Montage of Bank of England and £1 coin with binary numbers in the background
The Bank of England is considering issuing a digital currency © FT montage/PA/Dreamstime

The writer is a former senior manager at the Bank of England

Like many central bankers and governments globally, UK policymakers are assessing whether to issue a digital currency to enable households and businesses to hold money directly with the Bank of England. But the proposed design for the digital pound outlined last month means it is not clear why anyone would want to.

Unlike cash, digital currencies will not provide an anonymous way to pay. They will be more akin to bank deposits that leave digital footprints. Unlike bank deposits, however, central bank digital currencies will not pay interest. The UK authorities will also impose limits on the amount of CBDC each household and business can hold at the outset. Thus, the usefulness of CBDCs for safely holding balances beyond deposit insurance limits is ruled out by construction.

These design choices are driven by concerns that a CBDC will prompt consumers to move money out of banks into the central bank. If those outflows were sudden and significant, they might provoke a financial crisis. But the risks that CBDC will cause disintermediation must be balanced against the risk that it goes off like a damp squib, wasting valuable resources. That would be a shame, because a properly designed CBDC could improve public welfare.

The challenge for authorities is to develop a more compelling customer proposition for a CBDC. Their primary argument for one, framed around hypothetical monetary fragmentation and the vague promise of future payment innovations, are too abstract to persuade the public of its utility. Instead, authorities should highlight four key consumer benefits from a CBDC and reflect these in its design. First, a CBDC could give consumers greater choice by providing a digital means for making payments with fewer conditionalities. A CBDC would guarantee universal access to digital payment systems for people in an increasingly cashless economy, regardless of their credit history or political beliefs, and without imposing minimum balance or usage requirements.

Second, a CBDC could provide consumers with a truly risk-free asset. While banks can default on deposits, central banks cannot. Although deposit insurance provides some protection, researchers at the BoE have noted that it is a double-edged sword that encourages moral hazard in banks and systemic risk. Introducing a CBDC could pave the way for gradually phasing out government backed deposit insurance. The interest paid on bank deposits would also become more competitive if CBDCs were remunerated. As banks earn interest on their deposits with the central bank, it could prove politically difficult for authorities to pay none to households.

Third, the potential value for consumers from a digital pound extends well beyond the UK’s borders. Authorities are wise to propose making the digital pound available to non-residents. This could offer people in poorly governed countries a better store of value than their own domestic currencies. A digital pound could thus shore up sterling’s role as a reserve currency.

Finally, a CBDC could benefit consumers by protecting their data. Much of the controversy surrounding CBDCs has reflected concerns that authorities might abuse their access to transactional data for state surveillance. The consultation response proposed additional legislation to prevent them from doing so. But a CBDC could also furnish the public with a digital means for making payments that protects them from private sector surveillance. Alas, the preferred UK model for delivering CBDC through payment interface providers makes erecting such safeguards difficult. PIPs do not yet exist and may never do so because the numbers are not likely to stack up.

A business model based on user subscriptions or merchant acceptance fees is unlikely to generate sufficient margins given low or no transaction cost alternatives such as cash. More likely, PIPs will seek to generate revenue by using their customers’ CBDC data for cross-selling or showing ads paid by third parties. However, this model would not differentiate CBDCs from bank deposits in terms of data protection and fails to reproduce the privacy benefits of cash.

While it is a step too far to conclude, as a House of Lords committee did a couple years ago, that the digital pound is a solution in search of a problem, it is fair to say that its current design makes it a product without an obvious market. The supply of CBDC will not create its own demand. Policymakers need to better articulate its benefits and be bolder in its design if it is to succeed.

Copyright The Financial Times Limited 2024. All rights reserved.
Reuse this content (opens in new window) CommentsJump to comments section

Follow the topics in this article