The Digitalisation of Central Bank Money

Central bank digital currency – a new form of legal tender

Central banks around the world are an­nouncing the development and issuance of CBDCs, which are digital money and legal tender. They are issued by the central bank and – like cash or balances held at the central bank – represent a direct payment obligation of the central bank. There are two forms of CBDC: one that is available to consumers (retail CBDC) and another that is issued to companies specialising in the ex­ecu­tion of payment transactions (wholesale CBDC). CBDCs can be issued as value-based “tokens” using a blockchain that is managed by the central bank, thus enabling peer-to-peer payment transactions in the same way as cash, or they can be account-based, mean­ing that payment transactions are pro­cessed via accounts at the central bank.

As state money, CBDCs could become a reliable, widely accepted alternative to pri­vate digital money. Central banks see the provision of a secure and reliable digital means of payment as a necessary tool to safeguard the sovereignty of their monetary policy in the medium to long term, which is essential for maintaining financial stabil­ity and fulfilling their tasks. In view of the decline in cash holdings, which are close to disappearing in some countries, CBDCs are intended to guarantee access to central bank money in the future as well. A gen­erally accepted and trustworthy CBDC is required to guarantee efficient, secure pay­ments and interoperability between differ­ent private payment systems, as well as to ensure data protection and security in finan­cial transactions. The efficiency and productivity potential of new technologies (i.e. the blockchain and distributed ledgers) and innovations such as smart contracts should be publicly accessible and not exclu­sively tied to certain platforms. CBDCs could also offer potential benefits in combating money laundering, crime and terrorist financing; providing better financial inclu­sion; reducing costs; and creating possible new options in monetary policy. A brief overview of the potential costs and benefits of CBDCs can be found in the infobox on page 4.

According to the Atlantic Council, central banks in 134 countries and currency unions are currently examining the intro­duction of digital currencies. All G20 coun­tries, with the exception of the United States, are in the advanced stages of devel­opment. In the United States, the issue is highly politicised. In May 2024, the US House of Representatives even passed a bill prohibiting the introduction of a “digital dollar” by the US Federal Reserve. Three countries (the Bahamas, Jamaica, Nigeria) have already put CBDCs into circulation. The eurozone could introduce a digital euro on a trial basis by the end of 2025 at the earliest, in both the retail and wholesale sectors. The four BRICS founding countries (Brazil, China, India and Russia), on the other hand, are already experimenting with pilot projects on a practical level. China is the most advanced of the major economies, not least due to the firm support of the party and the state. The digital yuan could become the benchmark for the establish­ment of digital standards and the basis for the development of a China-centred, dollar-independent infrastructure for international payment transactions.

The e-CNY – China’s central bank digital money offensive

In China, there is a historical awareness that money and currency are an essential foundation of political power. Its own cur­rency, the renminbi (RMB), as well as its digi­tal offshoot, the e‑CNY, are integral parts of China’s state sovereignty, identity and na­tion­alism, and inevitably also of the Com­munist Party’s Marxist-Leninist claim to power.

The economic and social dimensions of money and currency in China are thus sub­ordinate to these ideological and political premises. Accordingly, the People’s Bank of China (PBoC), China’s central bank, is not legally independent but rather a subordinate authority of the State Council.

Against the backdrop of the party and state’s unconditional claim on control of the economy and society, there was an urgent need for Beijing to find a regulatory answer to the systemic and political chal­lenges posed by the Chinese digital economy (in the form of the large platforms Alibaba and Tencent in particular) on the one hand, and those emerging from outside in the form of private cryptocurrencies such as Bitcoin and Libra/Diem on the other hand, in order to preserve the state’s monetary sovereignty. Instead of passively accepting monetary innovations from the private digital economy, the Chinese state is seek­ing to shape the future of blockchain tech­nology, digital money and payment trans­actions as well as use new fintech systems to secure the power of the party and the state, at home and abroad.

China’s digital currency project began in 2014, when the PBoC put together a team to research and plan its CBDC. A digital cur­rency research institute was founded in 2016, and the PBoC launched the development phase together with commercial banks at the end of 2017. The first pilot projects were rolled out in April 2020, initially in four municipalities. Since then, the e-CNY has been successively introduced in other regions to more and more recipients. China is investing heavily in the technology, infra­structure and marketing of the new digital payment method and working to implement it quickly. However, the level of up­take by potential new users has been low, given the convenient payment methods already available from Alipay and WeChat Pay. It is estimated that around 260 million Chinese currently hold a digital wallet that authorises the use of the e-CNY, though it remains to be seen when the e-CNY will be generally available nationwide.

The e-CNY supplements and replaces physical cash in circulation with identical value (1:1). It is available to the general public (“retail-based”) and is intended to be interoperable with all private payment sys­tems. It is issued and administered centrally by the PBoC and put into circulation via commercial banks or other intermediaries. The e-CNY is fully backed by the central bank – it is booked as a direct liability of the PBoC. In order to be able to pay with e‑CNY, users must register an electronic wallet by providing their identity and bank details before filling it with an authorised amount. The wallet can be accessed via smartphone apps, chip cards and machines. The e-CNY can be used both as a value-based payment token, for example for peer-to-peer transactions, and as an account-based currency via commercial and online banks. “Offline” transactions, for example between two mobile phones, are already possible in principle. Payment transactions are cleared centrally via the PBoC by means of registration, authentication and veri­fication.

According to a white paper published by the PBoC, China is pursuing three goals with the e-CNY, namely (1) the provision of cash in digital form, especially in China’s less-developed areas, (2) ensuring secure, efficient and interoperable payment trans­actions between platforms and (3) prospectively using it for cross-border payments. However, the economic and political impli­cations of the new CBDC go far beyond the technical level. In the e-CNY, China has an instrument with a wide range of possible applications and far-reaching domestic as well as international implications.

Firstly, the introduction of the digital RMB will open up completely new options for China’s fiscal and monetary policy due to the programmability of the e-CNY. For example, the PBoC will be able to make direct payments to households and com­panies and limit or condition them in terms of time, region and usage. It also offers radical new options for monetary policy in terms of the tailored management of inter­est rates and the money supply.

Secondly, China’s security agencies will be able to view the available payment trans­action data in real time or trace it back if necessary. This opens up completely new possibilities for monitoring, prosecution and repression. Linking payment data to both the PBoC’s credit rating system and the government’s social credit system may enable China’s authorities to influence and control human thought and behaviour to an extent that is very disturbingly reminis­cent of George Orwell’s dark visions.

Thirdly, the aim is to use CBDCs in the future to process cross-border transfers using the blockchain, peer-to-peer, in real time and at low cost, bypassing the existing banking and clearing system. China’s tech­nological expertise and practical experience offer it the opportunity to play a leading role in the development of payment infra­structure and the standards that apply to it. China is working intensively at different levels and with various initiatives on the interoperability between domestic and international payment systems.

Fourthly, a digital RMB that can be used in international business transactions could enable China and third countries to circum­vent Western financial sanctions more easily. China has had its own platform for the clearing and settlement of international payments, CIPS (Cross-Border Inter-Bank Pay­ments System), since 2015. With a func­tioning digital payment system centred on China, making transfers outside of Western clearing houses and bypassing the SWIFT system could be carried out cheaply and easily in the future. This would make it dif­ficult to detect – let alone prove – sanc­tions violations.

The “digital euro” project

The project to introduce a digital euro is inferior to the Chinese project in terms of both the speed of development and ambi­tion. It was launched following a decision by the European Central Bank (ECB) Gov­ern­ing Council in July 2021. For the ECB, the aim is to maintain the role of the euro as a reference standard and payment obliga­tion that can be honoured at any time in the eurozone. The digital euro is intended to ensure that cross-border transactions with­in the monetary union can be pro­cessed smoothly, reliably and at low cost. Even 25 years after the introduction of the euro, payment transactions in the Euro­system are still fragmented and non-uni­form. Enrico Letta’s report on the future of the European single market from April 2024 points out that digital money in Europe could be an important element in the inte­gration of the European financial architecture. There is a diversity of payment sys­tems in the single market due to the large number of card payment systems and the dependence on US companies in this sector. Reducing this dependency would not only bring financial benefits, but also make pay­ments more secure, especially given the current political situation in the United States and the risk of trade disputes with the EU. In November 2023, the Eurosystem launched the second phase of the project, which was defined as the preparatory phase. This comprises the finalisation of a set of rules for the digital euro and the selection of providers to develop the digital euro plat­form and infrastructure. The new means of payment could be supported both by com­mercial bank applications and a special app for electronic devices developed by the Eurosystem, whereby offline payments should also be possible.

Although the plans are promising, Europe’s version of the CBDC project is being implemented with caution. It should be noted that consumers will only be able to dispose of digital euros up to a holding limit of presumably €3,000. Although an increase in this amount is conceivable at a later date, this measure will initially serve to limit the use of the digital euro. Accord­ing to the ECB’s plans, payments using digi­tal euros would only be possible with a cor­responding account at a commercial bank. The ECB does not want its project to jeop­ardise the position of commercial banks in order to prevent a potential migration of deposits to the central bank.

Furthermore, it is planned that the digi­tal euro will be limited to the 20 countries of the monetary union – at least for the time being. The draft regulation on the introduction of the digital euro of 28 June 2023 (COM(2023) 369 final) provides for some exceptions. Firstly, it will be possible to use the digital euro in EU countries out­side the eurozone if the ECB and the national central bank of the respective country sign an agreement to this effect. However, the scope of this use will be limited so that the national currency is not de facto replaced by the digital euro without the country in question fulfilling the convergence criteria. Secondly, the digital euro could be distri­buted in third countries, but only if the EU and the third country in question conclude an agreement beforehand. The distribution of the digital single currency would also be limited in this case.

The development of the digital euro has sparked a number of controversies. Com­mer­cial banks are concerned about com­petition for traditional bank deposits, as having digital currency in a central bank account could be seen as a safer deposit. Even though Europeans will only be able to access the digital euro with an account at a commercial bank, European banks and savings banks fear for their position in the European financial system.

The central banks’ CBDC project is also often criticised for its expected lack of in­clusivity. Concerns are centred on the fact that electronic money may only be used by a small, “digitally savvy” section of the popu­lation. It is also claimed that the introduction of the digital euro will lead to the abolition of cash. There are also fears that technocratic institutions, including central banks, will want to use digital cur­rencies to monitor and control citizens. Many populist forces in the EU portray physical money as a guarantee of individual freedom. They are fuelling fears about the loss of state sovereignty in terms of mone­tary policy and the disadvantages concerning individual privacy.

In addition to promoting the digital euro project, the EU has also made efforts to pro­mote the regulation of other digital cur­rencies – including cryptocurrencies and stablecoins – in the EU single market. The EU’s ability to shape its own regulatory environment for digital assets and ensure its effective enforcement will strengthen the stability of the European financial sys­tem, thereby increasing the EU’s autonomy and independence from other jurisdictions.

Similarities and differences

A comparison between China and Europe reveals similarities, but also fundamental differences. In China and Europe alike, state sovereignty in the monetary system and in payment transactions is being threatened by private providers: in China by Alipay and WeChat Pay, and in the EU by the credit card companies Mastercard and Visa as well as Apple Pay and Google Pay. In both China and Europe, monetary policy authorities are faced with the task of ensuring a for­ward-looking, universally accessible and sus­tainable infrastructure for payment transactions. The organisation and design of the new digital means of payment are similar. In China and Europe alike, the issu­ance and account management of CBDCs will be carried out by commercial banks serving as intermediaries. All forms of CBDC will be put into circulation: retail, wholesale, value-based and account-based. Both China and the EU are attaching great im­por­tance to data security. Offline use should also be possible. In China, however, there is no corresponding holding limit up to which European users may keep CBDC. The main design difference, however, is data protection. In China, every payment transaction is stored centrally, can be viewed by the author­ities and can be linked to other data systems. For the digital euro, on the other hand, the provisions of EU data protection rules apply, namely that control over personal data must remain with the individual user. The ECB will neither view nor store the data. The ECB’s default scenario envisages that personal data from payment transactions will only be collected by the intermediary and not by the central banks. In addi­tion, there is consideration about guaranteeing cash-like anonymity for payments of smaller amounts and offline transactions.

Another important distinction that reflects the different ambitions of the European and Chinese projects is that the digital euro is not intended to be programmable. In the EU, there were concerns that programmability could undermine the full convertibility of digital and traditional currency and weaken the protection of users’ personal data. This would not only restrict the func­tionality of the digital euro in economic and monetary policy, but also reduce its advantages compared to conventional elec­tronic bank transfers.

In terms of implementation, the obvious difference is, of course, that the digital yuan is much further advanced in its devel­opment towards becoming a usable digital currency than the digital euro. The e‑CNY can already be widely used in China, al­though Chinese households and businesses continue to make payments mainly through the established platforms of Alipay and WeChat Pay. Through early adoption and practical testing, China is advancing block­chain and distributed ledger technologies, setting technical standards, accumulating institutional expertise and gaining an inter­national reputation. With the rapid intro­duction of its new digital means of pay­ment, China’s authoritarian government and centralised structures are once again proving to be a competitive advantage. How­ever, it should not be ignored that China, as a CBDC pioneer, is taking political risks, as design errors in the e-CNY could lead to financial upheaval.

The ambitions of the Chinese party and state regarding the introduction of its CBDC are much more far-reaching than those of the EU institutions and member states. With the e-CNY, Beijing is pursuing indus­trial policy, foreign policy and security policy goals that go beyond the objective of protecting national monetary sovereignty. From the Chinese perspective, the current system of international payment transactions is not only costly and inefficient in economic terms, but also problematic in terms of security policy, as it gives the United States – its geostrategic rival – the power to exclude third parties. Individuals and companies from China, Hong Kong and Macao have already been the target of US financial sanctions on several occasions. A central bank digital currency now offers China the opportunity to pursue a disrup­tive new beginning. The People’s Republic is therefore making considerable efforts to develop blockchain-based payment platforms (“Universal Digital Payment Network”) and establish an internationally interoperable digital payment system (“mBridge”). Should it succeed in developing a new system of international payments based on interoperable CBDCs, this would no longer be a dollar-centric system. The resulting structures could create new dependencies in the future – now vis-à-vis China.

Although the scope of China’s ambitions is underestimated abroad (as has often been the case in the past), Europe, for its part, lacks strategic clarity, foresight and political ambition with regard to the digital euro. The European Commission and the ECB are not receiving enough of the necessary sup­port needed for their plans from European politicians. Instead, the financial industry, cash advocates and populist parties seem to be dominating the discussion.

Outlook

It is essential to implement the digital euro project, as it will pave the way for the estab­lishment of a pan-European payment infra­structure. Payments and payment systems are undoubtedly part of the critical infra­structure. It is problematic if cross-border payments in the Eurosystem are only man­aged by non-European service providers and if non-European platforms dominate elec­tronic retailing in Europe, while at the same time the use of cash is becoming in­creasingly less prominent. To ensure com­petition, security, resilience and reliability in payment transactions, the introduction of the digital euro is both sensible and nec­es­sary, not least in light of potential crises.

However, the development of the digital euro is of much greater significance than the mere harmonisation of payment sys­tems. The euro is exposed to currency com­petition with private and state players. Sov­ereignty over payment transactions is an indispensable prerequisite for the protection of state sovereignty. The ability to influ­ence the governance of cross-border payments is an important factor in inter­national relations. A geo-economic recon­sideration of the EU’s position with regard to the development and security of its digi­tal financial architecture with respect to its competitors is therefore necessary. The European digital currency project can only be successful if the EU demonstrates a simi­lar level of ambition as can currently be observed in China.

It is therefore crucial that, in the long term, potential users operating in countries outside the eurozone or the EU single mar­ket also have access to the digital euro. In this context, the project could play an im­portant role in the continued internationalisation of the single currency.

However, restrictions on the development of a European CBDC will remain in place for many years to come, even in the single market. The main reason for this is the persistent lack of trust in digital money and electronic payments in many countries, especially in Germany. The digitalisation of money is a multi-layered process that is not limited to experiments with currencies or payment systems. The process must also be inclusive, that is, it must be ensured that as many people as possible have access to the digital euro and can share in the poten­tial benefits. This also includes imparting knowledge about how the financial system works, the risks of speculating with digital assets, and the security of online and off­line payments.

Indeed, Europe is the only jurisdiction with such strong protection of personal data and consumer rights, which could be a decisive advantage in the future over com­peting projects such as the digital yuan. A prerequisite for this is accelerating the de­vel­opment of the digital euro and raising the ambitions of the project. This topic should be given greater consideration in dis­cussions on competitiveness in the EU.