The Digital Pound: What you need to know about UK's CBDC
A condensed and summarised content of the UK's CBDC consultation paper.
A couple of weeks ago, the Bank of England (BofE) and the HM Treasury (HMT) published their much anticipated “Central Bank Digital Currency” (CBDC) paper. While it’s not the first of its kind, the US has a paper on a digital currency and so does the European Union, it is the first of its kind to be as detailed and in-depth as it is, with not just one but two papers released simultaneously; A consultation paper and a technology working paper. For the scope of this post, we are only going to be focussing on the consultation paper. The aim here is to condense down the core points of the paper so that you don’t have to read the entire paper to know what the government is planning moving forward. Most likely, this is going to be somewhat of the beginning of the blueprint for other countries CBDCs in the future. To be fully up to date with the topic, I’d suggest reading the entire paper in it’s entirety.
This is going to be something quite different to the average Page One post and this is a condensed-down version of the 100+ paper which has been released. Despite my trying to condense it further, this is still going to be a quite lengthy and somewhat technical read discussing governmental policy, technology impact and economic tools that central banks utilise in the economy.
I’ve tried my best to structure this entire post in an intuitive way, so let’s talk a little bit about why the paper was released in the first place and what it aims to achieve. The BofE & HMT has basically laid out the case for a CBDC but this doesn't mean a decision has been made on whether or not to actually go ahead and create said CBDC. Prior to that, there needs to be overwhelmingly large support for this before it moves to the next phase and a big part of that is the consultation process. In the paper, there are 12 questions laid out at the end of the paper for which they are collecting responses until the 7th of June 2023; a 4-month period. After that, the responses will be assessed and it will be one part of the ultimate decision on whether or not this is going to be made.
These are the following 12 questions which they’ve asked and want answers on moving forward:
Do you have comments on how trends in payments may evolve and the opportunities and risks that they may entail?Do you have comments on our proposition for the roles and responsibilities of private-sector digital wallets as set out in the platform model? Do you agree that private-sector digital wallet providers should not hold end users’ funds directly on their balance sheets?Do you agree that the Bank should not have access to users’ personal data, but instead see anonymised transaction data and aggregated system-wide data for the running of the core ledger? What views do you have on a privacy-enhancing digital pound?What are your views on the provision and utility of tiered access to the digital pound that is linked to user identity information?What views do you have on the embedding of privacy-enhancing techniques to give users more control of the level of privacy that they can ascribe to their personal transactions data?Do you have comments on our proposal that in-store, online and person-to-person payments should be highest priority payments in scope? Are any other payments in scope which need further work?What do you consider to be the appropriate level of limits on individual’s holdings in transition? Do you agree with our proposed limits within the £10,000–£20,000 range? Do you have views on the benefits and risks of a lower limit, such as £5,000?Considering our proposal for limits on individual holdings, what views do you have on how corporates’ use of digital pounds should be managed in transition? Should all corporates be able to hold digital pounds, or should some corporates be restricted?Do you have comments on our proposal that non-UK residents should have access to the digital pound, on the same basis as UK residents?Given our primary motivations, does our proposed design for the digital pound meet its objectives?Which design choices should we consider in order to support financial inclusion?The Bank and HM Treasury will have due regard to the public sector equality duty, including considering the impact of proposals for the design of the digital pound on those who share protected characteristics, as provided by the Equality Act 2010. Please indicate if you believe any of the proposals in this Consultation Paper are likely to impact persons who share such protected characteristics and, if so, please explain which groups of persons, what the impact on such groups might be and if you have any views on how impact could be mitigated.
The entire paper is split into 4 main parts; Parts A to D. They are further broken down into:
Foreword
Part A - Our Proposal for the digital pound
The digital pound
Next steps
Box A: New technologies and payment functionalities
Box B: Forms of money in use now, and in prospect
Part B - The likely Need for the digital pound
Central bank as the anchor of monetary and financial stability
Supporting innovation, competition, choice, and efficiency
Box C: Future trends in payments drive the likely need for the digital pound
Box D: Other motivations for the digital pound
Part C - Monetary and Financial Stability
Financial Stability
Monetary Stability
Box E: Interactions between the digital pound and systemic stablecoins
Box F: Assessment of monetary policy as a motivator for the digital pound
Part D - Our Model for the digital pound
Section D.1 The platform model and public-private partnership
Box G: Alternative models for provision to the platform model
Box H: Wholesale CBDC
Section D.2 Data protection and privacy
Section D.3 User experience for households and businesses
Box I: Corporates and the digital pound
Box J: Financial inclusion
Box K: Lessons learnt from our engagement with civil society groups
Box L: Lessons learnt from the engagement Forum
I've done my best to condense & summarise the content of each main point listed above. While some sections will be shorter than others, do keep in mind that my summary might not cover everything that was covered in a particular section. With that being said, let’s finally begin.
Foreword
The BofE and Treasury are considering the possibility of issuing a "digital pound" (CBDC) as a new form of digital money for households and businesses in the UK. They believe it could provide a platform for private sector innovation, promote choice and competition, and improve the resilience of payments in the UK. However, the development of a digital pound would take several years and require a high level of public trust. To begin building this trust, they have launched a four-month consultation period to gather feedback and views on the proposal (with the questions portion ending on the 7th of June 2023). The responses will inform a future decision on whether to progress with the development of a digital pound.
Part A: Our proposal for the digital pound
The BofE and HMT believe a digital pound (a retail CBDC for everyday use) will be needed in the future, but it's too early to decide on building the infrastructure for one. The next stage of preparatory work is justified as the payments landscape evolves, both in the UK and abroad. The possibility of privately-issued digital money and international developments in CBDCs will also be important factors in determining the need for a digital pound. A digital pound would benefit by maintaining trust in the monetary system, promoting innovation and choice, and boosting the UK economy. The BofE and Treasury's priority is to step up development work, explore potential technology solutions and maintain a dialogue with stakeholders to ensure the digital pound meets their needs. This consultation paper is about a retail CBDC, which differs from a wholesale CBDC used for high-value payments between financial firms. The retail CBDC is being more handled by the treasury whereas the wholesale CBDC and large financial settlement system are being delegated to the BofE. The majority of payments have been changing due to digital innovation and the use of cash has declined while the use of private money has increased. New services and technologies are emerging in money and payments and the BofE and Treasury aim to work with the private sector to ensure the digital pound meets the evolving needs of the digital economy.
The digital pound
The UK Bank is proposing the creation of a digital pound, a public-private partnership where the Bank provides the central infrastructure and the private sector offers digital wallets for end-users to access and use the digital pound. The digital pound would be a direct claim on the Bank, denominated in sterling, and would be used like a digital banknote for everyday payments. Firms providing digital wallets would be regulated, and the digital pound would have privacy and data protection standards. The digital pound would not be anonymous but would have at least as much privacy as current forms of digital money, and users’ personal data would only be known to their payment interface provider. The digital pound would be designed to support the government's commitment to mitigate climate change and would be available to both UK and non-UK residents. Unlike cash, the amount of digital pounds an individual or business could hold would be subject to some restrictions, during an introductory period at least. It would be for a further decision, in the light of experience, whether those restrictions should be made permanent.
Next Steps
This consulting paper is a result of the culmination and finishing of phase 1. We can summarise the public roadmap into 3 distinct phases:
Phase 1: Research and Exploration
Phase 2: Design
Phase 3: Build
A decision on whether or not to proceed to a build phase would be made at the end of the design phase, around the middle of the decade. After the completion of phase one, The key objectives for Phase 2 are the following:
Cut lead times on development and equip ourselves with the knowledge and capabilities to move into a ‘build’ phase, should there be a decision to introduce a digital pound.
Determine the technological feasibility and investment needed to build a digital pound.
Articulate, in detail, what the technology and operational architecture for a digital pound would look like.
Assess and evaluate the benefits and costs of the digital pound architecture.
Deepen the Bank’s knowledge of CBDC technology and the private sector’s understanding of our technology approach.
Support the development of the broader UK digital currency technology industry through experimentation and proofs of concept.
Provide the basis for a future decision on whether to introduce a digital pound and move to a ‘build’ phase
The end of Phase 2 will have evaluated comprehensively the technological feasibility of a digital pound, determined the optimal design and technology architecture, and supported business model innovation through knowledge sharing and collaboration between the private and public sectors.
As such, the design phase of a digital pound has two objectives. The first is to create a comprehensive conceptual architecture as a blueprint for future construction. This involves setting out detailed requirements and the implications of a digital pound. The second objective is experimentation and proofs of concept with private sector innovators to inform the development of the architecture and build digital currency knowledge. The Bank will participate in these experiments through an open and transparent process and share lessons learned.
The costs of the design phase will be funded by the Cash Ratio Deposit (CRD) scheme and the BOfE Levy. If a decision is made to proceed to a build phase, a prototype digital pound technology would be developed and tested before a launch. The launch of a digital pound would require significant investment, extensive evidence, and public engagement. The decision on whether to build it would be made in the mid-decade and the digital pound would be introduced in the second half of the decade. Building user familiarity and innovative applications will be critical to its success
The remainder of this paper is structured as follows. Part B sets out why there is likely to be a need for the digital pound. Part C sets out the implications of the digital pound for the Bank’s objectives of monetary and financial stability. Part D sets out the detailed model of the digital pound that we propose, subject to consultation, to develop further in the next stage of our work.
Box A: New technologies and payments functionalities
The recent advancements in technology and new entrants in the payments market have led to the development of new digital payment services and technologies. These new services and functionalities are already impacting wholesale and B2B payments, leading to improved business models and efficiencies. In the future, these technologies could also improve retail payments, and private firms may use them to provide services to digital pound users. The technology working paper explores the potential application of these technology trends in the design of a digital pound.
The technologies they note are:
Embedded finance
This is an innovation that could shape the retail payments experience. Think "in-app" purchases in mobile games, "one-click buy" on social media apps and even marketplaces in the metaverse.
Blockchain
This introduced digital assets supported and distributed in a peer-to-peer fashion backed by cryptography alone and stored on an immutable distributed ledger.
Smart contracts
Automate business logic based on pre-determined terms and conditions. While this concept existed prior to Blockchains, their recent usage has been popularised by Ethereum dApps
Decentralised finance, or ‘DeFi’
These are 24/7, ‘always on’, automated markets and products. DeFi applications use a combination of these technologies, including blockchain and smart contracts, to enable users to buy, swap, sell and settle crypto products without reliance on central intermediaries or institutions.
Atomic swaps
Where the transfer of assets is linked to ensure that the transfer of one asset occurs if and only if the transfer of another asset also occurs.
Cryptography
With the pseudonymous and public nature of permissionless blockchains of blockchains, there has been a lot of research done into prominent in Privacy-Enhancing Technologies such as zero-knowledge proofs. These can minimise the risk of personal data exposure and maximise data security
Part B - Forms of money in use now, and in prospect
First and foremost, to serve its important role in society, money must satisfy three criteria: it must be a store of value, a medium of exchange and a unit of account.
There are several forms of regulated money in the UK monetary system:
‘Public money’ or ‘central bank money’ is issued by the BofE. It is currently available to the public in the form of physical cash.
‘Private money’ by contrast, is typically a claim on a regulated private commercial bank, in the form of digital bank deposits held by households or businesses
According to the paper, new forms of money such as ‘stablecoins’ could provide money-like instruments but some risks need to be satisfied by the Financial Policy Committee (FPC) for them to be used as money-like instruments.
The payment chains that use stablecoins should be regulated to standards equivalent to those applied to traditional payment chains.
The stablecoins used as a money-like instrument should have standards equivalent to those that apply for commercial bank money in relation to the stability of value, the robustness of legal claim and the ability to redeem at par in fiat. (In simpler words, be backed 1 to 1)
Stablecoins issued by non-banks could be offered under a tailored regulatory regime proposed by the Treasury in the future
The paper also states (unsurprisingly) that "Unbacked crypto assets" are not money as they are high-risk, speculative assets. They specifically name Bitcoin and Ether as they represent 90% of the total market capitalisation. Unbacked crypto-assets do not represent a claim on a future income stream or collateral because of their volatile nature.
The market capitalisation has since fallen to under US$900 billion at the end of November 2022, so it now represents under 0.2% of global financial assets.
Part B - The likely need for a digital pound
The primary motivations for the digital pound are the availability of central bank money as an anchor for confidence and safety in money and for promoting innovation, choice, and efficiency in payments.
There are two primary motivations:
To sustain access to UK central bank money – ensuring its role as an anchor for confidence and safety in our monetary system, and to underpin monetary and financial stability and sovereignty;
To promote innovation, choice, and efficiency in domestic payments as our lifestyles and economy become ever more digital.
Central bank money as the anchor of monetary and financial stability
For this central bank money needs to anchor the monetary and financial stability of the overarching economy. Money in all forms needs to be uniform. £1 in any form should always be equal to £1, while being liquid and movable without restriction. The three pillars that deliver this stability are explained best via this diagram
Uniformity and safety could be threatened by a combination of lower cash use and the emergence of some new forms of private digital money.
The decline in the use of cash as commerce and payments become more digital is a problem for the Central Bank. New forms of private digital money, such as stablecoins, are expected to emerge, but there is a risk of fragmentation and non-convertibility.
Fragmentation may occur through walled gardens and closed-loop systems such as WeChat Pay in China, Venmo is the US as they are connected to what is referred to as a "non-bank." Converting from digital to physical or whatever another medium may also be expensive.
The digital pound is needed to preserve uniformity and the role of cash in a highly digitalized economy. The digital pound could support new forms of private digital money by acting as a bridging asset, promoting interoperability, and providing a financially risk-free means of payment while acting as an anchor. It could also play an important role in preserving sterling as the unit of account in the UK.
Supporting innovation, competition, choice, and efficiency
Innovation boosts the UK economy and supports growth and inclusivity.
Recent innovation which has increased productivity and helped the growth of the UK economy include:
Contactless Card Payments: Now used by close to 90% of people and makeup almost a third of all payments in the UK. Increased the speed and convenience of smaller transactions.
Mobile Payment Apps like ApplePay & GooglePay: They offer integration into e-commerce, security benefits, and convenience
Payment facilitators such as Paypal, Square & Zettle: Have helped merchants, particularly smaller businesses, to accept card payments and join the digital economy
Open Banking: Enables consumers and small and medium-sized enterprises (SMEs) to share their transaction data securely with trusted third parties and allows them to initiate payments directly from their payment accounts to the bank account of their payee
Innovation in payments is always ongoing, there is potential for further efficiency and cost reductions.
However, the development of new technologies and market entrants may also lead to market concentration. The UK authorities have identified potential risk factors such as network effects, economies of scale, and data advantages. The Financial Conduct Authority acknowledges that market concentration is not inherently harmful but may limit consumer choice and competition in the long term.
This is where the idea of a digital pound is introduced as a system to facilitate public-private partnerships designed to support innovation, choice, and efficiency in payments. The digital pound would allow for greater efficiency in retail payments and may offer additional benefits such as financial inclusion and improved cross-border payments with greater transparency. Namely, it should not crowd out other forms of digital innovation.
Box C - Future trends in payments drive the likely need for the digital pound
The digital pound would only be introduced if it supported both the Bank’s and HM Government’s objectives and as such, they have listed out a number of future trends in payments that would build a case for this digital pound.
Cash usage in declining and will continue to do so, despite signalling that the central banks will continue to support it.
The emergence of new forms of private digital money issued by new payment entities. This includes e-money, stablecoins and deposits at ‘narrow banks' (non-bank firms/smart contract systems).
New forms of private digital money display adequate interoperability. How easily can old money be converted into new money and vice-versa. How fast can it be transferred between individuals and where are they accepted as forms of payment?
International developments in CBDC and private digital money. Discussion on CBDCs has already occurred through the EU with Digital Euro and Digital Dollar in the US. A survey of central banks showed that 68% consider it likely or possible that they will issue a retail CBDC in the short or medium term.
In addition to these trends in retail payments, there is also innovation in wholesale payments. The BOfE is renewing its Real-Time Gross Settlement (RTGS) system to support more efficient wholesale settlement in central bank money
Box D: Other motivations for the digital pound
The digital pound could improve financial stability as a new payment system that operates outside existing ones. The BofE and UK authorities must ensure the digital pound has high standards of resilience against risks such as electricity outages and cyber-attacks.
The digital pound could also complement existing financial inclusion initiatives, for example through offline payments for those with limited internet access.
The use of the digital pound to improve cross-border payments is an opportunity but requires international cooperation. Cross-border payments are typically expensive, slow, and opaque. While CBDCs like the digital pound can help avoid frictions between existing national payments systems, they will not address all issues, such as differences in Anti-Money Laundering regulations. Enhancing cross-border payments will work with other countries to ensure its design does not introduce barriers to payments with other currencies and offers potential for interlinking if other countries issue their own CBDCs, essentially starting from a clean slate.
Part C: Monetary and financial stability
New forms of digital money, both the digital pound and stablecoins, could adversely impact banks’ business models and affect the cost and availability of credit
The impact of a digital pound on bank disintermediation and the cost of credit would depend on the speed and scale of its adoption, which is uncertain. A BofE 2021 paper estimated that with 20% of commercial bank retail deposits being migrated to digital money, lending rates could rise by 20 basis points in a steady state, but there is uncertainty around this estimate.
During the transition period, limits on holdings of the digital pound could manage the extent of deposit outflows and the impact on credit cost and availability. In times of financial stress, demand for the digital pound could be strong and banks might have difficulty replacing lost deposits. However, the financial stability risks could eventually be managed if the financial system has time and flexibility to adjust. The risks of relying on wholesale funding instead of deposits also exist.
Monetary Stability
The digital pound would not fundamentally alter the traditional channels of money creation, but it might affect monetary stability.
The creation of money in the UK currently occurs through two channels - the BofE and commercial banks. The digital pound would not change these channels but would offer a new form of money for everyday transactions. The introduction of the digital pound could have impacts on monetary stability through monetary policy transmission, implementation, interest rate, and productivity.
Bank disintermediation might affect the transmission of monetary policy to the real economy.
The introduction of a digital pound could impact the transmission of monetary policy from the central bank to the real economy, either positively or negatively. This impact is uncertain and will be closely monitored by the central bank. However, the motivation for introducing the digital pound is not to use it as a tool for monetary policy transmission. The shift of deposits from banks to the digital pound could lead to banks becoming more reliant on wholesale funding, which could either strengthen or weaken the transmission of monetary policy. A greater proportion of lending by non-bank financial intermediaries, which is typically less responsive to monetary policy than lending by banks, could also impact the transmission mechanism. These effects could be amplified in times of stress and the central bank could take actions to ensure the continuation of effective monetary policy transmission.
Keeping the digital pound retail-focused would help to ensure that monetary policy is implemented effectively
The BofE's approach to implementing monetary policy involves keeping short-term market interest rates close to the Bank Rate, which is transmitted through the remuneration and supply of central bank reserves held by commercial banks. The wide use of the digital pound by wholesale actors could change the relationship between reserves and sterling money market rates, but keeping the digital pound retail-focused would reduce this likelihood. If households and businesses switch to the digital pound, it could reduce the quantity of reserves held by commercial banks. If the demand for the digital pound causes reserves to fall below the minimum level demanded by banks, the Bank would intervene to supply reserves to ensure effective monetary policy implementation. The Bank's Short-Term Repo Facility would be available to meet the demand for reserves in normal situations, but longer-term lending operations may be used in stress. No decisions have been made on the framework for meeting the demand for the Bank's liabilities in the future.
The digital pound could affect the level of productivity, but the direction is uncertain.
The digital pound could have both positive and negative effects on productivity. On one hand, the digital pound could increase efficiency in payments, leading to more spending on productive activities and potentially a direct increase in productivity. On the other hand, the disintermediation of banks could lead to tighter financial conditions, lower investment, and a decrease in productivity. The overall effect on productivity is highly uncertain and judged to be small in the long term, but there could be large effects during a transition period if banks adjust to deposit outflows. Holding limits on digital pound holdings would limit bank disintermediation and contain changes to the equilibrium interest rate and productivity.
Box E: Interactions between the digital pound and systemic stablecoins
Stablecoins are a form of digital currency that aims to maintain a stable value, usually pegged to existing fiat currencies. They are believed to have the potential to be widely used in payments and can offer benefits such as lower costs and better functionality. Stablecoins are currently traded on centralized exchanges and used in decentralized finance applications, and their functionality and use cases could drive their widespread adoption for retail and wholesale payments. The BofE is working with regulatory authorities to establish a framework for stablecoin regulation and to determine their impact on financial stability.
The bank proposes that a systemic stablecoin issuance would need to be fully backed with high-quality and liquid assets and considers different models for backing, including central bank liabilities and other liquid assets. Stablecoin regulation would need to balance the risk to financial stability with the benefits of a new digital payment method. The bank believes that the digital pound, issued by the central bank, would still have a significant role to play, as it would preserve access to retail central bank money and support the uniformity and interoperability of different forms of money. However, private stablecoin issuers may not have the same motivation to ensure uniformity, which could result in low interoperability between different forms of money.
Box F: Assessment of monetary policy as a motivator for the digital pound
The digital pound is not being issued with the intention of making monetary policy more effective through remuneration (positive or negative interest rate). Although it could potentially strengthen the monetary transmission mechanism by enhancing the impact of changes in Bank rates on household spending and saving decisions, the actual effect of remuneration on the real economy is uncertain and untested as no CBDC has been used at scale. The existence of cash and its nominal interest rate of zero creates a risk of hitting the effective lower bound (ELB), limiting the ability of monetary policy to stimulate the economy. The digital pound, whether remunerated or not, would not reduce the ELB, and an unremunerated digital pound could increase the level of deposit rates at which the ELB occurs. Any decision to revisit the approach to remuneration would be preceded by a review with full consultation and adequate lead time.
Part D: Our model for the digital pound
Section D.1 sets out the platform model for provision of the digital pound. This describes the roles and expectations of the Bank and of the private sector in its delivery.
Section D.2 sets out considerations around data and privacy. This describes the robust protections around data protection and privacy for users that would be part of the design for the digital pound.
Section D.3 sets out the user experience. This describes the design features of the digital pound that would benefit households and businesses and how they might interact with it.
Apart from the criteria that were set out in Part B, a set of criteria for the model of provision of the digital pound has also been identified:
To ensure that central bank money acts as the anchor of monetary and financial stability, the model should ensure access to financially risk-free central bank money, a direct end-user claim on the Bank and settlement finality for any transactions.
The model should be interoperable with other forms of money, in particular cash and bank deposits.
To support innovation, choice and efficiency, the model should be extensible and flexible reflecting the fact that the future payments landscape is innovative and dynamic.
The model should ensure a standard of operational resilience necessary for major national infrastructure.
Furthermore, the proposed model should support private sector innovation, safeguards data protection and privacy, and promotes accessibility.
Section D.1 The platform model and public-private partnership
The BofE proposes a digital pound that would be issued as a public-private partnership. The digital pound's objective is to encourage payments innovation by the private sector and support small and medium-sized businesses' participation in the digital economy. The Bank proposes a platform model where digital pounds would be issued and recorded on a "core ledger" by the Bank and then accessed by Payment Interface Providers and External Service Interface Providers to develop innovative services using the digital pound. The private sector firms would handle customer interactions and be responsible for users' digital pound funds, but they would never have possession of the funds. The platform model provides a robust user claim on the Bank and supports a diverse, innovative, and competitive ecosystem while providing a single infrastructure to support extensibility.
The platform model would encourage payment innovation and competition in three ways: mobilising PIP participation, providing accessible and open infrastructure, and supporting ongoing innovation. PIPs would not need extensive prudential regulation typical of some financial institutions because the digital pound would be financially risk-free. The public infrastructure would be open to all innovators who meet specific requirements set by the Bank, enabling new entrants to offer innovative payment services without developing extensive infrastructure. The Bank proposes that the digital pound system be open to all innovators who meet the criteria for participation. The Bank's infrastructure would provide the minimum necessary functionality for the digital pound, while the private sector would be responsible for user-facing interactions, handling customer information, and developing and offering innovative services.
According to the BofE, digital pass-through wallets would allow users to hold and use the digital pound, which would always be a direct liability of the Bank. Wallet providers would be encouraged to provide an array of novel and user-friendly features and services, but all wallets would need to provide certain minimum functionality, including access to digital pounds, make payments, view balances and transaction history, and mobility.
External Service Interface Providers (ESIPs) might also participate in the digital pound ecosystem. ESIPs might provide services that augment digital pound wallets and are of value to users and merchants, including business analytics, budgeting tools and fraud monitoring. Revenue models will be important for incentivising innovation, and it is essential there are commercial opportunities for Payment Interface Providers (PIPs) and ESIPs in the digital pound system. The participation of non-financial firms as PIPs or ESIPs in the digital pound ecosystem could bring significant benefits for choice and innovation, and for example, micropayments might allow content-sharing platforms and broadcasters to generate revenues from individual content, rather than relying on subscriptions. The BofE envisages that Payment Interface Providers (PIPs) and External Service Interface Providers (ESIPs) would operate within a robust legal and regulatory framework to protect users and ensure the resilience and integrity of the system. PIPs and ESIPs would be robustly yet proportionately regulated to ensure resilience, continuity of operations and protection of customers. The regulation governing them would be based on the precise activity performed, proportionate to the risks they pose to themselves and the wider financial system, and agnostic to the nature of technology. As operator of the digital pound system, the Bank would impose principles for operation for PIPs and ESIPs, including technical standards, alongside regulatory requirements.
Box G: Alternative models of provision to the platform model
The BofE discusses various models of provision for the CBDC. The platform model, which is the preferred approach, involves all holdings being stored on a core ledger, with transactions processed between users on this ledger. An alternative approach is the delegated model, where individual Payment Interface Providers (PIPs) have their own ledgers recording customer holdings, with transactions facilitated on the Bank's core ledger. However, the delegated model is considered less effective and places greater technical and operational requirements on PIPs.
It also describes the bearer instrument model, where ownership of digital pounds is recorded on individual user devices, and transactions take place between users with no interaction with the central bank. This model is not considered appropriate as the only operating model for the digital pound due to several challenges, including the risk of double spending, anonymous payments, and the complexity of conducting transactions between two individuals over distance. Finally, the text notes that reserve-backed stablecoins would be economically similar to the digital pound but are not considered a CBDC, as they are not a claim on the central bank.
Box H: Wholesale CBDC
The BofE and Treasury are considering the introduction of a retail CBDC to enable the use of central bank money for everyday payments by households and businesses. While there are various models under investigation, five key outcomes are expected: transparency, availability, efficiency, atomicity, and access. A wholesale CBDC could support innovation and experimentation in wholesale markets, such as the development of distributed ledger technology-based exchanges and settlement systems, where tokenised financial securities could be traded.
Three approaches could be taken to achieve these benefits: enhancing existing systems, enabling private sector innovation, or establishing a new wholesale CBDC platform. Enhancing the existing systems, such as the Real-Time Gross Settlement service, would offer more efficient wholesale settlement and greater digitisation. In contrast, private sector innovation policies and structures enable non-bank payment service providers to access central bank money and allow an operator of a payment system to fund their participants' balances with central bank money. This method will support innovative use cases of central bank money to improve access. Finally, the Bank could establish a new wholesale CBDC platform to provide reliable settlement services on a 24/7 basis, expanding the use of central bank money for settlement.
The BofE is currently exploring various models to deliver enhanced wholesale settlement using new technologies. It has collaborated with various firms, including Baton Systems, Clearmatics Technologies Ltd, R3, and Token to develop a DLT proof of concept and to ensure that the RTGS service can connect with systems based on DLT and other innovative technologies. The Bank also developed new policies and structures to enable the benefits of innovative technologies to be delivered by new types of private sector firms. The Bank continues to engage with private sector firms to understand potential new models of wholesale settlement and how these can be supported in the future.
Section D.2 Data protection and privacy
The Bank has emphasized the importance of privacy and data protection in the design of the digital pound. Users' privacy, user control, and the proper use of personal data in line with UK data protection laws are of paramount importance to the Bank and the Government. The digital pound would have at least the same level of privacy as a bank account and would also allow users to make choices about data use.
All digital payments made by individuals today, such as card payments or bank transfers, generate personal data. Digital transactions account for the majority of transactions in the UK today. These personal data are held and used by providers such as banks and other payment firms, for anti-fraud and financial crime reasons. Personal data from bank account transactions is used and stored by firms to comply with legal and regulatory data capture requirements in the UK's Anti-Money Laundering (AML) and Combatting the Financing of Terrorism (CFT) Regimes.
Access to these data is governed by applicable UK data protection laws, which are supported by ICO guidance. Law enforcement agencies or competent authorities which seek to access and process personal data for the primary purpose of law enforcement have to do so on a fair and lawful basis. Firms that hold personal data can also share those data provided that there is a lawful basis. Before sharing individuals' personal data, Article 6(1) of the UK GDPR requires that firms must be satisfied that sharing personal data with a law enforcement authority is lawful.
The BofE proposes that Payment Interface Providers (PIPs) would manage user wallets, but the Bank would run the digital pound infrastructure by operating and maintaining the core ledger. PIPs would anonymize personal data before any sharing with the Bank. The Bank will conduct tests and evaluate the legal, technical, and operational standards needed to operationalize such a system in the next phase of its work. While the Bank would not have access to users' personal data, it should have access to anonymized transaction data and aggregated system-wide data. This would provide an overview of the total transactions taking place over a given period.
In conclusion, the digital pound would be a digital currency system designed to promote a more digital economy and to provide an alternative payment system to commercial bank accounts. The BofE has emphasized the importance of privacy and data protection in the design of the digital pound, which would have at least the same level of privacy as a bank account and would also allow users to make choices about data use. The BofE proposes that Payment Interface Providers (PIPs) would manage user wallets, but the Bank would run the digital pound infrastructure by operating and maintaining the core ledger. The BofE and Treasury will consult on what data might be collected and for what purposes in due course.
Section D.3 User experience for households and businesses
In this section, it discusses the proposed digital pound would be designed for households and businesses to use for everyday payments, both in-person and online, and all UK residents would be able to hold and use digital pounds, as well as non-UK residents visiting the country.
The Bank's consumer research found that most P2B in-store payments are made using debit and credit cards, but cash is still relevant for two in five consumers. Online, card payments are most popular, while other options such as wallets like PayPal provide an increasingly used alternative. The digital pound could offer an easy method of P2P payment and add to the current choices available.
Initially, using digital pounds would be designed to feel like existing payment methods. It would need to work with existing online and in-store payments technology, such as card readers. That would mean that merchants would not have to buy new infrastructure, encouraging adoption. Encouraging innovation is a priority for the digital pound, with the expectation that innovators could develop new devices and ways to pay which offer more convenience and functionality, such as wearables and IoT devices.
The Bank does not propose to develop a digital pound that enables government or central bank-initiated programmable money, but Payment Interface Providers and External Service Interface Providers would be permitted to implement such functionalities themselves. All payments should be able to be made using the digital pound so long as they are lawful, observe any restrictions, and comply with regulatory obligations laid down by authorities. Over time, the digital pound could enable a broader range of payments than those commonplace today, and there may be scope to improve existing methods used by individuals to make transfers.
The BofE is proposing individual limits of between £10,000 and £20,000 on holdings of digital pounds during the introductory period to manage risks to financial and monetary stability. The limits would be set in a way that supports wide usability of the digital pound, such as accommodating roll-over balances and supporting transactions. Chart D.9 shows how various limits on digital pound holdings could affect usage depending on users’ income, with a £20,000 limit allowing 95% of income earners in the UK to use their digital pound wallet to receive their salary without regularly reaching their holding limit. A lower limit of £5,000 would be more effective at curbing potential large and rapid bank deposit outflows, but only about one-third of people would be able to comfortably receive their salary and bonus as digital pounds. The Bank is seeking feedback on the proposed limits.
However, the report also notes that there are potential risks and issues associated with CBDC, including cybersecurity and financial stability risks, and that the introduction of a CBDC could have implications for monetary policy, financial stability, and competition. The Bank will continue to explore these issues and consult with stakeholders before making any decisions on whether to issue a digital pound.
Box I: Corporates and the digital pound
The BofE is exploring the use of a digital pound for both individuals and businesses. While the principles for corporate use are similar to those for individuals, there are some issues that need to be addressed, such as limits on the amount of digital pounds that corporates can hold and which types of businesses should have access to the digital pound.
For retail payments, businesses would need to be able to accept payments made in digital pounds, but there would be restrictions on corporates to safeguard against risks to monetary and financial stability. The Bank is considering setting a relatively high limit for corporates to ensure they can receive payments at peak times, but technology solutions might also support a lower limit by automatically transferring excess funds into a nominated bank account. The Bank is also exploring which types of business should or should not have access to the digital pound, with a focus on maintaining a retail focus and preventing wholesale financial activity from being conducted in digital pounds.
Box J: Financial inclusion
The BofE prioritizes financial inclusion to ensure that everyone, regardless of income or background, has access to useful and affordable financial products and services such as banking, credit, insurance, and financial technology. The government works with regulators, industry, and the third sector to advance financial inclusion and financial capability to build people's confidence and skills to engage with their personal finances. Recent government initiatives include access to banking and bank accounts, legislation to enable credit unions to offer more products and services, and piloting a no-interest loan scheme.
The introduction of the digital pound has the potential to encourage innovative approaches from industry to tackle financial inclusion issues. However, it may not present the same benefits as in other countries with less established payments infrastructure. Moreover, the digital pound must be simple and straightforward to use and be designed in a way that provides for those who are digitally excluded, to avoid driving further exclusion of this population from valuable new financial services. As the digital pound is a new form of money, understanding and trust among the public are crucial, and the roles of government, the central bank, and industry need to be set out clearly.
Digital exclusion is another challenge in achieving financial inclusion, where some individuals may not have the digital skills or access to the right technology required to navigate and access financial services and products. Therefore, digital inclusion must be promoted alongside financial inclusion to avoid driving further exclusion from innovative and valuable new financial services.
Box K: Lessons learnt from our engagement with civil society groups
For many people, the physical nature of cash is a key feature for budgeting purposes, so digital alternatives like the digital pound could struggle to deliver the same functionality.
We discussed how trust and familiarity were key reasons to use cash for certain groups of people – the role of trusted intermediaries was identified as very important for a potential roll out of the digital pound, as especially vulnerable individuals would need support from trusted third parties to become comfortable with a new payment method; we discussed the possibility of civil society groups becoming wallet providers (Payment Interface Providers) for vulnerable groups.
Consumer protection was considered crucial for adoption of the digital pound by vulnerable groups, as they could be at risk when using a new payment method.
Overall, civil society groups thought the digital pound was not necessarily the only way to tackle financial exclusion and that existing policies could be improved to achieve some of the inclusion goals.
Box L: Lessons learnt from the Engagement Forum
The BofE and Treasury established a CBDC Engagement Forum to gather input from a diverse group of experts and perspectives to inform the exploration of the challenges and opportunities of CBDC. The Forum has discussed a range of topics, including potential use cases for a retail CBDC, opportunities to tackle financial exclusion, and co-existence with other forms of money. Forum members largely supported the idea of CBDC as a basic but extensible platform to allow the private sector to innovate and emphasized the need for clarity around policy choices and technical and regulatory parameters for CBDC. The Forum also discussed the opportunities that CBDC could offer for person-to-business (P2B) payments and financial and digital inclusion.
The Forum identified opportunities for CBDC to tackle financial exclusion and emphasized that a CBDC would not be a 'silver bullet' and that its effectiveness would depend on a range of policy and regulatory questions. Forum members also discussed the obstacles that some individuals face to access basic banking and payment services, especially in an increasingly digital economy. The Forum acknowledged that achieving widespread adoption of new payment methods was complex but suggested that programmability, smart contracts, or micropayments could drive demand for CBDC payments
Conclusion
The BofE and Treasury believe that a digital pound may be necessary in the future to sustain retail access to central bank money, support confidence in different forms of money, and promote innovation, choice, and efficiency in payments in an increasingly digital world. However, a decision on whether to build the infrastructure for the digital pound has not yet been made, as it depends on how the payments landscape evolves and the extent to which cash use further declines.
The next stage in the development of the digital pound involves the design phase, including the development of a comprehensive architecture and experimentation with proofs of concept in partnership with the private sector. The government and the Bank will decide at the end of this phase whether to proceed to build the digital pound, and the legal basis for the digital pound will be determined alongside consideration of its design. Feedback from stakeholders will inform the next stage of work and contribute to the final decision on whether to build a digital pound.
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