Blueprint for a digital wallet

My analysis of the latest news from the European Central Bank about the digital euro. On July 4, 2020 I published my first article about a wallet for the digital euro. I still defend that vision and am happy to say that many of the concepts anticipated two years ago are now on the drawing board.

Mr. Fabio Panetta's remarks are a good opportunity for understanding the status and the trends of the activities about the digital euro. He chairs the Eurosystem High-Level Task Force on Central Bank Digital Currency, and the Committee on Economic and Monetary Affairs of the European Parliament (ECON Committee) is one of his counterparts. On November 18th, 2021 he gave some introductory remarks on the design of a digital euro. Last March 30th, 2022, he delivered an introductory statement about the digital euro, the same day the European Central Bank published the results of the focus groups.

Main takeaways

• The investigation phase of the project was started on July 14, 2021, and was intended to last 24 months, targeting Q3 2023.
• According to Mr. Panetta's remarks, design-related decisions will be finalized by the beginning of 2023 and the following months will be spent in developing a basic prototype. From available information, it looks that many of those decisions have already been taken.
• Although the European Central Bank appears focused on the basic version of the digital euro, it also intends to develop many additional functionalities to support the use and diffusion of central bank money.

The general plan of the focus groups

The London-based Kantar Group set up groups in all the 19 euro area countries, focusing on four segments: 2,160 members of the general public, 142 tech-savvy participants, 138 merchants and retailers, and 89 individuals with limited banking/internet access. It is highly probable (although by no means certain) that the people involved had no previous exposure to the concept of the digital euro. These results, although of little statistical value, are an indication of the general reactions to the idea of the digital euro.

The digital wallet is the easiest way of introducing the digital euro to the public

Few people have a clear concept of central bank money, which (according to common experience) is not quite easy to grasp. So, the group discussion initially centered on the concept of the “digital wallet” as a new payment method. The next logical step was to analyze what functionalities should be expected from such a device. The full concept of the digital euro was approached only at the end of the discussion, with the goal of exploring the level of knowledge and of receptiveness for that issue.

The baseline approach to the digital wallet

• The most important requirement is universal acceptance, with the parallel requirement of the capability to support multiple payment methods.
• Biometric authentication takes second place in requirements. Successful operation of the device depends on a cost-effective, easy, secure, reliable and fast way for both onboarding and identification.
• Most respondents perceive confidentiality as a medium level of financial privacy: banks may access transaction data, as long as they do not share with third parties.
• About loading money into the digital wallet, the most preferred solution is the manual transfer from commercial banking accounts with automatic reminders when the balance of the digital wallet is below a customizable threshold.
• This probably means that the initial version of the wallet will be operated by a commercial bank and will be linked to an already existing account.
• Less frequently requested features were the ability to use the device without an internet connection, long-autonomy and low cost.
• Other nice-to-haves were the support of cashback schemes and conditional payments to charities, and smart ways of starting a payment, i.e. via a QRcode.

Compared to the previous survey (which was based on voluntary contributions), the focus group's main concern shifted from privacy to general acceptance and ease of use. The paltry role assigned to QR codes should not come as a surprise, after the several unsuccessful attempts to introduce them in the Single Euro Payments Area and in the United States. QR codes as a payment device became popular in Asia and Latin America, where the credit card industry failed to acquire a dominant role.

The difference between commercial bank money and central bank money

The basic communication problem of the digital euro is that we overestimate the euros we already use for digital payments. As we can withdraw cash from ATMs anytime we want, we are led to believe in the absolute convertibility between commercial bank money and central bank money. While that belief is the necessary foundation of commercial banking, discovering that it is not always true is quite a hard experience. The most sensible approach to payments is to decouple payment risk from credit risk at an acceptable cost.

Non-European payment providers already handle around 70% of European card payment transactions. National European cards can be used abroad, but only thanks to specific agreements between the commercial banks and the international credit card companies. Users of the German EC-Karte and of the Italian Bancomat know that when they are abroad, cash withdrawals work under very different rules and conditions.

According to Regulation (EU) 2015/751 of 29 April 2015, interchange fees for card-based transactions should be capped at 0.3 % of their value. As a comparison, the fees of the TIPS instant payment system will remain fixed at €0.002 per transaction until 2023. ACHs also pay an additional €0.0005 per transaction for having their operational accounts managed by the ECB TARGET2 Real Time Gross Settlement system.

Under the directive 2014/49/EU of 16 April 2014, when a bank fails and deposits become unavailable, the guarantee schemes must reimburse depositors up to €100 thousand each. From mid-2015, the deadline for that is presently set at 20 working days (extendible to 30), which will be gradually reduced to 7 working days by 2024. Still, 20 days may be quite a wait for getting back what's yours.

What's beyond the baseline approach

These features are not expected to be available in the first release of the digital euro. In most of the cases, technical support may be already available but there is no clear legal advice about liabilities arising from improper use or abnormal behaviour of the feature itself. On the other hand, the risk profile of all the use cases listed below would be really improved if transactions were implemented by instant payments in central bank money. As the European Central Banks wants to encourage the use of this means of payment, these features will probably be covered in future releases of the digital euro.

Programmable money

The main property of cash is that its present owner has total control over it. On the contrary, many use cases require some liquidity to be assigned a specific behaviour. For example, a government subsidy should refuse being spent on anything different from its original goal. Commercial banks like the idea of programmable money, as it is the key for offering value-added services to the basic banking account. Technical support for this feature is already available: at blockchain level, smart contract factories allow associating a pre-set algorithm to the amount involved in a transaction. However, who should be liable for the correct operation of such an algorithm?

Offline operation

Cash allows instant payments without any third-party support (although their max amount is stated by national regulations). An offline protocol for the digital euro may enable the establishment of a subsidized economy right after catastrophic events, even when the mobile network becomes unreliable. Moreover, a digital wallet offering offline operation would be a convenient solution for low import transactions in our day-to-day activities. As for programmable money, technical support for this functionality is already available (at blockchain level, many layer-two protocols already support off-chain algorithm execution). Experts have come to regard offline operation as a very risky functionality, as it may allow the execution of transactions without any external guarantee about compliance to AML/CFT.

Machine-to-machine payments

In the case of autonomous vehicles, a sensible approach could be to allow the consumer to pay an all-included fee, while the vehicle itself will deal with its operational expenses like tolls, energy and services. In an automated building, the apartment itself should originate requests for services and okay payments for utilities. As is always the case with autonomous entities, we are lacking a clear attribution of the liabilities involved in these operations.

Delivery versus payment platforms

Settlement in central bank money should be an option for all transactions supporting the concept of delivery versus payment. The issuing of treasury debt certificates has been already targeted as a very promising use case. However, the concept of DVP is not limited to the financial markets, as demonstrated by certifiable personal property rights (typically, real estate and vehicles). Many of the proposed architectures for these platforms are based on Distributed Ledger Technologies. The basic issue here is about whether central bank money should circulate on a blockchain and in what form.

Cashier's checks

Cashier's checks are widely used throughout the Euro area. Although similar to cash as their payment is always guaranteed, their life cycle is more similar to that of a personal check. Were they replaced by instant payments in central bank money, the velocity of circulation of money would really improve. However, the amounts for which a cashier's check is usually issued are quite larger than the max monthly allowance initially accorded to a personal digital wallet.

Once these functionalities have been released, the synergies developing among them may become the major benefit of the digital euro. Machine-to-machine payments could be implemented on a Distributed Ledger and may take advantage of programmable money functionalities. Tokenized versions of cashier's checks may enjoy limited circulation in a Delivery Versus Payment platform, and so on.

This article was prepared by the author. The views expressed in this article are the author’s own and do not necessarily reflect the views of the Digital Euro Association.”