CBDC - the future of payments and money in the UK?
09 February 2023
Back in April 2022 I wrote an article about the future of cryptoassets, payments and money in the UK. At that time, the UK government announced that it intended to bring in a regulatory regime for stablecoins used as a means of payment.
Consideration of the merits of stablecoins as private money is often taken together with its public counterpart – the proposal for a central bank digital currency (CBDC). So now, in February 2023, we have the latest development in the UK Bank of England and HM Treasury’s position and preparation for a UK retail digital pound – a UK CBDC.
Has a decision been taken yet?
No. But the Bank of England and HM Treasury judge it likely that a digital pound will be needed in the future. They have just published a four-month consultation, following which they will proceed with the “design” phase. A decision on whether or not to go ahead with the digital pound will be taken at the end of the design phase – in 2025 or 2026.
The consultation paper contains a lot of detail. However, we have distilled some of the key points of interest below.
What factors will inform the decision?
The Bank of England and HM Treasury have indicated that the following factors will be relevant to any decision:
- how the payments landscape evolves in the coming years, both in the UK and abroad;
- whether the decline in the use of cash continues, diminishing the public’s access to and use of central bank money meaning the monetary system could become fragmented, posing a risk to monetary and financial stability;
- whether new forms of privately-issued digital money emerge and how they interact with existing forms of money and payments – and thus whether there is a need to support the safety and interchangeability of money;
- the need to promote innovation, choice, and efficiency in domestic payments as our lifestyles and economy become ever more digital; and
- international developments in the provision of CBDCs by other countries, and their potential to affect the UK domestically and as a global leader in finance.
Ensuring the uniformity and safety of money is necessary for monetary and financial stability
The digital pound could support the uniformity of money by replicating the role of cash in a highly digitalised economy. It would offer continued access to retail central bank money: a financially risk-free, highly trusted, and accessible means of payment for households and businesses.
But why is this important?
The stability of the UK economy and monetary system relies on the uniformity of money: that all forms of money – both bank deposits and cash – are valued equally (‘at par’ or ‘face value’), denominated in a common currency (sterling) and interchangeable with each other.
Access to public money – which is a safe liquid asset backed by the state – and the uniformity of money are critical for the smooth functioning of the economy. That is because they ensure that households and businesses can be confident in the value of money, regardless of its form and issuer.
Widely usable public money that will always be accepted helps to anchor both the perception of uniformity and its reality. Holders of commercial bank money can convert their money into public money at any time they choose. Uniformity and safety could be threatened by a combination of lower cash use and the emergence of some new forms of private digital money – those that cannot easily be converted into other types of money. Fragmentation may arise if holders of one form of money can only interact with others using the same system or from the same issuer. It may also arise if there are restrictions on accessing certain services based on the form of payment.
A potential countermeasure to a threat to monetary and financial sovereignty?
A new form of non-sterling digital money may threaten uniformity if it were used for a significant amount of retail transactions in the UK. If that were to happen at scale, sterling might no longer be the unit of account for a significant portion of UK transactions. This could compromise monetary sovereignty – the UK authorities’ ability to achieve price stability through monetary policy. The Bank of England might also be unable to gain assurance about the robustness and supervision of a foreign-operated form of digital money. This could compromise financial sovereignty – the UK authorities’ ability to effectively regulate systemic financial institutions and payments systems.
If, in future, digital money denominated in other currencies became widely available, the digital pound could play an important role in preserving sterling as the unit of account in the UK by offering users the new functionalities in sterling as offered by new non-sterling digital money.
A means to address the potential concentration risks of new forms of private money?
The future development of private digital money issuance could tend towards a small number of firms taking a significant market share due to network effects (where platforms become more valuable to their users as they grow), economies of scale and scope (which can act as a barrier to entry for small firms), and data advantages (which allow incumbents to hone and personalise their products in a way that is difficult for new entrants to replicate).
The digital pound would be a public-private partnership designed to support innovation and competition.
How would it work?
A digital pound would coexist with and complement both existing and new forms of private digital money.
In brief, a digital pound would represent a direct claim on the Bank of England as cash does today. £10 of digital pounds would always have the same value as, and be interchangeable with, a £10 banknote. In terms of implementation, a platform model is proposed. The Bank of England would provide the digital pound and the central infrastructure, including the ‘core ledger’. Private sector companies – which could be banks or approved non-bank firms (known as payment interface providers or PIPs) – would be able to integrate into the central digital pound infrastructure and provide the interface between the Bank of England and users. They would do this by offering digital ‘pass-through’ wallets to end users. The wallets could be integrated into their other services. End-users would interact with these wallets rather than directly with the Bank.
A digital pound would not pay or charge an interest rate as it is not a savings product, and although it would need to be widely available and useable, it does not need to be the dominant form of money for retail payments. Therefore, remuneration is not required to provide incentives for its uptake.
Programmability, delivered by PIPs with consent of users, could enable the use of smart contracts, which carry out specific actions based on pre-defined terms and conditions e.g. immediate payment of a supplier on signed receipt of goods, rather than having to wait for an invoice to be issued and then paid. Or it could enable micropayments, which are payments of extremely low value. Supporting micropayments could enable new business models, such as paying a small amount to read a single newspaper article, rather than having to pay for a whole subscription. HM Treasury and the Bank of England will not be pursuing government or central bank-initiated programmable functions.
Bridging the divide between public and private digital money
The digital pound could, if designed appropriately, complement and support new forms of private digital money and payment services by acting as a digitally-native ‘bridging’ asset between different forms of digital money, thereby supporting their convertibility and enabling them to trade at face value. Interoperability among different digital platforms could be facilitated. It would also provide a widely usable backstop means of payment, giving households the security that they could exit the banking sector or private payment platforms to a digital, financially risk-free asset.
Would a digital pound improve cross-border payments?
The digital pound could potentially be used to improve cross-border payments, but it would require international co-operation to deliver. Several initiatives are under way globally to improve existing systems (for example through linking up national faster payments systems).
Would money in this format raise data privacy concerns?
The digital pound would be at least as private as current forms of digital money, such as bank accounts. PIPs would identify and verify users, but anonymise personal data before any sharing with the Bank of England. As a result, neither the government nor the Bank of England would have access to digital pound users’ personal data, except for law enforcement agencies under limited circumstances prescribed in law and on the same basis as currently with other digital payments and bank accounts more generally.
What impact would the introduction of a digital pound have on existing financial providers?
The introduction of the digital pound would result in households and businesses switching some of their bank deposits to digital pounds. That loss of deposits for commercial banks is known as ‘bank disintermediation’ and, depending on the speed and scale, could have implications for financial stability. The extent of bank disintermediation and impact on the cost of credit (alternative sources of funding typically being more expensive) depends crucially on the speed and scale of adoption of the digital pound. This is uncertain and would vary between transition, steady state and stress. Limits on holdings of the digital pound during a transition period would constrain the extent of outflows from bank deposits and allow UK authorities to learn more about its impact.
Who might benefit from the innovation potential of a digital pound?
Innovation has not come to an end and there is likely scope for it to further reduce payment costs and generate further efficiencies in payments. Micropayments might allow content-sharing platforms and broadcasters to generate revenues from individual content, rather than relying on subscriptions. Digital pound wallets might also at some stage be integrated into ‘Internet of Things’ (IoT) devices for machine-to-machine payments. The Bank of England and HM Treasury highlight that the following sectors in particular may benefit from adding a digital pound wallet to their services:
- Media and social media
- Broadcasters and content sharing platforms
- E-commerce and online marketplaces
- Device manufacturers, consumer and home electronics and developers of smart
and IoT devices
- Charities and community groups
Conclusion – the acceptable co-existence of new forms of private and public money
This was the subject matter of an article I wrote back in early 2020. Since that time there has been a significant shift in the authorities’ perspective on the future of money, from new forms of private money being something to be countered by a CBDC, to something that can be encouraged and regulated and complemented by a CBDC. It makes perfect sense that the private sector was permitted to develop first in this area, given the very significant operational risks in addition to the monetary and financial stability risks that would be entailed for the public sector. In the fullness of time it seems likely that the answer to the question of whether the UK will introduce a digital pound will be ‘yes’.
Read more: 'The future of cryptoassets, payments and money in the UK'.