What is this article about?
The article discusses the Bank of England’s exploration of a digital pound and its proof-of-concept for integrating it with existing point-of-sale systems.
Why is it important?
This exploration is crucial as it could modernise the UK’s payment systems, improve efficiency, and reduce transaction costs, positioning the UK at the forefront of financial innovation.
What’s next?
Further collaboration between public and private sectors is needed to overcome integration challenges and ensure a smooth and secure roll-out of the digital pound.
The rise of digital currencies and the success of private digital currencies such as Bitcoin and stablecoins have led central banks worldwide to investigate central bank digital currencies (CBDCs).
The UK aims to stay at the forefront of financial innovation, ensuring the stability and efficiency of its payment systems and addressing the decline in cash usage.
Implications of a digital pound introduction are important to note. Enhanced payment efficiency through faster transactions and 24/7 availability could enhance convenience for both consumers and businesses.
Meanwhile, lower transaction fees and streamlined processes mean less of a need for intermediaries and less operational costs for businesses, particularly regarding retail and e-commerce.
According to Ripple’s Head of Product Management, Anthony Ralphs, CBDCs promise to offer new models for value movement built on forward-thinking technology. He says: “For a globalised economy like the UK, stablecoins and a digital pound could deliver huge benefits in international trade by reducing friction and risk in international payments, which in turn could support the opening up of new markets.
The accessible nature of CBDCs means that greater financial inclusion can be promoted, unlocking support for underserved communities. Additionally, increased payment security features will help reduce fraud through more advanced encryption and authentication methods. The transparency and traceability of digital currencies also provide clear benefits for the fight against fraud.
A digital pound would also be more programmable than cryptocurrencies like Bitcoin, Ralphs claims. “With a digital pound, trust can be ‘baked in’ to transactions, providing certainty of value movement which in turn reduces risk and associated costs.”
In 2020, both the Bank of England (BoE) and HM Treasury (HMT) began conducting extensive research on the potential benefits, risks and implications of introducing the digital pound. In March of that year, the BoE published a discussion paper outlining the opportunities and challenges, inviting feedback from stakeholders.
Academics, financial institutions, fintech companies, and the public gave their views as part of the process to gather diverse perspectives and insights. The following year, the BoE and HMT established a joint taskforce to coordinate the exploration of a potential CBDC in the UK economy.
Currently, the BoE is conducting experiments and proofs of concept (PoC) in collaboration with private-sector innovators regarding the currency’s design. The point of the preparatory work is to reduce the lead time if there is a decision made on implementing a CBDC in the UK.
The primary objective of the experiment is to assess three key areas: technical feasibility, technology, policy, and their implications. As part of the design phase, the team has been examining the possibility of using existing point-of-sale (POS) hardware to facilitate digital pound payments, should the concept come to fruition.
For the PoS POC, the BoE has consulted with several stakeholders to help test the digital pound. Consultancy Consult Hyperion was heavily involved in this phase of the payment initiation using POS software that was already available.
The devices used to help simulate a digital pound transaction in-store included:
Payment Flows | ||
|---|---|---|
PASSTHRU | Where a request for payment is sent to the BoE API via the merchant’s Payment Interface Provider (PIP) | This flow assumes that balance is stored remotely on the core ledger provided by the Bank |
DIRECT | Where a request for payment is sent directly to the BoE API, bypassing the merchant’s PIP | This flow assumes that balance is stored remotely on the core ledger provided by the Bank |
PEER | Where a payment is made between two devices without network connection, supporting offline payments | This flow assumes that balance is stored on the user’s device. Therefore, payments can be made offline, with immediate confirmation and settlement |
The BoE successfully set up two payment methods, PASSTHRU and DIRECT, using different payment terminals: traditional, mobile, and software-based.
For the DIRECT method, all payment terminals had to connect directly to the BoE’s system, which added a lot of work for managing security keys. Payments were sent with a secure hash of the account number instead of the actual number, keeping it hidden from the BoE.
This method didn’t follow the usual UK standard (APACS 70) because that standard requires the full account number.
Due to limited access to their software, the PEER method worked with traditional and software-based terminals but not with mobile ones. Despite this, the PEER method allowed offline payments, meaning transactions could happen without being connected to the BoE’s system. Unlike the other two methods, this method required updates to the terminal software.
The BoE successfully implemented two ways to verify payments: CDCVM and Online PIN. These methods allow the payer’s payment provider to confirm their identity. CDCVM worked for all types of payments, both online and offline.
Online PIN verification was used in the PASSTHRU and DIRECT methods but was more complicated in the DIRECT method. It required sending encrypted PIN information to the merchant’s provider before payment processing. Since an Online PIN needs an internet connection, it wasn’t suitable for offline payments.
This test showed that existing payment terminals can be used for digital pound payments, helping the BoE understand what’s needed for both online and offline payments.
However, this test made several assumptions about the design of the digital pound, such as which terminals to use, whether to use cards, where to store balances and how to handle PINs. These decisions are still in the air, with many other factors besides technical feasibility.
The PoC demonstrated that using current POS hardware to accept digital pound payments is technically possible. The PoC was based on certain design assumptions, but no final decisions have been made.
While the BoE is examining the feasibility of digital transactions in the event of a roll-out, in the eyes of merchants, there are likely to be other challenges and benefits. Ralphs believes a successful roll-out will reduce risk for merchants.
He says: “Improving cash flow by enabling the receipt of funds at the point of sale, rather than potentially days later when processing a card transaction; second, whilst the cash is real-time settlement, businesses won’t need to physically keep the cash on the premises or take it to a bank, which improves physical security.”
“The reduction in transaction fees will all also help lower the cost burden imposed by other electronic methods, enabling new ways to pay that might currently be cost-prohibitive, such as low-value payments that are expensive to process with cards”.
Xapo Chief Legal Officer Joey Garcia agrees with this sentiment; however, he claims that the exact cost benefits will depend on the implementation and network fees associated with the currency.
He says: “Merchants should evaluate these factors to understand the true cost implications, but I would certainly expect higher volume businesses to expect significant savings.”
Cohesive Architecture Chief Technology Officer Sudeepta Das echoes the statements, believing that although transaction costs are likely to become more competitive as reliance on major global card schemes decreases, the shift could make card transactions cheaper. Das adds: “Increased competition between technology providers will drive prices down, but for retailers and potentially consumers, this is good news, as it could lower the cost of processing payments.”
The integration of the digital pound with existing POS systems may pose some challenges. Current POS systems generally lack the necessary blockchain-native integrations, potentially necessitating new hardware components and infrastructure to enable smooth transactions, Joey Garcia explains.
Garcia advises Payment service providers (PSPs) to collaborate closely with merchants and technology partners to ensure compatibility and interoperability. He adds: “There will also be compliance-related sensitivities depending on the openness of the networks on which the digital pound functions, as those systems will not have integrated data analytics and monitoring tools included. The objective will be to minimise disruption to merchant operations, but there will be a number of technical steps required to achieve this.”
Ralphs agrees that collaboration between the public and private sectors is crucial, with the private sector providing technology and subject matter expertise for the application and deployment of new technologies in the real world.
He adds: “Businesses and the private sector are also at the coalface of the customer experience, so they can provide perspectives of the ‘voice of the user’ and understand how to drive adoption; at the same time, engaging with policymakers and regulators means that we also understand the expectations they have for the industry. It’s important to prioritise public/private collaboration – it’s at the core of good regulation for innovative and emerging technologies.”
Garcia claims that educating consumers will also likely present an initial challenge, with merchants needing to prioritise user-friendly interfaces. He says, “A key piece around this will be the interactions with regulated digital wallet providers or banks, including blockchain native wallet functionality in a seamless way to ensure that users do not feel any form of exposure to the new technology and no functional difference.”
Das believes that integrating the digital pound with existing POS systems will be challenging but possible, as seen with the Sand Dollar (Bahamas), eNaira (Nigeria), and e-CNY (China).
He claims that new opportunities for fintech startups will emerge once existing software starts processing digital pound transactions. He says: “Especially as identity-based payments and wallet-based clearing systems gain traction. Since banks are taking individual approaches to digital currency, new tech providers will be crucial in bridging the gap, helping to connect wallet-based systems with banks’ digital currency setups.
The BoE’s exploration of a digital pound represents a significant step towards modernising the UK’s payment landscape. While the proof-of-concept (PoC) demonstrates that current point-of-sale (PoS) hardware can indeed accommodate digital pound transactions, the road to full implementation is lined with challenges and opportunities.
Collaboration between the public and private sectors will be essential to ensure seamless integration, address compliance concerns, and foster consumer adoption. Ultimately, the successful roll-out of a digital pound could lead to a more efficient, secure, and inclusive financial ecosystem, reinforcing the UK’s position at the forefront of global financial innovation.
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