article posted: 21st July 2023 13:00pm BST
This week at BlockStrata Ltd, we have had the pleasure of providing a work experience placement for Alex Palomino. Alex started the week knowing little about the world of cryptocurrency and blockchain and so was an excellent guinea pig for our latest ‘Introduction to Cryptocurrency’ training resources.
Once he was up to speed we set him a task of writing a guest blog post. Given that he is working towards a University place studying economics and geography, the hot topic of CDBCs seemed a natural fit. Also, as luck would have it, the Digital Pound foundation were hosting a meetup and panel event on this very topic in London that we were able to attend to give Alex a deeper understanding of the debate around this topic.Alex’s post is aimed at people who have maybe heard about CDBCs but do not yet have a grasp on why the topic is important or how it might affect us all.
Introduction:
Central bank digital currencies (CBDCs) is a term that may be unfamiliar to those beyond the realm of finance and crypto, yet it has become a pressing topic amongst economists and politicians as technological advances accelerate the transition into a ‘digitised economy’.
So, to bridge this chasm in knowledge and understanding, this guide aims to provide insight into a development that is set to revolutionise the influential constant in all our lives – money.
What are CDBCs?
With much speculation over their uses and consequences, the most important question is often overlooked … What is a CBDC?
To put it simply, they are digital versions of a country’s fiat currency that are issued by that nation’s central bank;
They are largely a response to;
a) the declining use of cash and
b) emerging forms of money that may challenge central bank power and influence and also undermine financial stability.
A CDBC would be issued by a Nation’s Central Bank and regulated by it’s government institutions. The State-backed CDBC thus would seek to ensure stable value and strong guarantees of its ongoing value. This is its main advantage over other ‘digital currencies’ such as Bitcoin and Ethereum, nascent assets that are notorious for their volatility.
The Digital Pound:
In the UK the ‘Digital Pound’ project has been proposed by the Bank of England as the UK’s prototype implementation of a CDBC. The aim is to provide an electronic version of cash, without completely eliminating the use of physical cash.
This development hopes not only to retain the attractive features of physical cash, such as its stability and easy transactions amongst peers, but improve on them.
For example, an implementation of cash existing in a digital world would allow peer-to-peer transactions to be done instantaneously, without the added friction and costs that custodians, intermediaries and other third parties add to each transaction in today’s model..
Although so far this may sound like your average bank transaction, the ‘digital pound’ would not rely on commercial banks (e.g. Barclays, Lloyds). The absence of requirement to pass through these gatekeepers would deliver far less friction in the flow of money. The idea is that two parties can transact ‘peer-to-peer’, with just one step to the payment, making transactions much quicker and more efficient.
The introduction of a Digital pound is driven by both positive and negative developments in the UK’s modern economy. A Digital Pound could help alleviate mounting concerns over financial instability, given that cryptocurrencies are becoming increasingly popular in the UK and are notoriously volatile in terms of prices and widespread stories of failed projects with people losing all they had put in.
Also despite common misconceptions, the Digital Pound does not seek to replace cash. Instead, it aims to provide a trusted option for the population to make a transition into the evolving digital world.
The programmable and interoperable nature of cryptocurrencies has led to an explosion of innovation. The digital pound could harness this potential, whilst providing users with the necessary assurances and stability that cryptocurrencies can often lack.
Why hasn’t the Bank of England issued this already?
The Bank of England (BoE) is, by nature, a cautious institution that would not rush into any implementation that could destabilise the currency.
With any new development the BoE makes, meticulous care will be given to testing and allowing for consultation before widespread implementation.
The critical nature of stable money in all our lives heightens the need to examine the consequences of the development. If this ‘Digital Pound’ is a failure, the consequences would be severe, so it’s imperative that this is not rushed.
There are potential risks that could come with implementing any CBDCs such as the digital pound:
- Users Privacy concerns – CBDCs would likely allow central banks to have more visibility into transactions, which raises privacy issues. There would need to be careful rules around data privacy and anonymity. The BoE has so far been very keen to emphasize that the Digital Pound will be private and they will not store user details.
Having said that, it is almost certain that the providers of ‘wallets’ that are used to hold digital pounds will be licensed agents who conduct KYC and AML operations. - Financial stability risks – Widespread use of CBDCs could facilitate bank runs during times of economic stress. If it’s easy to quickly convert bank deposits to CBDCs, it could accelerate withdrawals.
- Monetary policy implications – By allowing easier access to central bank money, CBDCs could lead to disintermediation of commercial banks. This could reduce the effectiveness of monetary policy and the ability of central banks to influence lending/credit conditions.
- Cybersecurity and operational risks – CBDCs would be a new digital infrastructure that could expose central banks to cyberattacks if not properly secured. There could also be risks around uptime and reliability of the CBDC system.
- Anti-money laundering – Anonymous CBDCs could enable greater money laundering, tax evasion, and financing of criminal/terrorist activities if not properly designed. Rules around KYC may be needed.
- Geopolitical risks – Some worry CBDCs could allow greater government/central bank control and financial surveillance. This raises concerns about authoritarian regimes using CBDCs to restrict citizens’ rights.
Overall the risks would need to be managed through careful design choices and regulations. But CBDCs may provide meaningful benefits that offset the risks in many cases.
CONCLUSION:
There are great concerns over this proposed idea, making it a highly controversial topic that has reached the top of political debate today. With widespread scaremongering, speculations and differing views on the ‘Digital Pound’, it seems as though nobody can truly grasp the consequences of such a drastic change to our established and trusted monetary system.