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Adopt the Euro or a National Digital Currency? Estonia Challenges the European Central Bank

In a recent press conference, European Central Bank (ECB) President Mario Draghi voiced a resounding no to the question whether an EU member state can create its own currency, proclaiming: “The currency of the eurozone is the euro.” This rejection is lodged at the Estonian government’s plan to adopt estcoins, a state-backed digital currency to support its e-Residency program to attract foreign entrepreneurs by providing them a digital identity on the blockchain.

The key questions coming out this press conference:

Why Eurozone Countries Use the Euro?

The euro is used by 19 European Union member states. Two countries, Denmark and the UK, have retained their own independent currencies within the EU: the krone and pound. There’s a group of member states joining the EU’s Exchange Rate Mechanism — a transition stage — where they must demonstrate they can meet certain economic and financial targets before eventually adopting the euro. Estonia joined the European Union in 2004, met those EU targets, and adopted the euro in 2011.

What are the benefits of the Euro?

Member states approved the Treaty on European Union (i.e. the Maastricht Treaty) with the determination to have a strong and stable currency for the global economy. The euro common currency offers certain advantages and benefits over the previous situation where each member state had its own currency: closer economic cooperation fosters an internal common market for trade; removing fluctuation risks and exchange costs (i.e. exchange rate volatility); and allowing easy access among Member States for a stable currency with price transparency.

Why would countries not adopt the Euro?

The global financial crisis of 2007–2008 revealed some disadvantages of the euro. Eurozone economies that suffered the worst blow — such as Portugal, Greece, and Spain — did not have the economic independence to set monetary policy to target their national recovery. This is because the common currency imposes a system of central monetary policy, set by the European Central Bank. With the ECB setting uniform monetary policy, macroeconomic policy targets for one member state may not be suitable for economic conditions in another member state. The U.K., a non-euro country, had flexibility to act decisively in response to the 2007–2008 financial crisis by slashing interest rates in October 2008 and subsequently a quantitative easing program in Q1 2009. The ECB did not embark on its own version of quantitative easing until 2015 after extensive debate and market turbulence.

Lacking economic policy independence also created challenges for housing markets in Portugal, Spain and Greece. The historical share of variable rate mortgages is much higher in these countries, relative to fixed-rate. Being tied to the ECB’s monetary policy decisions, those member states may not be nimble enough to reduce benchmark interest rates to ease financial conditions. Also, euro member states can’t have their national central banks serve as a lender of last resort; rather, that function is delegated to the ECB as the ultimate liquidity provider. Euro-member states also lack independence in inflation controlling measures. If inflation gets out of control, interest rates are often seen as a measure to contain upward price pressures.

Future Path for Estonia’s Ambitions: How to Secure Legitimacy of its National Virtual Currency?

Estonia has positioned itself to be the first for many digital initiatives: declaring Internet access as a basic right, casting digital voting ballots in national elections and now contemplating a state-issued cryptocurrency. Lest this stokes market speculation, Estonia doesn’t necessary need to opt out of the euro; they could retain the euro and also introduce a cryptocurrency, but it likely would need to follow a negotiating process under the relevant Treaty(s). If this approach prevails, there would be a dual currency environment: one fiat and the other crypto.

The above scenarios all assume that stakeholders collectively treat Estonia’s proposed cryptocurrency as a truly state-backed national currency that has economic functions equivalent with that of fiat currencies such as the Franc, Deutsche Mark, and Estonian Kroon before those currencies were replaced with the euro.