Usefulness of the article: This note aims to detail three phenomena that should be closely monitored in order to fully understand the direction that the European retail payments market will take in the coming years. These are, first, the European Payments Initiative (Section 1), non-European blockchain-based retail payment infrastructures and solutions (Section 2), and their European alternatives (Section 3).
Summary:
- The European Payments Initiative aims to create a European card system, a digital instant payment solution, and a peer-to-peer exchange instrument, without seeking to offer blockchain-based solutions.
- The most credible private blockchain-based retail payment infrastructure and solution project to date is Facebook’s Diem stablecoin, which plans to set up a system to manage the supply of Diems in real time and distribute it efficiently, while promoting the emergence of new related services.
- Nevertheless, the European Union wants to promote European stablecoins, as indicated in the MiCA regulation.
- Lugh is the first stablecoin managed by a major European bank with the backing of the authorities. This commercial bank digital currency could pave the way for others.
- Nevertheless, the ECB may opt for a central bank digital currency, the supply of which would be managed by it.
On January 13, Christine Lagarde announced that the European Central Bank was seriously considering launching a central bank digital currency within the next few years. Meanwhile, in the private sector, Lugh, the first commercial bank digital currency, was announced on March 17, 2021, with the ultimate goal of allowing customers of certain major retailers to purchase certain products in stores with this digital currency based on a decentralized transaction system with cryptographic validation, similar to blockchain[2]. Finally, Coinbase, one of the world’s largest cryptoasset exchange platforms, including stablecoins, made a very successful IPO on April 13, 2021, achieving the best performance in terms of valuation since Facebook’s IPO in 2012, at $85.6 billion, taking derivatives into account[3].
Thus, in addition to the trends presented in the first note on retail payments, the future of the European retail payments market remains dependent on new phenomena that are currently marginal but could change the game in the coming years.These phenomena are: the creation of a new European payments player, the European Payments Initiative (EPI) (Section 1), the emergence of private non-European retail payment infrastructures on the blockchain (Section 2), and the emergence of European central bank and commercial bank digital currencies (Section 3).
1) The European Payments Initiative[4]
The EPI project will be decisive for the future of the European retail payments market. On July 2, 2020, 16 European banks committed to creating a pan-European multi-purpose payment solution within the EPI, with initial delivery scheduled for 2021 and full operationality in 2023-2024. Today, the initiative includes 31 European banks and two payment service companies. This payment solution could:
(1) Compete with Visa and Mastercard in the international card payments market thanks to a European card system that can eventually be used anywhere in the world and online. Initially, a « meta-payment scheme » encompassing the existing national payment systems in the participating countries (e.g., Carte Bancaire in France or Girocard in Germany) is envisaged.
(2) compete with digital remote payment solutions developed by major digital companies such as Google, Apple, Amazon, and Facebook through a digital and mobile payment solution based on instant payment infrastructures (see section 2.3); and
(3) provide remote peer-to-peer payments via the banking system.
The European authorities support the initiative. Ultimately, it is not impossible that the EPI will also incorporate innovations from China (use of facial recognition[6] and QR codes) or the United States (a payment platform similar to that offered by Stripe, connected to EPI solutions). With regard to the latter, Worldline, a payment company participating in the EPI, has just announced the creation of its payment services platform, Axium.
However, EPI will face many challenges in Europe, starting with Germany and France. In Germany, EPIwill need to offer a compelling payment method to compete with widely used direct debits. If participating banks offer it as a direct alternative to direct debits, users may be more inclined to adopt it quickly. In France, the solution proposed by the EPI should seek to take market share from checks, which are still widely used.
2) Non-European blockchain-based payment infrastructures and solutions
As mentioned in the introduction, cryptocurrencies as alternative payment methods are gaining popularity and accessibility. They offer both innovative infrastructure and solutions.
In addition, the growing number of companies accepting them as a means of payment is gradually bringing them into the realm of inclusive payment methods. Nevertheless, questions remain about the security of the system they offer, as well as their « scalability »—that is, their ability to handle a much larger volume of payments while maintaining their initial transactional efficiency.
For the time being, the most credible large-scale project in this area in terms of potential retail payment volumes is Facebook’s Diem (formerly Libra), as presented in its latest white paper in April 2020. The project envisages that the cryptocurrency would operate as follows:
(1) A reserve bank would be responsible for creating and deleting Diem based on customer demand in order to maintain absolute parity with the currency on which Diem is backed. The bank’s balance sheet assets would consist of 80% highly liquid assets with very short maturities (mainly three-month sovereign bonds) and 20% cash deposits placed with the central bank, preventing the reserve bank from implementing a traditional banking business model[13].
(2) The reserve bank would supply units to selected distributors, which would also be unable to operate as traditional banks. Their role would be to interact with end consumers. The Diem network would carry out frequent checks to ensure that these distributors comply with the rules.
(3) Other players would intervene to ensure strong competition and innovation in the Diem market. More specifically, these would be virtual asset service providers and non-custodial wallets, which would provide different types of services to consumers.
(4) Blockchain would be used and its validation process would be carried out by validators selected by the Diem network. To do this, the network would assess a score for each validator based on objective criteria. Depending on their score, validators would be authorized or not to validate transactions and collect commissions.
(5) The transaction validation protocol would use an approach that would allow it to function properly even if some validators—up to one-third of the network—were compromised or failed.
However, it will be difficult for Facebook to set up this alternative retail payment infrastructure in Europe due to the upcomingEuropean MiCA regulation . This regulation stipulates that authorities reserve the right to refuse a cryptocurrency if its issuer’s business model « poses a serious threat to financial stability, the transmission of monetary policy, and monetary sovereignty. ». Given the market potential represented by users of Facebook group applications (Facebook, WhatsApp, Instagram, etc.), it is likely that the European authorities will reject Diem, especially as they wish to promote their own solution in this area, probably in the form of European central bank or commercial bank digital currencies (see 3.3).
3) European central bank and commercial bank digital currencies[16]
3.1 The digital euro
As mentioned in the introduction, ECB President Christine Lagarde recently stated Europe’s desire to create a « digital euro, » which could be a safe, efficient, and inclusive response to the emergence of alternative blockchain-based retail payment infrastructures.To this end, a consultation was held, the results of which were published in April 2021[17]. Privacy is the most important feature that the digital euro will need to take into account, both for citizens and professionals. Security, inclusiveness (online and offline), and free of charge are the next most important factors. The digital euro should be included in existing payment solutions and banking products. Many participants would like it to be based on blockchain technology.
In terms of how the euro could be used, respondents to the consultation want it to be fully inclusive, i.e., usable with all available means of payment (cards, transfers, direct debits, mobile solutions, e-commerce, etc.). To avoid undermining financial stability by encouraging depositors to migrate their deposits from their commercial banks to the ECB, which would destabilize the business model of commercial banks, respondents mention a limit on the amount of digital euro deposits held with the ECB. They also mention imposing a positive deposit and transaction cost for large amounts of digital euros, as well as free of charge for small amounts, making it possible to discriminate between depositors using their digital euros for retail payments—mainly individuals—and those using them for wholesale payments—mainly businesses. Finally, respondents would like to have fast, or even instant, digital euro payment methods for international transactions.
However, the consultation does not mention the distribution structure of the digital euro. Given the ECB’s lack of expertise in providing payment services to businesses and individuals, it may delegate this function to Eurosystem banks, which could distribute the digital euro through a structure equivalent to that of Diem, the main difference being that the ECB would be the reserve bank (see Section 2). This public-private partnership in the management of the digital euro would make it a « synthetic Central Bank Digital Currency » (hereinafter sCBDC).
3.2 sCBDCs
An sCBDC would enable the ECB to quickly make a central bank-linked digital currency available to users in a cost-effective manner, thanks to private sector expertise. It would allow the ECB to limit the reputational risk involved in managing blockchain-based transactions. This could indeed undermine the credibility of central banks in their traditional activity of monetary policy, i.e., targeting inflation and sometimes output, rather than the distribution of digital currency. Furthermore, since the money supply would be supervised by the ECB through the reserve bank, the ECB would retain, or even strengthen, control over the transmission of its monetary policies.
If Eurosystem banks were responsible for managing the sCBDC, their customers would not necessarily have to migrate their deposits to an ad hoc financial structure responsible for distributing the sCBDC while maintaining parity with the euro. They could manage them directly on their banking management platform, for example by transferring them to an internal account, capped to prevent excessive migration to these accounts in the event of a financial crisis, as the digital euro is backed by the central bank, which guarantees its value. On the other hand, given that commercial banks would be unable to grant interest-bearing loans on the basis of their digital euro deposits, this could reduce their overall capacity to grant loans and ultimately weigh on economic activity, inflation, and unemployment. Digital euro account limits should also take this risk into account, perhaps by varying the limits in a countercyclical manner (lower in times of crisis, higher in times of growth).
Lugh, the first European commercial bank digital currency, is an experiment similar to the proposed sCBDC model.It is managed by Société Générale, which will therefore be responsible for maintaining parity with the euro and will manage the supply of Lughs accordingly. The first use cases are the ability to make instant transactions, protect against volatility, and reduce certain transaction costs[20]. Ultimately, Lugh will be used as a loyalty point at major French food retailers to purchase certain products. This mode of operation is a « gateway » to retail payment, a condition set by the authorities for implementing this project. Alongside Lugh, other commercial bank digital currencies could emerge in Europe, with similar approval from the European authorities. It is too early to say whether these stablecoins could constitute a form of « digital euro » as understood by the ECB. Nevertheless, this option would allow commercial banks to retain their deposits, which are at the heart of their business model.
Conclusion
In addition to the trends outlined in thefirst note, the future of the European retail payments market thus depends on emerging phenomena that could completely disrupt the current landscape. The success or failure of the EPI and European stablecoins, whether publicly or privately managed, will be decisive in shaping the future of the sector in Europe.
However, there are still some unknowns. Consumers’ reluctance to change their payment habits could slow down the changes underway, even though the COVID-19 crisis has shown that everyone is capable of evolving in this area. Consumer appetite for emerging payment solutions and infrastructures will therefore be the key variable to watch in order to determine the speed of change. The adoption of the European solutions proposed in this note should enable Europeans to retain their own payment solutions and infrastructures in the long term.
European sovereignty over retail payments is indeed essential, as it allows banks to use payment data to tailor their financial product offerings, thereby ensuring their profitability, and to use deposits to increase the size of their balance sheets and provide credit. on the other hand, authorities not to depend on foreign powers, which would otherwise be able to disrupt retail payment systems in the EU. Despite the ambition of European projects, the technological lead of American and Chinese retail payment solutions and infrastructures raises fears that this sovereignty may slip away. The next few years will therefore be crucial in this regard. The European retail payments market is at a crossroads and must now choose the right destination.
[1]Le Monde, In Europe and the United States, the race for digital currencies is on, January 14, 2021.
[2]Les Échos, Casino wants to open the way for consumers to pay with crypto, February 17, 2021. For more details on how blockchain works: Input from the European Policy Center, The currency of tomorrow?, 2020.
[3]Financial Times, Coinbase valued at $76bn in coming-of-age moment for cryptocurrency, April 14, 2021.
[4]Section inspired by the European Policy Centre’s Input on the EU’s retail payments strategy, January 2021.
[6]Le Monde, In China, your face is your wallet, July 5, 2019.
[7]Zonebourse, Worldline launches Axium, a payment services platform, April 6, 2021.
[8]ECB, Payment statistics, 2020.
[9]Ibid.
[10]While the blockchain system remains inviolable to date, the fact that access to one’s cryptoasset wallet depends solely on a key, which can be lost or stolen, makes the use of cryptoassets as a real means of everyday retail payment fragile. Furthermore, cryptoassets are still not supervised or regulated by public authorities. CNBC, Thinking of buying bitcoin? What experts say about big crypto concerns: « You have to be mentally prepared, « April 9, 2021.
[11]« They are not a scalable means of payment: with bitcoin you can do five transactions per second while the Visa network does 24,000. » Financial Times, Nouriel Roubini: bitcoin is not a hedge against tail risk, February 10, 2021.
[12]Diem, White Paper. In 2021, Facebook is expected to limit itself to launching a Diem backed by theUS dollar, like USD Coin and Tether.
[13]Traditionally, banks make profits from the difference between the interest they earn on their assets and the interest they pay to their depositors, savers, and creditors. They can use their deposits or create money to increase their credit volume.
[14]Stablecoins are cryptoassets whose characteristics make them suitable for use as currency: store of value, unit of account, and medium of exchange. They are considered stable because they are pegged to a fiat currency such as the euro or the dollar.
[15]Art. 19(2), Regulation on Crypto-Asset Markets, September 24, 2020.
[16]Section inspired by the European Policy Centre’s Input, La monnaie de demain ?(The currency of tomorrow?), 2020.
[17]ECB, Eurosystem report on the public consultation on a digital euro, April 2021.
[18]Ibid, p. 3.
[19] Given the expected positive impact of a massive digitization of retail payments on consumption, trade, and wealth creation (see note1 ), it cannot be ruled out that a synthetic central bank digital currency could have an effect on inflation. Nevertheless, the caps imposed on deposit accounts should mitigate the risk of inflation rising in the wake of the widespread adoption of such a digital currency.
[20]Lugh, by the way.
