From physical to digital – the advancements of a retail uk central bank digital currency | Bryan Cave Leighton Paisner
SUMMARY
On 28 February 2023, the House of Commons Treasury Committee questioned representatives from the Bank of England (the “BoE”) on the latest developments on its plans for the proposed UK Central Bank Digital Currency (“CBDC”). Sarah Breeden (Executive Director, Financial Stability Strategy and Risk), Sir Jon Cunliffe (Deputy Governor for Financial Stability) and Sasha Mills (Executive Director, Financial Market Infrastructure) were the representatives. Now that the CBDC is advancing into the Design Stage, we consider what is next for a CBDC in the UK.
TIMELINE[1]
HM Treasury and the BoE launched the CBDC Taskforce in April 2021. Whilst the Treasury and the BoE have concluded that there is a ‘likely’ need for a future digital currency, a decision is yet to be made on whether a CBDC will be issued. The path for the proposed digital pound is set out below.
- Phase 1: Research and exploration stage. This took place in 2022. To conclude this phase, the BoE and HM Treasury issued its Consultation Paper in February 2023 which set out the CBDC Taskforce’s assessment of the usefulness and practicality of the proposed digital pound. This was accompanied by the BoE’s Technology Working Paper, which sets out the initial technology considerations for a CBDC platform[2].
- Phase 2: Design stage. This stage has already begun and will continue until at least 2025. This stage involves a significant investment in the technical creation of a proposed model for the digital pound. This assessment will enable the BoE to decide whether the digital pound can be built and if so, the selection of an appropriate model.
- Phase 3: Build stage. This may be initiated from 2025 at the earliest. The CBDC Taskforce intends to create prototypes and undertake live pilot testing during this stage.
Following the conclusion of the Build stage, the CBDC Taskforce will determine whether a digital pound can be launched for consumers.
There is an opportunity for market participants to provide input and thoughts during the current consultation period, which is open until 7 June 2023.
TREASURY COMMITTEE ORAL HEARING – 28 FEBRUARY 2023[3]
The reasons behind a retail digital pound is quite clear: consumers are using less cash and innovation is at the forefront of industry and governments alike. The proposed digital form of sterling will complement cash as its counterpart, equating to the same value.
To the frustration of eager market participations, the slow progress of CBDC development in the UK seems to revolve around the significant time spent in the research and exploration stage. That said, the BoE is confident that this investment of time will lead to shorter implementation periods, particularly as the model for the digital currency will rely predominantly on the private sector.
Is the UK’s progress so slow that we are falling behind other economies in the race for digital currency advancements? The Bahamas is trailblazing ahead with the launch of the Sand Dollar in 2020, but Europe seems to be firmly stuck in the research and investigation stage. The European Central Bank began its investigation phase in October 2021[4] and it is expected to conclude in October 2023. Contrastingly, Sweden is making significant advancements: Sveriges Riksbank began its investigation stage into CBDC in 2017. A pilot of the e-krona launched in 2020, and continues today. Whilst the inquiry into whether Sweden will issue a permanent digital currency remains in progress[5], a decision to launch might be made sooner than in the UK.
Arguably, progress is being further delayed by the sheer number of hurdles that are yet to be worked through. During the House of Commons Treasury Committee hearing on 28 February, the BoE set out that there was no current intention for the Bank Rate to be payable on the proposed CBDC. In essence, this means the dealing rate at which the BoE is willing to enter into transactions[6] would not be payable by the BoE. This contrasts the position of Bank Rates and cash. The positions on interest rates and transaction fees respectively are also yet to be determined. With that in mind, it should be reasserted that the BoE has clarified that its motivation behind creating a digital pound is purely based on creating an alternative payment method, as opposed to the establishment of a new savings product.
Some of the immediate challenges in creating a digital pound include the need to ensure the infrastructure of the digital platform is robust, and to the largest extent possible, fraud-proof. This may become easier with the support of a clearer legislative framework in the near future, as the existing regulatory framework is far from satisfactory when it comes to addressing cryptoassets. The current position may soon change as the Edinburgh Reforms set out a path for cryptoasset regulation and the Government has set out its commitment to this in the recent Consultation Paper[7]. Above all, public confidence in the infrastructure of the digital pound will be fundamental to its success.
While the proposal of a digital pound does not intend to solve a ‘specific problem’[8], the Treasury and BoE intend for a CBDC monetary policy that promotes innovation, economic stability, and competition – all things the UK can benefit from during this time of unprecedented fiscal and social uncertainty.
PRACTICAL OPPORTUNITIES FOR THE FINANCIAL SERVICES INDUSTRY
As the digital pound would be regulated from its launch, it will automatically carry with it a layer of security that other cryptoassets do not currently benefit from. This layer of security may encourage consumers and businesses alike to diversify their financial holdings in a risk-averse setting. The speed of CBDC transactions would also accelerate the way in which we do business, and the digital wallets will maintain similar levels of privacy as standard bank accounts. This suggests that, whilst conventional banks will indeed need to adapt to accommodate a digital currency, the process of incorporating changes should not be too challenging, and will in fact be a catalyst for financial institutions to update their operations to suit the modern digitised world.
As mentioned above, the platform for the digital pound will require the engagement of payment service providers (“PSPs”). Stakeholders will have the opportunity to innovate in a market where a new type of interface services will be required. This opens up a world of opportunity for PSPs, allowing them to take advantage of a new wave of demand, with the most innovative being best placed to attract new customers.
CHALLENGES
The BoE has proposed an initial restriction on holding amounts of £10,000 to £20,000[9] of the new CBDC. This seeks to protect consumers from potential fiscal risks associated with the digital pound, especially in the early days. However, external risks will still remain. The completely transparent nature of distributed ledger technology reveals a tension between the need for privacy and the risk of a CBDC being used for criminal activities[10]. The BoE’s CBDC ledger would need to be robust enough to withstand threats of international and domestic cybersecurity threats but also remain open and accessible for monitoring purposes. The interaction of this with data privacy laws will need to be ironed out during Phases Two and Three, lest fears of over-monitoring a supposed ‘free market’ reduce public faith in the digital pound. The burden of compliance with unknown and evolving regulatory requirements will fall upon the players providing the payment interface services. The best way for future market participants to be prepared is to begin to anticipate from now how compliance may need to adapt.
The BoE also acknowledged the challenges that arise in respect of digital exclusion, an issue that was discussed in the House of Lords Economic Affairs Committee session on CBDC[11]. It is inevitable that those without access to digital devices would fail to reap the same benefits of the digital pound as those who are technologically literate. We are awaiting a proposed solution to address this. One argument in favour of continuing with the launch of the CBDC despite the risk of exclusion is that there would be nothing necessitating use of a CBDC as it would simply be an alternative payment method, much like a contactless debit/credit card is to cash.
IMPACT ON BCLP AND ITS CLIENTS
The regulatory and technical landscape of CBDC will remain unknown for some time, however, the Design stage of the digital pound presents an opportunity for industry innovators to consider their prospects in developing infrastructure complementary to a digital pound. If you wish to stay informed on these developments and discuss further, contact Daniel Csefalvay or Nazia Sohail.
This article was created with assistance from Trainee, Miriam Walters-Manneh.
Bank of England HM Treasury, Consultation Paper: (link )
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