Central Bank Digital Currencies Are Coming: Interview with CBC Governor Constantinos Herodotou

Constantinos Herodotou, Governor of the Central Bank of Cyprus, discusses the implications of digital currencies for the euro area, how they will affect monetary policy, as well as the ways in which technological advancements will disrupt central banking.

By Adonis Adoni

We have recently seen central banks from the UK to China deepening their efforts to roll out digital cash – the European Central Bank is one of them– in part to rival the ever-growing crypto market. What would a central bank digital currency look like?

The decision of a central bank to issue a digital version of its currency is in line with a rapidly digitised economy. In this new era, a digital euro would combine the efficiency of a digital payment instrument with the safety of central bank money. The digital euro would be an electronic form of money issued by the Eurosystem and accessible to all citizens and firms. It would give an additional choice on how to pay and make it easier to do so, thereby contributing to accessibility and inclusion. On October 1, 2021, the Eurosystem entered the investigation phase of the digital euro project, which is estimated to be completed in about 24 months. The investigation phase will not prejudge any future decision on the possible issuance of a digital euro. Accordingly, the Eurosystem will proceed to create and test possible solutions, working together with banks and companies that could provide the technology and the payment services. In effect, a digital euro would guarantee that citizens in the euro area maintain costless access to a simple, universally accepted, safe and trusted means of payment.


In a world where virtual currencies from central banks had become widely adopted, how would that affect the banking model that we know today? Would we see an unbundling of banking services?

Virtual currency adoption by central banks could be another facilitating factor in reshaping the banking model as we know it today. We see attempts by other private actors, like BigTech, to become involved in the virtual currency and payment services market and this has the potential to disrupt banking services. However, regulation has a role to play regarding the extent to which this will happen. The challenge for regulators will be to keep a level playing field that strikes the right balance between fostering innovation and preserving financial stability. Consumer protection issues would also be of paramount importance.


What are the implications for monetary policy and financial stability in a world with a Central Bank Digital Currency?

Decisions on monetary policy in the euro area are taken by the European Central Bank (ECB) Governing Council, after thorough discussion and consideration of the multitude of factors and variables involved and the analyses provided by the ECB experts. A digital euro could replicate some key features of cash and, as such, would affect monetary policy. Like any other new instrument, depending on its design features, it may entail certain challenges, including the implementation of monetary policy, monetary transmission and financial stability. The ECB is aware of these challenges and the CBDC will only be introduced when the desired design features are finalised, so that all the potential adverse consequences of its issuance are mitigated.  In particular, a number of alternatives are being examined with regard to the advantages and weaknesses of specific types of digital euro and how they would meet the needs and expectations of European citizens, businesses and financial intermediaries. Some digital euro design options could affect the intermediation function of banks and their funding costs, especially in situations of stress. The ECB will design the digital euro to avoid any possible undesirable implications for the fulfilment of its mandate, for the financial industry and for the broader economy.


Regulators have been used to setting the boundaries to well-defined financial instruments so far. However, the advent of fintech products, like crypto, has given birth to service providers in shapes and forms that are difficult to categorize. So, how do you see regulators shifting to accommodate the currently unaccountable nature of many fintech companies?  

In September 2020, the European Commission adopted the Digital Finance Package aiming at transforming the European economy in the years ahead. Its ambition is to foster the competitiveness of the fintech sector in the EU. This effort includes a prospective legislative proposal on crypto-assets, called Markets in Crypto-assets (MiCA), which was developed to help streamline distributed ledger technology (DLT) and virtual asset regulation in the European Union, while protecting users and investors. Even before this project, the EU amended its AML directive to list Virtual Asset Service Providers as obliged entities, having recognised the vulnerability of these entities to Machine Learning and Terrorism Financing risks. The implementation of MiCA is expected to affect this evolving market.


Assuming that artificial intelligence (AI) technology continues to mature at an exponential pace, can you imagine a scenario where, in 2050, the Governor of the Central Bank of Cyprus is advised on monetary policy changes by an AI robot? While this scenario might be far-fetched, in what ways do you see AI transforming central banking in the coming decades?

AI systems have the potential of becoming an integral part of the analysis required to reach informed decisions, by providing data to decision makers. A number of Central Banks in the Eurosystem are already experimenting with various AI methods in their daily data pipelines to aid with data analysis and interpretation, in order to provide decision makers with a more accurate and holistic view of the factors affecting financial behaviour. With more data being constantly accumulated, from any source imaginable (from financial transactions to real estate market trends, etc.), we have an immense wealth of information to analyse, draw conclusions and even make predictions. The purpose of AI is by no means to take decisions on its own, but to make all these potential analyses feasible, accessible to and understandable by the relevant decision makers.