What is the digital euro and how does it work?

6 min read

According to the European Central Bank, Europeans are relying more and more on digital payment methods. That’s why the EU is taking action to make sure people’s transition into cashless payment is as safe, smooth, and effective as possible. But while paying via card or even via smartphone might be becoming more common, a new form of totally cashless payment is on the rise: digital currency.

Digital currency is a type of currency that exists primarily digitally rather than as physical cash, such a cryptocurrency. Approximately 50 central banks around the world are experimenting with or carrying out research on digital currencies. Some of the banks exploring CBDC (Central Bank Digital Currency) include the Riksbank of Sweden (with the E-krona) and the Central Bank of the Bahamas (with the Sand Dollar). Currently, China’s is currently leading the way in terms of national digital currency—the digital renminbi (e-CNY) is already being tested in some Chinese cities and is almost ready to be rolled out nation-wide.

The EU has also seriously considered the idea of creating a digital currency—the digital euro—for the Eurozone. But what exactly is the digital euro and how does it work? Continue reading to find out everything you need to know about this potential new form of virtual money.

What exactly is the digital euro?

The digital euro will become the CBDC of the Eurozone. It should operate like cryptocurrencies, or virtual currencies, but with some unique caveats. Essentially, the digital euro is a virtual currency that:

  • will have legal value guaranteed by the European Central Bank

  • can be used alongside banknotes to make payments in the 19 countries in the Eurozone

  • will provide a fast, secure and innovative payment method

  • can be used by both businesses and private citizens.

How the digital euro and cryptocurrencies work?

In order to explain how the digital euro would work, let’s take a look at the most similar type of existing currencies: cryptocurrency and other virtual currencies. The Bank of Italy defines these as “digital representations of value that are created, used, and stored in electronic form.” In other words, cryptocurrencies:

  • are created on the internet

  • are not subject to issue, guarantee, or control of central banks or public authorities. Instead, they’re issued by private individuals

  • allow for peer-to-peer transactions. That is, instant money exchanges through special apps or digital platforms that don’t necessarily require intermediation from a bank

  • they don’t have a connection with common legal tender currencies such as the euro (EUR) or the dollar (USD)

  • their value is very volatile

There are many known cryptocurrencies (investopedia listed 4,000 in January 2021). You’ve probably heard of the most well known cryptocurrency—bitcoin. Bitcoins and other cryptocurrencies require a crypto wallet in order to store and to spend these virtual currencies. These wallets allow you to make secure and traceable transactions that are recorded using a complex technology chain known as blockchain.

What can you use cryptocurrency for? Cryptocurrencies are mostly used for investment purposes. Many of these wallets, however, can also be used to make payments in online shops and even physical stores where they’re accepted as a payment method.

Is the digital euro a cryptocurrency?

Not exactly. Like cryptocurrencies, the digital euro is a virtual asset. But unlike cryptocurrencies, which have no entity that creates and distributes them, the digital euro will be issued by the European Central Bank (ECB).

In the way that it operates, however, the digital euro will be similar to cryptocurrencies like bitcoin in that:

  • it will be managed and regulated using blockchain technology.

  •  to use it, you’ll need to create a digital wallet, but you won’t have to open a bank account. In fact, the money can be deposited directly at the European Central Bank. This way, you can carry out peer-to-peer transactions without needing a commercial bank to act as an intermediary.

Will the digital euro substitute the physical euro?

No, the digital euro won’t replace the physical euro. It’ll simply work alongside it to make payments even easier and more secure.

What is the difference between payments made with the digital euro and electronic payments? 

The biggest difference is that the digital euro is real, digital cash. For this reason, its use won’t be tied to any intermediary banking institution. Unlike electronic payments, which are normally linked to the use of payment cards or to the intermediation of multiple banks, you won’t need to have a bank account to use the digital euro. When managing your money, making payments, or receiving refunds, you’ll have to use a digital wallet, similar to those used with cryptocurrencies.

The advantages of having a digital euro

Why do we need a digital euro? The main goal of this new digital currency is to provide a modern payment tool for all private citizens and businesses in the Eurozone. Once it’s approved, the digital euro will enable simple and immediate payments, and money transactions that are completely digital.

The advantages of this include:

  • Streamlining of processes—purchases and money transactions will become simpler and more immediate with the digitization of payments.

  • Decrease in costs—costs associated with payment systems will be significantly reduced with the digital euro.

  • Decreasing ecological footprints—the ecological footprint associated with monetary and payment systems would also be drastically reduced.

  • Immediate support measures—governments could immediately provide economic aid to their citizens in times of need.

  • Anti-money laundering—the registration of transactions would drastically reduce money laundering and tax evasion.

  • Financial inclusion—allowing people without a bank account to use the digital euro will give everyone the opportunity to make simple and secure digital payments.

What risks are associated with the digital euro?

Of course, there are also some potential risks associated with the digital euro. Specifically, there are a number of issues that still need to be clarified:

  • Privacy—the digital euro would complement physical cash, which is an anonymous payment method by nature. Tracking payments with the digital euro would help with anti-money laundering regulations, but could place limits on the privacy of citizens.

  • The role of banks—deposits to credit institutions could decrease, which could mean that banks will be less likely to offer loans. What’s more, with the increased use of the digital euro, credit institutions and other intermediaries involved in payments systems could be forced to at least partially revise their business models.

When will the digital euro launch?

According to ECB President Christine Lagarde, implementing the digital euro will take up to 5 years. Before that happens, further discussions will need to take place on issues such as payment privacy and the actual role of the ECB in overseeing the operation of the digital euro. 

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By N26

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