Author: Daan Schrage
May 25, 2021

You might have read about it in the news recently. The European Central Bank is experimenting with a digital Euro. While having your money stored digitally might sound like the regular bank account that you already own, the ECB assures us that it is not. Then what is it that makes a digital Euro so special, and why would you use it over just stuffing cash under your mattress?

As you might know, the numbers on your bank account are just that: numbers. If everybody were to go to the bank right now and withdraw every cent from their account, the banking system would collapse. This is because of a system called fractional reserve banking. It essentially means that banks are only required to keep a fraction of deposits as liquid assets. The rest is all invested or extended as credit to consumers and businesses.

The digital Euro is different. What exactly the system is going to look like and how it is going to work is still unclear, but one common theme is that the digital Euro could be stored directly at the central bank. This would allow people to bypass the commercial banking system entirely, without the need to store cash in an old sock at home. The reason the digital currency would be kept at a public-owned institution, rather than as a decentralized cryptocurrency is stability. As cryptocurrencies have no formal institution backing them, their prices are volatile. Ideally, people would have as much faith in the digital Euro as they do in the physical, which is not possible using cryptocurrency, according to the ECB.

However, what is the added benefit of using a digital currency over a physical one? Why jump through all these hoops when keeping a stack of cash and opening a bank account also suffices? One of the reasons is security. During a financial crisis, it can happen that commercial banks run into liquidity problems. This causes people to lose confidence in the banking system, and in the worst case it can even lead to something called a bank run, which is when account holders all rush to withdraw their money from their bank accounts, as they believe the bank might collapse soon. The idea is that this will not be an issue with the digital Euro. After all, your money is stored directly at the central bank, and as long as the Euro will be around, so will the central bank.

Another benefit is that of monetary transfers. Let’s say that in the future the EU will be in some kind of global crisis, not unlike the current pandemic. In that case, the ECB might want to issue monetary transfers to citizens. Right now, people would have to apply, provide their bank account, and wait for their request to be processed administratively, after which the money would be deposited in their bank account, at which point they technically do not even own the money anymore. However, with a digital Euro, it could be as simple as adding the amount to people’s accounts at the central bank. A digital Euro would allow the ECB to stimulate the economy directly through its citizens.

However, if you’re worried that your Euro bills might become worthless, fear not. The digital Euro is not intended to replace cash, but rather to be used alongside it. While it might still be years until we can use a digital Euro for the first time, it is an exciting prospect, nonetheless. It would be a new digital way to pay for a new digital age.

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