The Bank of England is consulting on the design of digital pound but they are asking the wrong question: they should be asking whether the digital pound is the best answer to the challenges that motivate them; – it is not.
Executive summary
The Bank of England in their February 2023 consultation paper is asking for comments on its design principles about a digital pound. It claims as primary motivations;
- ensuring the role of UK central bank money as an anchor for confidence and safety in our monetary system, and
- the promotion of innovation, choice and efficiency in payments.
In my response to their 2020 consultation, available here, I argued that the digital pound will fail to take off. I still believe that to be true for the reasons given then. I will go against my better judgement in this article and assume it can be found to be attractive to enough people and businesses and so I will consider the question of whether the introduction of a digital pound is the best move to give the Bank of England what they want.
The second motivation mentioned above is common to both the 2020 and 2023 Bank of England consultations. The Bank of England suggests creating a brand-new currency, with new technical paradigms and a whole ecosystem of payment instruction providers. Given there is a perfectly good working set of payment systems already in place, this cannot possibly be the best way to promote competition. It must be quicker and cheaper to promote open API standards in banking and other sectors such as telecoms; to support legal and technical standards for smart contracts to work with existing payment systems, along with leading the provision of industry wide solutions to common operational problems such as bereavement, KYC/AML, and Court Orders.
The importance of monetary sovereignty as a motivation is a change in comparison with its position in 2020. This is central bank “speak” for fear that another currency controlled by another state or controlled by a group of tech giants becomes the money of choice for a large part of the great British public. The chance of such a situation arising is remote in the retail/consumer world. It is quite plausible in the B2B space. If the Bank of England is worried about losing monetary policy control it will be much better focusing efforts on supporting a digital pound to be a payment token of choice for trade related actions. For example they could broker digital payment standards for industry supply chains and sponsor proofs of concept of various smart contracts, legal and/or technical, for goods in the supply chains. These notions will probably be enhanced by a digital pound aimed at businesses not consumers.
The Bank of England’s motivations
In March 2020 the Bank of England consulted on possible introduction of a digital pound. The problems that the Bank of England stated it was proposing to solve with the digital pound in 2020 were essentially threefold;
- increase payments resiliency
- provide access to risk-free central bank money
- provide a platform for payment innovation
In April 2020, I forecast in an article that a retail digital pound would fail and the Bank of England should not pursue it for consumers. Essentially, I believe the Bank of England have massively overestimated the chances of consumers and businesses taking up the digital pound. In short;
- On the supply side, it would require a change the scale of which the financial system has never undertaken. The development of the Bank of England’s digital pound ledger would be a major project but only a small part of the degree of change required. To be usable by a large number of consumers it would require changes at, for example, at POS terminals, utilities’ monthly billing systems, ATM schemes, websites’ checkout pages, bank branches and many many other places that make and receive payments.
- On the demand side, the benefits to individuals of a digital pound are not obvious (in comparison with commercial bank money), as the system would not be cheaper (most payments are already free to consumers) nor quicker (card payments and faster payments are already instant for individuals).
I will not replay this argument but I claim it is still valid and that the development of the digital pound will most likely fail through lack of take up. However for this article I will put this obstacle to one side and suppose a digital pound can achieve a high degree of use and acceptance. The question then is whether it is the best way to address the motivations of the Bank of England.
The first thing to note is that the Bank of England’s motivations have changed in three years and it now claims its primary motivations are
- ensuring the role of UK central bank money as an anchor for confidence and safety in our monetary system, and
- the promotion of innovation, choice and efficiency in payments.
In 2020 the Bank of England used to lead with payments resilience which has now fallen out of favour as a requirement. The perceived need for consumers and small businesses to access risk-free assets has also disappeared. A platform for innovation continues to be a motivation and a new motivation is needing to be able to control money supply. The next sections look at these two motivations and whether a retail digital pound is the best answer.
How best to improve competition and innovation?
The thesis is that because the digital currency will be built on a new payment architecture, one based on API’s, new players from outside the financial services sector will join and create new services that will be useful to consumers and businesses. Examples the Bank of England cites include;
- Smart contracts; systems where contractual events (including payments) are automatically triggered by computer systems
- Nano payments; e.g. pay-per-view of publication articles where the cost is less 1p
- Internet of things; machines with intelligence generating events and triggering payments – to my way of thinking these are a particular, physical form of smart contract.
The first thing to note is that smart contracts are not a new concept, just one that got a breath of new life with distributed ledger technology (DLT) and distributed finance (DEFI). The core idea, that a payment is automatically triggered in software by an event has been around for years. Billing systems have done these on for decades. Banks have offered sweeping and pooling services based on a balance on an account for decades as well. More recently companies like Moneybox offer roundup services to sweep small amounts of money to savings and investment accounts. What makes a smart contract hard to establish is not the current payment technology but developing the legal frameworks that underpin them and the operational processes to deal with them at scale (e.g. to include awkward cases of rejected payments, fraudulent claims, money laundering checks, deceased customers et cetera).
The reason why smart contracts have become so fashionable in the DLT world is that the DLT world is lawless and so the legal constraints are not an impediment to their development. The problem for the DLT/DEFI world is that the absence of a robust legal framework means the market penetration of smart contract-based services is, and will remain, small among the vast majority of retail consumers.
The simplest and quickest way to extend innovation competition is to continue the work of the competition and markets authority and the EU (via PSD2) and extend and enforce regulations to make the open banking world more open and more extensive. Examples of actions would include; enforcing the “spirit” of open banking; e.g. making it unacceptable for banks to put unnecessary friction into open banking transactions with clunky/out-of-date authentication process requiring all banks to adopt all aspects of the whole field of open banking (art are to be, COPD et cetera).
- Extending banking sweeping instructions to be compulsory and free all banks for all purposes, not just to sweep savings accounts
- integrating open banking with other “open” efforts telcos, utilities and insurance.
- Sponsoring a digital ID and associated education protocols and Apis
- all of these would be much quicker and cheaper than developing a whole new currency and payments ecosystem. Furthermore nearly all the infrastructure costs would fall on the banking system members, not on the British taxpayer.
They could further help innovation by building the next layer of standards on top of the existing open banking standards by;
- sorting out legal frameworks and contracts for smart contracts in various industry sectors (transport, insurance, retail, energy et cetera), based on current payments technologies Cards, Open Banking etc.
- fomenting and creating industry solutions to the operational problem cases that beset all schemes such as court orders, bereavement, AML/KYC.
Both sets of actions are low cost in comparison to the billions of pounds needed to build a new payments infrastructure and ecosystem. They also require much less time to have an effect.
What is the risk to sovereign control of the money supply that bothers the Bank of England?
The Bank of England is concerned that if some form of currency were to become the money of choice for a large part of the British economy, the Bank of England would not be able to influence things like interest rates or money supply and hence not be able to carry out its mission. Such circumstances might arise because;
- some other country’s currency (digital or other) such as the euro or the USD becomes the preferred currency of a large part of the economy, or
- a large part of British economic activity is carried out on an all encompassing platform with its own money such as is carried out today in We-chat in China or with M-Pesa in Kenya. A different version of the same idea would be if Visa and/or MasterCard were to offer a token/wallet scheme which would mean that customers and traders no longer needed to leave the Visa/MasterCard system to use central bank controlled money.
There is some precedent for countries retail populations preferring to use a currency other than that provided by their own central bank: USD is much the preferred currency in countries as diverse as Panama, Lebanon and Argentina. Both these types of precedent do not have a context that is easily applicable to the UK. In the case of countries’ populations preferring the use of a dollar, the reason for such preference is not because of the superior technology of USD. Indeed the dollar is normally cash and the indigenous currency normally benefits from superior technical services such as electronic transfers and card schemes. It is because the actions of countries’ governments and/or central banks mean the local currency fails in its basic functions. Usually it fails to be a safe store of value if the country’s inflation erodes its purchasing power.
It is not very likely that the UK would encounter such economic mismanagement (although the short lived Liz Truss government gives pause for thought), but if it were to happen the fact that the population had an option of the digital pound, as opposed to commercial bank pounds or sterling cash would not stop the population preferring the dollar or the euro as a safer currency. The UK population is not easily moved to use another currency. In the run up to 2002, when the euro was fully adopted across the euro zone, there was considerable fear the UK option population would start using it as a second currency for British to British payments. The banking system even went so far as to create a UK euro Automated Clearing House for euro credit transfers. Some shops in London and tourist locations geared up to price things in both currencies. In reality there was no demand and the euro ACH was closed down a few years later.
The lesson from all this is that it takes an enormous amount to get a population to change their trust in one currency for another and when they do lose faith in the currency it is not because the currency has a particular technological form.
Turning to the risk of platforms taking over the currency, there are also precedents. We-Pay in China and, to an extent, M-Pesa in Kenya of are examples of retail money staying in a platform where people use a value stored in wallets for much of their economic activity including the extension of credit. The contexts for the success of We-Pay and M-Pesa do not apply in the UK however. The background for their growth was the complete absence of any bank account/ wallet for the majority of the population. The platforms were effectively competing against a completely cash/ barter alternative. This does not apply in the UK where there is a very high level of take-up of bank accounts and e-wallets and these electronic stores of money are supported by extensive, resilient and secure payment systems. The marginal utility of a platform currency would be very low over current bank accounts and wallets in the UK. In comparison, the marginal utility of We-Pay over its alternatives at the time it grew was very high.
The Bank of England may be concerned that some consortium of tech US giants creates a money that could grab a large share of the economy as more of the world’s commerce goes online. The Libra (later renamed DIEM) initiative certainly was a major driver of central banks interest in digital currencies. The fact that the tech giants walked away in the face of political and central-bank hostility and the lack of obvious business case means it is perhaps not the threat they were worrying about. It is still a possibility as would a move by Visa and/or MasterCard taking out a licence and issuing some form of money to add to their ubiquity as a consumer payment device which has increased enormously with the take-up of contactless payments rapidly replacing cash for most consumers. These possibilities, do not seem likely to be a major threat, as the current payments and bank account/ e-wallet ecosystems is rich and efficient.
An unlikely event does not mean that contingency planning for it is a bad thing and since the Bank of England is only proposing to carry out design work, in case a digital pound is needed it could be argued that their work is required on this contingency basis. In the next section I argue that it is the wrong contingency plan because it is missing the more important threat to monetary sovereignty.
Alternatives to retail digital pound for retaining control of monetary supply
The section above argues that the chances of another monetary token being used in the retail space is quite low, whereas in the B2B world I consider it quite likely. This is because;
- it already happens in large measure with the USD being used for lots of traded goods, even when neither party is USA based, and
- there are significant inefficiencies in the information and payments chains associated with the BTB supply of goods and services.
The values of individual transactions are higher relative to consumer payment and the number of parties involved are smaller (tens of thousands of companies as opposed to millions of consumers). Hence the possibility of introducing a new form of money into supply chain is much easier than trying to introduce it across a large population of individuals. Furthermore, lots of the currently paper contracts and supply chains would lend themselves to smart contract type payment processes (e.g. part payment on release from Customs type clauses).
By having a digital pound as the platform for one or more B2B industry segments (defence, oil and minerals, commodities, insurance et cetera) the Bank of England might be able to win “share” of essentially British economic activity that is currently denominated in dollars. Conversely, a successful foreign commercial digital currency, particularly a USD based stablecoin, might wrest even more economic activity, currently denominated in GBP out of the Bank of England’s control.
The British government’s vision of the UK being an open, global trading nation would be reinforced/ supported if trading using the digital pound made trade better (in terms of increased speed and certainty and reduced cost of transactions). This trade related area, seems a more fruitful area for the Bank of England to focus its efforts with digital currency, both in terms of likelihood of success, but also of addressing its monetary control concern.
Conclusion
Even if a retail digital pound can be made usable, something the author doubts, the Bank of England could better achieve its aims of trying to foment innovation and anchoring control in Central Bank money by expending its resources on efforts other than the development of retail digital pound.
