The Treasury and Bank of England have launched a consultation on the creation of a ‘digital pound’ – possibly to be released into circulation by 2030.
This type of virtual money is known as central bank digital currency (CBDC). But what exactly is CBDC and does it mean the end of notes and coins? Get up to speed on the future with our Q&A.
What is central bank digital currency?
CBDC is currency – or money – issued and governed by a country’s central bank, such as the Bank of England. But instead of being physical money (notes and coins) it is in digital (or electronic) form. All transactions using this digital currency are also recorded in digital form – such as on an encrypted database.
What is CBDC worth?
Central bank digital currencies are fiat currencies. The term ‘fiat currency’ means a government-issued currency that isn’t backed by a physical commodity, such as gold – but by the government that issued it.
As state-backed currency, CBDC would be worth exactly the same as the equivalent physical money. So, 10 pounds in CBDC form would be worth the same as a £10 note.
Would CBDC replace cash?
No. If introduced, the idea is that a digital pound would be interchangeable with cash and bank deposits, complementing cash use rather than replacing it.
That said, the use of physical cash is in decline. Despite a resurgence during the cost of living crisis – as more people use cash as a way of budgeting better – contactless and digital payments are growing rapidly. It is not difficult to foresee a time in the future where there is little need for physical cash.
How would the digital pound work?
The Bank of England would issue the digital currency and it would be held in smartphone wallets for individuals – or an equivalent digital platform for financial institutions and businesses.
It would sit alongside conventional currency and people would be able to use it in person and online to pay for goods and services, and to pay friends and family, in the same way as with cash.
According to the Treasury and Bank of England’s consultation paper on the proposals, it is expected that private companies (banks and other regulated financial firms) would offer the digital wallets to retail customers so they could hold digital pounds.
How is CBDC different to cryptocurrency?
While on the face of it central bank digital currency appears to work in the same way as cryptocurrency they are fundamentally different. This is because a CBDC is issued by a central and state-backed financial institution (the Bank of England in the UK) and has the same value as the associated fiat currency.
In contrast, cryptocurrencies, such as bitcoin and Ethereum, are decentralised and not linked to central government. CBDC is legal tender, where cryptocurrency is issued by private companies and is largely unregulated.
Unlike CBDC, cryptocurrencies have an investment value (they are sometimes referred to as crypto assets) and their value can rise and fall as they are traded on a market, in a similar way to buying stocks and shares on a stock market.
Is CBDC safe?
As central bank digital currency is government-backed digital money it is as safe, and no different in terms of value, to the traditional money we have in the bank. This is different to the volatility we have seen in the unregulated cryptocurrency markets – where some currencies have experienced large drops in value overnight.
What are the benefits of a digital pound?
The Bank of England says our payment methods are changing and people and businesses are using less physical cash. In 2021 60% of all payments were made by card and half of those were contactless, according to trade body UK Finance.
Introducing a digital pound, it says, will give consumers more choice about how they pay. Digital currency should make payments more efficient and it could also reduce fraud and money laundering activities.
The digital pound could also be useful for cryptocurrency investors. Depending on how it is set up and designed, the CBDC could complement and support new forms of private digital money and payment services.
The Bank of England says: “by acting as a digitally-native ‘bridging’ asset between different forms of digital money, it could support their convertibility and enable them to trade at face value.”
What are the disadvantages of CBDC?
The introduction of a digital pound could further hasten the demise of cash – and cash machines – leading to less choice for consumers. Access to cash is still important for many people, particularly those who struggle with online and digital payments, for example.
It is possible that a new digital currency could have the knock-on effect of reducing the availability of consumer credit – credit cards, personal loans and mortgages, for example.
This could happen if people moved their cash savings out of retail bank accounts to hold money in digital pounds instead, in a digital wallet. With less cash flow, commercial banks could potentially tighten their criteria on lending.
In reality, it is likely that regulated financial firms will offer the digital wallets for customers to hold their digital pounds – so there is likely to be a way for firms to innovate and generate income from this service.
Another issue is privacy, with some consumers having concerns that a centralised digital currency would enable the government to have more information about individuals’ spending habits.
But, according to the Treasury and Bank of England, no individual or personal details would be known by the Bank – and data would be subject to the same standards of privacy and data protection as with the current banking system.
How soon could the digital pound be available?
No decision has been made. The Bank of England and the Treasury are consulting about the creation of a digital pound, possibly by 2030.
But a formal decision on this is not likely before 2025. Other countries, including China, the US and those in Europe, are looking into creating their own central bank digital currencies.
The Treasury and the Bank of England have published a consultation paper The digital pound: a new form of money for households and businesses that contains survey questions to allow the public and other parties to offer their thoughts on the subject.
The deadline for responses is 7 June 2023.
