Pablo Hernández de Cos: New digital technologies and the financial
system - fintech, crypto and CBDCs
Speech by Mr Pablo Hernández de Cos, Governor of the Bank of Spain, at the 20th
Anniversary Conference of the BIS Representative Office for the Americas, Mexico City,
20 November 2022.
* * *
Good morning.
I am delighted to be here to celebrate the 20th anniversary of the BIS Representative
Office for the Americas. This office was established, inter alia, to promote cooperation
among central banks and to develop research activity. I believe these aims are just as
relevant nowadays, if not more so, than they were back in 2002. In fact, the issues we
have on the agenda today are a good illustration of this need to join forces in analysing
and addressing common challenges.
Financial innovation, the focus of this session, is certainly a case in point. For years,
technology has been an important driver of change in the financial sector but the advent
of the digital revolution and the restrictions imposed by the pandemic-related lockdown
have certainly helped enhance its role on a much wider scale. It goes without saying
that our behavioural patterns are far more digitalised than they were not long ago. And
this trend is most surely here to stay.
The landscape that lies ahead promises a wealth of benefits for both the financial
system in general and for central banks in particular. For instance, robotisation,
alongside the use of AI and ML-related tools, allows increased efficiencies and, when
properly conceived, can further help increase financial inclusion, thus fostering growth
and employment alike. However, as with any innovation we should not only welcome
the potential benefits but also set against them the new and traditional risks that could
emerge with these tools.
I would like to structure my address today into three interrelated fields: first, the
European experience in regulating crypto-assets; second, the Eurosystem experience
in developing and providing a digital euro; and third, the promotion of innovation and the
Spanish experience with a sandbox.
The European experience in regulating cryptoassets
Over the last two years or so, cryptoassets have certainly attracted growing attention in
the public debate. Their steady, exponential growth was the initial trigger, followed more
recently by an equally impressive rapid decline. Yet, despite recent events, crypto-
assets and their underlying infrastructure, are another good example of the potential of
new technologies to help overcome certain shortcomings in the existing financial
ecosystem and, perhaps, even to create new business opportunities. Take the potential
possibility to fractionalise real-world assets (especially non-tradable ones), through
tokenisation, which opens a wide door to, among other things, an expansion of the
investor base and broadening the range of collateral that is available and acceptable,
beyond traditional items.
The flip side of digital assets are, however, their inherent risks which, as just
demonstrated by the collapse of FTX, can have far-reaching implications for their very
markets and, eventually, spill over to the regulated financial system through various
types of exposures for conventional players. Hence, authorities need to develop and
deploy swift and appropriate regulatory responses, of which, I think, MiCA is a telling
example.
The European Union's Regulation on Markets in Crypto-assets, on which we have
acted as one of the advisors to the Spanish Treasury, lays down a set of common rules
applicable to both crypto-asset issuers and service providers with a view to providing
crypto-asset users with legal certainty and adequate legal protection. In the same way
as we deal with banks, MiCA foresees an ex-ante authorisation of the new types of
crypto-asset service providers. Moreover, it sets out a number of prudential,
organisational and transparency requirements, as well as others relating to the
safekeeping of client funds, conflicts of interest and outsourcing. With regard to their
issuance and offering, MiCA introduces rules on both the authorisation of the respective
players and on how to draft the "white paper" that should reflect all the necessary and
accurate information future investors may require.
MiCA leaves outside its scope non-fungible crypto-assets. Furthermore, it does not
apply to crypto-assets that may be classed as financial instruments. The latter will still
be governed by the existing legislation on financial services. Yet, MiCA stands out from
other legislative initiatives in how it tackles stablecoins, of which it distinguishes two
types: electronic money (e-money) tokens and asset-referenced tokens. E-money
tokens purport to maintain a stable value by referencing to the value of one official
currency. As such, they are considered electronic money. Their issuers are limited to
credit institutions and electronic money institutions, which must comply with MiCA and
the existing provisions in this field.
Asset-referenced tokens, on the other hand, are a different kind of animal. These
cryptoassets are not e-money tokens and purport to maintain a stable value by referencing to
any other value or right, or a combination of both, including one or more official
currencies. The composition and administration of the underlying reserve assets thus
become key elements and, consequently, MiCA extensively addresses the conditions
which should guide their management.
As such, the reserve assets may only be invested in highly liquid financial instruments
with minimal concentration, credit and market risk. Moreover, MiCA requires that the
reserve be managed in such a manner that the liquidity risks associated with the
permanent redemption rights of the holders are addressed, and that the risks
associated with the assets referenced by the asset-referenced tokens are covered.
Finally, in order to protect the interests of token-holders, the reserve will have to be
operationally segregated from the issuer's estate.
Despite the significant progress achieved, MiCA is unfortunately facing what I hope
proves to be one last delay in its adoption process. In fact, reflecting the complexity and
exhaustiveness of this text, it is now heading for a February slot before the European
Parliament, which is expected to give its final endorsement. From then on the clock will
start ticking on what will most likely be a profound game changer for this industry.
Contributing to shaping the regulatory framework, as we have done with MiCA, is
probably the most straightforward way to deal with new developments. Nevertheless, it
may not be enough to avoid certain undesired effects, and crypo-assets are a good
example in this regard. Let us imagine what would happen if stablecoins denominated
in a currency other than the official one were extensively used. They may not pose risks
to the financial system, if properly regulated and supervised, but this situation could
introduce fragmentation, undermine the role of central bank money as monetary
anchor, and, ultimately, bring instability and hinder monetary sovereignty. Therefore,
central banks need to stand ready to take additional measures, if needed, which leads
me to the second part of my address.
The Eurosystem experience in developing and providing a digital euro
One of the additional measures that could be adopted to respond to the challenges
raised by financial innovation is the development of a retail Central Bank Digital
Currency (CBDC). In fact, a CBDC's potential contribution to boosting the strategic
autonomy of the European Union, by offering a fast and efficient alternative to other
payment providers, is one of the key reasons why the Eurosystem is assessing the
issuance of a digital euro. But it is not the only one. The role of the euro as monetary
anchor is not only being put to the test by these new developments, but also, and
probably more importantly, by the natural evolution of society. The increasing
digitalisation of every aspect of our daily lives is reducing the use of cash as a means of
payment. Should it reach the point where cash is hardly used, the convertibility of
central bank money and private money would be put at risk, affecting people's
confidence in the latter. We believe that having a digital euro to ensure convertibility
between these two types of money would underpin and protect the integrity of the euro
as a unit of account.
A digital euro could also foster innovation, increase the efficiency of payments, and
reduce our current reliance on non-European payment solutions and technologies. I
think the benefits of issuing digital central bank money for retail use are clear, but we
cannot forget the other side of the coin. CBDCs come, indeed, with a number of
challenges. The technical or operational ones, such as setting up a whole new payment
infrastructure, giving digital access to central bank money to every citizen and delving
into the intricacies of retail payments are obvious difficulties to surmount. However,
what seems more challenging to me is being able to reach the delicate balance
between achieving our policy objectives and, at the same time, avoiding collateral
damage, to the transmission of monetary policy and particularly to the stability of the
financial system.
It would probably be short-sighted to think that a CBDC would have no impact on the
financial system. Of course it may replace cash to some extent, but it is difficult to
believe that it will not attract a fraction of deposits as well. This means that a CBDC
could have implications for financial stability, monetary policy, and the allocation of
credit to the real economy. However, dispensing with its issuance in order to preserve
the status quo is not an option either. Let me explain. We are in the middle of a
whirlwind of change, so the question should not be "what should we do to avoid
change?" but rather, "what should we do to ensure the stability of the financial system,
in the midst of change?".
That said, CBDCs may come in different shapes and forms; therefore, adequate design
and implementation are needed in order to minimise their impact. This is not a minor
task and requires careful analysis. There are many interlinked design options and they
all have to be considered, both individually and holistically, in order to ensure they are a
perfect fit. This is, in fact, what the Eurosystem is currently doing in the context of the
digital euro. No decision has yet been made regarding its issuance or its final design,
but we launched the investigation phase of the project last year in order to ensure we
are prepared in the event that future developments warrant its launch.
Our work is now focused on deepening the conceptual analysis by assessing the
different design options, as well as the distribution model. The first step was to identify
the use cases to focus on, namely those that better support the policy objectives of a
digital euro and facilitate network effects. Payments in e-commerce and physical stores,
as well as person-to-person payments are, clearly, natural candidates. They either
represent important market segments or have a clear potential to grow, and they rely
heavily either on cash or on non-European providers and technologies. Payments
between governments and individuals have also been considered a priority, given their
potential synergies with the aforementioned ones. In any case, focusing now on these
payment segments does not mean ruling out others, but simply leaving them for future
stages.
The next step of the analysis has covered what we consider to be the foundational
design options. They refer to the way a digital euro should be transferred, the level of
privacy and the tools to control excessive use and, hence, limit its impact on the stability
of the financial system. As regards the transfer mechanism, we have decided to
prioritise a digital euro solution in which transactions are transmitted online and
validated by a third party, since this model covers the broadest set of use cases and
supports the Eurosystem's policy objectives. Peer-to-peer validated offline payments
are also going to be further explored, but this option presents a number of technical and
regulatory challenges that make its time to market more uncertain.
Privacy is a design consideration that was rated high in importance by respondents to
1
the public consultation we carried out at the end of 2020. In principle, a digital euro
should provide the same level of privacy as current digital payment solutions in order to
comply with the regulatory framework. However, we are also exploring, together with
the co-legislators, the possibility of attaining a higher degree of privacy in situations
considered of low risk, such as online transactions for amounts below a certain
threshold or offline payments, since they need to be carried out in close proximity. Full
anonymity, however, is not considered a viable option from a public policy perspective.
Complete visibility by the Eurosystem is not deemed desirable either, so it would be
limited to what is strictly necessary to perform its tasks or is required by regulation.
Last, but not least, we have assessed different ways to ensure a digital euro is used as
a means of payment rather than as a store of value. Both holding limits and
remuneration-based tools are considered effective means to limit the use of a digital
euro as a form of investment. However, no decision has been made yet on the precise
way they should be combined or the parameters to use. Rather, a more flexible
approach has been agreed, ensuring that the design of the digital euro includes a wide
set of tools, while leaving the decision on which ones to actually implement to a later
stage.
These foundational design decisions, which were recently endorsed by the Governing
2
Council, are an important stepping stone but constitute only the tip of the iceberg of
our analysis. We have continued exploring design and distribution options and we are
close to reaching a decision on the settlement model, the distribution model, the role of
intermediaries and the basic principles that funding and defunding functionalities should
observe. Involving all relevant parties in these decisions is of utmost importance, and
that is why we are actively engaging with a large number of stakeholders, not only from
the industry but also end-users and European institutions.
Our analysis is not conceptual only. We are also developing a prototype that will help us
validate the different design decisions. In order to do so, the Eurosystem is building the
back-end infrastructure and we have requested the cooperation of the private sector to
provide end-user interfaces. An expression of interest was launched last April and five
3
companies have been selected from a pool of 54 front-end providers. This will allow us
to test end-to-end transactions for different use cases, both online and offline. This
prototype, which is expected to be completed in the first quarter of 2023, is only
relevant for investigation purposes, and there is no plan to reuse it in a production
environment.
We are now halfway through the investigation phase and our aim is to complete it by
the end of next year. Then, the Governing Council will decide whether to move into the
implementation phase, in which technical solutions and business arrangements for a
digital euro would actually be developed and tested with a view to their potential launch.
The promotion of innovation and the Spanish experience with a
sandbox
The direct provision of payment services, as would ultimately be the case with the
digital euro, is not the only strategy or tool that central banks have to respond to
increasing digitalisation and use of new technologies by the financial sector. The
instruments adopted by each supervisor or regulator differ depending on whether they
are more focused on maximising the benefits stemming from digital innovations or on
mitigating their potential risks. For instance, as MiCA illustrates, regulation could be
useful to curb these risks, but the authorities may also hamper innovation in a
jurisdiction, should the regulations not be well calibrated.
On the other hand, the deployment of innovation hubs and accelerators, which
takes me to the last part of my address, may successfully contribute to maximising
and better understanding the benefits of new technologies for society. Hence, they
could encourage financial innovation and/or increase the adoption of these technologies
by the supervisory authorities in their functions. Indeed, regulatory sandboxes try to find
a balance between these two objectives: they are defined as controlled and delimited
environments in which technology-based financial innovations can be tested and
monitored by the supervisors, while minimising the risks to the financial system and
consumers. This is the main tool adopted by Spanish financial authorities since 2020 to
respond to the emergence of new technologies in finance.
The Spanish sandbox has opened up new ways for supervisory authorities to engage
and cooperate with the fintech sector, whose players frequently do not have at their
disposal other ways of interacting with financial authorities. More importantly, the
sandbox has increased the participating firms' understanding of regulation and
supervisory expectations and improved their regulatory compliance through their close
interaction with the supervisor. The sandbox has also enhanced the supervisors'
understanding of both the new technologies applied by the financial sector and their
underlying benefits and risks, as well as of the potential regulatory barriers faced by
innovators. Four cohorts have been run up until now, and the Banco de España has
already published reports with the conclusions of six projects. The overall experience
has been positive and encouraging. That said, the sandbox is a learning process both
for the authorities and the participating firms, and we are constantly working on possible
ways to improve its functioning and usefulness for both the authorities and the private
sector.
In summary, central banks and other authorities have a range of tools and roles to play
when facing the challenges posed by the increased digitalisation of the financial sector.
I have tried to provide some European experiences from the regulatory angle (MiCA),
but also from the perspective of the provision of services (the digital euro project) and
from the more informal interaction that innovation hubs and sandboxes allow, with the
Spanish sandbox as an example. Carefully choosing and calibrating the right tools is
key to making the most of the opportunities that digitalisation offers, while mitigating its
risks. Let me stop here, and thank you very much for your attention.
1
43% of respondents ranked privacy as the most important aspect of the digital euro
(well ahead of other features) in order to maintain trust in payments in the digital age.
2
For further details on these decisions and next steps, see "Progress on the
investigation phase of a digital euro", available at https://www.ecb.europa.eu/paym
/digital_euro/investigation/governance/shared/files/ecb.degov220929.en.pdf.
3
Caixabank, for peer to peer online payments; Worldline, for peer-to-peer offline
payments; EPI, for point of sale payments initiated by the payer; Nexi, for point of sale
payments initiated by the payee; and Amazon, for e-commerce payments.