The Bank of England Is Considering Jumping on the CBDC Bandwagon

News and Analysis

The Bank of England (BoE) has published a discussion paper, exploring the pros and cons of a potential issuance of CBDC pegged to the British pound. In the paper, BoE offers more pros than cons and pledges to hear out thoughts on the matter from the general public.

Fiat Money Is Dying

The paper opens with an admission that despite there being the record amount of fiat money in circulation, it is being used for payments less with each year. According to UK Finance payment markets summary, while 60% of payments (by volume) were made using banknotes in 2008, in 2018 this figure fell to mere 28% and is predicted to fall even lower, reaching 9% by 2028.

“We are in the middle of a revolution in payments. Banknotes—the Bank’s most accessible form of money—are being used less frequently to make payments. At the same time, fintech firms have begun to alter the market by offering new forms of money and new ways to pay with it.”

Cash payments share compared to other means of payment

Cash payments share compared to other means of payment. Source: UK Finance

These sentiments echo earlier conclusions made by other central banks. The recent Deutsche Bank report went as far as to predict the final downfall of fiat money in the next decade.

“The forces that have held the current fiat system together now look fragile and they could unravel in the 2020s. If so, that will start to lead to a backlash against fiat money and demand for alternative currencies, such as gold or crypto could soar.” 

Pros and Cons

Currently, the general population can only hold money issued by the central bank in the form of banknotes. Only banks and certain other financial institutions can hold electronic central bank money, in the form of central bank reserves. CBDC, suggests the BoE, will combine positive qualities of both modes of money, being essentially digital banknotes that can be used by households and businesses to “make payments and store value” without interacting with commercial banks.

Yet while, on the one hand, CBDC is expected to make the financial system more robust, because it will not rely on the network of commercial banks, this same fact is viewed by BoE as potentially posing a risk to economic stability.

“The initial introduction of CBDC is likely to lead to some substitution away from the forms of money currently used by households and businesses (i.e. cash and bank deposits). If this substitution was very large, it could reduce commercial bank funding, with potentially harmful impacts on the level of credit that banks could provide.”

BoE also made a point of comparing CBDC to certain forms of cryptocurrencies that emerge within the rapidly changing payment landscape, such as stablecoins. BoE believes that CBDC may actually provide safer payment services while branding stablecoins as “risky” and “not real money.”

“CBDC would be something fundamentally different from ‘cryptocurrencies’, such as Bitcoin. Many crypto-assets are privately issued and not backed by any central party. They are not considered a currency or money because they do not perform the essential functions of money: they are too volatile to be a reliable store of value, they are not widely accepted as a means of exchange, and they are not used as a unit of account. 

“Some privately issued crypto-assets, known as ‘stablecoins’, aim to overcome these shortcomings and provide stability of value via some form of backing. Depending on the nature of assets backing the ‘coin’, and how they are held, the stablecoin may be unable to provide stability of value and may come with other risks. In contrast, a UK CBDC would be a new risk‑free form of a (digital) pound sterling, issued by the central bank, and would, therefore, perform all the essential functions of money.”

Another curious con mentioned in the paper pertained to the possibility of cash being completely phased out by CDBC. In BoE’s opinion, this might be problematic because physical cash has certain unique characteristics that would be lost if it were to fall out of general use. Namely, the level of privacy transactions performed with a cash offer, which is impossible with most existing electronic fiat payment systems and will certainly be unavailable for CBDC.

No Technical Vision Yet

BoE recognizes that any CBDC implementation would require a ledger, to keep a record of transactions, and to maintain the overall stock and supply of the currency. The most obvious reason for this is to prevent double-spend.

Yet the paper levies critique of DLT systems, questioning their performance in terms of throughput, security, and privacy and advocating a “permissioned” system, with the central bank granting access to the network.

The paper specifically mentions that while involving DLT and blockchain technologies is on the table, they are by no means necessary.

“Although CBDC is often associated with Distributed Ledger Technology, we do not presume any CBDC must be built using DLT, and there is no inherent reason it could not be built using more conventional centralized technology. However, DLT does include some potentially useful innovations, which may be helpful when considering the design of CBDC. For example, elements of decentralization might enhance resilience and availability, and the use of smart contract technology may enable the development of programmable money.” 

That being said, BoE does not rule out selective use of certain features of DLT systems like smart contracts or cryptography.

What to Expect Next

According to the BIS report, as of February 2020, 17 CBDC-related research papers and reports were published by different central banks worldwide. A few jurisdictions, including Denmark and Switzerland, already determined that the costs of a retail CBDC would outweigh the benefits. But a larger number continues to actively develop retail CBDCs.

Bank of England is among the latter, discussion paper marking only the early stage of decision-making. British citizens are invited to send over responses to the paper until June 12.

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