Central bank digital currencies: a solution in search of a problem? Contents


Central bank digital currencies

The Bank of England and HM Treasury have created a Joint Taskforce to explore the potential of a ‘retail’ central bank digital currency (CBDC). A retail CBDC is different to privately issued cryptocurrencies such as Bitcoin. Instead, it would be a form of electronic money issued by the Bank of England that could be used by households and businesses to make everyday payments—in essence a ‘digital banknote’.

Over 90 central banks are exploring CBDCs. In developed countries, there are two common motivations. First, central banks are concerned that big tech companies, such as Meta/Facebook, could issue their own digital currencies to the users of their vast networks, enabling them to accrue excessive market power. Second, many central banks are concerned by the decline in the use of physical cash, which some have said anchors public confidence in the monetary system.

However, the introduction of a UK CBDC would have far-reaching consequences for households, businesses, and the monetary system for decades to come and may pose significant risks depending on how it is designed. These risks include state surveillance of people’s spending choices, financial instability as people convert bank deposits to CBDC during periods of economic stress, an increase in central bank power without sufficient scrutiny, and the creation of a centralised point of failure that would be a target for hostile nation state or criminal actors.

Overall conclusion

We have yet to hear a convincing case for why the UK needs a retail CBDC. While a CBDC may provide some advantages, it could present significant challenges for financial stability and the protection of privacy. The Joint Taskforce should answer the following questions before deciding on whether to proceed:

  • To what problem is a CBDC the answer?
  • What is the precise threat posed by privately issued digital currencies, what it is that a CBDC could do to offset any threat, and what is the role of regulation?
  • How can a CBDC be a competitive payments option without causing a level of banking sector disintermediation that would have negative consequences for credit allocation and financial stability?
  • What additional monetary policy options would a CBDC provide to the Bank of England, and would these be proportionate to the Bank’s current mandate for monetary and financial stability?
  • How can a CBDC ensure strong privacy safeguards while also meeting financial compliance rules? Which organisations will be able to access sensitive CBDC payments data, and for what purpose will that data be used?
  • What are the main international and national security risks that arise from a CBDC, and how can these be managed? How can a CBDC be made secure against current and future threats without sacrificing useability?

We recognise that consumer payment preferences, technological developments and the choices of other countries may enhance the case for a UK CBDC in the future. The long lead times involved in scoping and developing a CBDC mean the Joint Taskforce should continue to assess the rationale and technology in preparation for such a measure being needed in future.

Parliamentary scrutiny should be an essential part of assessing the case for a CBDC and if the Government decides to proceed, Parliament should have the opportunity to vote on any final decision, along with the governance arrangements for any such system, during the passage of primary legislation. The Government should set out the costs of introducing and operating any design that is proposed.

Risk of private money creation

The market for stablecoins and other crypto assets is growing quickly but these digital assets are unregulated and are increasingly seen as a risk to financial stability. Central banks are concerned that big tech companies could use the same technology to issue their own digital currencies which could be popular enough to compete with central banks and their control of monetary systems. While we agree this is a risk, the introduction of a CBDC may not be a necessary or complete response. Private entities of a size that can compete with the existing payments systems can and should be regulated.

Declining cash use

While the number of banknotes in circulation has continued to rise in the UK, most payments that were made in cash are now made via debit and credit cards. This trend is likely to have accelerated because of the COVID-19 pandemic. However, cash continues to be widely accepted in the UK and it is not obvious that the properties of CBDCs would satisfy the demand for cash, which is often valued for its physical properties and the privacy that it can provide. We note that the Bank of England has said that it will continue to issue cash on demand and that the public need for money without default risk is covered for most savers by the availability of cash and deposit protection.

Implications for the monetary system

If a CBDC is introduced, it is inevitable that some people will transfer money out of their bank accounts and into CBDC wallets. This process is known as disintermediation, but it is unclear how much might take place, and will depend ultimately on how a CBDC is designed. Without safeguards, such as limits on the amount of CBDCs individuals can hold, financial instability could be exacerbated during periods of economic stress as people seek to replace bank deposits with CBDC which may be perceived as safer.

Limits on CBDC holdings, or charges on large holdings, may reduce the attractiveness of CBDC to users, which could undermine other objectives such as increasing financial inclusion or crowding out privately issued stablecoins. The Bank of England should conduct further studies to assess what would be the effect on the banking system if more than 20% of deposits are converted to CBDC. This would help the Bank to better understand what limits or other design choices might be necessary.

A CBDC could enable central banks to conduct forms of unconventional monetary policy more easily. While the Governor of the Bank of England told us that he did not see CBDC as a way to implement monetary policy, we note his successors may disagree. Such measures may increase the Bank of England’s role and influence in the economy and any changes to the Bank’s monetary policy toolkit should be scrutinised carefully. We recommend that the Joint Taskforce publishes its assessment of the potential for monetary policy via a CBDC in its 2022 consultation to assist this scrutiny.

To prevent their use in large-scale criminal activity, any CBDC system could not support anonymous transactions in the same way that cash can be spent anonymously. While there are design options that would provide some privacy safeguards, technical specifications alone may be insufficient to counter public concern over the risk of state surveillance. The Bank of England risks being drawn into controversial debates on privacy.

The Bank has indicated that it favours a private sector led approach for managing necessary ‘Know Your Customer’ checks on CBDC account holders. However, the requirement to provide these checks could reduce the incentives for new companies to provide CBDC account services, which may undermine the objective to spur competition in payments. It is also unclear what kind of digital identification may be needed to ensure payments are made securely and legally. This should be set out.

Implications for households and business

While the UK’s existing domestic payments system is secure and efficient, a CBDC system could spur innovation and competition in payments, but this would be in addition to those that are already taking place. Increased competition from CBDC technology could lead to a reduction in card fees paid by merchants, which could be passed on to the consumer. However, few other significant potential advantages for UK consumers were predicted by our witnesses. We recommend that the Joint Taskforce include additional representative consumer groups on its engagement forum to help it to identify what benefits, if any, a CBDC could provide.

Cross-border payments can be expensive and slow. Interoperable, cross-border CBDC systems could bypass some of the existing frictions with lower costs. Nevertheless, such a system would still have to comply with oversight frameworks, national laws and international technical standards which are a long way from being agreed. Cross-border payments are already improving because of innovation and competition in the fintech sector. Furthermore, a great deal of international collaboration is under way both in the private and public sectors to improve cross-border payments, which should make them more efficient with or without CBDCs.

Should the acceptance of cash decline significantly, a CBDC could be a way to ensure greater financial inclusion in that it would provide access to digital payment services that are like bank accounts. However, for some, not having a bank account is a choice and for others, the technological requirements for CBDC transactions may exclude them from accessing it. It is likely that there are more straightforward and targeted ways to support access to financial services than to launch a CBDC.

International implications

The global reliance on the US dollar and the SWIFT messaging system which supports cross-border payments has enhanced the US’s ability to implement sanctions. For some countries, reducing their reliance on the US dollar and trying to avoid sanctions is a motive behind CBDC development.

In the short term, barriers to bypassing the US-dominated international payments system remain formidable. Complex agreements on standards, design and governance would have to be agreed by all countries concerned. However, agreements between small groups of countries could be negotiated more quickly, and it is apparent that there is political will in certain countries, such as China, to create alternatives to the existing international payments system. This trend could erode the US dollar’s sanctions leverage. We recommend that HM Treasury’s Office of Financial Sanctions Implementation assesses whether similar risks exist for sterling and the euro.

There are two main security risks posed by a CBDC. First, individual accounts could be compromised through weaknesses in cyber security. Second, the centralised CBDC ledger, which would be a critical piece of national infrastructure, would be a target for attack from hostile state and non-state actors. While no design can guarantee absolute security, any CBDC system will need to be adaptable to emerging security threats and technological change, including fast-developing quantum computing.

The UK is well placed to lead on developing international standards for CBDCs. It would derive most long-term benefit by ensuring global standards and rules on governance, privacy, security, and interoperability are compatible with the national interests of the UK and its allies.

Finally, we heard the development of a ‘wholesale’ CBDC could support the UK’s competitiveness as an international financial centre. Wholesale CBDCs, unlike universally available retail CBDCs currently being examined by the Joint Taskforce, would only be used in transactions between financial institutions. While the wholesale operations of the monetary system are already highly efficient, principally through the Real-time Gross Settlement system (RTGS), and there is ongoing improvement work, a wholesale CBDC may help to further enhance efficiency in securities trading and settlement. We recommend that the Joint Taskforce consults on whether a wholesale CBDC would have any material advantages over the continued development and widened membership of the RTGS alongside its 2022 retail CBDC consultation.

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