WHAT IS THE DIGITAL-MONEY DEBATE REALLY ABOUT? / PROJECT SYNDICATE

What Is the Digital-Money Debate Really About?

Both the US and Europe are moving to create digital money, but neither has the right idea about how to do it. The key is to allow “narrow banks,” which issue money but not credit, to keep their reserves in central banks and provide capped interest payments to coin holders.

Lucrezia Reichlin

LONDON—The debate over stablecoins and central bank digital currencies (CBDCs) may seem to be about technology, but it is actually about the architecture of money. 

It is thus not a new debate, but rather the reopening of an issue that most economists thought had been settled long ago. 

How this renewed debate plays out will have far-reaching implications—not least for determining whose money Europeans end up using.

Central to the debate is the question of whether the primary issuer of digital money should be the state (CBDCs) or private firms (stablecoins). 

The United States under President Donald Trump has, perhaps not surprisingly, embraced the latter: its 2025 Guiding and Establishing National Innovation for US Stablecoins (GENIUS) Act welcomes dollar stablecoins, lets non-banks issue them, and rules out a retail digital dollar.

By contrast, the European Union’s Markets in Crypto-Assets Regulation (MiCA) marginalizes private euro stablecoins, obliging issuers to park their reserves largely in bank deposits and limiting the use of foreign-currency coins for payments. 

This would make the privately issued euro stablecoins on offer less attractive than the bank deposits Europeans already hold.

And yet, the same will be true of the public retail digital euro that the eurozone is planning, owing to strict limits on how much one may hold and a prohibition on interest payments. 

Although the GENIUS Act also bars issuers from paying interest, the exchanges that distribute the coins partly circumvent this rule by handing out “rewards,” such as cashback options and loyalty points.

But why shouldn’t digital money pay interest? 

After all, you earn interest on your deposits. 

As Milton Friedman observed, preventing money from bearing interest amounts to imposing a tax on holding it. 

In a forthcoming paper, Bruegel’s Ulrich Bindseil, a former director general of market operations at the European Central Bank, shows that, across every modern form of money, the rules suppressing remuneration exist mainly to protect banks’ “deposit franchise” (the cheap funding lenders enjoy), which is not necessary for stability. 

When such rules bind, they usually backfire. 

America’s ban on interest created the Eurodollar market in the 1950s and money-market funds in the 1970s.

A Money-Credit Breakup

If interest is allowed to accumulate on digital money, the question becomes: Who pays it? 

To answer that question, we must consider the system’s design.

In the two-tier system we have, banks are credit institutions: they create money by lending, they pay interest on the resulting deposits, and they alone hold reserves at the central bank. 

Money and credit are fused in a single institution, which enjoys exclusive privileges: deposit insurance and the backing of the central bank. 

Together, these privileges guarantee the “singleness of money”: in any circumstance, a euro of bank deposits is worth a euro.

Stablecoins disrupt this arrangement, because they pull the two functions apart. 

A stablecoin issuer creates a means of payment but extends no credit. 

This is money unbundled from lending, issued by an institution that is neither a commercial bank nor a central bank. 

What stablecoin issuers lack in lending power they make up for in efficiency: because a stablecoin is a bearer token that settles on a programmable network, it can move instantly, around the clock, and across borders at a fraction of the cost of the banks’ correspondent chains. 

Coin issuers do not lend, but they may pay better than the banks do—and that is what worries regulators.

The issue comes down to credit. 

To the extent that stablecoins channel deposits away from commercial banks (disintermediating them), they reduce the funding on which bank lending depends, and thus potentially reduce the supply of credit itself. 

A retail digital euro raises the same concern: money that migrates from a bank deposit into central-bank money is money that is no longer financing loans. 

This explains the restrictions on both the digital euro and euro stablecoins: neither may pay interest, and stablecoin issuers are also kept away from the central bank’s reserves. 

Regulators are attempting to contain the erosion of credit.

But the principle that ought to govern here is neutrality: the same rules and risks should apply, whatever the issuer’s legal form. 

By that standard, withholding reserve access gets matters backwards, because reserve access is precisely what would make a stablecoin safe.

A stablecoin is only as sound as what backs it. Today’s dollar coins are backed by Treasury bills and other short-term paper, which are safe enough in calm times, but liable to lose value in a crisis—exactly when holders rush to redeem. 

Only central-bank money holds its value with certainty in a crisis. 

So, if the EU wants a safe euro stablecoin, it should let the issuer hold its backing at least partly as reserves at the ECB. 

It should also give that issuer access to the ECB’s lender-of-last-resort facilities—the backstop that safeguards the rest of the backing when markets seize.

A Narrow and Secure Bank

A money issuer with an account at the ECB holds the public’s money partly as central-bank reserves, on which the ECB pays interest. 

That interest is the issuer’s income, part of which should be passed through to the people who hold its coins. 

The rate of interest it passes on may be capped below the policy rate—high enough that the coin is viable, but low enough that holding it never becomes more lucrative than a bank deposit (so that it serves payments without draining the banks). 

Such an issuer—one that creates money without extending credit—would be a “narrow bank.”

Narrow banks have been unpopular. 

Nothing technically stops an ordinary bank from offering a fully backed account paying the central bank’s rate. 

But banks do not do it, because this would cannibalize low-cost deposits and tie up capital. 

Moreover, central banks discourage it, as a reserve-backed account would be a magnet for deposits and a haven in a panic. 

When a firm called The Narrow Bank tried to offer such a service in the US, the Fed refused it a master account. 

That refusal is the (dis)proof of concept.

But concerns that such banks would depress the quantity of credit are overblown. 

After all, the funds that leave the banks do not disappear; they simply move onto the central bank’s balance sheet. 

The central bank can thus immediately lend them back to commercial banks or other credit institutions. 

The new reserves the central bank issues are matched by new loans to the banks, and the banks’ lost deposits are replaced by central-bank funding. 

The plumbing is different, but the results are the same.

Princeton’s Markus Brunnermeier and Dirk Niepelt of the University of Bern made this point in 2019, noting that swapping private money for public money can leave credit and the wider economy undisturbed, so long as the central bank passes the absorbed funds back to intermediaries on equivalent terms. 

In principle, they argue, public and private money are interchangeable.

In practice, though, the swap is not perfectly clean. 

Banks are still losing a particular kind of funding—the cheap, granular, and dependable balances households leave in their current accounts—to be replaced by a potentially pricier alternative, which must be collateralized. 

While the quantity of credit is preserved, its cost, and the character of the funding behind it, is not. 

Nor is the power to decide where credit goes: the central bank can impose conditions relating to borrowers, collateral, and pricing.

That is not necessarily a bad thing. 

Cheap credit today is effectively paid for by savers, who earn nothing on the money in their current accounts. 

Ending the bank’s deposit franchise simply means aligning the price of credit with its actual cost, while removing the burden on savers. 

Moreover, central banks already influence credit allocation through the collateral they accept, the assets they purchase, and the financing they issue to reward banks for lending. 

The proposed system merely enhances this influence, and the interest cap limits how much money migrates.

A New Architecture

Ultimately, we face a choice among three institutional arrangements. 

The first is the one we have: money and credit creation combined in the commercial bank. 

The second makes money entirely public, with everyone holding central-bank money directly. 

But this would blow up the central bank’s balance sheet and force it to decide how credit is funded, raising the specter of state-directed finance.

The third architecture permits the coexistence of different types of institutions: traditional banks (which still create both money and credit), other safe, reserve-backed institutions (which create money but do not lend), and separate, market-based institutions that also fund credit. 

A reserve-backed euro stablecoin would be a step in this direction—a competitor operating alongside the banks, not a means of destroying them. 

This is the core of what I have proposed with Bo Sangers and Jeromin Zettelmeyer: narrow banks issuing a reserve-backed euro stablecoin with access to the ECB’s balance sheet and lender-of-last-resort backing.

This brings us to the final question: Who bears the risk when banks are no longer the only issuers of money? 

In the US, the answer is clear. 

The Fed backs the dollar; the Treasury backs the Fed; and the taxpayer backs the Treasury. 

In Europe, which has no single Treasury to fulfill this role, the risk is routed through the ECB.

To be sure, the ECB’s balance sheet does not, on its own, ensure safety; the assumed backing of Europe’s governments, and their taxpayers, is essential. 

In the absence of a common Treasury, it is Europe’s banks that absorb a large share of their governments’ debts, standing between sovereigns and savers. 

That quasi-fiscal role is a major reason why they occupy so privileged a position, and why the system guards them so jealously. 

The sovereign is already lodged within the banking system.

But the backing of governments and taxpayers is as necessary in the current system as it would be if a narrow bank issued a reserve-backed euro stablecoin. 

All that would change is the mix of institutions involved.

Lucrezia Reichlin, a former director of research at the European Central Bank, is Professor of Economics at the London Business School.