The digital euro gets ready for beta testing

Over the past month, the EU’s digital finance ecosystem has quietly taken several important steps into the future. In late June, the European parliament’s economics committee voted through a proposal to establish a retail central bank digital currency (CBDC) for the euro area. Last week, the full legislature authorised negotiations over such a digital euro with the Council of the EU (where member state governments are represented).

At the same time, the Council issued a statement on how it wants the bloc to shape its overarching policy on digital finance. (Readers may remember I have complained that the EU lacks a strategic vision in this area. This is a step in the right direction.)

And on Tuesday, the European Central Bank announced the participants in the pilot of the digital euro. They will now start technical preparations for the pilot, which will run next year. In parallel, the ECB is working on “Project Pontes” for a publicly provided digital settlement asset suitable for transactions on decentralised digital ledgers. In time, this should become a full-fledged wholesale CBDC — central bank reserves for tokenised finance, if you like.

These are the — not very widely noticed — counterpoints to news that EU regulation is leading all but 12 per cent of crypto companies operating in the bloc to shut down (including Binance, the exchange). A superficial reading would be that this is again Europeans regulating all innovation out of existence. Superficial and wrong: my overall take is that the EU is more on the ball in digital finance than in many other areas. Today, some thoughts about why.

I have had many conversations with people in the thick of these topics recently. Combining those with the public statements and policy measures, here are some of my takeaways.

The digital euro will happen

It’s not formally quite a done deal — parliamentarians and governments still have to iron out their differences over some detail — but everybody now treats the politics of the digital euro as settled. It is interesting, too, that some of the EU’s biggest banks have signed up to the pilot: it suggests that despite past scepticism, they may be getting on board with the programme.

Next year, we will see digital euros in action. Staff at Eurozone central banks will be able to use digital euros to pay for lunch in their canteen and transfer money between one another. It will be particularly interesting to watch the promised ability to make private payments from one offline device to another, to make the digital currency mimic physical cash as far as possible.

The EU is ever more fintech-friendly . . .

EU policy is often criticised (including by me) for being too protective of the bloc’s legacy banking system and not sufficiently open to new players, non-bank finance and innovative products, such as stablecoins. But I sense there is a change. Certainly the official language is ecumenical — the finance ministers’ statement says:

To accelerate the scaling of tokenisation in Europe, our policies should remain technology-neutral and support the development by the private sector of a range of instruments and use cases . . . 

The focus has, I think very helpfully, moved towards thinking about how public sector initiatives can make it easier for the private sector to innovate productively:

Without shared standards, the multiplication of [distributed ledger technology] networks risks recreating and compounding the fragmentation that we have been trying hard to overcome in the EU financial and payment systems. The EU should therefore seize this historic opportunity and engage in setting common standards and promoting interoperability — both among different DLT networks and between DLTs and traditional systems.

The core policymaking circles now see the digital euro as a tool for facilitating this, for example. But the most important tool will be Pontes, which is also set for a pilot soon. The ministers endorsed central bank work on “a public DLT-based settlement asset and the agenda for expanding eligibility as Eurosystem collateral to further DLT-based assets”. Among the expert officials I have talked to, there is a clear sense that this could be a game-changer for European digital finance in its competition with the US.

. . . but it still likes its legacy banks

As I have written before, I still detect a preference among many EU policymakers that the digital transformation should not be too disruptive for banks. That is not the same as saying they always do what legacy banks want them to (as one person told me, “if this was the case, we would not have gone ahead with the digital euro”).

But there is a strange blend of preference and expectation that Europe’s banking sector will, in the end, make fintech innovations work for it. As I wrote a few weeks ago, for example, many in Europe think tokenised deposits will outcompete stablecoins. Perhaps — but as I wrote, better not count on it. In private conversations, many admit that it is only when threatened — including by a public initiative such as the digital euro — that Europe’s banks get their act together to invest what it takes to improve their products against technologically superior competition.

The ecumenical “technology-neutral” approach set out in the ministers’ statement, and which I also hear endorsed in private conversations, seems to me the right one. But it has to be for real. It is hard to reconcile, for example, with forcing stablecoin issuers to hold a lot of their reserves in banks. It is also hard to reconcile with very low holding limits for digital euros, to prevent them from becoming too attractive an alternative to bank deposits. There is still a risk that being too protective of European banks against European non-bank fintech could cede advantage to non-European fintech against both domestic sectors.

The tokenisation of everything is the future

Still, the embrace of tokenisation is a good policy platform as it does put in place a degree of openness. It suggests — or it should at least entail — that smart contracts and “agentic” payments will be welcomed by policymakers.

(I have it on good authority that the use cases getting excited reactions among top EU policymakers are things such as airline and train tickets that automatically pay the legally required compensation when real-time data shows that the flight or train is late.)

There is also a legitimate hope that tokenisation will help unify and grow capital markets by transcending the fragmentation of the old financial market plumbing along national lines. A fast rate of innovation, in fact, gives the EU a chance to leapfrog the difficulties it has in harmonising national approaches, by opting for common rules by default for the new. It would be a huge wasted opportunity, for example, not to centralise regulation of innovative financial products as much as possible; this will be one of the battlegrounds in the work on the EU’s “Market Integration and Supervision Package”.

So the jury is still out over whether the EU can pull this off. One question is sheer competence — in the private sector the misgivings are less over the direction of travel than doubts about whether the public products will be good enough. Another is philosophical: whether the ostensible technological openness is genuine even if it disrupts the banking-centred model Europe has been run on for centuries. That combines payments, money creation and credit allocation to the same two-tier structure of central banks and licensed private sector banks. Whether Europe is flexible enough to countenance alternatives to that model will in the end determine where these best of intentions lead.

Other readables

● If EU member governments hunker down in their usual trenches over the new seven-year budget, other solutions for financing big common projects will have to be found, I write in my latest FT column. And yesterday, a former Polish finance minister proposed one intriguing option: the EU could borrow to develop its own revenue-generating assets of common benefit, on the model of its satellite systems.

● Could a new plan finally get Europe’s electrification share to come unstuck?

● The Institute for Government takes stock of Sir Keir Starmer’s premiership.

● An impressive list of top economists call for action now to ensure AI benefits people and economies.