The Bank of England (BoE) recently published a consultation paper detailing its retail CBDC vision. Although a final decision will only be taken in 2025 at the earliest, the paper’s authors judge “it is likely a digital pound will be needed”, echoing the sentiment from the ECB and other central banks pursuing their own projects, each with their own vision.
The BoE cites the usual central bank arguments: a CBDC would help drive digital payments innovation and choice alongside private money, support financial inclusion, and improve cross-border payments. In a world of declining cash and the ongoing shift to digital, the BoE believes a CBDC would preserve access to risk-free public money as an anchor of monetary stability. We might question how much of a public concern this is likely to be given governments continue to backstop troubled commercial banks creating the impression that today’s deposits are already equally risk-free.
Structure and privacy
Similarly, to most other retail CBDC projects, an indirect structure is proposed, with the private sector expected to provide the interface between the central bank’s core ledger and end users to whom they would offer distribution and wallet services.
The BoE seem fully conscious of the need to assuage privacy concerns and emphasise privacy by design – customers would be anonymous to the central bank, with KYC via intermediaries, following a similar structure to today’s monetary system.
At launch, the digital pound would be non-interest bearing (like physical cash), though the door seems open to future change after “review with full consultation” so are presumably considering building in programmability. It makes sense to do so. Any new monetary platform for the digital age needs to anticipate innovative future use cases in everything from dynamic monetary policy to atomic swaps and IoT micro-payments. Albeit the BoE will need to tread carefully to avoid inflaming public sensibilities over too big a government.
The BoE recognises the importance of offline payments for financial inclusion but also the technical challenges. Though not impossible, offline capability does impose a responsibility on wallet providers to correctly code double-spend controls and manage reconciliation processes once reconnected. Nimble fintechs and non-bank players may look to jump in, but wallet offerings from trusted banks may provide greater reassurance. Both India and China have launched their retail CBDCs with wallets from major banks.
Limits and commercial bank impacts
The BoE outlines plans to limit wallet balances whilst they assess impacts on deposit outflows. The proposed caps of up to £20,000 for individuals seems high for daily payment needs and would allow wallets to become stores of value.
The paper discusses but ultimately downplays the potential disintermediation impact on commercial banks, citing market forces would push banks to pay higher interest to retain deposits, passing on costs through lending rates. They do recognise uncertainty in the stress this may cause to banks’ business models. The recent banking sector instability is a stark reminder of the fragility in the system during crises of confidence, and as a result, we surmise these wallet limits may get reviewed and downsized, at least during a transition period.
Furthermore, what the BoE hints at, and what we might additionally see, is an alternate form of digital money more closely linked to the banking sector. Commercial bank consortiums in countries like the US, Germany, and Switzerland have already laid out their own visions for inter-bank tokenised deposit networks that could be backed by CBDC held at the central bank as an extension of today’s reserve banking system.
Integration and interoperability
Ease of movement between cash, deposits and CBDC is underlined. The BoE is right to emphasise a tight integration into the existing financial system: eliminating friction will be key to adoption. Commercial banks could help here with automatic account sweeps to deposit accounts, keeping wallet balances within limits.
An open and flexible CBDC platform is crucial for interoperability with future cross-border initiatives. Recent BIS projects, such as with mBridge in Asia and IceBreaker in Europe, show just how CBDC systems could function across multiple jurisdictions.
The BoE has outlined a comprehensive vision, a major step along the road. Nevertheless, many questions remain, such as assuring public adoption, confirming private sector monetization incentives, and managing commercial bank impacts.
According to their timetable, it seems unlikely we will see a digital pound much before the end of the decade. Though time to market may be a concern, the BoE is likely to prioritise a slow and steady approach – any wrong step would immediately kill trust.
The future payments landscape is shaping up to be a panoply of new public and private digital options, combined with enhanced traditional rails. Trust, interoperability, and added value services such as for embedded finance will be key to success. It should be good news for consumers, competition will drive better service and lower costs.
Jeremy Boot is product strategist at banking software company, Temenos