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For over 300 years, the Bank of England has issued banknotes carrying the pledge, “I promise to pay the bearer” and the value in pounds sterling of the note.
This legal commitment has long underpinned the heart of finance because commercial banks are required to be able to convert customers’ money into physical cash at all times, thereby tying these private providers of money and payments systems into the central bank’s orbit.
But the use of cash is dwindling, undermining this central feature of the financial system and leading the BoE to fret that notes and coins might become less relevant in future. While there is little evidence that volatile cryptocurrencies such as bitcoin are attracting investors as an alternative to sterling, there is a fear that the costs of transactions in sterling might leave the currency vulnerable to stablecoins — digital currencies pegged to an external reference such as the dollar, or even digital currencies issued by foreign central banks.
That could undermine financial stability in Britain and the BoE’s ability to set interest rates to control inflation.
With these threats in mind, the BoE and Treasury are investigating issuing a central bank digital currency, a digital sterling, of its own for the public’s day-to-day use.
For users, a central bank digital currency would be little different from current digital payments bank accounts except that it would be automatically guaranteed by the state, as cash is now, thereby reducing the risk of using it and potentially lowering costs of transactions.
When using digital sterling backed by the central bank, the money would either be sourced from an account directly linked to the BoE or it would be a digital token backed by the BoE just as a £10 note is a paper token also issued by the central bank.
It would, however, require elements of a new payments infrastructure.
Advocates hope that a central bank digital currency would reduce the cost of payments and increase the inclusivity of digital payments for those without bank accounts in a world where fewer retailers in future might accept cash.
A recent survey of academic economists run by the Chicago Booth School of Business found that 63 per cent agreed that the benefits of a central bank digital currency would exceed the risks while only 7 per cent disagreed.
No decisions have been taken in Threadneedle Street and there is no timescale in mind. But bank officials said they were exploring the case with “pace and purpose”, reinforced by the knowledge that the European Central Bank launched its digital euro project last month.
Jon Cunliffe, BoE deputy governor for financial stability, has highlighted the potential for technological change to result in the current form of public money — cash — disappearing. “We should not let this happen by accident,” he said.
Without committing to a digital sterling, he outlined the hope that “a well-designed and effective public money alternative in combination with regulation where necessary would provide a more efficient and a more robust answer [to the coming changes in payments technology]”.
Although there might be advantages, few economists think they will be transformative and a digital sterling, if it were to be introduced, would probably feel just like another means of payment, leaving many other features of the modern economy unchanged.
Professor Olivier Blanchard of the Peterson Institute of International Economics and a former chief economist of the IMF, found he could not get excited by the prospect. “I may miss the vision thing. [Central bank digital currencies] may improve the plumbing [of the financial system]. But to me, it seems like much ado about not much,” he said.
The BoE has made clear there are important design features it needs to get right and potential risks it wants to avoid in introducing a digital sterling.
Privacy is perhaps the greatest immediate design issue with central bankers wanting sufficient ability to be able to fight crime without the state having visibility over every transaction that people make.
Cunliffe stressed that the state would need to strike a balance here and that balance would apply both to public digital currencies and private tokens such as stablecoins. One advantage of central banks being involved, he added, was that the state would never collect and sell data on individual transactions for marketing and commercial purposes.
The other crucial issue for the BoE to determine is whether it would pay interest on any retail central bank digital currency, as it does with the digital currency it currently issues to commercial banks, or not as is the case with physical cash.
This will be a thorny issue: paying interest would reinforce the BoE’s monetary policy potency, especially if it wanted to impose negative rates to encourage spending. But if it paid interest it might prove to be extremely attractive to consumers, undermining the health of the banking system, reducing deposits and raising the costs of loans.
Professor Stephen Cecchetti of the Brandeis International Business School and a former chief economist of the Bank for International Settlements, which oversees the international payments system, is worried about this potentially destabilising aspect of central bank digital currencies.
He sees central banks essentially racing to introduce digital public currencies because they are followers of fashion rather than as a force for good. It would undermine domestic banks, generate a “tidal wave” of money flowing away from developing economies seeking a stable place to park money and would damage privacy, “tempt[ing] authoritarian governments by providing access to everything we do”.
“This all leads us to be very concerned,” Cecchetti added.