Holdings limit will prove central to the digital euro’s future

As the digital euro moves closer to reality, one decision more than any other will dictate what role the currency plays in the economy: how many digital euros a single user can hold at one time.

The European Central Bank is studying whether to issue a digital euro, with a decision on next steps coming in October 2023. A limit of €3,000 is on the table, which would set the digital euro up as a cash alternative but not a place to keep substantial liquid assets. In contrast, the Bank of England has said it could allow holdings of £10,000 to £20,000, enough to handle most everyday transactions if the digital pound emerges, while India has emphasised the potential for cross-border remittances. Worldwide, e-money is evolving rapidly, with more than 100 central banks looking into central bank digital currencies (CBDCs) and a handful, including China, already putting such currency in use.

Vision for the digital euro

Whether or not the European Union really needs a digital euro, many policymakers seem to have decided they want one. Debate will step up in June, when the European Commission will publish a legislative proposal on principles for the digital euro, ahead of the ECB’s decision on whether to advance to an experimental phase. Privacy, consumer protection and financial inclusion, rather than technical constraints or international mandates, should be the focus of democratic oversight. The central bank should decide mechanics, including whether and how to pay interest.

So far, the ECB has been firm that its CBDC is not intended to be a store of value. The goal is increased access to safe, secure and low-cost payments without destabilising banks or expanding into direct consumer service. Having phased out the €500 note to avoid encouraging money laundering and mattress stuffing, the Eurosystem should not create a new way to sidestep the financial system. Nor should it entertain talk of the digital euro as a potential crisis management tool.

Conservative limits on holdings and usage seem the best way to keep the project within scope. The ECB has floated a monthly limit of 1,000 transactions, possibly with a maximum value of €50 each. It should aim to supplement cash, not replace bank accounts, and should help people outside traditional channels take part in the economy even when physical bank notes are no longer practical.

Rising bank turmoil

Recent financial-sector turmoil, combined with the euro area’s lack of true joint deposit insurance, may put pressure on the ECB to entertain higher allowances. Already, critics such as Michiel Hoogeveen, vice chair of the European Parliament’s economic and monetary affairs committee, wonder if the CBDC could weaken the banking system overnight if customers immediately fill their full allowance. The ECB needs to engage with those who say a digital euro could serve as a backdoor deposit backstop via increased limits in the middle of a crisis, while making clear that is not the project’s objective.

Ignazio Angeloni, former member of the ECB’s Bank Supervisory Board, found that around €1 trillion of deposits could switch out of bank deposits and into digital euro, given the currently proposed limits. This total is unlikely, since any such trend is likely to be gradual, and also in the aggregate would represent only about 10% of total overnight bank deposits. Nonetheless, such moves could destabilise banks that are already weak.

Strategic design

The ECB’s digital euro strategy will be built around three main levers: features to reduce excessive usage, a distribution model that encourages intermediation, and an ability to steer liquidity conditions as needed. Consumers would access digital euro through banks and licensed providers, with no fees for basic use. Costs would instead be born by merchants and payment providers, as with other regulated interchange fees. Most recently, ECB Governing Council member Fabio Panetta said the next phase of digital euro exploration would include small towns, not just financial-sector stakeholders.

While the ECB is looking at whether to align its existing wholesale payment platform with emerging CBDC standards, more experimental designs are off the table. For example Panetta said the digital euro will never be “programmable money,” in the way that privately-managed decentralised finance technologies can be used to set smart contracts. For now, consumer usage is where the EU focus is.

The ECB should consider financial technology opportunities as supporting goals, not a primary driver. Some central banks have emphasised innovation as motivation to move ahead. Yet private developers will doubtless charge steeper fees for more sophisticated services, serving only a fraction of future CBDC users.

The main point should be to make electronic payments available to all euro-area residents, regardless of what country they live, work or travel in. By addressing their needs, rather than plugging every hole in the financial infrastructure with this one new tool, the ECB may be able to create a digital currency that actually works.