What is required to deploy the digital euro into production?

Virtually all central banks in the world have been working on projects for CBDC for many years. First in the form of analytical work where relations to the payment market and financial stability have been crucial. Both of these topics are extensive and analyses continue. In recent years, various technologies have also been tested, mostly related to Blockchain and DLT. Now, a very few countries have put CBDC into production or in pilot, without any country so far being particularly successful. This blog's purpose is to shine a spotlight on the task of deploying retail CBDC in production in a democracy such as Europe and to try to start the process of taking on the challenges that will be involved in implementing a successful project and estimating the scope and costs.

How to measure a successful introduction?

The digital euro is a new form of money, in addition to and not a replacement for today's money. This means that money in the form of central bank cash and private bank account money will also dominate in the future, which in turn means that MasterCard, Visa, ApplePay, GooglePay, AliPay Etc. will dominate the payment market. But it is most likely a desire from the central bank that the digital euro will create competition and take 20-30% of the payment volume. If it is to create competition, it must necessarily take parts from what exists. This may cause existing providers to improve their services and/or reduce prices. If the digital euro volume becomes very low and the value to society is small, the projects can hardly be called successful and it would perhaps be better if the project was not put in production in the first place? Central banks should set target goals for how large a market share the digital euro should get.

What is needed to create a network effect?

In digital innovation and digital platforms, the word "sticky" is used a lot. You create a new innovative service with a few early users. These few users think the service is so good that they bring their friends and business partners with them. They in turn bring more people with them and you have created a positive spiral because the services "stick" to the entire circle. The crucial thing is that the service is so good that the positive spiral escalates and both the technology and the services actually scale. If the service does not have enough value, you get into a negative spiral that is very difficult to get out of. Even for a central bank. It is typical for those who succeed that they are able to facilitate the support of many others services to expand the offer. As for example Apple did with the introduction of the AppStore. Open-source code and standard API have often been the key to digital success.

Digital euro as a legal tender

Virtually all central banks have assumed that CBDC should be a legal tender on par with cash. This means that everyone should be able to use the digital euro, even those who for various reasons are not digitally mature or have physical limitations, such as the elderly without a mobile phone and computer. It also means that all retailers (online and offline shops) must be able to accept the digital euro as payment for a trade, both in physical stores and online. This is very ambitious and will be a comprehensive and expensive project. In the EU, for example, there is a big difference between Finland and Romania when it comes to the level of digital infrastructure. If such a project is to succeed, it will require resources far beyond what the ECB and most central banks have at their disposal today. A public-private project is probably the only way forward, but who does and pays for what?

Distribution and two-tier infrastructure

Most central banks envision banks and PSPs (Payment Service Providers) distributing CBDC to their customers. The central banks issue (mint) digital euros that are sent to banks/PSPs when they order. The banks pay the central banks by drawing on their central bank reserve accounts, similar to what they do for cash today. The digital euro is then recorded as a claim on the central bank in the bank. A customer of a bank/PSP can then request digital euros to be added to their digital euro wallet by having the bank deduct the amount from a deposit account. Some suggest that it will be possible to top up the digital euro wallet from a deposit ATM with cash if you do not have or want to use a bank account. It will be crucial that central banks find business models that motivate the entire distribution chain end-to-end.

Regulation and law

Privacy and GDPR are important, both for regulatory reasons and for public trust. Anonymous payments should probably be possible, especially for offline payments and small amount? At the same time, society's need for protection against money laundering, tax fraud and payment for illegal activities is important, in addition to investor protection. "Compliance by design" has been mentioned by several as today's money allows for extensive illegal activities. The UN has suggested that as much as 5% of the world's GDP circulates in environments for illegal activities, and only a very small number are prosecuted. This poses major challenges and generates additional costs for digital euro projects both in connection with design, implementation and ongoing improvements.

Lack of expertise

It seems clear that most central banks most likely do not have the expertise they need to deploy a successful CBDC in production. Central banks have employees with solid expertise in macroeconomics, payment infrastructure, interest rates and currencies, as well as conditions that affect financial stability. Introducing a new form of money with a new form of technology is a completely different project that requires a completely different form of expertise. One solution could be to establish a new organization with new employees, but is there the right expertise in Europe and if so, do they want to be employed in a central bank?

Speed

While the digital euro project is developing at a slow pace (they probably think it's going fast), the payment and financial world is changing at a great speed. Stablecoin and crypto are flowing into the general economy on all continents, including Europe. DeFi with both payment, loans and deposits is taking an increasingly larger place at the expense of old regulated entities and banks. In addition, completely new and innovative financial services. And now another wave of new services based on AI is coming. New services based on new technologies are here to stay and will (as always) accelerate. This means that digital euro project will have to compete harder for their place in the future value chains. This in turn requires new forms of interaction of the entire value chain.

Technical start-up costs

The ECB issued a "Call for applications for digital euro component providers" in January 2024. It was to obtain offers from private companies to develop parts of the solution, with a cost framework of 1.2 billion euros. Based on this, the costs will quickly become 3-4 billion Euros for the ECB. In addition to the ECB, each of the 20 central banks in the Eurozone countries must make their investments.

When the costs are discussed here, it is important to remember that everyone in the value chain still has to invest in today's solutions with cash, private bank account money and new regulations that are coming at just as fast a pace in the future as they are now. DORA is now on the horizon and money laundering is in strong focus in most countries.

Central banks must at least be able to:

• Issue (mint)
• Delete (burn)
• Accept orders to/from banks/PSPs
• Bookkeeping and administration
• Establish supervision and monitoring of the digital euro market
• Establish separate units (IT and administration) or departments for digital euros
• Establish a new organization

Cost estimate per central bank on average 20 million €

With 20 central banks in the Euro this will be 400 million € + a few billion at the ECB.

The banks/PSP must at least be able to:

• Order and return digital euro from and to the central bank
• They must be able to keep track of their own digital euro holdings
• The digital euro must be booked in the same way as cash
• They must be able to "onboard" customers who will have wallets and digital euro
• As the digital euro will likely become "custodial" similar to bank account money, they must keep track of the holdings and transactions for their own customers
• They will also be responsible for any cap holdings for their customers
• Anti-money laundering and reporting must also deal with digital euro
• Establish the necessary organization for digital euro and maintenance of IT systems
• Integration with core banking systems.

Many banks are groups where the parent bank takes most of the costs. Nevertheless, there are costs for each bank branch.

Estimated cost per group of bank/PSP group 10 million €

With 400 estimated groups of banks in the EU (there are 4,100 banks in the EU) that can cooperate on technology and administration, this will be 4 billion euros. 

The retail sector (shops) must at least be able to:

• Accept the digital euro as a means of payment by changing payment terminal/online checkout
• Bookkeeping digital euro (ERP systems + own processes)
• Settlement with the bank to/from digital euro and bank account
• Pay employee salaries and subcontractors in digital euro?
• Pay advance tax and VAT in digital euro?

It is assumed that suppliers of ERP systems and payment terminals take a large part of the costs. An average of 10,000 NOK/1000 Euro per store is assumed here. Significantly more for large companies with many employees and less for small one-man stores. The costs will be more in the form of annual license costs than first-year investments. There are 630,000 registered companies in Norway, 206,000 companies with turnover and 123,000 SME companies in Norway. I estimate that half, about 60,000, will be affected by a retail CBDC in Norway. There are 26 million registered companies in the EU. With similar logic as for Norway, 2 million companies will be directly affected by digital euro. There are an estimated 120 banks in Norway and 4,100 banks in the EU.

A "fast and dirty" estimate is about 1.6 billion Norwegian kroner in establishment for Norway and 6.4 billion Euros for the Eurozone countries. It is assumed that around 65% of the total costs rest on providers of banking and payment. A question is of course who will absorb these costs when the ECB and most central banks have pointed out that end-customers should not bear the costs, that is, digital euro should be free for end-customers.

It is common to assume that annual maintenance of digital services constitutes 20% of the first year's investment. In this case, new processes and possibly organizations should often be established in addition to technical innovation, maintenance and new software versions so that annual costs are likely to be in the order of 30% of the initial investment. That in turn means around 500 million NOK in Norway and 2 billion Euros in the EU.

The views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy or position of the Digital Euro Association.