Jonas Gross, Johannes Sedlmeir, Matthias Babel, Alexander Bechtel, and Benjamin Schellinger

Designing a Central Bank Digital Currency with Support for Cash-Like Privacy

Most central banks in advanced economies consider issuing central bank digital currencies (CBDCs) to address the declining use of cash and to position themselves against increased competition from Big Tech companies, cryptocurrencies, and stablecoins. One crucial design dimension of a CBDC system is the degree of transaction privacy. Existing solutions are either prone to security concerns or do not provide full (cash-like) privacy. Moreover, it is often argued that a fully private payment system and, in particular, anonymous transactions cannot comply with anti-money laundering (AML) and countering the financing of terrorism (CFT) regulation. In this paper, we follow a design science research approach (DSR) to develop and evaluate a holistic software-based CBDC system that supports fully private transactions and addresses regulatory constraints. To this end, we employ zero-knowledge proofs (ZKP) to impose limits on fully private payments. Thereby, we are able to address regulatory constraints without disclosing any transaction details to third parties. We evaluate our artifact in interviews with leading economic, legal, and technical experts and nd that a regulatorily compliant CBDC system that supports full (cash-like) privacy is feasible.

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Alexander Bechtel, Jens Eisenschmidt, Angelo Ranaldo, and Alexia Ventula Veghazy

University of St.Gallen, School of Finance Research Paper No. 2021/10

Quantitative Easing and the Safe Asset Illusion

The massive recourse to quantitative easing (QE) calls for a better understanding of its effects on safe assets. Based on a simple balance sheet framework, we show how QE impacts the total amount, cross-sectional distribution, and composition of safe assets in the economy. Analyzing the ECB's Public Sector Purchase Programme (PSPP), we find that the amount of universally accessible safe assets decreases and there is a transfer of safe assets from the non-bank to the banking sector. We call this phenomenon the safe asset illusion. The sectoral shift in the holding structure of safe assets has important implications for fi nancial stability and the cost of secured liquidity.

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Alexander Bechtel and Daniel Otto-Schleicher

EUBlockchain Observatory and Forum Research Paper

Possible Characteristics of a TIPS-Based Digital Euro

On 2 October 2020, the European Central Bank (ECB) published a report on a digital euro (European Central Bank, 2020). The report examines the necessity to issue a central bank digital currency (CBDC) in the euro area. To this end, the ECB formulates seven scenarios under which a digital euro would become relevant. Based on these scenarios, it derives seven requirements for a digital euro. In this paper, we examine if the ECB can use existing technology and payments infrastructure in order to develop a CBDC that fulfils these requirements. More precisely, we propose an account-based version of the digital euro that is deployed on the TARGET Instant Payment Settlements (TIPS) system and we examine if this CBDC would meet the requirements set out by the ECB in its report.

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Alexander Bechtel, Jens Eisenschmidt, and Angelo Ranaldo

University of St.Gallen, School of Finance Research Paper No. 2021/01

Does Quantitative Easing Mitigate the Sovereign-Bank Nexus?

The credit risk of the sovereign affects the financial health of its banking sector and vice versa, creating an adverse feedback loop known as “sovereign- bank nexus”. We show that Quantitative Easing can effectively mitigate the sovereign-bank nexus. Our results indicate that the ECB’s Public Sector Purchase Programme reduced the co-movement of sovereign and bank credit risk by almost 80%. The mitigation is driven by the euro area periphery and works through three channels: (i) a reduction in government bond holdings of banks, (ii) an increase of government bond prices, and (iii) an increase in excess liquidity holdings of banks.

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Alexander Bechtel, Agata Ferreira, Jonas Gross, Philipp G. Sandner

The Future of Payments in a DLT-based European Economy: A Roadmap

Distributed ledger technology (DLT) enables a wide range of innovative industrial use cases and business models, such as through programmable payments and the seamless exchange of assets, goods, and services. To exploit the full potential of a DLT-based European economy, it is crucial to integrate the euro into DLT networks. In this paper, we propose a framework for developing payment solutions for a DLT-based European economy. To this end, we decompose the digital payments value chain into three pillars: (1) contract execution system, (2) digital payment infrastructure, and (3) monetary unit. Based on this framework, we systematically compare account- and token-based payment solutions, including a bridge solution, e-money tokens, synthetic central bank digital currencies (CBDCs), and a central bank digital currency (CBDC). Taking into account current circumstances, we conclude that no individual payment solution will be sufficient to address all emerging use cases. Instead, a broad array of payment solutions will emerge and co-exist. These solutions will apply to a variety of different use cases and will be launched at different points in time.

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Alexander Bechtel, Angelo Ranaldo, and Jan Wrampelmeyer

Review of Finance 2022, 1-24

Liquidity Risk and Funding Cost

We propose and test a new channel that links funding liquidity risk and interest rates in short-term funding markets. Borrowers with high liquidity risk are willing to pay a markup to lock in their funding, independent of risk premiums demanded by lenders. We test the channel using unique trade-by-trade data and reveal systematic and persistent differences in borrowers' funding liquidity risk that lead to systematic and persistent heterogeneity in funding costs. Our results have important implications for financial stability, the transmission of monetary policy, and banks' asset and liability management.

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