Digital pound

Plans for a digital pound are moving forward as the Bank of England and UK government agree it has a use case, but a launch is still years away. By Marina Reason and Pat Horton of law firm Herbert Smith Freehills.

The world of money is changing. The received wisdom of ‘cash is king’ has long been declining and the world is gradually moving to a more digitised banking space where digital deposits and payments have become dominant. New forms of currency such as stablecoins, and even volatile and unbacked cryptocurrencies, have also entered the payments ecosystem. The next big thing is the central bank digital currency (CBDC). 

The UK government and the Bank of England (BoE) have been toying with the idea of a UK CBDC – a digital pound – for a while now. In February they published a consultation on the next step of their explorations. But if you were hoping to purchase your morning coffee with a digital pound, you will need to hold off until the end of this decade at the earliest.

The consultation is a positive development nonetheless. In it, the BoE and government conclude that there is a sufficient use case to warrant a move to the design and development phase (from the current exploratory phase). However, the final decision on whether there will be a digital pound will not be made until 2025/2026. A subsequent build phase, which will be a major piece of infrastructure build, is likely to take us to the end of the decade.

The BoE sees the changing dynamics in payments and money, as well as the declining use of cash, as a risk to monetary and financial stability given the fragmentation of access to ‘public’ money. A digital pound could help with the ‘uniformity’ of money in a future where the majority of payments are digital.

So, there is a real policy drive and momentum behind the digital pound; enough to shift gear and move to the design phase. Yet the digital pound will only be launched if it meets the government’s exacting standards for security, resilience and performance. The government is looking to bring public consensus along for the journey and aims to build public trust, which is central to establishing the digital pound. 

The desire for a UK digital pound is by no means universally held. The House of Lords Economic Affairs Committee concluded last year that it had “yet to hear a convincing case” for why the UK needs a CBDC. It is now pushing for both Houses of Parliament to have the opportunity to vote on any final decision on a digital pound. 

Some economists have also used public platforms to urge caution, highlighting the running costs, reputational risks and the risk of bank disintermediation as key challenges. The message could not be clearer: reflections on lessons learned from other CBDC launches, whether live or pilot, will be important.

A race to CBDC 

The UK is not alone in its flirtation with a CBDC. Most central banks are exploring CBDCs and more than a quarter worldwide are now developing or running concrete pilots (the digital rupee in India, the Eastern Caribbean Central Bank’s DCash, and the Chinese e-CNY are three examples). Others, such as the Bahamian Sand Dollar, have already been launched. 

In Europe, the digital euro is still in the investigation phase. Like the proposed digital pound, a digital euro would involve direct liabilities held at the central bank, with supervised intermediaries responsible for all end user-facing roles in the digital euro ecosystem. 

The digital euro’s investigation phase ends in autumn 2023, at which point the European Central Bank will decide whether or not to move on to the realisation phase. Any issuance of a digital euro would not be earlier than 2027. 

How would digital pounds work? 

The likely approach would be via a public-private partnership. The BoE would issue digital pounds, while customers would use wallets provided by regulated private sector firms, who would create a link through an application programming interface with the BoE. The difference from traditional digital deposits with commercial banks is that a digital pound would offer users a direct claim to the BoE in the way that cash currently does.

There are a number of other likely features to consider. To begin with, the digital pound will likely be denominated in sterling and interchangeable with cash and bank deposits. However, until the impact of the digital pound on the financial system is understood, there will, at least initially, be a limit on how many digital pounds a person can hold.

With that in mind, it is also worth noting that the intention is for the digital pound to be used for payments. It is not designed for savings and interest would not be paid.

Many will be comforted to know that neither the government nor the BoE would have access to users’ personal data except in limited circumstances required under criminal law. The digital pound, however, would not be anonymous: the ability to identify and verify users is needed to prevent financial crime. 

Private wallet providers would undertake “know your customer” and anti-money laundering checks and handle user data. The liability and compensation framework for instances of fraud in the digital pound system will also need to be ironed out.

Is it worth it? 

Ultimately, the advent of a digital pound could encourage innovation and efficiencies, and result in more choice, faster payments as well as lower costs for end users. Bringing new entrants into the market, both financial and non-financial (which could include retailers, online marketplaces, media and device manufacturers) would improve competition. Non-payment firms might also participate in the digital pound ecosystem and provide overlay services such as budgeting tools, business analytics and fraud monitoring. 

For banks, the impact of the adoption of digital pound on bank disintermediation and the cost of credit is difficult to forecast, but something which will no doubt be a consideration for the BoE in its decision on the digital pound. Banks will also be exploring the commercial opportunities which might arise with the launch of a UK CBDC. 

That said, providing a digital pound service would require significant investment from private firms and the BoE. Because it is currently envisaged that the digital pound would not be remunerated (i.e., it would not pay interest), prospective private firms/banks will need to generate revenue streams to support the provision of digital pound services. This could be through transaction fees levied on merchants/individuals, commercial use of data or fees for value-add services beyond basic wallet functionality.

Whether or not we end up with a digital pound in the future, the payments landscape is evolving: the Financial Services and Markets Bill will introduce a regime to allow for the regulation of fiat-backed stablecoins used for payments and the Treasury is consulting on regulation of cryptocurrency.

As the saying goes, the only constant is change and this certainly applies to the payments market.  


Marina Reason is a partner and Pat Horton is a professional support lawyer at international law firm Herbert Smith Freehills.


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