New developments in the journey of the "digital pound"

On 7 February 2023, the Bank of England ("BoE") and HM Treasury ("HMT") published a joint consultation paper on the potential introduction of a central bank issued digital currency or "digital pound" to be issued by the BoE for retail use (used by individuals and businesses for everyday payments), that would exist alongside physical cash.

No final decision has been made on whether a digital pound will be implemented, but in view of the likely need and the lead time to introduction, the consultation paper takes the next step towards detailed policy and technical development of the digital pound.

This article sets out some of the key takeaways from the consultation paper and explores what this could mean for the payments landscape in the future.

• Why is the digital pound being proposed? Justifications for the potential requirement for a digital pound focus on: (i) the need to promote innovation in domestic payments as the economy becomes increasingly digital, (ii) the decline in the use of physical cash, and (iii) the risks to financial stability posed by private digital money such as stablecoins.
  The consultation paper highlights the speedy decline in the use of physical cash from 55% to 15% of transactions in the UK over the past decade [1] and the fact that around 95% of the funds held by individuals to make UK payments today are held as bank deposits in commercial banks. Currently, the BoE only issues money in the form of physical cash and so a digital pound would complement physical banknotes and ensure that the BoE continues to provide money that is relevant to the way people choose to pay, both today and in the future. The digital pound would be another form of central bank money where the public would have a direct claim against the BoE.
  
  
• Public-private partnership and the preferred ‘platform model’. The consultation paper proposes a public-private partnership, where the BoE would issue the digital pound and manage the central public infrastructure through a ‘core ledger’ built and operated by the BoE, whilst regulated private sector firms, referred to as Payment Interface Providers (“PIPs”), would enable users to access and manage their digital pounds through ‘pass-through’ wallets.
  These wallets are described as ‘pass-through’ because the user interacts with these wallets rather than directly with the BoE and these wallets simply pass instructions anonymously from the user to the BoE’s core ledger. The PIPs and other External Service Interface Providers (“ESIPs”) would access this public infrastructure via an application programming interface (“API”) and would be responsible for designing a variety of services that provide all user-facing interactions.
  The PIPs would never be in possession of the end users' digital pound funds, and the transfer of holdings and settlement occurs at the BoE level. As such, PIPs would not pose counterparty or credit risk to their customers and therefore, are thought unlikely to need extensive prudential regulation. ESIPs are firms whose business is not payments (unlike PIPs), and it is through that ESIPs might provide services that augment digital pound wallets and are of value to users and merchants. Examples of these kinds of services include business analytics, budgeting tools and fraud monitoring.
  
  
• Privacy and Security. Alongside the Consultation Paper, the BoE published a Technology Working Paper which outlines the BoE’s initial thinking on the technical requirements for the digital pound, and explores six technology design considerations including privacy, security and resilience. Interesting from a data privacy perspective, the consultation notes that the PIPs (referred to above) would identify and verify the users but would anonymise any personal data before sharing with the BoE. Consequently, neither the UK Government nor the BoE would have access to user’s personal data except in limited circumstances such as for law enforcement purposes.
  
  
• Use of Blockchain and DLT. Interestingly the BoE has made no decision yet on whether a digital pound or the ‘core leger’ referred to above would be based on a blockchain or use some other form of distributed ledger technology ("DLT"). The Technology Working Paper sets out high-level requirements for a core ledger, but makes clear that these could be fulfilled by conventional or DLT technology. In a speech on 07 February 2023, Sir Jon Cunliffe Deputy Governor of the BoE noted that DLT will be “appropriately considered”.
  
  
• How does it compare to physical cash? Similar to physical cash, the consultation paper proposes that the digital pound would not pay or charge an interest rate, it would not be a cryptoasset, and it can be used for both in-person and online everyday payments through several methods from point-of-sale to smart devices. However, unlike physical cash, they have proposed a limit on individual holdings of the digital pound between £10,000 and £20,000, for at least the introductory phase, to reduce any threat to financial stability from mass withdrawals from commercial banks.

Conclusions and Next steps

The consultation closes on 7 June 2023. The BoE and HMT will then review the responses and consider whether changes to the proposed model outlined in the consultation paper are necessary. The final decision on whether to launch a digital pound will be made at the end of the design and development phase, taking account of developments in money and payments as well as the operational features and technology needed to deliver a digital pound. This is likely to be in 2025 at the earliest.

The PIPs and ESIPs described in the consultation paper do have some notable similarities with the way open banking providers access commercial banking infrastructure today. We could therefore see some of the lessons learned from open banking rolled across into the technical and regulatory architecture of the digital pound.

Its also interesting to see how non-financial firms as PIPs or ESIPs seem to play a central role in the BoE’s vision for the digital pound ecosystem, with social media, online marketplaces, broadcasters and content sharing platforms all being expressly mentioned in the consultation. It is thought that these types of players could integrate digital pound wallets and/or payments into their wider offering bringing “significant benefits for choice and innovation”. This further highlights the increasing trend of embedded finance, but also how financial institutions could increasingly take a back seat in terms of managing relationships with end users.

Although roll out of the digital pound may seem a long way off, it is without a doubt that there has been a proliferation of new developments in the payments and monetary landscape over the past 5 years, with the likes of open banking, stablecoins and embedded finance, to name but a few. This consultation paper is a vital opportunity for the regulators to take stock of where we are at the moment and what “good” could look like in the future, whether that be via a digital pound or otherwise.

Authored by

Christina Fleming and Arif Doha

If you would like to read Bird & Bird’s previous alerts, please check out our FinTech webpage here

[1] UK Finance (2022) – UK Payment Markets Summary.