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Blockchain 22 Jun 2021

Spanish banks get ready for the digital euro

BBVA, together with the other 15 major Spanish banks, took part in the first tests leading to potential issuance of the digital euro. The initiative, coordinated by Iberpay, involved the Bank of Spain as an observer and its findings are included in the report.

The proof of concept, "Smart Money," has just been successfully completed. The 16 leading Spanish banks and the Bank of Spain collaborated in this first industry-wide proof of concept, which focused on testing the technical aspects and analyzing the different design options for the digital euro. The main purpose of "Smart Money" is to prepare the industry for the potential decision of the European Central Bank (ECB) to issue a digital euro as a complement to cash.

Central banks are making their move in the arena of digital currencies. China and Japan are running street-based pilot projects, while Europe is considering the creation of a digital euro as a payment option to complement cash. In mid-2021, a decision will be made on whether to go ahead with it.

The Smart Money initiative was unveiled in November 2020 as a response from Iberpay and the Spanish banking industry to the ECB's request, through its Report on the digital euro published in October 2020, to conduct technical and design tests, followed by a public consultation on the digital euro.

A range of digital money designs considered by the ECB in its report were tested, such as models based on account entries and tokens, distributed and centralized DLT technologies, online payments and the possibility of offline payments when no internet connection is available, limits on the holding and use of digital euros and important issues such as anonymity or programmability through use of smart contracts.

The initiative was coordinated by the Smart Money & Payments Group, made up of participating banks' leading experts in the fields of payments, innovation, blockchain, public policy and legal affairs, who contributed decisively to the project with their knowledge and experience, bringing a multidisciplinary, sectorial and collaborative approach.

Results and conclusions of the Smart Money initiative

The test recently wrapped up with a phase of technical and practical trials of potential designs of the digital euro in Red-i (interbank 'blockchain' network managed by Iberpay, in operation since 2019 and used in other innovation initiatives), which confirmed the feasibility of a sectorial distribution model of the digital euro. A wide range of stimulating conclusions were drawn:

Digital currencies backed by central banks, such as a digital euro and a digital yuan, may become a reality in the next few years. Unlike cryptocurrencies, such as Bitcoin and Ethereum, central-bank currencies promise lower volatility and greater security. They will be supported by their respective monetary institutions, which are responsible for ensuring financial stability.

A dual-layer model, where the ECB issues digital euros and the financial sector distributes them through financial market infrastructures to end users, would be preferable to a centralized model, as it would leverage existing distribution channels and banking services, facilitate rapid deployment and use of the digital euro, enable better management of risks related to the prevention of money laundering and terrorist financing, and leverage the customer knowledge and expertise of the financial sector.

A digital euro model based on account entries (which would be closer to current bank money) can coexist on the same infrastructure with another model based on tokens (a digital representation of the euro that would be closer to cash). However, the token-based model would entail intrinsic risks, with the end user directly managing digital euros in a digital wallet on his or her mobile device, analogous to cash in a physical wallet.

Offline payments, allowing the use of the digital euro without an Internet connection, present enormous opportunities, although it is necessary to continue exploring possible solutions to resolve certain barriers, such as the standardization at European level of QR codes or certain restrictions on the use of NFC.

The feasibility of applying limits to holding and using digital euros for online and offline payments has been tested and confirmed. In addition, mechanisms were tested to automatically manage excess balances in a digital wallet without interrupting the receipt of payments when the maximum limit is exceeded.

A financial market infrastructure, such as Iberpay, which is already regulated and supervised for similar roles such as cash distribution and national payment system management, could provide the platform for wholesale distribution of the digital euro, leveraging its existing connections to ECB platforms and its unique ability to settle in central bank money.

The tests took place on a pseudonymous permissive network, in which the details of the transactions of the end users would only be known by their financial institution, with Iberpay and the supervisor having access to general information on the transaction, but not personal data. It is also thought necessary to study the techniques that strengthen the anonymization of immutable data in the blockchain network in order to comply with the strict legislation on data protection.

It is necessary to move forward with the development and use of a digital identity for managing users' wallets. There are encouraging developments in this respect following the announcement of the proposal to amend the e-IDAS Regulation.

Incorporating programmability into the digital euro would open the door to major financial innovations and new business models for companies and financial institutions, thus speeding up the digitalization of the economy and society.

The results and conclusions of the initiative were set out in the Smart Money Initiative Sector Report published by Iberpay in partnership with the participating banks.

Next steps

Now that this experimental phase is complete and the feasibility of an industry-based distribution model for the digital euro has been confirmed, we await the imminent announcement by the European Central Bank of its decision on the potential new currency and the next steps to be taken on the road to the digital euro over the coming years.

The Spanish banking sector is now in an advanced position, leading the changes arising from the swift transformation of the world of payments and digital money and ready for the development of new high-value digital services for companies and individuals based on programmable smart digital money. These forward strides are expected to bring new business models and revenues to the sector and place Spanish banks at the forefront of innovation in the face of technological giants.