Overview
Frequent readers of this blog know that we have been keeping a watchful eye on the UK’s evolving approach to the potential launch of a central bank digital currency (CBDC).
CBDCs have formed part of the regulatory dialogue in the UK since 2020 following the Bank’s initial discussion paper published in March of that year. At that point, many commentators queried whether they were a solution without a problem. In 2021, in one of our more popular posts, we mused on the possible usefulness of CBDCs in the context of the metaverse in an attempt to propose a problem for CBDCs to solve. We then covered the Bank and HM Treasury (HMT) joint consultation paper on the potential of CBDCs in February 2023. That consultation confirmed certain key design principles, including the fact that any CBDC launched in the future would be a retail CBDC rather than a wholesale CBDC, and posed a number of questions.
The Bank and HMT have now published their joint response (Response) to the February 2023 consultation paper. The Bank and HMT received over 50,000 submissions in response to the consultation paper, proving, if nothing else, the continued prominence of CBDCs in the national debate concerning the evolution of money and payments in the UK.
The Response explains that the Bank and HMT remain undecided as to whether a CBDC ought to be issued, although further preparatory work is “justified” in their view, which should be considered a positive development by those in favour of a CBDC’s issuance. The Bank and HMT will not reach a firm decision on that point until 2025 at the earliest, but in any event only after any related primary legislation is passed.
Although the key question of whether a CBDC will be issued remains open, the Response does confirm a number of points in relation to the CBDC that could one day be issued by the Bank. Despite those clarifications, doubts remain whether a CBDC’s benefits would outweigh the harm they could pose to the wider UK economy, particularly in the medium to long term.
Design of the CBDC
The Bank has reiterated a number of points regarding the design of any future CBDC. To recap:
- A CBDC would be issued by the Bank and denominated in sterling so that £10 of CBDC would always have the same value as, and be interchangeable with, a £10 banknote.
- The Bank would provide the core infrastructure, including a ledger, while private companies would be able to provide the interface between the Bank and users.
- A CBDC would initially be designed for use with in-store payments, online payments and person-to-person payments (although the scope would broaden in the future).
Privacy concerns
A significant portion of the Response is devoted to addressing privacy-related concerns which are driven by the fact that CBDC payments would be traceable.
In response to those concerns, the Government has now committed to enshrining objectives related to privacy and programmability into any primary legislation that would be introduced prior to the issuance of a CBDC. Under that primary legislation, a CBDC would be subject to a regime that is at least equivalent to the current regime for digital payments.
Unlike cash, CBDC payments cannot be totally anonymous, as the ability to identify and verify users is necessary to prevent financial crime. In light of that reality, the Bank and HMT have proposed the following measures to alleviate respondents’ concerns: (i) introducing legislation to guarantee the privacy of users; (ii) using technological options that prevent the Bank from accessing personal data through its core infrastructure; and (iii) launching a working group dedicated to privacy issues as part of the design phase.
Under the proposals set out in the Response, the Bank has sketched out a framework whereby it would only be responsible for ensuring the processing and settling of payments using anonymised data. Private-sector CBDC wallet providers would first anonymise a user’s personal data before transactions are then processed and settled by the Bank. Under that proposal, the Bank would not have access to personal data, and customers would interface with private businesses rather than directly with the Bank.
Further, private-sector CBDC wallet providers would only be able to program digital pound payments with user consent, a process that would be subject to a robust regulatory framework. This dovetails with the Government’s overarching commitment that neither it nor the Bank will ever control how customers spend their money. To that end, the Response explains that cash will remain available even if a CBDC is launched.
Although it is encouraging to see the Bank and HMT engaging with respondents on the critical issue of privacy, the plans that have been provided at this stage are high level. It is clear that the devil will be in the detail and all eyes will be on the publication of draft primary legislation to better understand how a CBDC user’s personal data would actually be protected in practice.
Monetary policy concerns
Interestingly, the Response also confirms that the Bank and HMT intend to proceed with plans to set limits on the holding of digital pounds, which could range between £10,000 and £20,000. Corporates would also be limited, but the corporate limit would be significantly higher. These limits are designed to manage risks to financial and monetary stability associated with outflows from bank deposits, although we note that certain respondents (including the Treasury Committee in their 2 December 2023 report, “The digital pound: still a solution in search of a problem?”) have called for these limits to be lowered even further.
The issue of whether or not to impose such limits presents an interesting dilemma. On the one hand, it is difficult to imagine CBDCs truly competing with other forms of payment, as envisaged by the Bank and HMT, with such limits in place. On the other hand, it would be extremely concerning if no such limits were proposed given the potential impact significant outflows from bank deposits would have on the wider UK economy (i.e., a potential decrease in commercial lending due to increased lending costs). At this point in time, it is unclear how that tension could be resolved.
As a more general point, there are concerns that a CBDC could increase centralised risk. In the hypothetical scenario where a significant proportion of the UK population converts their commercial bank deposits into CBDCs during a period of financial market stress, it is difficult to envisage how that would not result in a slow-down of commercial lending and place further strain on the Bank and the UK’s financial regulators.
Although the Response explains that, as currently contemplated, the CBDC would be unremunerated at launch (i.e., no interest rate would be applied so it is less likely to compete with commercial bank accounts), we note that the aforementioned hypothetical could still become a reality as the Bank and HMT have left the door open for a future re-evaluation of a CBDC’s remuneration via a separate consultation process. We also note that the Bank and HMT have been under pressure from the Treasury Committee (amongst other respondents) to “not preclude the possibility of paying interest on the digital pound” in order to explore how that could make monetary policy more effective (as set out in the Treasury Committee’s December 2023 report).
Next steps
Looking forward, the Bank and HMT expect to decide on whether to issue a CBDC “around the middle of the decade”.
At present, we remain in the “design phase,” which is focused on the “operational, functional and technology model for a digital pound.” The Government hopes that this design-focused work will ultimately support a more well-informed future assessment of the costs and benefits of building and running CBDC infrastructure. As part of the design phase, the Bank and HMT are also developing “the criteria that will inform the decision as to whether to proceed to build the infrastructure,” as explained in their 25 January 2024 response to the Treasury Committee’s December 2023 report. As such, it remains unclear what criteria will eventually be used to determine whether a digital pound is worth issuing.
In any event, the Government has committed to introducing primary legislation before a CBDC could be launched. As there are currently no signs of such legislation being drafted, we remain in limbo for the foreseeable future.