The European Central Bank (ECB) is gearing up to allow blockchain-based transactions in central bank money as early as next year. This move comes as preparations for the much-anticipated digital euro issuance are underway. However, the privacy features of this new digital currency are still in the hands of EU lawmakers, who will ultimately determine how data protection is handled.

ECB executive board member Piero Cipollone made headlines on Friday when he disclosed that the institution plans to enable Distributed Ledger Technology (DLT) transactions in 2026. This development is crucial as the ECB aims to issue a digital euro that would facilitate both domestic and international cross-border transactions.

Cipollone emphasized that the ECB is not only preparing for the digital euro but is also focused on connecting its system internationally. This would allow for seamless settlements between different central bank digital currencies (CBDCs), thereby enhancing the efficiency of cross-border payments. The infrastructure supporting the digital euro is designed to be accessible to other financial institutions, which could settle transactions using different CBDCs.

Looking ahead, Cipollone mentioned that holding limits and a reduced interest rate environment are expected to maintain the traditional role of banks in credit intermediation and monetary transmission. If everything goes according to plan, initial transactions using the digital euro could commence in 2027, with a full rollout of the CBDC projected for 2029, pending legislative approvals.

ECB President Christine Lagarde has also weighed in on the matter, stating that the ECB's role is largely complete. The design elements of the digital euro, particularly its privacy features, now rest with EU lawmakers. According to Cipollone, the digital euro aims to support both online and offline transactions, ensuring resilience and privacy for users.

The necessity for a CBDC stems from the EU’s fragmented retail payment landscape and the slow pace of cross-border transactions. Cipollone pointed out that without a centralized digital currency, the ongoing tokenization and DLT adoption could lead to further fragmentation and increased credit risk across the financial system.

Interestingly, the ECB's proposed tokenized digital euro will also cater to the digital asset market, potentially mitigating fragmentation issues. Cipollone acknowledged that while stablecoins can expedite cross-border payments, they also pose risks to existing currencies and financial systems. He raised concerns that an expansion of dollar-based stablecoins could undermine the euro's international standing.

Delving into the privacy aspects, the ECB's 2023 opinion states that the digital euro should not be designed to restrict how it can be spent, although conditional payments would still be permissible. The bank is advocating for privacy features akin to those found in cash transactions. This offline model of the digital euro would ensure that not every transaction requires validation by a third party, aligning with data protection principles of necessity and proportionality.

The offline digital euro would be stored locally on devices, allowing for direct device-to-device payments without the need for an online ledger check. The ECB is exploring the use of secure elements in mobile devices for offline storage and is even considering smart cards reminiscent of cyberpunk credit chips.

However, these recommendations contrast sharply with the EU's recent push for increased surveillance. EU lawmakers must approve the CBDC blueprint, which has faced scrutiny due to the European Commission's previous attempts to mandate private message scanning. An internal EU document revealed that member states are open to extensive data retention practices, raising concerns about privacy rights.

The EU's Anti-Money Laundering (AML) Handbook, published in May, has already signaled a crackdown on crypto privacy, banning accounts that enable transaction anonymization starting in 2027. This follows the EU Innovation Hub's critical stance on privacy-preserving technologies in the cryptocurrency space.

As the ECB continues to push forward with its digital euro initiative, the interplay between innovation and privacy remains a hot topic. The next few years will be crucial in shaping the future of digital currencies in Europe, balancing the need for efficiency with the imperative to protect user privacy.