Central bank digital currencies (CBDCs) have gained traction globally. In 2023, 94% of central banks have been engaged in some form of research, experimentation, pilot programme or deployment, a survey by the Bank of International Settlement (BIS) published in June 2024 found.¹

“Retail CBDC projects are generally much more advanced than wholesale ones,” says Marion Laboure, Macro Strategist at Deutsche Bank Research. Yet, central banks are now shifting their focus from retail applications (used by consumers in everyday transactions) to wholesale applications  (used by financial institutions), as explained in the flow article Wholesale CBDC projects to follow. The BIS now sees the likelihood that central banks will issue wholesale CBDCs by 2030 exceeding the likelihood of retail CBDC issuances.

The European Central Bank (ECB) has embarked on its journey for a digital euro in October 2021.² In a webinar hosted by Deutsche Bank Research on 21 November 2024 – titled The ECB’s approach to CBDC: an update – Jürgen Schaaf, Adviser for Market Infrastructure and Payments at the ECB outlined the approach the Eurosystem is taking for both retail and wholesale CBDCs and what the roadmap for the years ahead might look like. This article pulls together the main takeaways from the webinar.

Schaaf began his presentation by explaining the different technological dimensions of CBDCs in Europe. “The retail approach aims to provide the public with a digital equivalent to cash. It would mean a genuine digitisation of banknotes, but where cash would still be issued,” he said. “It's not a replacement of cash; it is a complement to it, which is needed in an increasingly digital world.”

Differently, wholesale CBDCs would be used to settle interbank payments and securities transactions in central bank money with new technologies. Rather than implementing digitalisation for the first time, as is the case with the retail CBDC, wholesale CBDCs aim to introduce new technologies to allow for efficiency gains and innovation. “This is about the involvement of distributed ledger technology, or blockchain,” explained Schaaf.

“A retail CBDC is not a replacement of cash; it is a complement to it”
Jürgen Schaaf, Adviser for Market Infrastructure and Payments, ECB

Schaaf listed a number of benefits that the application of blockchain technology for central bank digital currencies may have:

• Reduced need for intermediaries and therefore lower settlement costs;
• Decentralised programmability and reduced reliance on a single authority facilitating smart contracts for automated execution;
• Immutability for increased data integrity;
• Atomic transactions (without trusted intermediaries);
• Facilitation of 24/7 trading hours;
• Reduced risk of fraud and errors; and
• Increased transparency and resilience to attacks.

That said, there are also risks and challenges associated with blockchain technology, conceded Schaaf. “Using blockchain will not remove regulatory barriers in the post-trade industry, that exist for example due to different legal systems when it comes to dealing with insolvencies of market participants in Europe.” Additional challenges according to Schaaf currently include scalability, inefficiencies in decentralised systems, and the accelerated risk of bank runs due to programmability and structural pro-cyclicality.

Having set the differences to one side, the next part of the presentation provided a deep dive on each approach – starting with the digital euro, which, according to Schaaf, has three main drivers.

1. Alignment with payment preferences
   The first is to keep pace with changes in the way we pay, with a growing preference for digital payments over cash. “People pay less and less with cash,” explained Schaaf. According to an ECB survey published in December 2022, the proportion of cash payments at the point of sale in the euro area fell from 72% in 2019 to 59% 2022.  Nevertheless, the study also showed that most people still want to have the option to pay with cash.³ Therefore, the optimal approach might be to provide consumers with digital money fit for the digital age, but also to continue to issue banknotes. The ECB aims to follow this approach.
   
   
2. Simplification
   A further motivation is simply to make peoples’ lives easier. By offering a digital means of payment issued by the ECB, users would be able to make payments, free of charge, anywhere within the Eurozone.
   
   
3. Europe’s strategic autonomy
   The final motivation is somewhat political. As it stands, as many as 13 of the 20 countries in the bloc don’t have a national card scheme and therefore mainly rely on the handful of non-European credit card companies. As of May 2024, international schemes account for 64% of all electronically-initiated transactions with cards issued in the euro area.⁴ The introduction of a digital euro would therefore help to preserve “Europe’s strategic autonomy while reducing our dependence on non-European payment providers”, said Schaaf.
   
   During the Q&A session at the end of the presentation, one attendee queried whether a digital euro was necessary, suggesting that the extension of existing private-sector solutions could support similar use cases. In response Schaaf explained that while the digital euro would not necessarily bring features that you can’t do today, many of the existing or currently developing solutions are limited to specific jurisdictions – and are, therefore, not pan-European in scope.
   
   He added that the private sector has had the opportunity to solve these challenges over several decades, but progress on this front has been limited, and further fragmentation has often resulted. In this way, the digital euro could provide a way to overcome the fragmentation.

With these drivers in mind, Schaaf turned to what a digital euro would look like in practice. “Once up and running, the digital euro would have cash-like features, but in a digital world,” he explained. Not only would the digital euro have pan-European reach – both online and offline – but it would also have the highest level of privacy achievable, Schaaf claimed. Notable use cases for the retail CBDC include person-to-person payments, point-of-sale payments, and e-commerce transactions – all in a fully digital format (see Figure 1).

Figure 1: Features of a potential retail CBDC launched by the ECB

Source: Deutsche Bank Research Webinar The ECB’s approach to CBDC: an update

While the digital euro would be issued as a liability of the ECB, the implementation will not be undertaken by the ECB alone. “Distributors will be mainly payment service providers, including banks. They will take care of the exchange, customer relations, and services that go along with the digital euro. They would also be able to sell innovative solutions and services on top of the digital euro,” said Schaaf.

In a bid to limit the appetite for the digital euro and avoid disintermediation from bank accounts which could lead to bank runs, the ECB has also put several mitigation measures in place. The first one includes holding limits for end users, explained Schaaf. Secondly, there will be waterfall and reverse waterfall functionality. “If you want, you can hold all your liquidity in your bank account and use your digital euro wallet application for the transfer, and it will then transform the commercial bank money into central bank money for the recipient.”

On the receiving side, the waterfall mechanism inhibits holdings of digital Euros beyond the maximum holding limit. For merchants / corporates, the holding limit will be 0€ meaning every Euro they receive will be automatically defunded on their bank account. Finally, the ECB doesn't plan to pay interest rates for the digital euro, as this “will lower the incentive to hold the currency beyond what is deemed necessary”, adds Schaaf.

Originally, the ECB kicked off its retail CBDC project with an investigation phase in October 2021, now the central bank is during a preparation phase with a potential development and roll-out phase possibly starting in November 2025 (see Figure 2). “If and when there will be an issuance of a digital euro will rely heavily on technological progress, we make but also on the legislation currently under discussion by the EU parliament and the member states,” Schaaf said. Deutsche Bank Research expect the digital euro to be potentially available in 2028/2029.⁵

Figure 2: Timeline for the retail CBDC

Source: Deutsche Bank Research Webinar The ECB’s approach to CBDC: an update

Turning his attention to the wholesale side of the equation, Schaaf observed that while the digital euro continues to face some resistance, the financial industry is pushing strongly for the introduction of a European wholesale CBDC.

This is being driven by the maturity of the underlying technology and the use cases it supports. For example, in the past five years there has been an increasing number of high-profile bond issuances using distributed ledger technology (DLT) in Europe, with momentum being further accelerated in 2023 and 2024 when the Eurosystem’s started its exploratory work in this area⁶ (see Figure 3).

Figure 3: DLT securities market activity in Europe

Source: Deutsche Bank Research Webinar The ECB’s approach to CBDC: an update

“If the market goes more and more in the direction of using DLT solutions for trading and settlement, we need to provide central bank money issued by the ECB as a settlement asset and anchor of the two-tiered monetary system as we know it,” added Schaaf. “In other words: the technological advancement in the private sector requires accompanying measures by the central bank to provide  central bank money.”

“Technological advancement in the private sector requires accompanying measures by the central bank to provide central bank money.”
Jürgen Schaaf, ECB

Expanding on his point, Schaaf highlighted how this promotes the integration of European payments solutions and capital markets, as exemplified by the work being done around the Digital Capital Markets Union project. In addition, it will help to safeguard open strategic autonomy and promoting the international role of the euro.

So what action is being taken to make this goal a reality? The short answer is plenty. From May to November 2024 the ECB has undertaken practical work with market stakeholders focused on three different interoperability solutions offered by the national central banks Bundesbank, Banca d’Italia and Banque de France. This work falls across two areas (see Figure 4):

• Experiments. Mock settlement of the cash and asset legs in test environment
• Trials. Actual settlement of transactions in central bank money in a limited setting for a limited time

Figure 4: Results of Eurosystem exploratory work

Source: Deutsche Bank Research Webinar The ECB’s approach to CBDC: an update

In these tests, the ECB is exploring three potential solutions for the settlement in central bank money on DLT based transactions. The first is a trigger solution developed by Deutsche Bundesbank, whereby the asset leg is on the blockchain, and the cash leg is represented by a token on the blockchain that triggers the established way how high value payments and securities are settled on T2.⁷

The second – TIPS Hash Link by Banca d’Italia⁸ – is “similar to the first solution but it uses a form of the TARGET Instant Payment Settlement (TIPS) infrastructure, which is normally used for fast settlement of retail payments, instead of the Target2 securities platform.”

The third option is a Full-DLT Interoperability by Banque de France⁹, whereby both the asset and cash legs run on two interoperable blockchains. “This means you don't need this trigger moment, and you save one technological layer,” Schaaf added. As testing continues, he concluded "the jury is still out on who which of these will emerge as the best solution".

Deutsche Bank participated in three projects testing the Bundesbank Trigger Solution: a pilot transaction with Deka, SWIAT and four other investors where Deutsche Bank settled four primary transactions of a €300mblockchain-based bond of Siemens¹⁰ and an experimental transaction with Börse Stuttgart where secondary market transactions of blockchain-based securities were settled¹¹. In both transactions, Deutsche Bank settled the transactions, and credited the money on the account of the corporates. In a third experimental transaction, UBS and Deutsche Bank partnered with the fintech Adhara to test the integration of the Bundesbank Trigger Solution for settlement of tokenised deposit transactions between two bank-centric blockchain networks of each bank¹².

The ECB will inform about its next steps in more detail in 2025. In a speech on 7 October 2024, Piero Cipollone, member of the ECB’s executive board highlighted the potential to build an integrated European solution based on Blockchain to realise the European capital markets union¹³.

Sources

¹ See bis.org
² See ecb.europa.eu
³ See ecb.europa.eu
⁴ See ecb.europa.eu
⁵ See Deutsche Bank Research Report Central Bank Digital Currencies & Cash: A long, Quiet River by Marion Laboure and Sai Ravindran (September 2024)
⁶ See ecb.europa.eu
⁷ See ecb.europa.eu
⁸ See bancaditalia.it
⁹ See ecb.europa.eu
¹⁰ See press.siemens.com
¹¹ See group.boerse-stuttgart.com
¹² See adhara.io
¹³ See ecb.europa.eu