The Six Key Drivers for Digital Currency
The Bank of England and the UK Treasury have announced a Central Bank Digital Currency (CBDC) Taskforce to coordinate the exploration of a potential British CBDC.
But why does Britain want a CBDC? Well, I've been through several central bank reports on digital currency — in particular the Bank of England's March 2020 paper and the more recent European Central Bank (ECB) report on a digital Euro from October 2020 — and I’ve brought together and organised what I think are the pressures for digital currency into half a dozen key drivers.
Spoiler alert: The six key drivers for digital currency are monetary policy, influence, resilience, cashlessness, the environment and (most importantly, in my opinion) invention, innovation and competition in money.
I think it's interesting to work through all of these drivers and see what they might mean for digital Sterling and Britain's post-Brexit global financial services proposition but you might also want to mentally consider them in the context of a digital Dollar, digital Euro or digital anything else.
Monetary Policy
We have to start here. There is an important aspect to any decisions made here because a CBDC not only has domestic financial implications for the issuing economy; it has also implications for the rest of the world. Economic simulations suggest that CBDC increases asymmetries in the international monetary and financial system (IMFS) by reducing monetary policy autonomy in "foreign" economies (in other words, there are countries where the citizens might prefer to hold digital Sterling instead of their local currency) and suggest that introducing a CBDC sooner, rather than later, could give rise to a significant first-mover advantage.
I hope the UK taskforce take this priority on board! What would happen to Britain's ability to set monetary policy if everyone with a smart phone is using Diem or digital Yuan? As ECB board member Fabio Panetta said last year "We must avoid a situation in which European payments are dominated by non-European providers, including by foreign tech giants potentially offering artificial currencies in the future". He was referring to Diem here, of course, but his point applies equally to the UK. This is not a euro-centric view, by the way. Tim Macklem, governor of the Bank of Canada, said something similar when he confirmed that the country is working with other members of the G7 commission to launch a CBDC:
If another country has one and we don't, that could certainly create some problems… So we want to make sure we're ready."
Influence
There are two sides to the influence game. Not only do we Brits not want our Pound dumped in favour of digital Yuan or digital Loonies but we also want some of what America has: soft power exercised through money. We are not the only nation to think about this. Speaking at a forum last month, a Chinese central bank official repeatedly said the digital Yuan is aimed at protecting "monetary sovereignty". But China undoubtedly sees that the digital Yuan could give those that the U.S. seeks to penalise a way to exchange money beyond its control. The Wall Street Journal says that the chance to weaken the power of American sanctions is central to Beijing's marketing of the digital yuan.
Perhaps a British or European digital currency could obtain traction by providing privacy for global citizens while remaining under the control of the west, a point I made in The Economist back in February.
Resilience
One of the great attractions of building a new digital cash infrastructure to implement a digital currency, instead of just laying a simple peer-to-peer protocol on top of the existing digital money infrastructure is that it would add to diversity and therefore resilience. If the digital money infrastructure goes down for any reason - and this does happen from time to time, look at the complete failure of all payment transactions within the Euro Target2 system for several hours last year (with backup systems and contingency modules also initially unable to function) — then the parallel digital cash system should carry on working. The ability to transact between devices that are not connected to a network because of natural disaster is a key design requirement for the Chinese digital currency and it should be one for ours too.
Cash Replacement
While people often use Sweden as a case study for cashlessness, I think that what is happening in the UK is just as interesting. The head of Britain's ATM network recently said that "The Bank of England will issue e-pounds within two years as cash dies out", and he may well be right. Cash was half of retail payments 20 years ago but it was an eighth last year and will be a twentieth within five years. (There are similar trends around the world. Cash payments for in-store purchases in Australia are forecast to slump from 8 per cent in 2020 to just 2 per cent in 2024, making Australia the fourth most cash averse country behind Sweden, Denmark and Hong Kong).
Allowing cashlessness to just happen, without a strategy, is a really bad idea. In some of the UK's most deprived areas, where people are more likely to depend on cash, there has a significant shift from free-to-use cash dispensers to machines that generally charge up to £2 per withdrawal. The response should not be, as I wrote here in Forbes last year, to continue to use cash despite the expense, inefficiency and inconvenience, but to find an effective digital alternative for those trapped in a cash economy and a resilient digital cash system would be an obvious place to begin the search.
Environment
One area that the ECB touched on that I had not previously considered to be a driver for digital currency is the environment. It should not have been a surprise. As other private companies and government bodies respond the public demand for environmental awareness and sustainability, why should central banks be any different? Therefore I was interested to see Britain's Chancellor of the Exchequer, Rishi Sunak, accompany the announcement of the taskforce by talking about a vision for a more "open, greener, and more technologically advanced financial services sector".
In this case, I think that there are two green imperatives: reducing the environmental impact of cash (after all, driving around armoured trucks full of cash is a bit of a waste of carbon) and minimising the environmental impact of the digital currency cash replacement. This agenda suggests that Bitcoin may not be the best alternative to physical cash, given that as of February 2021 it was using more electricity than Argentina.
Competition
Lastly, but most importantly for the UK, is the role of digital currency as a means to bring innovation to the financial world. Given Britain's leading role in fintech, and the renewed commitment to the sector following the "Kalifa Review", I think the issue of competition is critical. The point well made in the Bank of England's report last year was that the introduction of "smart money" (either by some form of smart contract usage or API interface) was really where the benefit of a digital currency will come from. CityUnited, a London think-tank, made this same point just last week, arguing that digital Sterling must be "at the heart of Britain's efforts" to strengthen London's global role as a financial centre.
Taken together, these drivers could mean a new digital Sterling that projects British values, British financial services and British confidence out into the world to trigger a new wave of innovation. I am serious about the magnitude of this opportunity, which is not about me spending digital cash in the supermarket but about people, bots and things engaging in sophisticated economic exchange to increase trade (and therefore prosperity) while reducing the costs of intermediation. If the taskforce plays its card right, it will give British fintech (and perhaps even global fintech) an incredible boost.
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