The Digital Euro: A Blessing or a Curse? Part 2 – Disadvantages, Dangers, and Next Steps

The rise of Central Bank Digital Currencies (CBDCs) did not happen out of nowhere. As early as 2018, concerns arose about the decline of cash and citizens' dependence on private banks. Following a motion in the Dutch Parliament, the Scientific Council for Government Policy (WRR) released a report with recommendations in 2019. The primary recommendation was the establishment of a new public savings bank as an alternative to deposits with commercial banks such as Rabobank, ABN Amro, and ING, and the introduction of more restraints on money creation and credit provision. However, the public savings bank was never established, and the government, partly on the advice of DNB and the ECB, leaned toward the creation of a digital euro, which was designed to alleviate some of the identified issues. To understand why, I need to provide more context about how our current system works and where the interests lie.

The trend of disappearing cash is strongly driven by policies of banks and payment companies to discourage cash payments. This makes citizens even more dependent on digital bank balances with private banks. This is advantageous for the banks because, without a digital alternative to a bank account, banks are guaranteed funding through savings. This allows them to finance themselves more cheaply than if they had to raise money on the market like other businesses. This changes when citizens can suddenly place their savings with a public bank, backed by the state and without the risk of bankruptcy. The banks understandably do not want competition from such a digital euro.

Commercial banks use our bank balances (their debts to us) to make a lot of money, and they usually take little to no risk in the process, leading to a 'moral hazard': taking excessive risks where the profits go to shareholders and the losses can be shifted to taxpayers through nearly guaranteed bailouts. This was a significant factor in the 2008 financial crisis. That crisis, in turn, led to a reaction: the creation of Bitcoin by Satoshi Nakamoto in 2009 and the accompanying blockchain technology. That technology eventually led to the invention of various cryptocurrencies, with stablecoins being particularly relevant. These stablecoins, in terms of ease of payment, could compete with regular fiat money (such as dollars and euros). When the first big tech company announced its plans to launch its own currency on a large scale (Facebook with Libra), central bankers woke up, and now most countries are working on their own CBDCs.

Central banks have many choices to make when designing a CBDC, such as retail versus wholesale, whether or not it should bear interest, and more. Some of these choices can work out well, but some have the potential to lead to rather dystopian scenarios. The most significant concern is related to privacy and data protection. The centralized nature of the digital euro can open the door to monitoring citizens' financial activities. However, one step beyond monitoring is the potential for paternalistic control, which becomes possible when digital money is designed to be "programmable." This programmability can lead to personalized monetary policies: high interest rates for you, negative interest rates for your neighbor, based on constantly changing criteria. You can spend your euros on approved products and services, but not on things the government wants to discourage. It starts with something as simple as tobacco products or pocket money that cannot be spent on candy, but it can quickly slide into a centrally managed surveillance state. Moreover, you will also face "parity loss": euros with an expiration date or a limited spending purpose are intrinsically worth less than regular euros.

On the other hand, if you want to keep the option of so-called helicopter money in monetary policy open, a certain degree of programmability is likely unavoidable. The World Economic Forum is in favor of programmable helicopter money (with an expiration date). And if it were up to the Bank for International Settlements (BIS), the central bank of central banks, there would be a lot of programmability to give central banks complete control, coupled with a large new e-ID project (digital identity). However, the BIS also acknowledges the various dangers associated with this, stating: "The combination of transaction, geolocation, social media, and search data raises serious concerns about data misuse and personal safety."

Commercial banks are doing their best to influence the design choices of the digital euro in their favor. It is commendable that Dutch banks are encouraging a societal debate on this topic. This is important because the implications of incorrect choices can have long-lasting and far-reaching consequences. The positions of the banks often contradict the recommendations of the Scientific Council for Government Policy (WRR) from 2019, whose report is worth reading. The information provided by the ECB is also at odds with the WRR's recommendations.

According to the WRR, an alternative to private money would have a 'disciplining effect' on the risk-seeking behavior of banks and 'reduce the dependence of households and businesses on commercial banks for savings, loans, and payment services.' This could then 'stimulate the resilience, innovation, and customer focus of banks.' Customers can vote with their feet (or fingers) and withdraw their money from commercial banks, either through a public deposit bank or by converting it into a CBDC.

The substantive debate about the desirable design choices that we, as a society, should make is finally taking place in national parliaments, rather than in the ivory tower of the ECB and its lobbyists. However, this debate started rather late, according to Mahir Alkaya, rapporteur for digital central bank money for the Dutch House of Representatives, in an opinion piece.

In addition to concerns about privacy and the erosion of the anonymity of cash transactions, there are also concerns about cybersecurity and increased dependence on digital systems, as well as concerns about the stability of the financial system. During financial crises (when citizens lose trust in banks), a sudden rush to digital euros can lead to unwanted volatility and systemic risks. Ironically, the existence of a secure fallback location can trigger or worsen a 'bank run.'

The ECB is currently on a course, in terms of design choices, to create digital public money while barely disrupting the hegemony of commercial banks. The current proposal from the European Commission includes two crucial elements:

Central bank accounts that citizens can hold directly with their central bank will:

Not bear interest

Have a maximum balance of 3,000 to 4,000 euros per citizen.

In addition to a maximum balance per citizen, there is also consideration of a maximum limit on the number of transactions per period. In short, the ECB wants the digital euro to be 'successful, but not too successful.' These design choices make the digital euro an impractical means of payment that is not suitable for saving. The added value seems limited from the outset, making it difficult to convince European citizens of its usefulness. However, with different design choices, that added value could indeed be realized, so it does not remain a solution in search of a problem.

Returning to the aforementioned programmability of the new digital currency, with spending restrictions, the ECB explicitly states that this will not happen, and state-of-the-art security and privacy techniques will be applied. However, the risk remains, at least in my opinion, that future rulers may think differently. It seems undesirable to me that more authoritarian leaders might use the digital euro to control citizens' behavior. This concern could be significantly reduced by choosing a technological basis in the design phase that makes such a future change impossible. Privacy-by-design, irreversible, as some cryptocurrencies also have. In a recent interview on a BNR podcast, the DNB manager was asked about this. The somewhat reassuring answer was that 'technically, everything is possible, but we do not have this on our agenda now, and it is not relevant at the moment.'

So, the proposal for the digital euro is on the table. What's next? It is now up to the (democratically elected) European Parliament to review the proposal from the (non-elected) European Commission, primarily based on recommendations from (non-elected) ECB members, and to consider the substantive criticisms from independent experts and think tanks.

The digital euro offers some potential benefits, particularly access to a safe haven with public digital money. However, it also brings significant challenges and concerns, especially regarding privacy, security, and financial stability.

The decision to introduce a digital euro, and how to do it, must be carefully considered, with design choices often requiring a balance between various societal interests. This calls for a broad political debate where contributions to policy objectives and the impact on financial stability can be assessed. It is crucial for policymakers, the ECB, and other stakeholders to work together to create a stable, secure, and inclusive payment system that serves the needs of all European citizens while preventing a potential transformation into a future surveillance state.

If you find this interesting or want to participate in the discussion about CBDCs in general or the digital euro in particular, contact Paul Helmich via Highberg or on LinkedIn.