19th century commerce was a busy mix of private banks’ unstandardised, often unbacked promises to pay. With the introduction of the Bank Charter Act 1844, the government of the time strengthened the Bank of England’s authority to print money, standardising the market, building confidence in the value and legitimacy of banknotes, and paving the way for modern commerce.
Over 175 years on, we are on the verge of another revolution in payment. Bitcoin’s introduction in 2009 began a wave of digital currency experiments that rely on cryptographic mechanisms to encourage trust outside traditional institutions. But their high volatility and limited uptake in everyday commercial transactions over the past 12 years still call into question their viability as digital money.
Instead, a Bank of England-issued Central Bank Digital Currency (CBDC) would usher in much-needed credibility to the digital currency space, bringing together the promise of this new form of money and the institutional legitimacy required for broad uptake and price stability. A well-designed system would make core public services available to all, with an accompanying infrastructure enabling private innovators to build their value-added services on top. The Digital Pound is the next step in the long history of transformation of the oldest currency still in continuous use.
Individuals and businesses rely on electronic payments more and more. Cash transactions represented only 28 per cent of payments by volume in the UK in 2018, down from 60 per cent on the previous decade. But digital payments pass through an increasingly complex network of banks and private payment service providers, resulting in settlement risk, time inefficiencies, fees and opportunities for rent extraction by financial institutions.
The Digital Pound would be an electronic form of money issued directly by the Bank of England and managed on computer systems it controls. While the Bank already maintains electronic reserve accounts for commercial banks, individuals and businesses only have access to paper cash or electronic deposits with commercial providers.
Central banks across the world have formally explored this concept since as early as 2016. The Bank of England joined with the Bank for International Settlements and the central banks of Canada, the Eurozone, Japan, Switzerland, Sweden and the US to lay out governing principles for CBDC issuance, establishing the foundations for the international collaboration that will be necessary for interoperable use of digital money in cross-border payments. The People’s Bank of China meanwhile is developing a digital yuan (and accompanying payment app), which is set to become the world’s first CBDC. Concurrent policies to open the domestic bond market to foreign investors is priming the Chinese market for an influx of investment, lowering the country’s borrowing costs and potentially strengthening demand for its digital currency. How this will impact markets and CBDC issuance in liberal democracies is unclear although US officials have expressed an openness to private stablecoins in lieu of a CBDC and a preference for stability over speed when it comes to their own digital currency, in response.
The recently announced Bank of England and HM Treasury CBDC Taskforce and discussion paper are important steps toward a Digital Pound, calling public attention to the economic and technical design criteria on which it would be based. The Digital Pound could take a range of forms, and these scope and design choices will dictate its impact on markets and society. So, how can the Bank of England and HM Treasury use this new system as a lever for greater economic opportunity, financial inclusion and technological innovation?
Core Public Services and Private Innovation Underpin the Platform Model
The Bank of England proposal envisages a “platform model” for the Digital Pound. In this model, the central bank builds a foundational technology with “minimum necessary functionality” for electronic payments. On top of this core, private “payment interface providers” would offer all customer-facing payment services (Figure 1). A platform model could be a powerful approach to public-sector innovation, creating the base infrastructure and standards on which private actors could build value-add services.
Figure 1 – A CBDC platform model with private “payment interface providers”
Source: Bank of England
But where should the central bank draw the line between core public services and private ‘overlay’ services?
This presents technical and economic policy trade-offs, with the effects reverberating through the economy. From a technical perspective, the Taskforce will need to balance the value of direct access to a public payment service in terms of financial inclusion against the value of specialisation that private payment service providers offer. From an economic standpoint, the platform model will facilitate new markets around legitimate features – including cryptocurrencies in contexts where anonymity or decentralisation serve a desirable purpose, and new banking services that attract capital by providing value-added payments, savings and loan services that go beyond core public functionality. A well-designed Digital Pound with direct, public access to core payment functionalities would stimulate private services to innovate while limiting the opportunity for these private providers to extract rents on necessary functionalities. Just as with cash, individuals should have the option to directly hold and transact legal tender without the need for a private intermediary.
Economic Design: The Behavioural Effects of Programmable Money
A new digital currency directly affects how people spend and save. The behavioural and political aspects of its design are therefore critical to its economic properties and implementation.
As a fully electronic resource, a CBDC could be programmed to directly enact a wide range of monetary and economic policy mechanisms. It could, for example, bear interest as a savings tool or support direct cash transfers to households as an expansionary policy lever. It could automatically execute payments when smart contract conditions are met or allow HMRC to directly levy tax payments on individual accounts. But interventions that may be desirable from a macroeconomic perspective – negative interest rates, expiring money, or a floating exchange rate between the cash pound and its digital counterpart – could introduce behavioural factors such as loss aversion at the individual level. These phenomena could affect the public’s trust in the central bank and in government in new and unexpected ways.
Any new capabilities should also address the significant gaps in financial literacy and access to banking across socioeconomic groups. New digital tools could help the 1.5 million UK residents without access to banking services and those with limited financial literacy to gain access to reliable funds and a mechanism for saving, particularly if the currency offers interest. However, they should be designed and implemented with care to ensure they address all of these groups’ needs. The Bank of England rightly identifies as a challenge the likely limited uptake among those who don’t tend to use traditional banking services and less technically literate groups. But by paying close attention to these behavioural considerations, a digital currency could be an active tool for financial inclusion. This is why any Digital Pound project must incorporate experts from product designers to behavioural economists and economic sociologists who can help to ensure an inclusive and effective design.
Connecting Digital Currencies to the Broader Technology Stack
The UK proposal is just one piece of ongoing innovation in the global digital currency space. Coinbase, the largest cryptocurrency exchange and the first to be listed on a US stock exchange, debuted at an $86 billion valuation on the Nasdaq in April. El Salvador became the first country to recognise Bitcoin as legal tender, opening up the country to cryptocurrency entrepreneurs and raising a host of international tax questions as Bitcoin moves from a property asset to a foreign currency.
A Digital Pound could bring stability to the space by displacing private currencies – including stablecoins (cryptocurrencies whose value is pegged to an external asset) that operate “with no reference to the democratic accountability mechanisms under which central banks operate”. While individuals and businesses may have legitimate uses for privately issued electronic currencies, this may simply be because a public equivalent is not available. Central banks should explore this demand to determine how a CBDC could fill the void. Doing so would enable private systems to serve niche uses where they fulfil a specific market need while mitigating the risk of systemic dependence on products that operate outside the regulated public-private banking system.
More broadly CBDCs will be integral to the broader technology landscape that enables financial, commercial, legal and social interaction, both domestically and across borders. For example, IndiaStack combines online tools that interact via APIs (Application Programming Interfaces) into a core digital infrastructure, providing access to the digital identification, record-keeping, payment and data-privacy capabilities necessary to engage in the formal economy in India. Balaji Srinivasan argues that integrating a digital rupee into this technology stack would complement cryptocurrencies, giving citizens direct access to both domestic and international capital.
Cross-Government Input for a Digital Service that Works for All
Given the implications of the Digital Pound, the Bank of England should actively address the economic and technology policy questions that any design would raise. As the central bank is apolitical by design, it should engage broadly across government to realise these wide-reaching policy outcomes. HM Treasury’s involvement in the Taskforce and external engagement forums are both promising signs that this opportunity will be leveraged to improve not only core payments and banking infrastructure, but economic opportunity, access and user experience for individuals and businesses across the UK.
The Digital Pound is a digital service as much as it is a new form of money. In this regard, it builds on recent successes in rapid, user-centric design and service uptake including GOV.UK, the NHS vaccine distribution system and the Covid-19 Tracing app. Some of the early respondents to the consultation argue the infrastructure-only model would promote private innovation, and the Taskforce on Innovation, Growth, and Regulatory Reform recently concluded it would enable the quickest time-to-implementation. These arguments undervalue existing digital service capabilities across government and underestimate the wide-reaching social effects it will have. As the Bank of England builds out this new digital service, it should capitalise on expertise within other agencies. These include the UK’s Government Digital Service to ensure innovative, inclusive, user-centric design, the Open Innovation Team to convene interdisciplinary experts in its development, and the National Data Guardian to protect anonymity in payments.
The Digital Pound could take many forms from an extension of planned, backend changes in electronic payment systems to a suite of user-facing technologies that revolutionise how individuals and businesses spend true digital cash. It will influence monetary policy mechanisms in new ways as individuals and banks change how they spend, save and manage funds. Economically, it could improve financial inclusion and open new fintech markets that rethink banking and payments for a digital age. Technologically, it will interact with a host of new services to build trust in digital transactions. And from a foreign policy perspective, it will shape global financial system stability and the use of cryptocurrencies in cross-border payments. These decisions represent not only technical criteria but also inherently political trade-offs among incommensurable policy priorities, underscoring the importance of cross-government cooperation to achieve an ambitious design.
The Digital Pound is as much a new digital service as it is a new form of money. With the UK government’s digital design expertise, the Bank of England has a unique opportunity to shape how individuals and businesses experience their money and public services for years to come. A change to the country’s money is governed as much by behaviours as by economics – the perennial challenge of implementing a dollar coin in the US is just one small example. The Bank of England should therefore partner with governmental digital service designers to prioritise broad public awareness, confidence, and uptake at minimal cost to the user. To this end, it should aim beyond the minimum necessary infrastructure and instead include a user-friendly, public interface option that allows anyone to directly hold Digital Pounds without passing through a private third party.
Given the changes in China and El Salvador, CBDCs are introducing new geopolitical dynamics. Therefore, it is more important than ever for the Digital Pound to represent UK values of international financial stability, privacy, innovation, equality of access and economic opportunity.
Digital currencies are bound to raise profound technological, economic and societal questions whether initiated by central banks or private groups. Over 175 years on from the Bank Charter Act 1844, the UK government stands to restructure the currency once more, to build in standardisation, stability, trust and inclusion so that everyone can benefit from digital payments.