The BoE (Bank of England) this month released a 57-page discussion paper entitled “Central Bank Digital Currency, Opportunities, challenges and design”, outlining the future of payments in the UK and the global implications of digital currencies.
BoE Governor Mark Carney introduced the document stating “A CBDC could provide households and businesses with a new form of central bank money and a new way to make payments” whilst also raising some “significant challenges for maintaining monetary and financial stability”.
What is a Central Bank Digital Currency?
Digital Currency is a type of currency that solely exists in digital form. It is a broad term which encompasses all digital-only money types, including cryptocurrencies. A Central Bank Digital Currency is a new type of Digital Currency being proposed by several governments, such as the UK and Sweden which would democratise access to central bank issued money by fundamentally changing the structure of how money can be obtained, although the BoE states that it would complement and not replace existing currency types, such as physical and electronic money, which are only issued by “selected financial institutions”.
In short, it reduces the need for individuals and registered entities, such as businesses or charities to access money directly from commercial banks, such as Barclays or HSBC.
Fundamentally Different to a Cryptocurrency
The BoE states unequivocally “A CBDC would be fundamentally different to cryptocurrencies or cryptoassets”, because CBDC is a public, government issued form of digital currency, whereas Bitcoin and other cryptocurrencies are privately issued by a decentralised ledger (crypto mines around the world that create this money on a blockchain, without a central bank). This is noteworthy (pun intended), as the Bank of England clearly sees the two as fundamentally different, which brings us on to the next point as to why the Bank still sees a benefit in creating CBDC.
So, What are the Opportunities for the in BoE Issuing CBDC?
The discussion paper outlines the opportunities of CBDC. In it, the BoE emphasises three key takeaways:
A More Resilient and Diverse Payments Landscape
The BoE’s role is to keep the UK’s financial system stable. With regards to a CBDC, the bank believes this could enhance stability by providing an alternative mechanism for payments, in the form of a peer to peer system of money transfer, which is one of the key selling points of such a digital currency. The paper mentions “Cards and cash are typically the only two options for point ‑of ‑sale transactions, with cards usually the only option for e‑commerce. Consequently, the operational resilience of the cards network is increasingly critical, and this increasing reliance on a single electronic payment method could reduce the resilience of the payments landscape”.
The thesis here is straightforward, introducing a CBDC could ease the burden on the existing payments systems because having three methods of payments instead of two would very likely reduce traffic on the other two systems. However, is this solely a network optimisation rather than a user-focused feature? The bank explains stating that holders of the currency would also possess more ways to make payments. Inferentially, this is referring to the absence of an intermediary commercial bank (as discussed earlier), which would allow users to pay by directly to merchants, or through some non-bank entity which could act as a new intermediary with some user-focused utility.
The implications of this appear to be vast, as it could democratise the role of commercial banks as the incumbent custodians of currency, thus enabling all types of firms to play such a role.
Preventing the Creation of New Forms of Private Money, such as Cryptocurrencies
It’s no surprise that central banks would like to retain control of all currencies in order to maintain financial stability, which according to the BoE includes providing an alternative to cryptocurrencies. This is due to the banks belief that such currencies are typically offered by firms which may not implement an adequate regulatory framework to keep customers monies safe: “This safety and confidence may not exist to the same degree for new payment systems that have been proposed by a number of firms, including new entrants and existing technology companies”.
Furthermore, the bank sees CBDC as the alternative mechanism for peer to peer payments to take place, thus discouraging the commercial utility of cryptocurrencies. Conversely, this could not sit well with consumers, as the government would be aware of individual and corporate payment footprints, thus retaining the utility of cryptocurrencies which run on private decentralised ledgers (blockchains) which provide privacy and a true peer-to-peer means of transfer.
Enabling Better Cross-Border Payments
The BoE sees opportunities in providing better infrastructure for cross-border payments, which they state are currently “expensive, slow, and opaque”. They see CBDC as a potential solution for this, by working with other domestic CBDCs. “CBDC may offer a safer way to provide better cross-‑border payments. For example, central banks may be able to work together to link domestic CBDCs in a way that enables fast and efficient cross-‑border payments. Individual domestic CBDCs could be designed around a common set of standards intended to support interoperability”.
The context of this statement surrounded CBDC as an alternative to stablecoins, acting as the cryptocurrency solution for cross-border payments that proxy digital currency for fiat currencies, providing the benefits of a digital currency for fiats.
The argument is that stablecoins are largely untested and could be used for money laundering and terrorism financing activities; such conclusions were derived from the “G7 Working Group on Stablecoins (2019)”. Looking into this, document states “Significant work by stablecoin developers and further engagement with the public and authorities will be required before they can expect approval by relevant authorities, as the above considerations can only be adequately addressed by ensuring transparency and making more detailed information available for proper assessment”.
Potentially Significant Challenges for the Monetary System
The bank states that the monetary system could be significantly affected by the introduction of CBDC, this is due to the changing infrastructure of payment systems which could lead to a mass exodus of funds from commercial banks into CBDC, thus affecting “balance sheets of commercial banks and the Bank of England, the amount of credit provided by banks to the wider economy, and how the Bank implements monetary policy and supports financial stability”. However, they are quick to state that this could be mitigated based on how CBDC is designed.
Would CBDC be based on Distributed Ledger Technology?
In short, the bank is inconclusive on this matter. It clearly identifies some of the known benefits of DLT, whilst stating that this would require trade-offs and is thus not a flawless solution “For example, elements of decentralisation might enhance resilience and availability, and the use of smart contract technology may enable the development of programmable money. However, adoption of these features would also come with challenges and trade‑offs that must be carefully considered”.
When Will it be Implemented?
The bank is still undergoing its due diligences regarding CBDC and is planning to draw upon “the widest possible expertise” in order to conclude its feasibility. Nonetheless, whether it is implemented or not, it is clear that digital currencies (both public and private) are going to play a key role in the future of the UK and very likely the global monetary and payments ecosystems.