Bitesize Payments

CBDC – The next big thing in Fiat money

• Paul Thomalla • Season 1 • Episode 16

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Welcome to today's episode of Bitesize payments, where we'll be diving deep into the world of Central Bank Digital Currencies, or CBDCs. The latest revolution in Fiat Money since the bank note. From their origins to their potential impact on the global financial system. Probably a once in a lifetime event, we will also talk specifically about the Digital Euro.     I am joined today by Karel Lannoo, CEO of CEPS – Centre for European Policy Studies.

 

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Payments Industry Insights

History of Payments

Payment System Explained

Corporate Payments Strategy

Payment Regulations Impact

ISO20022 Standard

Digital Payments Evolution

CBDC Advancements

Cryptocurrency in Payments

Financial Technology Education


SPEAKER_01:

Welcome back, dear listeners, to Bite Size Payments, where we look at the history of payments, how they work, and of course, who does what. In this episode, we're going to delve into the hot world of central bank digital currencies, or CBDCs, from their origins to their potential once-in-a-lifetime impact on the global financial systems. We're going to dive into the digital euro as well. We've got it all covered. Let's get started. Here we go. I'm super pleased today to be joined by Carol Lanoue, the CEO of CEPPS, Centre of European Policy Studies, a very prestigious think tank based out of Brussels. Welcome, Carol.

SPEAKER_02:

Good morning, Paul.

SPEAKER_01:

I'd like to kick off by saying what a great pleasure it was to work with the team, giving feedback to the European Commission on the digital euro, a digital euro beyond impulse. Think twice, act once. I think the combination of people that you brought together from industry practitioners to academics across the board, I think that really brought out the best in the team. So well done to SEPS for bringing that together. But I think moreover, the report is a very, very insightful one and perhaps a critical one for this particular time.

SPEAKER_02:

Indeed, it was an interesting group. And I think that was the special... element of that group that we brought together different parts of the thinking on this matter but people who do not normally meet each other or discuss these things with each other whereas they're all these three or four different groups very much affected and very much interested in the matter

SPEAKER_01:

i have to say from my point of view i think i mentioned this to you last week that um In this part of the business, I'm generally very comfortable, but I was challenged several times by the academics, really bringing something very different and made me stop in my tracks and go, I'm not sure that I'm right here. I think that was a very powerful combination, as I said.

SPEAKER_02:

Yes, indeed, it was a good combination. Also, the academics appreciated a lot to be discussing these matters with people like you, payment systems experts who have been there their entire life. and the operations side of payment systems, but not talk about the monetary policy or the microeconomic side of these matters.

SPEAKER_01:

Absolutely. Okay, well, let's jump into the brief history of CBDCs. And although it is brief, it is marked by continuous exploration and development. The seeds, frankly, were sown very early in the 1990s with central banks like those in Finland and Sweden dabbling in digital forms of money. But as with many types of innovations, early efforts didn't quite take off. I think mostly to technology limitations and frankly, public disinterest, which maybe we'll pick up on that later on. But if you fast forward to the present day, the landscape has changed. The rise of cryptocurrencies and the digitalization of the global economy have reignited interest in CBDCs. In 2020, the Bahamas made history by launching the world's first fully-fledged CBDC, the Sand Dollar. And they weren't alone for long. Countries like Nigeria, China, and Jamaica soon followed suit. Today, over 100 countries are knee-deep in CBDC research. 11 have already launched their CBDCs, 21 are testing the waters with pilot programs. However, I would say that most notably, the EU has publicly committed itself to the digital Europe, and the long-awaited first draft was presented to the European Commission in June 23. And while they are digital natives, what are they, Carol?

SPEAKER_02:

Yeah, that's good to say, because there is a lot of confusion in people's minds. Let's say that the digital currency will be something like another... but a cryptocurrency issued by a central bank. But it's not that simple because a cryptocurrency by definition is decentralized, works on a distributed ledger technology, which basically is by definition something which is collectively governed, so to say. If you look and compare this with a central bank digital currency, it's just the opposite. It is a central bank with its very hierarchical structure with the governor on the top which will run it. And that's already a big difference. Also, we don't know, secondly, whether this central bank digital currency will function on DLT. No, we don't know it. I mean, this still has to be decided. And there may be in some other places around the world where it will be DLT, but we don't know. At the moment, I have the impression that DLT is a bit going backwards. But what is a central bank digital currency? It will be at least in the European element of it, I haven't studied all the different proposals which exist around the world, it will be a legal tender for the European Central Bank. So issued by the European Central Bank is like mints which are legal tender for the Eurozone countries. And what the Commission has done in June is proposing a regulation by which they say this currency will become the legal tender. which means that if it's in a digital form, meaning it's stored on a card or on a kind of mobile device, you will have to accept it. Today, if you can arrive with a merchant and you want to pay digitally and the merchant will say, but I don't accept this means of payment. In the future, if you have a digital euro in the EU, and I think we'll have one, I may have my doubts about this, whether it's a good thing, But you will have to accept it in a digital form. And that's, of course, what the ECB says is a big advantage because this would, I mean, push much broader acceptance of digital means of payments. It would promote financial inclusion. It would adapt the ECB to the digital age. But it raises so many questions about, above all, I mean, how will it interact with existing digital means of payment? And how will this work together, these two, let's say, the official legal tender and the private forms of digital euro which exists today.

SPEAKER_01:

Yeah, I think this cold question of legal tender is a huge topic just in its own right. But frankly, it's symptomatic of the things that we haven't talked about for a long time. Legal tender, fiat money, it's going to raise an awful lot of topics. This will go on for quite a while yet. So effectively, there are two real use cases here. There's retail CBDCs, and they're intended for people like you and I, citizens, to use in an everyday world to buy things from shops and to exchange money between friends. etc. And then there's what people call wholesale CBDCs and they're really aimed at trading floors and financial institutions settling very large transactions in a very quick way and facilitating smart contracts post-trade. But effectively they resolve to the same thing. The digital currency at the background is exactly the same. They're fiat currencies issued by central banks and they're arguably the first revolution in of fiat currency since banknotes. But they do open up this area that hasn't been touched for a long time. And it's rarely discussed. I mean, it's not that long ago that the conversation about fiat money or commercial money would be an obscure conversation. And now it isn't. And I think the thing here about legal tender is really quite a confusing issue for a lot of people.

SPEAKER_02:

Exactly. It raises another issue. Of course, one of the reasons, as I said, why the ECB is advocating, look, this will promote financial inclusion. We shouldn't forget we have countries in the EU, not necessarily in the Eurozone, but in the EU, which are still behind in their kind of degree of openness to bank accounts. For example, a country like Romania or Bulgaria, they're not part of the Eurozone, but they're participation in the financial system of their citizens is still much lower than any other European country. And then the ECB says, look, it will promote financial inclusion. But a big fear which has arisen in, for example, Germany and Austria is control. I mean, is this no way to control what we are doing? Because we know a classical mint or note has no color. I mean, everybody can go in a shop with a note and nobody will ask you, where is this coming from? Who did you get this from? Of course, that may be a reasonable request if you want to transact more than 10,000 euros in the EU. Let's say you have to show that this is not a procedure of money laundering, so you may have to demonstrate it. But for lower amounts, nobody can ask you. So it's totally anonymous. Whereas with a digital currency, it can always be traced who's behind it. And that's certainly the case in Austria and Germany at the moment. There is a fierce reaction against too much control by the state, too much loss of privacy everywhere to have a central bank digital currency. And of course, the IDCB says, look, no, no, no, we will have a system by which it will be just kind of, it will be totally encrypted, will be no proof, let's say, of no We won't be able to see who's behind, but everybody knows as soon as you have a digital transaction, there's always somewhere a trace. And that's something which will have to be addressed because, as I said, it is a fierce reaction above all in these two countries, also because of the history of these two countries. And this will have to be taken into account how to deal with this. Of course, on the positive side of it, You could say, look, it will be easier to control money laundering and to see on terrorism financing and also other forms of, for example, use and I think, I mean, human trafficking, trafficking of endangered species and so on. But on the other hand, how will you reconcile the demand for privacy with the demand for traceability? And one of the arguments which is used by DCV, we will be stronger in combating money laundering and we will have an international relationship digital currency, which will be used all over and which will be super safe. So that still has to be worked out. I personally don't fully understand how good it is.

SPEAKER_01:

No, I think they're very fair points indeed. I think underneath all of this, there's a matter of trust. And if that can't be resolved, then we're going to have some issues with CBDCs. And the point you make about Romania is very valid. 73% of all the transactions there are done in cash. They have a pretty high ratio of people that are unbanked. And those two things go together. Whereas those people that are used to not using cash and use electronic forms of payments and have a relatively high percentage of banked people mean that they do trust the system. I think that's what's got to be resolved here. Why is there so much interest in them now? Why now?

SPEAKER_02:

I think if you simply trace it back to the interest there was, or still is, in cryptocurrency, which comes from the fact, according to me, that cryptocurrencies came up rapidly between 2015, 2017, 2018, essentially because as a means of payment, above all, internationally, it was much cheaper than the ongoing traditional forms of payments, certainly through a banking system. And if you then think about countries like where I was last week, Spain, which has a lot of Latin Americans, which are sending back a lot of money back home. If you know that in a traditional payment, the cost of sending money to your family in Colombia or to an Ecuador is easily 7% to 8% of the transaction. And then, of course, which then pushed the emergence of crypto. Crypto may be entirely unsafe or unregulated, but if you used to use it and you see your money arrives with a cost of probably 1%, then, of course, as a central bank, you see this and international payments are extremely important. Then, as a central bank, you need to react. That is why the ECB now wants to promote it, look as a financially inclusive form of payment, but also depends on the design and how it will be worked out. And that we don't know yet. The ECB will, and by the way, the ECB is not an organizer of payment system. The ECB is a supervisor of payment. The ECB will now have to set up a licensing system for licensing private operators under the supervision of the ECB to issue payments It's legal tender digital money, which will then be allowed for use by the public at large. But how this will be done remains an open question because, I mean, licensing a payment system has a cost. And the ECB says, no, there will be no cost for the end user. But those who will operate the system will have to, I mean, kind of get a reward for their, I mean, being the kind of the official issuer of the digital money. And that we don't know yet how this will end. So it will be probably the shopkeepers or others which will have to pay for it or the banks. So the ECB says on the one hand, it will be very inclusive, but on the other hand, there will be operators who will have to pay for using the system. So again, that question has not been fully solved, which will be a big push on the ECB to try to make sure that the system is as cheap as possible. But again, how they will work it out, I have my big question, because if the ECB is the monopoly central bank, the only central bank for the Eurozone, which then decides on one or a group of operators to issue that official legal tender, which is the central bank European, central bank digital currency. That may stifle innovation in payment systems because how will the other payment systems then react if you know that there is one system which is the official digital Euro and then the other system are the private Euros. So there will be Will there still be enough competition between the system, the competition which we've seen until today, which has broader payment systems in Europe to where we are? Or will there be kind of a conglomeration around one system, but which may, on the long run, stifle innovation? And that, we don't know. That is something which I think the ECB will have to watch very carefully. But that's also something which may be dangerous in the sense, if we have one system which monopolizes it all, For example, if there is a problem with the system itself, if there is a gridlock in the system, what will you do? What will be kind of the fallback situation? But another big problem, which many academics have argued, if this is the only legal tender, it may be that in crisis situations, as we've seen around the financial crisis in 2008, 2009, everybody will put his money with the ECB. And there is a holding limit now of€3,000 in the case of what the ECB proposes for the central bank digital currency. But that holding limit will then, in a period of crisis, be lifted upwards, I think, from one day to the next, which will mean that all the deposits from the private banking system will flock into the official accounts of the ECB, which, even if they don't pay interest, will be supposed to be super safe. There will be all liabilities of the European Central Bank from private citizens, but it will undermine from the one day to the next the entire private banking system, but also the private way of setting interest for credit.

SPEAKER_01:

Yeah. I think it's probably also useful to try and think about it from a slightly different perspective as well, which is that if we think about it from a country or a regional government point of view and the effect that it has on central banks, these bodies want to make sure that they are still in control of their military policies. And to a degree, crypto could actually challenge that. So what do they do? Well, probably CBDCs is a good answer to that. And perhaps another way of thinking about it is, as we go into this digital world, how do we make sure that our currency is as relevant as it was in the analog world? or physical world. And of course, that's a big issue. We need to work that out. I think it's also worth commenting on the fact that in the UK and in the EU, there are concerns around the card networks and the fact that effectively they are controlled from outside of the UK and outside of the EU, of course. And it could well be that over time, CBDCs could be the challenger to their dominant position in the market

SPEAKER_02:

But we've just adopted at EU level, and the EU is very proud of it, let's say, our MICA regulation, which is the Market and Crypto Assets Regulation, by which we have a regulatory framework for issuance of, for example, stablecoins within the EU, within certain rules. Stablecoins are probably not as safe, certainly not as safe as what the ECB wants to do. But they will have to demonstrate that they have sufficient reserves for the stablecoins which they issue. And they will be allowed to issue it all over the EU with a single license, meaning you have authorization in one member state to issue stablecoins. You can do it for the entire EU. So that may be a bit contradictory that in this climate where you simply say now we are promoting privatization in the domain of further regulatory framework for the private use of cryptocurrencies, we're at the same time creating I mean, discussing the environment for creating an official legal tender or a publicly backed, not cryptocurrency, but a central bank digital currency.

SPEAKER_01:

Yep. And I think to be fair, the EU is committed to lead here. And I think it's worth noting that if you chat to the Fed, they're saying, hey, I think we're going to watch and learn. perhaps in the same way that they did with immediate payments. But I do think that the EU is committed and this will happen. Okay, so let's switch gears a little bit and sort of chat through how would they work? And I know this is a difficult question because we haven't got to the point, we haven't got a rule book yet. But in theory, how would they work, Carol?

SPEAKER_02:

Well, the ECB wants to do, you

SPEAKER_01:

mean? Yes, of course, yeah.

SPEAKER_02:

That we don't know exactly at this stage. As I said, I assume that this will be like, basically, they will ask private operators to submit proposals to the ECB. So the ECB will put out a form of a tender for operators to manage the central bank digital currency for the ECB. And the standard will clearly say, let's say, what are the criteria? And then the ECB will issue, say, or will authorize one or a group of operators to operate the central bank digital currency for the ECB under the criteria which the ECB sets like if you kind of like in a network of telecoms or an energy you get an authorization to basically use a public quasi public network like for distribution of energy, distribution of calls and a telecom network, you basically have a monopoly for a given period of time to do that service, which is a public service to issue that digital currency. And that will be for, say, for a given period of three years. And after three years, there will be a new notice after which you will have to re-propose your services. And of course, then the ECB can maintain the same operator or it can go for another operator. That's, I think, how it will go. The ECB will, in its kind of license notice, say, look, these are the criteria which you want to respect. It should be a hyper secure system. It should be the hyper safe system. It should respect the privacy. You will have to report to us on a daily or on a weekly basis how much is in circulation, that we can control everything. But then there is the big issue, as I said. What will be the cost for operating the system? The ECB says for the end user of the system, it will be free. But how will the operators who will want to issue the central bank digital currency be paid? Of course, it can be that they will be compensated in today's environment where interest rates are high by a difference between, say, there will be no interest on the issuance of central bank digital currency and what the interest rate which we get for... deposits today which is four to four and a half percent of course that's a nice business but we don't know if tomorrow or after tomorrow interest rates are very low again it may be much less interesting so these operators will have to think very carefully how they will do it whether they can earn money on the liquidity which they hold for a few hours, a few days on their accounts before they transmit the money, or will it be instant payments? All these things will have to be decided in the coming weeks and months by the ECB. But I'm sure that if I see the ECB, having followed European Central Bank and many other issues over the past years, I think they will go ahead. It's now been further confirmed two or three weeks ago that the ECB wants to go ahead. But many details still have to be clarified and they give themselves another three years to

SPEAKER_01:

do this. Yeah, and three years in the payments world, least we forget, is a short period of time. And when you combine that with the changes that are being made from a central bank point of view, three years feels awfully tight to me. It's also fair to say that the beginning of the conversation is about CBDCs. Central banks were saying, hey, we're going to be disintermediated by the ECB in this particular case. And I think that conversation has slightly gone away now. And I think there's a realization that we need central banks to work with the high street banks, commercial banks to be the bridge between the two. So I do think a lot of that has gone away. And I do believe that commercial banks will be playing a pivotal role here. Despite that, there are clearly big issues to get resolved.

SPEAKER_02:

For me, the biggest issue is clarity. Clarity in people's mind, what this is about. And that should be crystal clear because people I speak to today, there's a lot of confusion. What is this? Certainly to start with, let's say the confusion, which is start from cryptocurrency. Is this a central bank cryptocurrency?

SPEAKER_00:

Yeah.

SPEAKER_02:

And then people, as they see cryptocurrencies, this will be something totally different. It's basically only a digital translation of of the minting powers which the central bank has today for which they want to adapt and that is their main purpose of doing this. But we say, let's say that this should be clarified and then the whole way in which they issue this should be further clarified. So we call in our report for further studies by the ECB to be made to clarify how they will do all this and to make a very simple value proposition for before they issue the central bank digital currency because there are many questions. And as you said in the beginning, we believe that, for example, why should it be a retail central bank digital currency? Why not leaving this retail side totally in the hands of private operators under, of course, the control of the European Central Bank in the way which we do it with others as well, like normal commercial banks? But you could study, for example, to do it in the domain of the wholesale, where, of course, you need to have a form of a very quick backing of every transaction in central bank money just to i mean strengthen your payment system but also send your capital market system so that's one of the things we say the also the debate of privacy remains a very big one how will we ensure that privacy is there The whole debate about money laundering, how will we ensure that it will not be used for money laundering in combination with the whole debate about privacy. So all these things will have to be clarified and that I think the ECB will have to do in the coming years. But as I said, I think the ECB will be going ahead. I wouldn't be surprised if at some stage they were to say, no, we won't do this anymore.

SPEAKER_01:

Well, that certainly would be an interesting move. But I think the issue behind the issue here is that we are moving from an analog model that's been in place for a long time. It may not be perfect, but at least it's understood. And we're moving to a digital world. And that effectively means that all the models, the way the central banks work with commercial banks, the way the money is distributed, the way all the stakeholders are engaged, probably will change. And just as a small example, I don't really think that it's clear as to why you could only hold 3,000 euros, for example.

SPEAKER_02:

The holding limit is something also which has to be clarified and which many people think could be changed extremely rapidly. But why just a holding limit of 3,000 euros, which, by the way, would not apply for corporates. There would be no holding limits for corporates, nor for public entities which transact money through the central bank digital currency. They would not be allowed to have an account with the ECB. whereas you would think it would probably be better to have just the opposite, that we as private users wouldn't have an account with ECB, but that big corporate users and big public entities to pay pensions, for example, would have an account with ECB. So that's one of the big things which has to be done. So that's why we say, look, it should be as simple as possible and with very basic functionalities. It should rely on existing mechanisms and existing payment infrastructure with a kind of a clear case how you pay for it And it should allow for a level playing field with the payment ecosystem as we have today. Because we have a very efficient payment system in Europe. And if you go to the United States, you might say that the retail payment system which we have in Europe is a very efficient one. The problem, however, is that it may not be as efficient in every member state. And what we call the interoperability between systems is not sufficiently efficient. working. But we need to have competition between systems, because if you complain about the cost of making transactions through the banking system, I think you can only reduce it by increasing competition, which we've done basically by granting licenses to payment systems providers, which are not banks, like the Klarna, like the Revolut, which are providing competition to the banking system. It's not by creating a monopoly that you will reduce the cost, I imagine. And then finally, we'll have to look what is being done in other jurisdictions. And as I said, we see that there is a bit of hesitation at the moment, certainly a lot of hesitation on cryptocurrencies, but also on the technology on DLT to be used. So we'll have to look what other jurisdictions do and see as much as possible to act in combination with them. Of course, the most important ones for the EU are the US, the UK and Switzerland. There are certainly others to watch. Certainly, we'll be watching China, but China is not particularly a market economy. But that should also be done, that we check how it's going on and other sides. And of course, the ECB may, or the EU may be proud to be the first to, I mean, legislate to make it an official legal tender. But of course, it must clearly watch what the others are doing, not to be with somebody or with something which nobody is following.

SPEAKER_01:

Are there any last comments or points you'd like to make, Carol?

SPEAKER_02:

Of course, we will continue to follow this matter. And as I said, the ECB gives itself a further three years. So we'll certainly watch what's going on in the coming months in this sense and also watch how payment systems all over Europe and all over the world, private payment systems, react. because the issue about efficiency in payment systems is a very important one. And as I said, the interoperability between different systems and whether kind of our systems become even more cost efficient than they are already.

SPEAKER_01:

Thank you, Carol. It's an absolute pleasure to talk with you today. Thank you so very much indeed for your time and your insights.

SPEAKER_02:

Pleasure, Paul. Thank you. Thank you.

SPEAKER_01:

There you go. Bite-sized CBDCs, Central Bank Digital Currency. I think it's a big journey. We've got a lot to unpack. We have literally six, seven thousand years worth of infrastructure with regard to fiat currencies. And all the stakeholders and all the operators that go around it are based upon effectively an analog system. Changing all of that in one go is That's a tough ask. However, I think it's the right ask, and it is the right direction. Timing, well, maybe three years is a little bit tight, but frankly, there'll be other countries that'll be doing it too. So I think the EU will probably be the lead from a Western world point of view, but I think it's the right thing to do, and I look forward to getting my digital wallet unspelled in the digital euros, especially somewhere nice and warm. Big thank you to Carol. Hope you enjoyed it. Cheers, guys. Oh, and you know what to do. Please recommend it to a friend. Cheers.