This article was first published in The Banker on 3 March 2023.
Final decision yet to be made
The world of money is changing. The received wisdom of "cash is king" has long been declining and the world is gradually moving to a more digitised banking space where digital deposits and payments have become dominant; and new forms of currency such as stablecoins and even volatile and unbacked cryptocurrencies have also entered the payments ecosystem. The next big thing is the central bank digital currency (CBDC).
The UK government and Bank of England have been toying with the idea of a UK CBDC (digital Pound) for a while now. In that vein, earlier in February they published a consultation on the next step of their explorations. But if you were hoping to purchase your morning coffee with a digital Pound you will need to hold off until the end of this decade at the earliest.
The consultation is a positive development nonetheless – in it, the Bank and the government indicate that they have concluded that there is a sufficient use case to warrant a move to the design and development phase (from the current exploratory phase). However, the final decision on whether there will be a digital Pound will not be made until 2025/2026 and a subsequent build phase, which will be a major piece of infrastructure build, is likely to take us to the end of the decade.
The Bank sees the changing dynamics in payments and money and the declining use of cash as a risk to monetary and financial stability given the fragmentation of access to "public" money. A digital Pound could help with the 'uniformity' of money in a future where the majority of payments are digital. So, there is a real policy drive and momentum behind the digital Pound; enough to shift gear and move to design phase. Yet the digital Pound will only be launched if it meets the government's exacting standards for security, resilience and performance and the government is looking to bring public consensus along for the journey and toward building public trust, which is critical to establishing the digital Pound.
The desire for a UK digital Pound is by no means universally held. The House of Lords Economic Affairs Committee concluded last year that it had "yet to hear a convincing case" for why the UK needs a CBDC. It is now pushing for both Houses of Parliament to have the opportunity to vote on any final decision on a digital Pound. Some economists have also used public platforms to urge caution, highlighting the running costs, reputational risks and the risk of bank disintermediation as key challenges. The message could not be clearer: reflections on lessons learnt from other CBDC launches, whether live or pilot, will be important.
A race to CBDC
The UK is not alone in its flirtation with CBDC. Most central banks are exploring CBDCs and more than a quarter of them are now developing or running concrete pilots (the Digital Rupee-Retail in India, Eastern Caribbean DCash and Chinese e-CNY are three examples), while others such as the Bahamas Sand Dollar have already been launched. In Europe, the digital euro is still in the investigation phase. Like the proposed digital Pound, a digital euro would involve direct liabilities held at the central bank with supervised intermediaries responsible for all end user-facing roles in the digital euro ecosystem. The investigation phase for the digital euro ends in Autumn 2023, at which point the ECB will decide whether to move on to the realisation phase. Any issuance of a digital euro would not be earlier than 2027.
How would digital Pounds work?
The likely approach would be via a public-private partnership where the Bank issues digital Pounds, customers use wallets with regulated private sector firms which create a link through an application programming interface (API) with the Bank. The difference to traditional digital deposits with commercial banks is that the UK CBDC will offer users a direct claim to the Bank in the way that cash currently does.
There are a number of other likely features to consider. To begin with the digital Pound will likely be denominated in Sterling and interchangeable with cash and bank deposits. However, until the impact of digital Pound on the financial system is understood, there will, at least initially, be a limit on how many digital Pounds a person can hold. With that in mind it is also worth noting that the intention is for the digital Pound to be used for payments. It is not designed for savings and interest would not be paid.
Many will be comforted to know that neither the government nor the Bank would have access to users' personal data except in limited circumstances required under criminal law. The digital Pound however would not be anonymous – the ability to identify and verify users is needed to prevent financial crime. Private wallet-providers would undertake "know your customer" and anti-money laundering checks and handle user data. The liability and compensation framework for instances of fraud in the digital Pound system will also need to be ironed out.
Is it worth it?
Ultimately the advent of a digital Pound could encourage innovation and efficiencies and result in more choice, faster payments as well as lower costs for end-users. Bringing new entrants into the market, both financial and non-financial firms (which could include retailers, online marketplaces, media and device manufacturers) would improve competition. Non-payment firms might also participate in the digital Pound ecosystem and provide overlay services such as budgeting tools, business analytics and fraud monitoring.
For banks, the impact of the adoption of digital Pound on bank disintermediation and the cost of credit is difficult to forecast, but something which will no doubt be a consideration for the Bank in its decision on the digital Pound. Banks will also be exploring the commercial opportunities which may arise with the launch of a UK CBDC.
That said, providing a digital Pound service would require significant investment from private firms and the Bank. As it is currently envisaged that the digital Pound would not be remunerated (ie it would not pay interest), prospective private firms/banks will need to generate revenue streams to support the provision of digital Pound services (eg through transactions fees levied on merchants/individuals, commercial use of data, fees for value-add services beyond basic wallet functionality).
Whether or not we end up with a digital Pound in the future, the payments landscape is evolving: the Financial Services and Markets Bill will introduce a regime to allow for the regulation of fiat-backed stablecoins used for payments and the Treasury is consulting on regulation of cryptocurrency.
As the saying goes, the only constant is change and this certainly applies to the payments market.
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