Adopting ISO 20022 is essential for modernising cross-border payments, enhancing fraud prevention, and ensuring seamless interoperability and efficiency in international financial transactions.
“If you would have asked me 20 years ago if the central bank business model were destroyable or not, I would have said no. Now I’m not so sure.” These are the words spoken by the Deutsche Bundesbank’s president, Joachim Nagel, at the Bank for International Settlements (BIS) Innovation Summit 2024.
Nagel’s concerns stem from the rapid growth of digital currencies and the implications for central banking business models if adoption lags. His comments come after the European Central Bank (ECB) moved to the next stage of its digital euro project with a view to issuing a digital currency in the next few years, with Nagel informing the conference it was a “necessity” that a digital euro was rolled out and that process must “speed up”.
Earlier this year, the president of the ECB, Christine Lagarde, stated that a digital euro could offer Europeans more autonomy and resilience. She highlighted that many Europeans currently rely on non-European payment apps and cards.
The digital euro, proposed by the ECB, blends the familiarity of cash with digital flexibility, facilitating transactions in stores, online, and between peers. Accepted universally across the euro area without additional fees, it promotes financial inclusivity and is accessible even offline, setting it apart from other digital payment methods.
Advocates of the digital euro say that it upholds privacy, offers transaction anonymity, and maintains the stable value of physical euros, ensuring secure and reliable exchanges. Managed by the ECB, it ostensibly provides a stable alternative to cryptocurrencies, seamlessly integrating into both physical and digital economies.
According to the ECB, a digital euro could be necessary to adapt to the rapidly changing landscape of payments, particularly the increasing preference for electronic transactions over cash in the euro area.
The initiative aims to preserve the significance of public money and maintain trust in the currency by offering a safe and universally accepted digital payment option. While cash will remain accessible and relevant, introducing a digital euro aligns with the digitalisation trend in various aspects of life, ensuring inclusivity and privacy in the digital era.
By providing a secure and free means of payment across the euro area, the digital euro seeks to simplify transactions and strengthen Europe’s monetary sovereignty, making the payments landscape supposedly more competitive and resilient.
According to Jens Hachmeister, head of issuer services & new digital markets at Clearstream, the ECB trials are an important step to take the “Euro system into a digital settlement system.”
VE3 director, Manish Garg, adds that the ECB digital euro trials are “a testament to the transformative power of collaboration across different sectors, with each stakeholder group playing a pivotal role in shaping the digital euro, ensuring it is both robust and aligned with the diverse needs of the Eurozone’s economy.”
The digital euro’s development involves four stages, each with its own objectives and processes. The first stage is the design phase, where theoretical models are transformed into practical, user-friendly designs. During this phase, the ECB will work closely with various stakeholders, including banks, payment service providers, and other relevant organisations, to ensure that the digital euro is designed to meet the needs and expectations of end-users.
The second stage is the pilot projects phase, where the digital euro is tested under different scenarios and refined for broader use. The ECB will work on developing a secure and efficient infrastructure to support the digital euro and pilot the new system with a limited number of users. This phase will enable the ECB to identify and address potential security, usability, and scalability issues before the digital euro is rolled out to a wider audience.
A digital euro could offer Europeans more autonomy and resilience
The third stage is the assessment and iteration phase, where the impact of the digital euro is analysed and optimised for security, efficiency, and user satisfaction. During this phase, the ECB will improve the digital euro’s infrastructure, features, and functionalities based on user and stakeholder feedback. The ECB will also assess the impact of the digital euro on the economy and financial system, considering factors such as financial stability, monetary policy, and financial inclusion.
Finally, the fourth stage is the decision and possible roll-out phase, where the trial outcomes are reviewed to decide whether to proceed with a full-scale launch and plan for implementation. If the ECB decides to proceed with a full-scale launch, it will need to work on developing a comprehensive implementation plan, including measures to ensure the security, privacy, and interoperability of the digital euro. The ECB will also need to engage with various stakeholders, including policymakers, regulators, and industry players, to ensure that the digital euro is integrated smoothly into the existing financial system.
The trials aim to test different use cases, such as bond issuances, secondary market trades, and repos, to see how payments work in more complex capital markets products.
A diverse range of stakeholders from different countries are participating, including large banks, local banks, and sovereign issuers. The trials are an important opportunity to test whether digital ledger technology (DLT)-based solutions can work at an institutional grade level and provide efficiency gains at scale.
Hachmeister adds: “By the end of wave two, we expect to be able to assess the difference between the three different payment rails offered and how they compare in terms of supporting the various settlement use cases being tested by our clients. The goal is to understand how each network handles transactions and how the ECB builds upon the learnings from the trials. The trials allow us to offer our clients a maximum range of use cases that they can leverage to experience digital wholesale central bank money.”
DLT, a complex system for recording transactions, will enhance the ECB trials by enabling the real-time exchange of digital assets and payments, known as delivery versus payment (DVP).
In previous digital asset issuances, including those from EIB and Siemens, the digital asset was only issued, but the cash settlement still had to occur on traditional rails. In the ECB trials, both the digital asset and the cash settlement will happen on the DLT network for the first time, enabling real DVP directly on the network for transactions like bond issuances and secondary market trades. This is a significant step up from previous projects as it allows simultaneous testing of the settlement of both legs (asset and cash) on a DLT system.
This advancement has garnered praise from experts in the field. Garg, a prominent DLT advocate, highlights its potential, stating that DLT can fulfil the promise of efficiency in deploying a digital currency across the continent. While traditional payment systems often falter under heavy loads, he points out, “DLT addresses these issues by allowing transactions to be processed in parallel, significantly reducing bottlenecks and enhancing efficiency.
While there is promise that DLT technology could speed up the process, there are difficulties. For example, interoperability between different DLT networks/protocols used by payment systems could pose technical and regulatory challenges for cross-border transactions.
Meanwhile, DLT networks must scale to handle large volumes of transactions, as required to support institutional-grade payments and settlements. The trials are not focused on performance or scalability testing specifically.
Garg believes this can be achieved with relative ease. “DLT provides a robust framework that supports a large number of transactions simultaneously, which is vital for a digital currency aiming to serve millions across the Eurozone,” he says.
However, given the need to comply with local CSD/SSS regulations, there is a degree of regulatory uncertainty about using DLT networks for securities settlement across jurisdictions.
DLT provides a robust framework that supports a large number of transactions simultaneously, which is vital for a digital currency aiming to serve millions across the Eurozone
Interoperability and standardisation are important aspects that need to be taken into consideration while developing the digital euro. It is essential for the digital euro to integrate with existing payment systems and financial infrastructures seamlessly. Developing standards that allow for interoperability without compromising security is crucial for widespread adoption.
Financial stability and integrity are critical factors that must be considered while developing the digital euro. As a central bank-issued digital currency, it must not undermine the financial system. This involves regulating its issuance, distribution, and impact on traditional banking sectors to prevent disintermediation and ensure overall economic stability.
Garg adds that the stringent EU data protection regulations are a “critical regulatory challenge” for the project, requiring “innovative encryption and anonymisation techniques.”
The introduction of the digital euro, underpinned by DLT, marks a significant change in the finance industry, promising numerous benefits across various sectors. Its potential to transform cross-border payments is particularly noteworthy, as it offers a cheaper and faster pathway for transactions, thus revolutionising remittances and international trade. Additionally, the digital euro promises to advance financial inclusion by offering accessible, low-cost banking services to the unbanked and underbanked populations.
Furthermore, its programmable nature opens avenues for automated subsidies and smart contracts, introducing efficiency and transparency into various sectors like welfare distribution and supply chain management. As the digital euro integrates into existing payment systems, it will reshape the landscape for businesses, consumers, and the broader financial ecosystem. Businesses stand to gain from streamlined operations, reduced fees, and enhanced transaction speed, while consumers will enjoy more convenient, secure, and cost-effective transactions.
The digital euro’s impact extends to the financial ecosystem, stimulating innovation, challenging traditional banking models, and fostering more competitive markets. Increased transparency and reduced risks set the stage for a more efficient and inclusive financial future.
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