The European Commission this week publish legislation on a digital euro, bringing the bloc's long-mooted plans to introduce such a currency a step closer to reality.

On June 28 Mairead McGuinness, European Commissioner for Financial Stability, Financial Services and the Capital Markets Union, presented proposals to European governments and to the European Parliament on both the digital euro and a parallel law to protect the legal tender status of euro cash.

It's not the final step, though: Even if national governments and the European Parliament endorse the plans, the European Central Bank (ECB) will ultimately decide whether or not a digital euro will be issued. The ECB says it expects to make a final decision on the digital euro later this year sometime around October.

"The euro is the most tangible symbol of European integration," said ECB President Christine Lagarde in a statement. "It is highly valued and trusted by citizens. We look forward to continuing working together with other EU institutions towards a digital euro to ensure our currency is fit for the digital age."

What is the digital euro?

A digital euro would exist alongside the existing euro as an additional form of online or electronic payment. McGuinness says the digital euro would be a "complement" to physical cash and the euro itself.

It would be an exclusively digital or electronic form of the euro that could not be converted into cash. The key difference between a digital euro and an online transaction involving the euro is that payments made in digital euro could only be made electronically or digitally, whereas all standard online banking payments can theoretically be converted into cash.

Importantly, all euro and digital euro would be backed by the ECB. Users would likely be able to buy digital euro from their existing commercial banks and keep them in a separate account.

Why does the EU want this?

The rise of cryptocurrencies and other third-party payment systems have intensified debate around whether or not central banks should introduce their own digital currencies.

When Facebook announced in 2019 that it was planning its own virtual currency, some European policymakers worried it could eventually undermine the ECB.

In October 2020, the ECB launched a public consultation on establishing a digital euro and since July 2021, it has been looking at various design options and user requirements while trying to establish how a digital euro would actually work in practice.

The EU says such a currency could "support the Eurosystem's objectives by providing citizens with access to a safe form of money in the fast-changing digital world."

It also says that a digital euro could harness the technological benefits associated with other digital payment methods without the risk and instability that have been associated with others.

"That's also the real contrast to existing private digital currencies like crypto-assets," McGuinness told the European Parliament in April. "A digital euro would be safe, secure and sound."

Another reason the EU has given for a digital euro is the declining use of cash in the bloc. According to the ECB, cash payments for all point-of-sale transactions fell from 79% in 2016 to 59% in 2022. They expect this decline to accelerate in the years ahead.

The EU also points to the rising use of so-called stablecoins, which are crypto-assets pegged to other currencies. McGuinness says the bloc believes that if it doesn't come up with its own solution in this area, the risk increases of stablecoins or digital currencies created by other central banks filling the gap.

China's planned digital renminbi has been a particular cause for concern in that regard.

What is in the legislation?

The EU says the upcoming legislation will focus on the legality of the digital euro, as well as issues around privacy and financial stability. 

The draft legislation has been leaked and reported on by several media outlets ahead of time. The news site Coindesk reported that use of the digital euro will be free, with no interest charges, and will have to be available for cash-style, offline payments from its first day of use. It is also planned that digital euro will be available to both consumers and businesses from the start of its operation.

They were not far off. According to the draft legislation, the digital euro will be available across the entire euro area. It will be accessible through banks on request and basic digital euro services are free. It would be like a digital wallet and be available for both online and offline payment.

Merchants in the eurozone that accept digital payments will be required to accept the digital euro. But to stay competitive, digital euro fees for business and merchant are to be kept to a minimum.

Is it really needed?

The EU appears keen on the project, but many critics say it is not needed. Markus Ferber, a spokesman for the European People's Party grouping in the European Parliament, said the legislation looks technically sound but "it does not answer the question: Why?"

Many say the steep fall in the value of cryptocurrencies over the past few years suggests the apparent threat they posed to central banks has passed.

Banks themselves have been less than enthusiastic. The European Banking Federation has suggested that creating such a system could lead to bank runs, whereby people buy digital euro with their regular euro, as they will regard it as a safe haven in times of crisis.

With that in mind, it is believed the ECB is considering capping the amount of digital euro that can be held by an individual at around €3,000 ($3,280).

What are the next steps?

The European Commission has suggested that a digital euro could come into use by 2026 or 2027. But there is still a long way to go.

The Eurogroup, which comprises the finance ministers of countries which currently use the euro, have been debating the issue for two years. Some have raised serious concerns about how governments can justify introducing a digital euro to citizens around the bloc, considering that online and digital payment systems are popular and already work well.

If the legislation is broadly accepted and there is no major political opposition, the Governing Council of the European Central Bank will decide if they will proceed further or not. According to the bank, the next phase would "see the development of integrated services as well as carry out testing and possible live experimentation of a digital euro. This phase could take around three years."

The publication of the draft legislation is the first major test of the political waters.

Edited by: Tim Rooks