On 12 March 2020, the Bank of England (the “Bank”) published its discussion paper on Central Bank Digital Currency, Opportunities, Challenges and Design (the “Discussion Paper”).
The purpose of the Discussion Paper is to initiate a dialogue about the merits of introducing a central bank digital currency (“CBDC”) in the UK and the potential opportunities and threats associated with it. The Bank is clear that the Discussion Paper should not be taken as an expression of the Bank’s intention to introduce CBDC and emphasises the need for careful consideration and further research.
What is the Bank’s approach to CBDC?
The Discussion Paper focuses specifically on “retail CBDC” as a use case. Accordingly, the Bank defines CBDC as an electronic form of central bank money that could be used more widely by households and businesses to carry out payment transactions and store value – akin to a digital version of a traditional banknote. CBDC would be denominated in pound sterling and introduced alongside, rather than replacing, cash and commercial bank deposits.
It would effectively provide a new form of central bank money (with the Bank having exclusive control over its issuance) and a new payments infrastructure.
The Bank also points out that CBDC would be fundamentally different to “cryptocurrencies” (e.g. Bitcoin) which are privately issued, as it will be centrally issued by the Bank and will have the equivalent value of sterling.
What are the objectives for CBDC?
The Discussion Paper makes clear that the introduction of CBDC should be overlaid by the Bank’s objectives and mandate, and take account of public policy initiatives – perhaps most notably in recent terms is the emphasis on support for Fintech and related financial services innovation set out in the Government Budget published on 11 March 2020 (please find our previous discussion on this topic available here).
The Bank released the Discussion Paper with the following broad central objective for CBDC:
“Households and businesses should be able to make fast, efficient and reliable payments, and benefit from an inclusive, innovative, competitive and resilient payment system.”
The Bank also sets out that it intends for CBDC to be available for, at least, the following types of payments:
household to business payments – such as for goods and online services, in shops and online;
household to business recurring payments – such as for bills;
household to household payments – such as for gifts and rent;
business to household payments – such as for wages to employees; and
business to business payments – such as for goods and services from suppliers.
In this respect, the Bank’s vision is broad and captures a range of different payment methods currently available, such as cash, debit / credit cards, direct debits, standing orders, faster payments and Bacs.
The focus in this regard is solely on domestic retail payments in a single currency (i.e. sterling) whereas domestic wholesale payments, currently handled by CHAPS, and cross-border payments are not within scope. The Bank is addressing these types of payment as part of its renewal programme for the Bank’s Real-Time Gross Settlement system and in the context of its Future of Finance initiative.
The Bank’s platform model of CBDC
The Bank has outlined a “platform model” as a possible approach to introducing and operating a CBDC payment system in the UK. The Bank emphasises that its proposed model is not a “blueprint” for CBDC implementation but rather serves as an illustration and the basis for further discussion.
Key elements of the platform model comprise the following:
- the Central Bank core ledger;
- payment interface providers connecting to the platform through APIs (Application Programming Interface); and
- so-called “overlay services”.
Under the “platform model” it is envisaged that the Bank would build and operate a platform to provide the minimum functionality for CBDC payments – namely a “core ledger” which would provide relatively simple payments functionality. Effectively, the core ledger would provide the functionality for the purposes of recording overall stock and supply of CBDC (to avoid “double spending”) and to process payments and record all CBDC transactions.
The platform as a whole would be designed to allow appropriately regulated private sector firms, referred to as “Payment Interface Providers” (“PIPs”), to connect to CBDC users in order to provide them with customer facing CBDC payment services. PIPs would access the platform via an API and with a view to build “overlay services” (services which provide additional functionality) and develop user-friendly interfaces which would create competition and provide users with innovative and easy-to-use methods of obtaining access to the CBDC.
In addition, the Bank highlights that PIPs will be responsible for (amongst other things):
- applying “know your customer” checks to verify the identity of CBDC users;
- authenticating payments initiated by users;
- protecting users from fraud;
- protecting users’ personal data and ensuring cyber resilience; and
- applying anti-money laundering and sanctions checks to relevant payments.
How will the technology for CBDC operate?
The choice of technology used to implement CBDC will be key. It will determine the extent to which CBDC aligns with the design principles of being secure, fast, efficient, extensible, available, scalable and therefore able to meet the Bank’s policy objectives.
The Bank is clear that any form of CBDC would require a “core ledger”, run by the Bank to keep a record of CBDC transactions, and to maintain the overall stock and supply of CBDC. Much of the other technology required would be provided by PIPs. The Bank is also considering whether the ledger should be centralised or decentralised.
The Bank makes no presumption that CBDC should be built using Distributed Ledger Technology (“DLT”) but points out that DLT offers potentially useful component innovations. The Bank notes that several such innovations can likely be adopted independently of each other, allowing the Bank to focus on aspects of DLT most relevant. For example, decentralisation and distribution could be used to increase resilience and availability. Conversely, DLT could have negative impacts on issues such as privacy, security and overall performance (e.g. with regards to speed and scale).
The Bank considers the following to be relevant and useful elements of DLT that can potentially be adopted independently of each other:
- sharing of data;
- use of cryptography; and
The Bank notes that in designing a CBDC, it will not be possible to maximize outcomes on every design consideration; instead, a balance between design principles will be required. Notably, simplicity versus functionality and transaction throughput versus speed of settlement will need to be reviewed.
Whatever technology is chosen, whether it is based on centralised or decentralised systems, it must ensure that the Bank retains exclusive control of the creation of new CBDC. The Bank would always require overall control of the CBDC network. As such, any system would need to be permissioned so that the Bank controls access to the network. It is currently envisaged that only regulated PIPs would be able to connect to the core ledger.
How will the economics of CBDC operate?
Implementation of CBDC would create a new form of money which would allow households and businesses to directly make electronic payments using central bank money for the first time. The Bank notes that this development could have a profound impact on the way the Bank addresses its key objectives of maintaining monetary and financial stability, but also impact the banking system as a whole.
For example CBDC could, for some transmission channels, increase the speed and extent to which changes in the Bank’s policy rate are passed on to households and businesses. It could also change the amount and cost of credit provided to the economy by the banking sector. These benefits would have to be balanced against potential risks including disintermediation of the banking sector on credit provision.
CBDC would only benefit household and businesses if it was available to and held by these groups. It follows then, that households and businesses would need to convert some of their traditional funds into CBDC. The extent to which money is transferred and converted to CBDC would have to be managed carefully; such disintermediation could have a significant impact on the balance sheets and operation of both the Bank and commercial financial services sector.
The Bank highlights three tools it could employ to manage financial and monetary stability in the context of CBDC:
- remuneration of CBDC – determining how and whether CBDC would be interesting-bearing;
- the tiering and structure of this remuneration – headline versus tiered interest rates depending on the nature of transactions; and
- limits – the Bank could choose to limit, and incentivise either up or down, the amount of CBDC that businesses and individuals would be allowed to hold.
While there are clear economic considerations and tools that can be employed to manage these, the Bank admits that further research on outcomes and best practices is required.
The introduction of CBDC is increasingly being looked at across the world, and the Bank is not the first or only institution to explore the possibility. In January 2020, the Bank joined forces with the European Central Bank, the Sveriges Riksbank, the Bank of Canada, the Swiss National Bank and the Bank for International Settlements (BIS) to pool research and experiences in CBDC. Further, the People’s Bank of China has already started real-world testing of their CBDC, and the US Federal Reserve confirmed in late 2019 that it is carefully assessing the costs and benefits of a CBDC initiative.
While the Bank is yet to decide on whether it will implement a CBDC, it is encouraging to see that it is reviewing its feasibility; this aligns with the wider UK push, most recently set out in the Budget published on 11 March 2020, to lead and innovate in the Fintech area. It is quite clear that introducing a CBDC would present significant opportunities, but also challenges to payments, financial stability and monetary policy. However, the Bank’s analysis, in particular its approach which combines private and public sector collaboration, could present a roadmap for the future of payments in the UK, and so undoubtedly the payments industry will be keeping a close eye on these developments.
The Bank has welcomed anyone with an interest in CBDC and CBDC-related benefits, risks, and design aspects to submit comments on the specific questions set out in the Discussion Paper by 12 June 2020.
Co-Authored by Oliver Bridal