Public Money, Private Money, and Legal Tender

As of today, banknotes and coins are the only forms of European Central Bank (ECB) money granted legal tender status and made available to the public.

Legal tender refers to money that, by law, must be accepted as payment for debts and other financial obligations.

In Europe, although credit cards are a commonly embraced method of payment, they do not hold the status of legal tender. The funds transacted through credit cards represent private money, distinct from the public money embodied by banknotes and coins.

Public money, unlike its counterpart, is issued by a public institution and acts as a monetary anchor.

Private money, which constitutes the deposits held in commercial banks, fulfills a different role in the economy.

The trust in private bank money results from its convertibility into public money.

The Rise of the Digital Euro in an Increasingly Cashless Society

As digital transactions become increasingly prevalent, there is a noticeable absence of a digital counterpart for public money.

Recent surveys conducted by the European Central Bank (ECB) indicate a significant shift towards electronic payments, with cash usage on the decline.

This trend has been particularly accelerated with the introduction of contactless payments, a move further propelled by the COVID-19 pandemic and the increase in contactless payment limits to €50.

Additionally, the proliferation of fintechs and mobile applications, such as Lydia to pay his friends, has made electronic payments more accessible and convenient than ever.

Furthermore, the use of cash is not without its drawbacks.

• The necessity to find an ATM
• The inability to withdraw the exact desired amount, often leading to the need for change.
• The risk of loss of theft
• The inability to use it for online transactions

This is where digital euro comes into play.

The Digital Euro Project

The European Central Bank (ECB) clarifies that the digital euro is not meant to replace cash but to complement it, sharing similar characteristics such as instant settlement, privacy, being free to use, and legal tender status.

The issuance of digital euros is exclusively authorized by the ECB, mirroring the current system where only the ECB and national central banks can issue cash, while private banks handle its distribution.

The European Central Bank (ECB) also ensures the security of the digital euro in the event of a Payment Service Provider (PSP) bankruptcy. Digital euros remain protected as they constitute public money, immune to the financial instability of private entities. In contrast, private funds held within the bank face the risk of loss.

Digital Euro Account

A digital euro account can be created by a payment service provider (PSP), such as your commercial bank, or by some national public services (for example, postal offices).

Once created, the account can be funded in several ways: with cash (public money), from a bank account (private money), or by receiving digital euro transfers from another individual.

However, there will be a limit on how much can be held in a digital euro account. This limit aims to prevent excessive transfer of private money into digital euros, which could impact commercial banks and credit providers negatively.

It’s also notable that a digital euro account can be linked to multiple bank accounts simultaneously.

Yet, only one of these accounts can be used for the “waterfall” feature: given the account limit, any excess funds during transactions (whether paying out or receiving money) will be automatically transferred to or from this designated bank account.

Spending Digital Euros

To spend digital euros, individuals can use a mobile app or request a physical card designed for this purpose. The ECB will provide a mobile app working with any PSP. But every PSP has the possibility to create this own mobile app.

The issuance of digital euros is exclusively authorized by the ECB, mirroring the current system where only the ECB and national central banks can issue cash, while private banks handle its distribution.

The digital euro will hold legal tender status, as banknotes and coins currently. This means, in theory, no one can legally refuse a payment made in digital euros.

Pay to Everyone

Users will have the capability to make payments to individuals, businesses, and government entities throughout the eurozone. However, there will be exceptions, such as micro-enterprises and nonprofits that do not use any form of electronic payments, which may not be required to accept digital euros.

Instant Payment

Digital euro payments will be settled in seconds. This is much faster than credit card payments, which go through many steps:

1. The merchant verifies the availability of funds in the payer’s account.
2. The specified amount is then reserved (locked) on the payer’s account.
3. A few days later, the funds are transferred to the merchant’s bank.
4. Finally, the merchant receives the funds in their account.

This traditional settlement process can take several days.

Offline payment

A key benefit of cash compared to other payment methods is that it doesn’t require a network connection to complete transactions.

This advantage will extend to the digital euro through its mobile app. It seems that users will have the option to store digital euros on their devices for offline use, allowing them to make person-to-person payments nearby without needing an internet connection.

Infrastructure

The infrastructure for the digital euro is a collaborative effort between the private sector (PSPs), and the public sector (ECB).

The Eurosystem (ECB), is responsible for the “back end” operations. This includes managing pseudonymized account balances and limits, as well as settling transactions.

On the other hand, the “front end” operations will be managed by the PSPs. Their responsibilities include user onboarding, providing access to the digital euro system, developing the waterfall feature and facilitating account funding, validating transactions, and initiating settlements with the Eurosystem.

Operating such an infrastructure costs money, leading to the question: who pays these expenses ?

The ECB will cover the costs on its side, similar to how it manages expenses related to cash circulation.

PSPs will receive fees from merchants accepting digital euro payments.

These fees will be regulated by the ECB to ensure they do not discourage merchants from accepting digital euros. This is particularly relevant for small businesses, such as bakeries or bars, which might avoid card payments due to high bank network fees impacting their profit margins.

Privacy

Cash is considered the most private official payment method. For any banknote, it’s impossible to trace its history in transactions.

The European Central Bank (ECB) asserts that the digital euro will maintain a level of privacy comparable to that of cash.

For offline payments, privacy could closely mirror that of cash transactions, though it’s important to note that these transactions are conducted via phone, which may involve data like geographical location and the time of the transaction.

In contrast, online payments inherently lack privacy due to their digital nature.

The ECB will process only personal data that has been pseudonymized or encrypted, so it won’t be able to directly connect transactions to a person’s identity.

Yet, the ECB has mentioned it could link transactions to specific individuals when necessary, for reasons like stopping fraud, money laundering, and terrorist financing.

This process probably means PSP will have to encrypt or hash personal information for every user in the Eurosystem. With all PSPs implementing the same digital euro standard, the ECB might be able to ask for the person linked to a certain hash or encrypted value from the PSPs, to identify who was involved in a transaction.

Conclusion

On paper, the digital euro seems ideal for everyday payments, combining the benefits of both credit cards and cash without their respective disadvantages.

However, the digital euro centralizes all transactions within a single system managed by the public sector, potentially allowing for the linkage of every transaction to the individuals who conducted them.

Such centralization could lead to significant risks. This will be the subject of an upcoming article.