In today’s post, we refer to the extensive work by Philipp Sandner in the field of digitization of the monetary system, distributed ledger technologies (DLT) for digital currencies and blockchain euro.
On 15th of June 2020, Philipp Sandner, professor of Frankfurt Business School and Master’s in Global Blockchain Technologies, published in Medium a letter that proposed a high-level roadmap concerning the digital Euro, an initiative supported by a large and diverse group of experts from across Europe and other countries.
In what follows, we’re going to look into different DLT-based central bank digital currencies’ (CBDCs) projects currently underway, the advantages of implementing a blockchain euro, and the roadmap projected in the letter.
If you’re new to the subject, we recommend you to read up on the differences between cyrpto and banking system to have an overview of blockchain in the private financial services. This article is dedicated to the impact blockchain could have on the monetary system as a whole.
Current Monetary System
The current monetary system is anchored in physical cash being the only legal tender. The backbone of it is central banks, who issue cash in response to the demand of the commercial banks and their customers. However, physical cash represents only a small fraction of the money supply in the existing monetary system.
When speaking about the Euro area, around 87% of the money supply in circulation is commercial bank money, which is used for payments, e.g., via debit or credit cards. That money is recorded in citizens’ current bank accounts. The bank money is tied 1:1 to the value of cash and reserves and can be withdrawn at the same nominal value as cash.
Central bank reserves are another form of central bank money. They are used to transfer liquidity between banks and are not available to the general public. Similarly to physical cash, central bank reserves are a risk-free form of money that is also transferrable digitally.
Central Bank Digital Currencies (CBDCs)
According to this report by Bank for International Settlements (BIS) from January 2020, “some 80% of central banks are engaging in some sort of work, with half looking at both wholesale and general-purpose CBDCs”. Around 40% of the central banks have moved beyond conceptual research to the experimental or proof-of-concept phase. The banks that plan to make a move on CBDCs in the short-run and have developed pilot projects is around 10%, so it’s only a matter of time before the first CBDCs will be introduced.
Distributed ledger technologies, and blockchain specifically, are assumed to be the technological basis for the digitization of the monetary system and the introduction of a CBDC. And we have heard bits and bobs about different central banks looking into the possibility of the launch of their own CBDC.
The first to analyze the introduction of its own CBDC and pioneer the movement was Bank of England in 2014. However, China is likely to be the first developed economy to issue a retail CBDC: in April 2020, a test run of the Chinese CBDC kicked off in several cities where government salaries were paid out in CBDC into the wallets of the public official.
Meanwhile, the Swedish central bank (Riksbank) has also looked into the issuance of a digital version of the Swedish Krona (E-Krona) as a response to the decline in the usage of physical cash in the society and a DLT-based E-Krona prototype is currently underway. The Executive Committee of the Italian Banking Association has recently approved new general guidelines for a CBDC saying that Italian banks are available to participate in projects and experiments of the digital currency of the European Central Bank.
So to sum up, we can say that central banks around the world are thinking about the digitization of the monetary system and the introduction of central bank digital currencies (CBDCs).
Advantages of Blockchain-based Euro
In his article on the inner workings of blockchain euro, Philipp underlines that a DLT system designed for central banks has a slightly different structure than the DLT networks designed for cryptocurrencies. The main benefits of the blockchain-based euro are related to its immutable nature by bringing more:
Security – By storing transaction data simultaneously on a large number of computers, DLT would make the system more resistant to hacking.
Resistance to manipulation – The fact that the data is stored on several computers guarantees that it is impossible to manipulate it afterwards.
Automation and programmability of money – Smart contracts and peer-to-peer payments would become way more accessible when processed in euros and not unregulated crypto assets. That in turn would enable Internet of Things (IoT) devices to offer services on a pay-per-use basis. In the context of the machine economy, this means that the devices could transfer the money directly from wallet to wallet autonomously.
Efficiency gains – This system would bring along significant gains in efficiency by simplifying the payment system. Even between different currency areas, a DLT system would enable immediate settlement at very low transaction costs.
Wholesale CBDC vs Retail CBDC
Before we jump into the blockchain euro, we should explain that there are two ways a central bank can issue a digital currency: wholesale CBDC and retail CBDC.
Wholesale CBDC is a digital token that could only be used for interbank payments and held by financial institutions. The main goal of a wholesale CBDC is to increase the efficiency of the interbank market.
Retail CBDC, on the other hand, is a new digital means of payment meant for the general public. It’s a token that could exist alongside physical cash and commercial bank money. The main goal of a retail CBDC is to provide a solution to digitizing physical cash.
So, if we now speak about the Euro, it would mean significant changes in the monetary system as it will permit the central bank to the one who issues the digital money. In general, when we say that central banks are looking into and researching about CBDCs, we refer to retail CBDC.
Roadmap for Digital Blockchain-Based Euro
The roadmap proposed by Philipp Sandner and signed and supported by a long list of digital and financial experts is not focused on a wholesale central bank digital currency, but a digital means of payment that can be used as a cash equivalent. It’s goal is not to replace traditional cash but to complement it.
In the long-term perspective, the goal is for the digital Euro to be a central bank-issued currency (CBDC). However, most probably the digital programmable Euro will be needed in short-term. To tackle the long and demanding project that this issuance entails, the letter proposes a public-private partnership to take advantage of the best of both sectors whilst providing short-term solutions while meeting current and future demands as they arise.
Schematically the process is as follows:
To sum up, the digital Euro is an opportunity that would guarantee the competitiveness of the region in the digital age. DLT technology and blockchain in particular can be deemed the appropriate framework to achieve the benefits we discussed above and open up space for new business models.
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