Today European Central Bank (ECB) Director Fabio Panetta gave a digital euro presentation in which he outlined the current state of progress of the central bank digital currency (CBDC), including “principles of a compensation model to incentivise distribution”. He was talking at a European Banking Federation event.
The digital euro compensation principles are:
- Free of charge for consumers to meet their basic payments needs
- Network effects which generate economic incentives for acquirers and merchants
- Comparable economic incentives for issuers
- Eurosystem bears its own costs, as for the production and issuance of banknotes
The presentation didn’t say much more on the topic, so the rest is our analysis.
Compensation is one of four agenda items on the digital euro work program for the current quarter. And it’s a fundamental challenge.
Changing roles: cards v digital currency
There are parallels between the participants in card payments and a digital euro, with the card company’s network operator function replaced by the central banks. That said, Visa and Mastercard are still likely to have roles. For example, they’ve developed wallet technology and digital currency AML that banks can license. And there will be a need for debit cards storing digital euros for those that don’t use smartphones.
Payment systems are all about network effects, but four groups of participants need to be incentivized, with each addressed in one of the principles: the consumer, the merchant, the merchant’s wallet provider (acquirer) and the CBDC issuing bank.
For conventional cards, the acquirer is the bank that logs the debit card payments on behalf of the retailer. In a digital currency scenario, the acquiring bank will provide the merchant wallet that logs all the transactions. Likely, wallet providers will not be limited to banks.
Because the digital euro is intermediated, there are also issuing banks where the consumer has a hosted wallet. So it’s similar to a consumer getting a bank card but instead having a bank’s digital euro wallet.
In card payments, Visa, Mastercard or Amex operate the network. But in this CBDC system, it’s operated by the Eurosystem of central banks.
Now we’ve established the players, who gets paid?
Merchants should be the biggest winners
In the absence of additional details, it appears retailers could gain the most. With card payments, a significant chunk of the fees paid by merchants goes on interchange payments.
When a consumer makes a card payment, the consumer’s (issuing) bank pays the money to the merchant’s (acquirer) bank, which gives it to the retailer. And the acquirer bank pays the issuing bank the interchange fee. The issuing bank keeps some of the fees, but a big chunk goes to Visa or Mastercard.
The central banks don’t plan to charge anything for operating the CBDC, so the interchange fees should be very small, making the acquirer charge lower fees to merchants. However, Europe already has caps on interchange fees of 0.2% on debit cards. So even if there were zero interchange fees, is 0.2% a huge incentive for merchants?
The question is whether interchange fees will continue to exist. On the one hand, it seems necessary to incentivize issuing banks. But it looks like an overhang from a legacy system being brought into a new, more efficient system. The reference to ‘comparable incentives’ is a hint.
One argument is that merchants don’t need incentives because the digital euro will be legal tender, meaning they must accept it. Another argument is that with lower fees, merchants might be incentivized to favor the CBDC over other forms of payment. That includes cash because in many countries, depositing cash carries hefty fees that can be as high as 1%.
But is 0.2% enough to incentivize merchants to push the CBDC?
Consumers could be indifferent to the CBDC. Keeping merchants happy is critical to generating the network effects needed.
How to incentivize issuing banks
Note the reference in the presentation to consumers making free basic payments. That’s likely to mean if you make a simple p2p payment, an e-commerce payment or retail payment, it will be free. But there’s a lot of room for additional functionality with charges to go with them.
While the central bank issued digital euro will not be “programmable”, that’s only in the narrow sense. For example, the central bank will not restrict digital euros to being food stamps that can only be spent on food. But it will be possible for intermediaries to add a programmable layer, including conditional payments, recurring payments or far more complex logic, where the user could be charged transaction costs. It’s no coincidence that one of the other work program items for this quarter is value-added services.
A key remaining question is whether issuing banks will receive interchange fees.
