At a glance
● The Bank of England (BoE) and HM Treasury (HMT) have published a joint consultation paper on the case for a UK retail central bank digital currency (CBDC) – the digital pound. The BoE also published a technology working paper outlining emerging thinking on CBDC technology.
● With this consultation the UK’s digital pound journey moves from the research phase to a 2-to-3-year design phase, with a view to issuing a CBDC – if there is a decision to launch – in the second half of the decade.
● The consultation explores some key design features for a UK retail CBDC, and how it may interact with the broader financial sector and other traditional and emerging forms of private money, including stablecoins.
● There are some important elements here for financial services (FS) firms and payments innovators to consider such as the remuneration model, the public-private platform model to deploy the digital pound into the market, and the likely role of non-FS actors.
● The most significant risk from the digital pound to the traditional banking business model is the “pass-through” feature, where the wallet provider (account provider) will never be in possession of customers’ digital pound funds - it will pass them through to the central bank which owns the liability. As credit and counterparty risk are limited, so is the prudential regulatory burden on firms, lowering barriers to entry for payment innovators. This, coupled with the potential rise of regulated stablecoins, will undoubtedly disintermediate the traditional banking revenue and funding model.
● On the other hand, a digital pound, along with stablecoins, will provide much-needed competition and cost efficiencies in the payments sector and increase consumer choice. Nevertheless, the financial stability implications and the concentration risk to a potentially different set of systemic players will require careful consideration and management.
● Over the next few years, firms will be able to work closely with the BoE and HMT around proofs-of-concept, tests, and the development of a technical blueprint. These controlled environments will help firms shape the art of the possible and keep their strategic approaches under review as new information and details emerge.
● The consultation also confirms that the UK does not plan to introduce a wholesale CBDC. Instead, the benefits of a wholesale CBDC are expected to be delivered by enhancing wholesale settlements in central bank money through the BoE’s real-time gross settlement (RTGS) service renewal programme, including by providing near 24/7 availability, real-time transparency, and increased access for more types of institutions.
● The digital pound is part of a broader wave of change in banking and payments. Other (and, in many cases, more immediate) policy initiatives include the regulatory approach to stablecoins, trading and investment use cases in digital assets, Open Banking and the shift to Open Finance, UK New Payments Architecture, and access to cash. Firms should develop a strategic response to the digital pound as part of a broader firm-wide approach to the future of money, incorporating these initiatives.
● This blog sets out the key takeaways from the consultation paper and a selection of initial implications and considerations for regulated FS firms. It covers the following topics:
- What is the digital pound?
- A roadmap to potential go-live
- The digital pound’s model and proposed features
- Potential revenue streams
- C2B and C2C use cases
- Coexistence with stablecoins and other forms of money
- Strategic considerations and implications for the cost and availability of credit
What is the digital pound?
The digital pound would be a new form of sterling, similar to a digital banknote, issued by the BoE. It would be used by households and businesses for their everyday payments needs. It could be used in-store, online and to make payments to family and friends. If introduced, it would exist alongside, and be easily exchangeable with, cash and bank deposits.
A roadmap to potential go-live
This consultation marks the end of the research and exploration phase and opens the door to design.
By the end of Phase 2, the BoE and HMT will have evaluated the technological feasibility of a digital pound, and determined the optimal design and tech architecture.
If progressed, Phase 3 would include developing a prototype digital pound technology in a simulated environment, before moving to live pilots. A launch decision would only come after that exercise, the earliest date predicted to be in 2025. While this would broadly align with the digital Euro timings, it is likely that some Asian countries, such as China and India, may launch their own digital currencies sooner. Global systemic stablecoins are also likely to come into the mainstream market before a digital pound if the current estimated regulatory timelines around stablecoin regulation are met.
Platform model based on a public-private partnership
There are some important considerations for firms from the public-private partnership model that has been proposed.
How the platform model will work
The BoE would issue digital pounds. These would be a direct claim on the BoE, as cash is today. The BoE would also provide the central infrastructure, including the core ledger and the API layer that private players can plug into (see Figure 2). At this stage, there is no commitment to a specific technology for such an infrastructure, and both centralised and decentralised options will be considered.
Meanwhile, regulated private sector firms – payment interface providers (PIPs) and external service interface providers (ESIPs) – would provide the interface between the core infrastructure and users by offering wallets and payment services (see Figure 2 below).
- PIPs: provide interactions relating to digital pound payments, including providing digital pass-through wallets to allow users to hold and use the digital pound.
- ESIPs: firms whose business is not payments. They could provide services to augment digital pound wallets, e.g., business analytics, budgeting tools and fraud monitoring.
Crucially PIPs and ESIPs could be banks, authorised non-bank firms or participants from non-FS sectors.
The central bank will build a core ledger. PIPs and ESIPs will access the core ledger via an API. A payment made between two users would be processed and settled by a transfer on the BoE’s core ledger. PIPs would initiate these payments, but the transfer of holdings and settlement would occur at the BoE.
Providing wallets does not incur liability
The wallets would be operated on a “pass-through” basis. This means that CBDCs held in the wallets would not constitute a claim on the wallet provider in the way that a bank deposit is a claim on a bank. Instead, the wallets would hold all customer information and pass-through the customer’s payment instructions to the BoE’s infrastructure. Wallet providers would be responsible for recording the identity of digital pound users and carrying out KYC and AML checks. They would also have a responsibility to protect consumers from fraud, although the UK authorities need to consider the optimal liability and compensation framework in the digital pound system.
The digital pound would be financially risk-free as market, credit and liquidity risks are absent as the customer funds sit with the central bank. PIPs would not be in possession of the end-user’s funds and, therefore, will not need to meet the high prudential standards of a bank, thereby opening the door for payment innovators to play this role. But PIPs will need to meet high standards of operational resilience and manage the other risks to which they are exposed.
Overall, this means there are a range of strategic options for regulated FS firms – especially banks and payments firms – in distributing or building offerings around the digital pound. With a degree of clarity on the overall model and role for the private sector, these firms should engage strategy, product innovation and technology teams to start considering what roles they could choose to play in the value chain.
Phase 2 in the development roadmap (Figure 1) provides a range of opportunities for FS firms to shape their approaches, taking part in proofs of concept and experiments. These should also help firms determine the level of technology upgrades required to play their intended role in the digital pound ecosystem and start considering associated firm-wide capabilities. These include risk governance and risk management frameworks, and the key components of a target operating model.
Firms that leverage these testing opportunities may be better placed to be an early mover, if a go-live decision is made.
Clarity on three key design choices
The paper provides some welcome clarity on three key digital pound design choices – remuneration, limits on holdings, and privacy protections.
Clarity on these features will help firms understand how the digital pound might interact with other forms of digital money, including stablecoins (explored below), and shape their overall strategic response.
No interest paid
As with cash, no interest would be paid (or charged) on a digital pound. Its purpose is a means of payment rather than a savings product.
Limited amount per user (at least initially)
To balance potential financial stability risks and support wide usability, the BoE proposes to limit holdings of digital pounds to between £10,000 and £20,000 per individual. By contrast, the ECB’s preliminary suggestion for the digital euro is €3,000 to €4,000 per person .
A limit of £10,000 would mean that three-quarters of people could receive their monthly pay in digital pounds, while a £20,000 limit would allow almost everyone to receive their pay in digital pounds. Limits would be in place at least for a transition period, which could span several years.
The BoE and HMT intend the digital pound to have the same – or stronger – privacy protections as current forms of digital money, such as money in a commercial bank account or e-money. Inevitably, it will not be anonymous. As with bank accounts today, individuals’ personal details and transaction records would be known to their wallet provider. HMT or the BoE would not have access to these details.
Ensuring that there is clear public understanding and trust that the BoE and Government do not have access to this personal data will likely be key to ensuring wide uptake. Fundamental to this is developing a clear communications and engagement strategy around the digital pound. In our view, the design of such a strategy should also be a priority in Phase 2, alongside broader policy and tech design choices.
Potential revenue streams
Revenue models will ultimately be the key driver behind the extent to which FS firms decide to play in the digital pound ecosystem and which commercial propositions they pursue. The paper sets out some potential revenue streams:
- Transaction fees levied on merchants: one of the most common revenues for payment service providers today.
- Service or transaction fees levied on individuals: could apply to high-value, international and business-to-business payments.
- Subscription or product fees for value-add services: PIPs could charge a subscription fee for premium services that go beyond basic wallet functionality, e.g., budgeting tools.
- Commercial use of data: subject to legal and policy considerations, PIPs could use transaction data to improve existing operations or offer new services.
Concerning the commercial use of data, while we agree that there could be opportunities for firms, they may need help to realise them in practice. For example, in our experience, the real or perceived challenges concerning the UK General Data Protection Regulation requirements have deterred many firms from making better use of Open Banking payments data. As is the case for other technological innovations (e.g., AI), UK authorities must acknowledge and address the need to ensure coherence between CBDC policy and other FS and cross-sector rules. It will also be important for policymakers to consider whether commercial use of CBDC payments data could lead to the erosion of trust or affect public adoption.
Another critical question is the extent to which digital pound services should be viable on a stand-alone basis or whether cross-subsidy from other business activities is appropriate. Clarity on this will be important and likely inform the extent to which firms invest early and become an early mover or adopt more of a “wait and see” approach. Cross‑subsidisation “will be considered in further detail as the regulatory and operational requirements for PIPs and ESIPS are developed.”
This will be particularly important for payment firms with smaller product and service offerings and capabilities than banks. For these firms, the marginal cost of launching digital pound services will likely be higher and they will be less likely to cross-subsidise their CBDCs services. These considerations will be important factors for firms deciding whether to become PIPs and ESIPs and will affect competition in the market.
Policymakers and FS firms should also consider the potential role of non-FS firms as regulated PIPs and ESIPs. For example, BigTechs are already expanding their role in retail payments. The digital pound – if progressed – would provide another avenue for these firms to compete with FS firms in the payments value chain.
C2B and C2C use cases
The digital pound would be designed for households and businesses to use for everyday in-person and online payments. It would support two key types of payment:
- Consumer-to-business (C2B) – in-store and online.
- Consumer-to-consumer (C2C) – e.g. sending money to family.
Payments via phone and card will most likely – at least initially – underpin these use cases.
However, there is a clear mandate for the private sector to help shape other means of payment, e.g. including internet of things (IoT) devices such as smart speakers and TVs. Over time, the BoE and HMT expect the digital pound to enable a broader range of payments than exist today, e.g. including split or micropayments . Importantly, any programmable money use cases – enabling users to set rules on their digital pound payments – would be provided by PIPs and ESIPs, not the BoE. The Phase 2 experiments will likely provide a controlled space to help firms test the art of the possible and determine the feasibility of different use cases.
In addition, non-UK residents would be able to use the digital pound when sending money to either a UK or non-UK resident. However, as the paper acknowledges, using it to improve cross-border payments will take time and extensive international cooperation. There are some welcome indications that the UK will work with international counterparts to explore interlinking CBDCs and reduce unintended barriers, but the industry will eagerly await concrete international initiatives to give them the confidence to shape cross-border use cases. It is likely that a stablecoin provided by a global systemic firm will be a key challenge to this model.
Coexistence with stablecoins and other forms of money
The paper envisions a world where the digital pound would coexist with existing and new forms of digital money. It would essentially replicate the role of cash in the digital economy, offering continued access to retail central bank money, ensuring interchangeability of money. For example, the digital pound could help users move between and send payments to different stablecoin networks. In our view, some of the proposed digital pound key features would further support their coexistence, especially the proposed limits on holdings.
While stablecoins are currently primarily used to settle trades in other digital assets, increasing regulatory clarity could spur new use cases, such as domestic and cross-border account-to-account retail payments.
A regulated stablecoin arrangement is likely to emerge before a digital pound, and firms should consider whether to become a first mover in the stablecoin market. Potential roles include issuer, wallet provider or payment facilitator. They may be able to leverage their exploratory work and potential tech upgrades (e.g. to build stablecoin wallets) as part of potential future digital pound implementation work.
Strategic considerations and implications for the cost and availability of credit
The introduction of new forms of digital money – both a digital pound and stablecoins – would result in consumers switching some of their bank deposits to these new forms of money, particularly if payments become cheaper, or additional incentives are offered, with these new payment options. Depending on the speed and scale, this could affect the cost and availability of credit (Figure 3).
The overall extent of bank disintermediation and impact on credit is uncertain and would vary between the digital pound transition period, steady state and stress. Any transition period would include a range of unknowns, not least the extent of deposit outflows, and the non-bank sector’s ability to replace any drop in bank lending. This highlights the need to progress carefully, including by imposing holding limits during the transition period.
The growth of Open Banking capabilities could also compound the impact of CBDCs on banks’ liquidity and credit availability by making it easier for customers to move funds across different accounts and types of money. Moreover, as policymakers extend the principles of Open Banking through Open Finance, these liquidity challenges could eventually affect firms other than banks, such as investment funds. [Click here for a more in-depth analysis of these issues.]
All FS firms dealing with retail deposits and payments should start working through a range of possible scenarios in which a digital pound and systemic stablecoin could emerge. Strategy, product innovation and technology teams should work closely with finance functions to develop different scenarios and their impact across different customer segments and identify the types and volumes of deposits that may be at risk.
By working through these areas and engaging with the broader digital pound design phase, firms can position themselves to succeed in the future digital FS landscape.
The consultation closes on 7 June 2023. The BoE and HMT want to hear from a broad range of stakeholders across the economy, and plan to engage extensively across the UK during the consultation period. With increased clarity on the phased approach and the overall proposed digital pound model and key features, firms should start considering what roles they want to play in the digital pound ecosystem and how to engage with policymakers across the different phases.
Firms should also reflect on the broader business model impact and strategic choices available with the introduction of new forms of money, whether in the form of CBDCs or stablecoins.
 Split payments are where one payment instruction has multiple beneficiaries. Micropayments are payments for very small amounts.