding, especially for Know-Your-Customer (KYC) procedures and Anti-Money Laundering (AML) checks, would thus lie with the central bank. The digital Euro held by customers would constitute a direct claim against the central bank, and the central bank would execute the CBDC transactions.

4.1.2.2 The indirect model of a retail CBDC

In comparison, in the indirect model, retail customers do not interact with the central bank directly. Instead, banks and other financial institutions function as intermediaries. End customers would have a claim against their bank in the form of ‘intermediary CBDC’, which the intermediary must fully back with ‘original’ CBDC.

4.1.2.3 The hybrid or fiduciary model of a retail CBDC

In the hybrid or fiduciary model, as in the indirect model, the end customer does not get direct access to central bank money but uses an intermediary who acts between the end customer and the central bank. In contrast to the indirect model, however, the intermediary only has an administrative function in the execution of the transactions. The end customer acquires a direct claim against the central bank, which he can claim through his intermediary. In contrast to the indirect model, e-money institutions, as well as banks, can act as intermediaries in this case.

4.1.2.4 Evaluation of CBDC models

In January 2020, the ECB designed and published a CBDC model for a digital Euro (ECB, 2019a; Bindseil, 2020). A central element of this model was the issuance of the digital Euro to the general public (retail CBDC) via intermediaries with a two-tiered interest rate. Such an interest rate structure aims to make it unattractive to hold large volumes of CBDC to preserve financial stability.

For the introduction of a retail CBDC, various aspects have to be considered. Access barriers should be low so that the CBDC could compete with other, possibly international and non-regulated, digital forms of money. On the other hand, the introduction of a retail CBDC must not endanger financial stability. This is of particular importance as the economic interdependencies in the financial system are very complex, making unintended consequences of system changes hard to predict.

From this perspective, the first model of a ‘direct CBDC’ for the Euro area can be seen as critical. The ECB has already addressed the risk of disintermediation of financial institutions in the Euro area in previous publications. Besides, administrative tasks are associated with considerable and long-term costs. In this model, KYC and AML checks for each of the potentially millions of customers would have to be carried out by the ECB and, thus, outside ECB’s current core business and area of competence.

4.1.3 Machine CBDC: the programmable Euro for machines

As digitization progresses, it can be assumed that in the future also machines (e.g., autonomous vehicles, sensors, IoT devices) will take part in economic activities independently and thus also conduct payments autonomously. This assumption naturally presupposes that the legal and socio-economic issues associated with autonomous actions by machines have been addressed and solved and that machines have a corresponding digital identity. If these prerequisites are met, M2M payments and payments between persons and machines should be equally enabled for machines to avoid system breaks. Note that machines will not have their own accounts but could instead manage their Euro holdings directly via a blockchain-based digital wallet.

Depending on the digital progress, the need for and design of the programmable Euro for payments involving machines should be examined. It should also be analyzed whether a privately-issued digital Euro or a central bank-issued CBDC would be more appropriate.

4.2 Private organization issues the programmable Euro

As an alternative to an issuance by the central bank, programmable money can also be issued by private organizations. Legally, this is represented by individual obligations, i.e., by private contract law. This category also includes non-public forms of money, such as the Libra token. According to the publication of the adapted Libra concept (Libra 2.0) in April 2020, Libra is both a generic platform for various individual digital currencies and a digital form of money per se (i.e., stablecoins backed by various fiat currencies) (Libra Association, 2020). In this category, a distinction is made between issuance by a regulated organization, such as a bank (e.g., JP Morgan), and issuance by an unregulated organization (e.g., Tether).

4.2.1 Commercial bank money: issued by regulated organizations (e.g., banks)

In this category, a commercial bank privately issues the digital Euro under a regulated framework. Such money, therefore, represents ‘regulated digital money’. First regulated players, such as banks and e-money providers, have already started to issue a blockchain-based programmable Euro. In 2019, first products were introduced, and customers have already started to request such a programmable Euro for test purposes.

In addition, international financial institutions have started to establish their own digital money. One example is the JP Morgan (JPM) Coin, which is still in a conception phase. The JPM Coin is similar to a stablecoin (see below) and is 1:1 backed by bank deposits. The goal of the JPM Coin is to create a proprietary peer-2-peer interbank payment system that will compete with the crypto asset Ripple (XRP) used by some financial service providers. The SWIFT Global Payment Initiative is also likely to be the focus of this institutional token solution. The new Libra concept mainly falls into this category, as the Libra Association is expected to be regulated in the EU.

In the case of an issuance as e-money, e-money regulation must be taken into account. For example, pure e-money institutions can only issue tokens that are 100% backed — in contrast to fully licensed banks, which could theoretically create money out of the issuance. This is a significant advantage of fully licensed banks over e-money institutions, as fully licensed banks could supply the economy with both loans based on conventional bank money and the programmable Euro.

4.2.2 Private stablecoins: issued by unregulated organizations

Unregulated private organizations can also issue digital money. Note that they do not issue currencies accepted as legal tenders, but “only” money. Such blockchain-based digital money backed by fiat currencies and issued by unregulated organizations is referred to as private stablecoins.

4.2.2.1 Private stablecoins backed by one fiat currency

Private stablecoins such as Tether, EURS, or USDT exert a relatively high degree of price stability as they are pegged to the base currencies Euro or US dollar. In this context, commercial bank money is used as collateral, not central bank money. Price stability is ensured by liquidity management on crypto exchanges and is usually successful. Private stablecoins attempt to imitate fiat currencies and can also be backed by fiduciary accounts in which fiat currencies are held as collateral. There is considerable counterparty risk as, from an accounting perspective, the customer has a claim on the (unregulated) issuer. The most prominent example of a fiat currency-backed stablecoin is Tether, with a current market capitalization of 9 billion US dollars.

However, such stablecoins are not used by industrial companies due to the following reasons: First, stablecoins are currently unregulated, so risk-averse companies are reluctant to use an unregulated — and therefore risky — means of payment. Ultimately, a company seeks to transact in the local currency, but not in an unregulated — albeit price-stable — means of payment. Secondly, there are other considerable risks, such as counterparty and liquidity risk.

4.2.2.2 Private stablecoins backed by a basket of currencies

The most prominent stablecoin project is Libra, even if the system — as of today — is not in operation yet. Libra was announced in summer 2019 by the Libra Association, a consortium of more than 20 companies including Facebook’s subsidiary Calibra (Novi), and could potentially go live at the end of 2020. According to the initial concept (Libra 1.0), however, Libra is not designed to become a ‘classic’ stablecoin that is backed by only one fiat currency. Instead, Libra will be backed by a basket of different fiat currencies and short-term government bonds (multi-currency stablecoin).

Following intensive discussions with regulators and governments, the Libra Association published an updated Libra 2.0 concept in April 2020 and announced conceptual changes. In addition to a multi-currency stablecoin backed by various fiat currencies and government bonds, there will also be various so-called single-currency stablecoins. This includes a Libra Euro, which will be backed by Euros and Euro area government bonds, and a Libra US Dollar, backed by US dollars and US government bonds, respectively. Another significant change is the introduction of a compliance strategy to meet regulatory requirements. The Libra project shows how quickly hundreds of millions of users could be reached and shows the benefits of using a blockchain-based transaction system. Libra is, therefore, perceived as a “game-changer”.

The classification of Libra must be carried out cautiously. In addition to being classified as programmable money issued by a regulated organization, Libra can also be regarded as issued by an unregulated organization. Such a classification would be the case if the multi-currency Libra stablecoin was to be used in developing and emerging countries, where the Libra Association is not regulated. Libra can, therefore, not be classified unambiguously due to its hybrid character. Instead, it depends on the perspective of the jurisdiction, whether Libra would be considered issued by a regulated or unregulated entity.

4.2.2.3 Private stablecoins backed by crypto assets

In 2019, stablecoins backed by crypto assets (especially Ether) had become increasingly important alongside the growing field of Decentralized Finance (DeFi). DeFi is an interconnection of various smart contracts, whereby each component takes on own functions of the capital market. The interconnection creates a fully automated capital market, which is currently capitalized with approximately 1 billion US dollars (Defi Pulse, 2020). DeFi applications are primarily developed based on the Ethereum platform. Crypto-backed stablecoins are an integral part of such applications. The most popular stablecoin in DeFi is the DAI token of the project Maker DAO, which is linked to the US dollar.

Due to its price stability, capitalization, and the growing ecosystem, it can be assumed that DAI will be used in the future for various applications. As DAI constitutes programmable money, it could be used to automate payment flows. However, its widespread use in the industry is doubtable, as DAI is not a currency. Moreover, DeFi is still a small and young ecosystem, so that DAI is not yet ‘mature’ enough for large-scale use.

4.3 Interoperability of the programmable Euro

In addition to design considerations of the programmable Euro, technical and governance-related aspects must also be taken into account. Given the importance and diversity of payment transactions, the interoperability of the programmable Euro with a wide range of systems must be ensured: Interoperability with the SWIFT system, connection with legacy systems, transfer of the digital Euro to settlement systems or digital marketplaces to carry out integrated payment and delivery versus payment processes (DvP), conversion of the digital Euro into cash, integration into companies’ ERP systems and, finally, the use of tokens from different issuers on different blockchain infrastructures. It can be assumed that a large number of proprietary private-sector solutions will emerge that initially do not exhibit a high degree of interoperability.

It should be ensured that the digital, programmable Euro can be integrated into relevant business processes in order to avoid “system breaks”. An example of such a process is the “pay-per-use” purchase of sensor data: In this context, it must be ensured that the Euro is available on various IoT platforms that collect and process the data. In the field of trade finance and securities trading, it must be ensured that DvPs can be run efficiently as atomic transactions, as well.

It is, therefore, necessary to ensure that the platform for the programmable Euro provides open interfaces, possibilities for the integration with other systems, and also possibilities for transferring the digital Euro to other platforms. It is not sufficient to only create the technical possibilities — appropriate processes must also be implemented, e.g., with respect to governance.

Today, primarily technical issues regarding scalability and high setup costs of a new digital capital market infrastructure hinder the development of blockchain applications in the financial sector. Other obstacles are the lack of harmonized regulation across Europe, a lack of understanding of the numerous players involved, and that benefits of future use cases are not always obvious.

5. Conclusions

5.1 Central claim: Promoting dialogue and uniform regulatory framework

The programmable Euro could be the result of a long-term transformation process, which would consist of many small steps. Policy-makers should also support private initiatives by banks and e-money institutions in particular. In the short-term, innovative solutions are more likely to be driven by the private, not by the public sector. The challenge for the private sector is to establish a common position and standard quickly, which has not been possible so far.

This process should be started immediately through an intensive dialogue involving all stakeholders. This includes, in particular, the industry as a user of the programmable Euro. In addition, a uniform regulatory framework has to be established.

5.1.1 Necessity of a broad dialogue between finance, industry, retail and institutions

In the current debate about the digital Euro, the ECB is cooperating with various other central banks, which we highly welcome. However, the ECB has so far not sufficiently exchanged views with other stakeholders, which are significantly affected by the introduction of a digital, programmable Euro. These include, for example, banks and other financial organizations that might intermediate the digital Euro to end users in the same way as they distribute cash to the end users today. To date, also the potential users of a programmable Euro, such as industrial companies or retailers, are hardly involved in the dialogue. programmable Euro, such as industrial companies or retailers, are hardly involved in the dialogue. The ECB should develop the concept of how to implement the digital Euro in close coordination with all other players in the European market for financial services and payments. Above all, the involvement of end users in the dialogue is necessary — i.e., especially industrial and trade associations, industrial companies, etc. — as the programmable Euro will create entirely new business models. The digital transformation in certain areas, such as Industry 4.0 and Logistics 4.0, can be lifted to an entirely new level by developing new business models based on the programmable Euro. A roundtable with all stakeholders should be initiated to promote the discourse on the digital, programmable Euro to discuss the perspectives of the different stakeholders. National associations, such as banking and industrial associations, should also be represented. The topic of the digital Euro is by its nature interdisciplinary that stresses the necessity to involve all stakeholders in the dialogue. In Germany, the Federal Chancellery and the Bundesbank can take the lead, at a European level, the European Commission together with the ECB.

Europe urgently needs a cross-industry dialogue to become aware of the threats posed by Asian and US initiatives and to drive the digital transformation forward. The ECB should, together with the national central banks and the European Commission, lead this dialogue. The dialogue must be conducted with the utmost foresight. Existing infrastructures must be questioned, threat scenarios analyzed, and cross-industry actors sensitized for the need for the programmable Euro. The aim of the dialogue must be to maintain — or even strengthen — Europe’s competitiveness in the long run.

5.1.2 Performing test runs of the programmable Euro for different use cases

Test runs of the programmable Euro should be carried out for different applications under the leadership of the ECB and the European Commission, with the participation of associations, industrial partners, and the scientific community to gain experience and to be able to quantify the economic impact of a programmable Euro. The pilot programs should result in a learning process based on concrete use cases, which must go beyond the financial sector, to derive regulatory, political, and technological requirements.

5.1.3 Establishing a single regulatory framework

At the European level, there is an urgent need to create a uniform and harmonized regulatory framework for the digital, programmable Euro. The European Commission should take action in this regard. A roadmap for the EU would be desirable. Such regulatory framework concerns an EU-wide uniform regulatory classification of private stablecoins as well as the treatment of crypto assets in general and their custody in particular. If no single regulatory framework is established, regulatory arbitrage between individual EU member states can be expected. Unfortunately, the necessity of the programmable Euro has not yet been sufficiently well understood at the supranational level. The focus should lie on the value-added for cross-border payments (i.e., related to export and import activities), securities transactions, and the use in the growing machine economy (i.e., Industry 4.0, autonomous driving, logistics, Internet of Things).

5.2 Global interest in the blockchain-based programmable Euro

5.2.1 Blockchain as the technological basis

In the public debate, blockchain technology is often proposed as the technological basis for the introduction of a digital Euro. Although, in theory, a digital Euro can be implemented on a conventional database system, as well, the advantages of blockchain technology in the context of a digital programmable Euro are particularly significant (see Chapter 2). Central banks use blockchain technology for their prototypes of central bank digital currencies (e.g., the central banks in China and Sweden) and blockchain-based Euro test transactions by the first private companies (in Germany, France, and Iceland) reveal the advantages of blockchain technology in this context.

5.2.2 International interest in blockchain-based currencies

Within the last year, numerous countries and jurisdictions have announced that they will introduce central bank-backed digital currencies for the general public in the near future. According to a survey by the Bank for International Settlements (BIS), 10% of worldwide central banks plan to issue such digital central bank currencies within the next 1–3 years (Boar, Holden, Wadsworth, 2020).

5.2.3 China as a pioneer

China is currently testing a digital version of the Yuan; the Swedish central bank has also announced a prototype for a digital blockchain-based e-krona. Central banks mainly aim to increase the security and efficiency of payment systems substantially by the introduction of a digital currency.

5.2.4 Experiments in Europe and the USA

The direction is clear: more and more central banks are experimenting with (blockchain-based) digital currencies and plan to introduce CBDCs. The Deutsche Bundesbank fand the ECB have already analyzed the digital Euro in numerous experiments. Both the Bundesbank and the ECB have recently set up internal CBDC task forces to intensify efforts around the digital Euro. Nevertheless, it should be noted that the Chinese central bank is probably two to three years ahead of European initiatives. Developments in the US, like those in the Euro area, are only in an experimental stage and are years away from market introduction.

However, current market developments require rapid and decisive action. In various markets (USA, China, Scandinavia, etc.), not only regulated financial institutions are active but also private initiatives and “big tech” organizations. New global and unregulated — or partly regulated — digital forms of money could impose new threats for the stability of financial markets and entire economies. In this respect, it should be ensured that privately-issued digital money from unregulated companies does not develop from a mere unit of account into a de facto currency with its own money creation.

5.3 Implementation models for the programmable Euro

5.3.1 Wholesale and retail CBDC: First access for banks, then for everybody

The ECB could introduce the digital Euro in a two-step process: Since the digital Euro, as a pure wholesale CBDC, does not interact with the end customer, a wholesale CBDC could be developed, tested and implemented for transactions between the central bank and financial institutions in the background, without the general public being affected by any difficulties that might arise.

Once the digital Euro has been successfully implemented as a wholesale CBDC, the interface to the customer could be extended sequentially via existing touchpoints. This includes access to the digital Euro for the private end users as well as for businesses.

5.3.2 Private sector solutions by commercial banks and financial service providers

Complementary, solutions for the digital, programmable Euro can also be provided by regulated financial institutions and are already in their initial stages. These solutions are based on commercial bank money and not on central bank money and would be available for the clients of the issuing institutions (private customers, corporate customers, partner banks).

The programmable Euro can also be issued by financial institutions under their e-money license and could, therefore, provide a programmable Euro for the machine economy in a timely manner. Therefore, machines could be equipped with their own wallets and carry out micropayments themselves. It can be assumed that these necessary innovations will be offered by the private sector more quickly and will not be developed within CBDC solutions by the ECB.

5.3.3 Design principles of the programmable Euro: stability and anonymity

The following principles are essential for the design of the programmable Euro: First, the stability of the financial system has to be ensured — even in times of crisis. The digital Euro could make it easier for end users to exchange all their deposits for the digital Euro, for example, in times of economic distress. Such ‘bank runs per click’ can threaten the stability of the financial system. Therefore, effective mechanisms have to be implemented in a digital Euro system to prevent disintermediation of the banking sector.

Furthermore, societal issues and concerns should be taken into account: The introduction of the digital Euro impacts various socio-political issues, such as the anonymity of payments, while at the same time combating money laundering, or state interventions, for example, based on access to sensitive digital transaction data.

Remarks

With this article, we provide an unofficial translation of the German version of the paper with the goal to make the content also available to non-German speaking readers. More information can be found on the website of the German Federal Ministry of Finance. The PDF document can be found here.

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