In July, the European Central Bank (ECB) announced a new 24 month investigation phase on the digital euro. The aim is to ensure safe access to money from the ECB while at the same time prevent illicit activities and avoid undesirable impact on the financial stability and monetary policy. Eric Boulet, Project Manager at TriFinance Belgium, has studied and summarized the different terminologies regarding digital currencies. Here are some of his insights.
Digital currencies: what are they
We hear about digital currencies a lot, but what are they? And why are they a hot topic? As to the first question, there is no universally accepted definition regarding digital currencies. This makes it harder to discuss the topic let alone understand it. Below an attempt is made to define in simple terms some of the terminology:
- Electronic money (e-money) is like physical cash but in electronic form. Think of money in your bank account.
- Digital currencies are a form of e-money but have no physical counterpart, they exist solely in electronic form. They can be regulated or unregulated, i.e. they have been issued by a central bank or credit institution or not. An example would be money charged on the old Proton system.
- When digital currency is unregulated we call it virtual currency. Facebook's proposed Diem, formerly known as Libra, can be categorized as such.
- Cryptocurrency is a virtual or digital currency (i.e. it can be issued or not by a central bank or credit institution) that uses cryptography to generate and transfer currency units. Meaning that it is based on solving complex mathematical functions. Bitcoin can be classified as a digital currency, a virtual currency and a cryptocurrency.
It is important to note that per ECB's own words the digital euro would "complement cash, not replace it". Furthermore "a fast, easy and secure way" to make payments would be made available. And finally it would allow individuals to have deposits directly with the ECB.
With the digital euro the European Central Bank can become a direct competitor to retail banks as well as European FinTechs. This could have a huge impact on the current banking system.
Why are digital currencies a hot topic?
It is easier to answer the "why" question. For companies it's a way to make money. For central banks it's a way to remain master of the amount of money in circulation in order to keep inflation and deflation in check. Additionally it challenges the dominance of non-European companies such as Mastercard and Visa. And finally with a small investment, the ECB can propose an alternative to a foreign government or company controlled currency.
There are also negative aspects. The ECB can become a direct competitor to retail banks but also to European FinTechs developing payment systems. Then there is also the question of privacy. A currency that exists solely in electronic form will always be less anonymous compared to cash.
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