The digital pound: A critical analysis of its evolution and future

by George Iddenden, Reporter, The Payments Association

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What is this article about?

The discussions, considerations, and developments related to the potential introduction of a digital pound in the UK.

Why is this important?

It’s crucial for modernising the UK’s financial system, improving efficiency, and ensuring its competitiveness in the global digital economy.

What’s next?

The next steps include addressing considerations, legislative actions, and possibly testing regulated stablecoins before launching the digital pound.

Conversations about a digital pound are growing louder as the weeks roll by. With use cases popping up around the globe, is it time the UK followed suit? In a similar fashion to the way coins largely replaced banknotes, digital currency is the next natural progression in the evolution of money, whether consumers like the idea of it or not.

According to the BoE, one of the main goals of a potential central bank digital currency (BOE CBDC) is to ensure the sustainability and health of the UK’s financial ecosystem; this, it stresses, involves preserving cash access. The UK has always been a standard bearer for payments innovation. As it stands, a digital pound looks to be central to the government’s vision for a technologically advanced payments ecosystem. Ultimately, a digital variation of the nation’s fiat currency is the next iteration of the evolution of the global monetary system, something that various payment leaders maintain and must be realised by the UK to ensure its position on the world stage as a payments powerhouse.

Currently, legislation for introducing the digital pound is at a crucial stage, with the government announcing the requirement for primary legislation before a hypothetical launch. The BoE is anticipating a move towards CBDC adoption and recognises the need for primary legislation. This, according to The Payments Association’s (TPA) head of policy and government relations, Riccardo Tordera, resolves a longstanding debate over whether it could proceed without a vote from Parliament. He explains in his recent Payment Review article: “Some had suggested that the BoE could move forward without parliamentary approval. Still, the BoE’s acknowledgement underlines the importance of involving Parliament in such significant monetary decisions.”

Where are we at?

Currently, conversations about a digital pound are centred around addressing concerns raised by the consultation process. Significant considerations and challenges must be addressed, including ensuring data security, privacy, and interoperability on a global scale, conducting thorough impact assessments, and engaging with stakeholders in shaping the design and implementation of a digital pound.

According to Payabl CEO Sean Forward, a digital pound will be necessary in the future, and although a decision to launch one has not been made yet, it’s only a matter of time. Regarding the timeline, he claims that “initially regulated stablecoins will be used in wholesale markets and will be around for several years before the Bank of England issues a digital pound.”

As of now, no final decision has been made on whether to introduce a digital pound. The Bank of England (BoE) and HM Treasury are still evaluating its feasibility and design options off the back of consultations.

There are two major steps to implementing the digital pound. The first involves shifting towards the adoption of regulated stablecoins for business-to-business transactions. Once stablecoins have been integrated into the wholesale market, the focus will likely shift towards introducing the digital pound for retail transactions.

Simit Naik, director, commercial & strategy, of nChain, emphasises, “Whether the BoE is looking to implement a digital pound in the form of wholesale CBDC, retail CBDC or a form of privately issued digital money, it is important that the it take into account the drivers for change from all participants across the current payment ecosystem, including the goals they are looking to achieve, before deciding which digital payment solution is the most relevant for the UK.”

As far as notable other CBDCs across the globe, there are a few, as Manish Garg, managing director, Banksly points out, might be useful when considering the likelihood of success.

Country /Region Project Stage and Progress Objectives Use Cases and Features
China Digital Yuan (e-CNY) Advanced stage with extensive public trials in various cities. Increase payment system efficiency, enhance financial inclusion, and potentially internationalise the yuan. Tested in retail transactions and cross-border payments, showcasing adaptability and widespread applicability.
Sweden e-Krona Pilot projects to assess technical feasibility and public acceptability in response to decreasing cash usage. Promote financial inclusion and ensure public access to a government-backed currency. Aimed at providing secure and efficient payment methods, reflecting a move towards a cashless society.
India Digital Rupee Pilot phases for both wholesale and retail versions to test viability across economic sectors. Enhance financial inclusion and streamline the payment system to make financial services more accessible. Expected to reduce costs, streamline payments, and foster financial sector innovation.
Eurozone Digital Euro Exploratory phase by the ECB to understand how a digital euro could integrate with existing currencies and payment systems. Provide an alternative to private digital currencies and ensure the euro’s resilience. Focus on privacy, security, and broad accessibility, emphasising consumer protection.

Consultation consensus

Last year, the Bank of England and HM Treasury released a consultation paper proposing the currency. There was a consensus among members of TPA regarding the potential benefits and opportunities offered by a digital pound. However, there is a clear realisation of the challenges that lie ahead. They agreed that while the BoE and HMT’s vision for a digital pound is clear, there is still work to be done to realise its full potential and navigate the complexities of its integration into the broader financial ecosystem.

The consultation responses from members of TPA focused on the following points:

  • So far, there’s agreement on the platform model where the public sector provides central infrastructure while the private sector innovates. TPA Members argued that it’s absolutely crucial for the digital pound to remain a liability of the central bank, and wallet providers should be treated as technology providers, not financial institutions, and if allowed to hold users’ funds, should be subject to greater regulatory oversight. Collaboration between the public and private sectors is recommended to create user-friendly products while maintaining high levels of security. Some also suggested regulatory compliance for custodial providers to ensure consumer protection remains a strong priority.
  • Privacy-enhancing techniques should be tailored to different use cases with varying privacy levels. Spending limits should be linked to privacy levels, and the central bank’s access to transaction data should be limited.
  • High-priority payments should encompass in-store, online, and person-to-person transactions. At the moment, there is a need for clarity on merchant onboarding and infrastructure updates. While most respondents to the consultation advocate for all corporates to hold digital pounds, uncertainty remains regarding limits, especially for merchants.
  • While support for access to non-UK residents exists, it is strongly advised that impact assessments are required to mitigate risks. This could also strengthen the usage of the global pound. TPA members raised concerns about undervaluing industry innovation in the proposed design, emphasising the importance of commercial benefits, customer use cases, and interoperability. Financial inclusion efforts should prioritise digital inclusion, engaging stakeholders and fostering private sector innovation as always.
  • Another area of consideration should be the Public Sector Equality Duty, and further analysis on how protected characteristics could potentially be impacted and mitigated is needed on this area in order to move forward.

Conversations around the digital pound are making positive progress. However, additional research has been requested on various aspects, including existing CBDC adoption, technical trade-offs, privacy management, policy roles, user experience in cross-border payments, and public opinion on trust and communication.

Foreword claims that in the event of a rollout, in order to drive public trust, businesses could leverage the currency to boost customer loyalty. He tells Payments Intelligence: “By integrating their loyalty programs directly with digital pound transactions, businesses can enable automatic rewards accrual and redemption, making loyalty programs more attractive and easier to use for customers.” This would drive consumer trust on both sides.

For businesses, Forward says “the digital pound can also reduce transaction costs by eliminating intermediaries, enabling businesses to offer more rewards or discounts to loyalty programme members, thereby enhancing the perceived value of participating in these programmes.”

Positives to the digital pound

The feedback received during the consultation process notes many benefits of the digital pound. These include faster, more transparent, cheaper transactions and near-instantaneous 24/7 availability. In the eyes of Tordera, transparency is a significant benefit. A digital pound could also enhance interoperability, making cross-border transactions more seamless alongside national ones while helping to digitalise the whole ecosystem. He says: “At present, the system is still not digital because all we are doing is swapping ledger values between parties that keep records of it online. This is a form of instant payment, but we have not yet achieved instant settlement, and the system still relies on the legacy banking system.”

The digital pound presents a strategic opportunity for firms to redefine their positions in the market and drive innovation within the payments industry. More agile firms may be able to piggy back off early legislative frameworks to create important products and services for digital fiat currencies, putting themselves in the front seat.

Financial benefits for firms

  • Faster processing and settlement times: When it comes to financial benefits, a digital pound offers vastly faster transaction processing and settlement times than traditional banking systems. By leveraging this efficiency, firms can reduce operational costs associated with transaction processing, reconciliation, and liquidity management. Additionally, streamlined processes can lead to lower administrative expenses and a more efficient allocation of resources across the entire organisation.
  • Reduced transaction fees: Utilising the digital pound, which would operate on a decentralised ledger system, firms can bypass intermediaries and associated fees, leading to direct cost savings on each transaction processed.
  • Enhanced market access and revenue opportunities: Embracing the digital pound can expand firms’ market reach and enable access to new domestic and international customer bases. This increased market access can translate into higher transaction volumes and revenue streams for companies. Moreover, by offering digital pound payment solutions to customers and partners, businesses can attract new opportunities and strengthen existing relationships, driving revenue growth.
  • Improved risk management and compliance: The digital pound incorporates advanced security features, such as encryption and cryptographic authentication, reducing the risk of fraud, cyber attacks, and data breaches. By mitigating these risks, firms can avoid potential financial losses, regulatory fines, and reputational damage associated with security incidents.

Additionally, the digital pound could address risks related to data security, privacy, and cyber threats, providing enhanced protection for users. Offering access to non-UK residents could strengthen the pound’s global usage, benefiting transactions involving UK merchants and third countries. At the same time, the CBDC could advance financial inclusion driven by private-sector innovation and stakeholder engagement.

One of the main drivers behind introducing the digital pound is that it presents significant commercial opportunities that could potentially drive innovation within the payments industry. Overall, the responses indicate that a digital pound has the potential to streamline transactions, enhance security and privacy, foster global usage, promote financial inclusion, and generate commercial benefits.

Improved risk management and compliance opportunities

The digital pound offers businesses the opportunity to improve risk management and compliance. Advanced security features, such as encryption and cryptographic authentication, can help mitigate the risk of fraud, cyber attacks, and data breaches. By mitigating these risks, firms can avoid potential financial losses, regulatory fines, and reputational damage associated with security incidents. Unlike other forms of cryptocurrency, the digital pound adheres to regulatory standards and best practices, ensuring firms can remain compliant with applicable laws and regulations, reducing the risk of non-compliance.

Tordera also praises the programmability design choice. Programmability is a crucial aspect of the proposed CBDC design, offering two distinct functionalities: programmable money and programmable payments. Programmable money entails embedding rules within the CBDC, enabling governments to impose restrictions, interest rates, or usage limitations.

In contrast, programmable payments facilitate automatic transfers based on pre-defined conditions, such as monthly transfers or machine-to-machine transactions. While the programmability of money is integral to CBDC design, financial institutions can offer programmable payments as value-added services, enhancing user experiences. The choice between decentralised, account-based solutions and centralised, token-based solutions can significantly impact user experiences, with the latter requiring users to adapt to a new payment ecosystem.

The flip side

In addition to its potential benefits, the digital pound could cause disruption in the traditional banking sector. This is because it would allow direct central bank holdings, which could lead to a decrease in commercial banks’ deposits and impact their lending capacity. Customers may opt to hold funds directly with the central bank, bypassing commercial banks altogether. This decrease in deposits could impact the liquidity and funding sources of commercial banks, potentially affecting their ability to lend and invest.

Garg points out that monetary policy’s implications, such as the direct application of interest rates to digital currency, could result in unpredictable economic consequences. Also, the ease with which bank deposits can be converted to digital currency during financial uncertainties might cause significant bank runs that could threaten economic stability through increased inflation and interest rates.

Naturally, regulatory challenges, including consumer protection and anti-money laundering efforts, also need to be addressed. Without proper international coordination, cross-border complications may arise, affecting exchange rates and capital flows.

Transitioning to a digital currency system will require significant infrastructural changes and public adoption efforts. However, some people may resist it.

Moreover, the digital pound could accelerate the decline in cash usage, which could disadvantage cash-dependent individuals. Each of these challenges needs to be addressed through meticulous planning to mitigate negative impacts while leveraging the benefits of digital currency technology.

The treasury has its own concerns over the rollout. Garg believes there is a degree of apprehension that a digital pound could alter the dynamics of the banking sector, particularly regarding deposit holdings. He says: “If individuals and businesses opt to hold significant amounts of digital pounds instead of traditional bank deposits, this could impact banks’ ability to lend and may alter the transmission mechanism of monetary policy.

He adds that the Treasury is likely concerned about the cybersecurity risks associated with a digital pound. Garg says that ensuring the resilience of the digital currency’s infrastructure against cyber-attacks, fraud, and technical glitches is paramount to maintaining trust and the smooth running of the economy.

In Garg’s words, “While the potential introduction of a digital pound opens up new frontiers in finance, it brings with it a spectrum of challenges and considerations. The experiences of other nations embarking on the CBDC journey offer invaluable lessons. Still, the path forward requires a nuanced approach, balancing innovation with caution to navigate the intricate landscape of digital currency.”

Firstly, the adoption of a digital pound signifies a significant step towards modernising the UK’s financial system, enhancing efficiency, and ensuring competitiveness in the global digital economy. This transition presents both opportunities and challenges for businesses operating in the financial sector.

From a strategic standpoint, embracing the digital pound offers several advantages for payments leaders. Faster transaction processing, reduced costs, and enhanced security, all of which can directly impact a firm’s financial performance and competitiveness.

However, it’s essential to acknowledge the potential disruptions that may arise, particularly in the traditional banking sector. Direct central bank holdings through the digital pound could impact commercial banks’ deposits and lending capacity, necessitating a reassessment of business models and strategies, which could prove to be costly in both time and resources. Staying abreast of the progress of the currency will be crucial.

Collaboration between the public and private sectors will be vital in shaping the regulatory framework and designing user-friendly products that meet the needs of consumers while upholding security and compliance standards. While the digital pound presents exciting opportunities for innovation and growth, it also requires careful consideration and strategic planning to mitigate risks while maximising benefits.

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