The advent of Central Bank Digital Currencies is undoubtedly having a profound effect on jurisdictions globally, as well as in the UK. There are almost 90 CBDC programmes currently in progress around the world in places as diverse as the EU, Canada, Hong Kong, Sweden, Singapore, Cambodia and China. The Bahamas was the first nation to launch a CBDC, and China’s DCEP (Digital Currency / Electronic Payments system) is already in live commercial trials at scale, with the country intimating that it will fully launch in the near future.
Central Bank Digital Currency – what is it and how will it affect us as citizens and consumers
What are CBDCs, and why should we care about them?
What is a CBDC, and how does it differ from the digital forms of money that we have today? Isn’t money already effectively digital, given the increasing move to a cashless society, and the advanced state of electronic interbank payments? The answer is yes, with a few caveats. The digital payments infrastructure that we have today has been evolved incrementally over many decades, and many of the design features underpinning that infrastructure embody technological constraints at a point in time. The principle behind CBDC is that it is digital-native – it’s designed to meet the requirements of a modern and increasingly digital economy, and it can be implemented using frontier technologies that enable these requirements to be fulfilled.
What’s driving the rise of CBDCs? Initially, at least, CBDCs represented a reaction from central banks to proposed new forms of privately issued digital money, most notably Meta’s now-extinct Diem coin. There has since been a growing recognition of the wider benefits associated with CBDCs beyond their use as payments instruments, such as the opportunities for innovation and competition arising from programmable, digital-native central bank-issued money. Nevertheless, adoption of any CBDC is heavily dependent not only on its technical features, but also the way in which characteristics such as privacy, resilience, security and consumer protection are built into its design and that of its accompanying infrastructure.
A distinction is usually drawn between wholesale and retail CBDCs. These aren’t necessarily different types of CBDC as such (although some countries might choose to implement them differently); rather, they refer to the primary use cases for which the CBDC is intended, and may involve different delivery channels, payments systems or payments intermediaries. Retail transactions are those undertaken by individuals or businesses, for everyday payments purposes. Wholesale transactions occur between financial institutions, such as banks, to settle their liabilities to each other. There are overlaps between the two as well, as retail payments may give rise to wholesale settlements being required between two banks, for example.
So what can we do with a retail CBDC, that we couldn’t do before?
One of the most exciting features of CBDC is the potential for introducing programmable money – a form of digital money that, by design, allows for the execution of certain software code in the course of a transaction using that money. Programmable money can offer users – be they individuals, businesses, local authorities or government departments – a means of transacting in which all the consequences and obligations arising as a result of their transaction are managed seamlessly. For example, this could include automated tax reporting and tax deductions at the transaction level, greatly simplifying company accounting procedures and improving the real-time flow of tax receipts to HMRC. For government and local authorities, this could mean better policy delivery in real time, and for individuals and families it could mean cheaper, easier and more secure access to benefits and entitlements, via digital money, than is currently available.
The use cases and benefits associated with CBDC have gained significant traction in the wake of the COVID-19 pandemic, particularly with respect to the potential applications around financial inclusion – including improved capabilities around government distributions, and the achievement of existing and future public policy. A well-designed CBDC that encompasses principles of universal account access has the potential to enable greater financial inclusion. Payment service providers in a CBDC ecosystem could be incentivised to offer accounts or wallets to those customers that are excluded from conventional banking services. Greater financial inclusion, and more universal access to accounts, can generate wider social benefits, including improved credit ratings, lower costs of transactions (to the users of the services) and access to cheaper credit.
CBDC also forms a key enabler of the transition to a digital economy, and introduction of a CBDC can drive greater adoption and innovation of transformative technology paradigms such as artificial intelligence (AI), decentralised systems and applications implemented via distributed ledger technology, and the internet of things (IoT). Combining the power of AI and DLT with CBDCs – programmable or not – can give rise to a diverse set of new business models and applications associated with internet-enabled, networked hardware devices that can act as digital agents for their owners.
Will we have a CBDC in the UK?
The Bank of England has made clear that no decision has yet been taken as to whether the UK will have a CBDC. Nevertheless, it has been actively researching, consulting on and experimenting with digital currency for a few years. A CBDC would also take time to implement, and for us to realise its full benefits. More recently, the House of Lords Economic Affairs Committee (EAC) published a report, in January 2022, entitled “Central bank digital currencies: a solution in search of a problem?”. As indicated by its title, the report appeared to pour lukewarm water on the concept of CBDC – specifically retail CBDC – and concluded that there is no convincing case for why the UK needs a CBDC. Whilst this certainly does not signal the end of CBDC in the UK, it does show that there is an uphill battle for organisations such as the Digital Pound Foundation to demonstrate the benefits that CBDC adoption can bring.