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On June 28, 2023, the European Commission introduced the digital euro package. This package consists of several proposed regulations aimed at making the digital euro legal tender and provides a framework for its implementation.
This regulatory analysis will examine this digital euro package. It will review the legislative history and background to the digital euro and provide an outline of the legislative proposal by the European Commission. Finally, it will examine the potential commercial and regulatory implications on the payments and crypto industries.
Setting the Scene
The journey towards the digital euro started in late 2020 when the European Central Bank (ECB) decided to launch a public consultation. The consultation received a record number of responses, with more than 8,200 in the three months it was open, with more than 94 percent of responses coming from private individuals.
The central bank published a report outlining the results of its consultation in April 2021. In broad terms, the report stated that respondents were most concerned about the privacy aspect of using a digital euro, preferring that it be integrated into current payment infrastructures. The responses largely agreed that current hardware could support its implementation and believed that in theory the digital euro could facilitate better international payments.
Following the results of the consultation, the ECB then officially launched its digital euro project in mid-2021, beginning with a 24-month investigation phase, which was designed to engage with stakeholders and decision-makers, and form an adequate legislative framework to launch the digital euro.
The investigation phase involved the ECB undertaking engagements with various stakeholders, including the appointment of a 30-member Market Advisory Board consisting of experienced professionals. This board, which met quarterly and comprised finance professionals from both banking and payments companies, was created to provide the ECB with insights into the potential operations and challenges of implementing a digital euro.
The ECB also commissioned consumer research into payment preferences and began a digital euro prototyping exercise in late 2022, which would “allow market participants to develop frontend prototypes that can be integrated with the back-end infrastructure developed by the Eurosystem”.
Throughout this period, the ECB published regular progress reports on the investigation phase in the lead up to the European Council’s release of the legislative proposal on the so-called “payments D-Day”.
The Proposal
The European Commission’s digital euro package consists of several proposals, aimed at making the digital euro legal tender and establishing the framework for its operation and implementation. Both these aspects will be examined.
Creating Legal Tender
The commission intends to enact two regulations to address the issue of the digital euro being recognised as legal tender: the “proposal on the establishment of a digital euro”; and the “proposal for a regulation on the legal tender of euro coins and banknotes”.
In the “proposal on the establishment of a digital euro”, the commission states that the digital euro is legal tender (Article 7), making it unlawful for a payee to refuse the digital euro for the settlement of a monetary debt, with exemptions only for specific circumstances, such as small businesses and domestic circumstances (Article 9).
The commission also lays out the territorial scope of the digital euro (Article 8) and emphasises that it is interchangeable at par with physical euro notes and coins (Article 12).
Although the vast majority of the “proposal for a regulation on the legal tender of euro coins and banknotes” deals with access to coins and banknotes, which the commission states it wishes to guarantee for the future, the primary clause of relevance is Article 15, which states that digital euro units will be exchangeable at par for notes and coins. This means that effectively physical and digital euros are one and the same.
By making the digital euro interchangeable at par for euro banknotes and coins, the commission has cemented its intention to make the digital euro a retail central bank digital currency (CBDC). This is a different approach to a number of other jurisdictions, including Singapore, Australia, Malaysia and South Africa, which are currently working on a joint project with the aim of using their digital currencies for wholesale settlement purposes.
The Framework for Implementation
The bulk of the framework for the implementation of the digital euro is contained within the “proposal for the establishment of the digital euro” within Chapters IV to IX, each of which will be examined in this section.
Chapter IV
Chapter IV of the proposal defines the distributional responsibilities of payment service providers (PSPs) with regard to the digital euro. The chapter outlines to whom PSPs may distribute the digital euro (Article 13(1)), including:
- Citizens and residents of the member states.
- Visitors.
- Third country nationals in countries that have monetary agreements with the EU.
The chapter outlines the requirements of a digital euro account, including requiring a PSP to ensure that it is able to be funded and defunded (which is where a user exchanges cash or other funds for digital euros and vice versa) from a non-digital euro account (Article 13 (2),(3)) and allow users to defund their excess digital euros to a non-digital euro account (Article 13(4)). It also requires a PSP to provide free and accessible information on the digital euro account products it offers (Article 13(8)).
The chapter states that PSPs must make basic digital euro accounts accessible to all eligible applicants (Article 14(1)), provide support for vulnerable clients (Article 14(4),(5)) and take steps to ensure that persons who do not wish to possess a digital euro account are still able to access payments made in digital euros, whether this be through digital or physical means (Article 14(3)).
Chapter V
Chapter V delves into the objectives of the European Council for using the digital euro as a store of value and a means of payment.
The Council reiterates that it wishes to limit the use of the digital euro as a store of value and instead use it primarily as a means of payment (Article 16(1)). To achieve this goal, the Council proposes individual holding limits for the digital euro (to be set later on the basis of parameters set by Article 16(5) that will apply to all users (including visitors) and will be spread out across all accounts (Article 16(3-7)), resulting in users of the digital euro not being able to exceed the holding limit regardless of how many digital euro accounts they hold. The Council also specifies that users cannot earn interest on digital euro holdings (Article 16(8)).
The Council then answers the question of fees by stating that users must not be charged for using their digital euro accounts. Charges levied by PSPs (if any) should only be borne by merchants (Article 17(1)(6)). The same chapter also outlines the fee structure for PSPs, limiting when and how many fees they can charge to merchants (Article 17(2-5)).
By imposing holding limits and restricting interest, the European Council is intending the digital euro be used solely as a transactional tool rather than a store of value. Although there is a fee methodology in place, it still remains unclear if this will ultimately result in lower transaction fees or rates compared with more traditional payment methods.
Chapter VI
Chapter VI deals principally with the distribution of the digital euro. In addition to users located in member states, PSPs will be able to distribute the digital euro to users in member states that do not use the euro (Article 18) and even to users residing in third countries (Articles 19-20).
However, the European Commission emphasises that this may only happen where the regulators of those countries have agreements in place with the ECB and have adequate equivalent regulatory safeguards, such as data protection legislation and anti-money laundering rules (Articles 18-20).
The regulation also makes provision for cross-currency payments using the digital euro subject to agreements between countries (Article 21). This is potentially significant as the digital euro has often been touted as a way to reduce the costs and increase the speeds of cross-border payments. However, current CBDC on cross-border settlements, such as Project Dunbar and Project Nexus, are currently limited to wholesale cross-border settlement and it remains unclear how the digital euro, being primarily a retail payment tool, will fit.
Chapter VII
This chapter deals with the technical features of the digital euro and is broken down into several sections.
Section 1 of the chapter specifies the requirements of a digital euro account, including accessibility and account numbering requirements. It also reiterates the functionality requirements stated in Chapter IV, including mandating the availability of offline digital euro transactions.
Although the section permits conditional digital euro transactions (Article 24), it also expressly states that the digital euro cannot be regarded as programmable money (Article 24(2)), preventing PSPs from limiting the use of the digital currency for “buying specific types of goods or services”, or “subjecting currency to time limits after which they are no longer usable.”.
Section 2 deals with the modalities of operations, particularly interoperability. In Article 25, the regulation requires that frontend interfaces of the digital euro be interoperable or integrated with the European Digital Identity Wallet programme, which allows EU citizens to quickly and securely prove their identity and store important documents digitally.
The European Commission also plans to direct the ECB to ensure interoperability between the governing standards of the digital euro and other payment mechanisms (Article 26), in addition to requiring users to be given the choice between private or ECB-built frontend systems (Article 28).
This focus on interoperability extends to the necessary hardware and software to facilitate the use of a digital euro. In Article 33, the commission mandates manufacturers of mobile devices and providers of electronic communication services to ensure interoperability of hardware and software features for frontend digital euro providers and the European Digital Identity Wallet.
This focus on the consumer also extends to account switching, with Article 31 mandating PSPs to allow consumers to switch digital euro providers with minimal fuss. The same article also makes provision for account switching in the event a provider goes out of business, ensuring that a customer will always be able to access any remaining digital euros.
The rest of the chapter deals with the general operation of the digital euro, including dispute resolution (Article 27), settlement requirements (Article 30), compliance with sanctions (Article 29), and the implementation of general fraud detection and prevention mechanisms (Article 32).
Chapter VIII
This chapter lays out the privacy and data protection requirements of the digital euro, which respondents highlighted as some of their primary concerns in the ECB's initial consultation
PSPs, the ECB and their respective service providers are considered data controllers in the context of the data they process and are subject to the general data processing law and exemptions that arise from processing such financial-related data (Articles 34-36).
Of note, Article 34(1) states that the collection of data for offline digital euro transactions will be limited to funding and defunding of digital euro accounts only. Essentially, this provision means that any digital euro transactions made offline would, in theory, be totally anonymous. Although this squares with the European Commission’s aim to make the digital euro as accessible and attractive as conventional euros, it remains to be seen how big the transaction limits for offline digital euro payments will be and how big an anti-money laundering risk this may pose.
Another noteworthy clause is Article 35(8), which allows the ECB to establish a single mechanism/database in agreement with other central banks that PSPs can access to enforce digital euro holding limits. Although the clause states that the ECB will implement “appropriate technical and organisational measures including state-of-the-art security and privacy-preserving measures to ensure that the identity of individual digital euro users cannot be inferred from the information accessed via the single access point by entities other than payment service providers whose customer or potential customer is the digital euro user”, it remains to be seen exactly what form this will take, how complicated it will be or whether it will work.
Chapter IX
The final substantive chapter of the proposal deals with the anti-money laundering and counter-terrorism funding (AML/CTF) requirements applicable to the digital euro. Consisting of one article, it defines “funding” and “defunding” data.
This article states that PSPs and the ECB are prohibited from recording transaction data for offline digital euro transactions, effectively rendering them anonymous (Article 37(2)-(6)). This is an extension of the ban on transaction data monitoring for offline transactions discussed in the previous chapter.
This could potentially put the digital euro on the same level of anonymity as traditional paper-based cash when it comes to offline transactions. Although PSPs and the ECB are permitted to collect data on the funding and defunding of digital euro accounts, the fact they cannot collect transaction data when a transaction is made offline leaves a large AML/CTF gap. However, the extent of this concern will again depend on the holding and transaction limits, which are not yet known.
What Happens Next?
The legislative proposals will need to be adopted by the European Parliament (see last FAQ). It will then go through the standard EU legislative process. As this has not yet begun, nor has there been any clear indication as to when this could happen, it is still uncertain what the digital euro will look like.
What This Means for Payments Firms
The digital euro presents a variety of opportunities and challenges for payments firms from compliance, logistical and commercial perspectives.
Regarding compliance, the unique challenge of not being able to collect transaction data for offline transactions may present an AML/CTF risk. However, the size of this risk will again depend on the transaction and holding limits imposed by the ECB. That being said, the lack of transaction data monitoring could also mean a reduced compliance burden, as PSPs would only have to perform checks when funding and defunding digital euro accounts of customers that only make offline transactions.
The question of transaction limits also presents a logistical challenge for compliance firms. The European Commission’s aims of imposing a single limit across accounts, while consistent with its aims of making the digital euro a transactional tool rather than a store of value, is dependent on the ECB developing a system that is both accurate and efficient for PSPs to use. The latter is especially significant in light of the digital euro’s aim of reducing transaction times and costs.
The requirement to make the digital euro exchangeable for cash and coins, along with accessibility provisions, presents another logistical challenge for PSPs, as they would need to maintain a physical presence. Although PSPs could simply delegate this to an agent such as a post office, the fact remains that this is a burden that is not imposed on other digital payment operators in the EU, such as digital banks, which are arguably allowed to provide a greater variety of services with no need to maintain a physical presence or use agencies.
In terms of commercial opportunities, a digital euro should in theory reduce settlement times and compliance burdens, therefore reducing costs for PSPs. However, as mentioned above, this is largely dependent on the ECB introducing efficient, cost-effective and workable systems for PSPs to use. The physical presence requirements further add to the burden of costs.
Assuming the use of the digital euro does indeed cost less than traditional payment methods, it still remains to be seen whether these reductions in costs will be passed down to the merchants.
Another potential commercial opportunity for the digital euro is in cross-border payments, which the proposal allows PSPs to make, subject to conditions. The commission argues that CBDCs will reduce transaction times and costs for cross-border payments. The fact that the digital euro is a retail instrument also presents a great opportunity for PSPs to engage with the remittance market.
However, cross-border payments of the digital euro remain dependent on the ECB entering into agreements with other central banks. Even if this happens, it remains impossible to tell which markets these agreements will be signed with and whether these markets are attractive from a cross-border payment perspective.
In short, the digital euro presents a unique opportunity for PSPs to be pioneers in a previously mature European payments market. However, despite the current legislative proposals going a long way towards creating certainty, it remains to be seen whether the ECB’s final product will live up to expectations.
