Digital sterling is coming, but it won't be anytime soon

As the digital sterling is a once-in-a-generation change in the way that money works, David Birch strongly advises all stakeholders to take the time to work out exactly how it should work and make sure that it is implemented correctly.

After delving into the digital euro and exploring various pilots and CBDC developments, we're extending our CBDC series with a spotlight on the digital pound.

Earlier this year the Bank of England released a consultation document, together with an associated technology working paper, on Central Bank Digital Currency (CBDC). Sir Jon Cunliffe, the Deputy Governor for Financial Stability, gave an interesting speech at the time when he spoke about the need for such a digital currency. How exactly such a retail CBDC might work in practice is yet to be determined but he talked about a public-private partnership in which the Bank would provide the digital pound and the central infrastructure and the private sector (banks or ‘approved non-bank firms’) would provide the wallets and associated payment services. This is the ‘two-tier’ approach favoured by central banks worldwide.

The Bank aside, there are many, many stakeholders who will need to form a view and provide input to the consultation process. Andrew Griffith, the Economic Secretary to the Treasury (Britain’s Ministry of Finance) says there should be a ‘national conversation’ about it, and he is spot on: in addition to the views of the government and financial institutions, it is important to understand what retailers, law enforcement agencies, consumer groups, and others want from such a currency.

We need to gather and prioritise the requirements for, goals of, and constraints to a digital pound from the central bank, the government, the finance sector, and all elements of civil society. However, it seems to me that almost all of these groups are not in a position to provide the necessary feedback. Hence it will be some time before the Bank of England can be in a position to assess those requirements and begin work on an architecture that will deliver what the nation needs.

A global survey of Chartered Financial Analysts (CFA) Institute members found that 42% of respondents believed that central banks should launch CBDCs, while 34% disagreed. Interesting. But note that in that poll of informed industry observers, only 13% said they had a strong understanding of CBDCs. I’m not picking on CFAs, as I am sure the figure is much lower amongst other groups and, for that matter, the general public. If only 13% of the people you are asking understand what it is that you are asking about, what do the opinions of the people who do not understand what you are asking about matter?

It is clear that there is no consensus on CBDCs even amongst the experts! Writing in the Financial Times earlier this year, a senior advisor to the Bank of England said that a CBDC is the digital equivalent of cash and that since we already have electronic commercial bank money, we don’t really need it. Similarly, in the Wall Street Journal, a technology writer said that a retail CBDC isn’t any different from the electronic money in bank accounts today—it’s just a digital dollar.

But they are wrong: there is a fundamental difference between electronic money that lives in bank accounts and electronic cash that lives… well, anywhere. In phones, USB sticks, laptops, smart cards, cars, or wherever else we can put a microchip capable of secure processing. And the really crucial difference is that when I sent my sister the money that I owed her recently, it went from my bank account through the banking system to her bank account. But in the future, I will send her electronic cash from the wallet on my laptop to the wallet on her phone and it will never go anywhere near banks or the banking system. There won’t be any clearing or settlement, which is why the existence of instant payment networks has nothing to do with the need for CBDC.

Nevertheless, while the devil is in the details, generally speaking, this is very good news. Why? Well in my view, there are probably three key things to bear in mind about this interesting announcement about a retail central bank digital currency from one of the world’s oldest financial institutions.

First of all, and I think most people understand this crucial distinction now, digital currency is not cryptocurrency. Digital currency is linked to something in the real world (such as, in this case, sterling), while the value of cryptocurrency is determined only by supply and demand. When it comes to supplanting the pounds in our pockets, the stability of a digital currency is the fundamental requirement and stability supports trade, which supports prosperity.

Secondly, as noted, digital currency is unlike the electronic money that is currently in bank accounts (which is, by the way, almost all of the money that exists today) and as it travels around outside banking networks it will mean cheaper, quicker, and more transparent transactions.

Thirdly, I think it is better to think of a digital currency as a platform for innovative new products and services rather than as a product in its own right. I wrote in Forbes some time ago that the role of digital currency as a means to bring innovation to the financial world is critical for the UK. Given Britain's leading role in fintech and the renewed commitment to the sector following the ‘Kalifa Review’, the role of digital currency in creating a new generation of products and services will be where the long-term boost to the economy comes from. The point was well made in the Bank of England's 2020 original report on digital currency, where they pointed to the creation of ‘smart money’ (either by some form of smart contract usage or API interface) as to where the benefits of a digital currency will come from. People are going to build some amazing new things on top of money that has an API!

It’s that last point about innovation that interests me the most. We need a safe and sound banking system but we also need safe and sound money that can move around outside that banking system to provide not only resilience in the infrastructure but a platform for new products and services.

This is where the real excitement should be.

If there is going to be a digital pound, it should be in a form that is a platform for open innovation. Electronic cash, like cash, is a pre-paid product with no credit risk. Anyone should be able to use a digital pound API to create not mere emulations of the payment services that we have now, but new ways of transacting: micropayments, smart payments, conditional payments, whatever.

The entry barriers should be low, commensurate with the risk, since none of us know where innovation is going to come from. It may come from the fintechs or the techfins, but it’s just as likely to be a roomful of students who come up with the killer use case that would never occur to any of the incumbents.

Rachel Greener, from the Bank of England's Central Bank Digital Currency Division wrote about this in her excellent piece on Enabling Innovation Through a Digital Pound in their Quarterly Bulletin (August 2023), noting that one of the lessons to be learned from other successful ecosystem plays (eg, Aadhar) is to ensure participation from a wide variety of organisations and to ‘allow tiered authorisation of participants’ where the level of access to the CBDC ledger can be tailored to the risk that an organisation poses to the ecosystem.

What does all this mean then? Well, there is no doubt that CBDC is coming. Predictions are of questionable use in this space, since so much is unknown, but it is not implausible that the global value of CBDCs out there will grow dramatically from some USD 100 million today to USD 100 billion plus at the end of the decade as suggested by Juniper Research.

Incidentally, that research predicts (and I am sure that this will be the case) that 92% of CBDC transactions will be local, which suggests an uphill struggle for the adoption of cross-border payments. A Digital Monetary Institute report came to a similar conclusion, noting that while central banks are pursuing CBDC for various reasons and many thought that inter-linking CBDCs offers a promising avenue for improving cross-border payments, ‘none cited improving cross-border payments as the main motivation’ despite the positive conclusions coming from early experiments in that space, such as SWIFT’s recent sandbox interoperability, which they reported as showing that both central and commercial banks see ‘clear potential and value’ in cross-border CBDC use.

We should focus on the needs of the national economy then. And our national economy will need a CBDC. The Bank of England and Treasury are indeed saying that a digital pound will be needed but that as it is what the Governor of the Bank of England calls a ‘profound’ decision about the future of money, they quite reasonably want to get it right. I could not agree with them more on this!

As a long-time advocate for digital currency, I look forward to digital sterling in action, but as I said on the CBDC panel at Merchant Payments Ecosystem in Berlin back in March, it has to be the right kind of digital sterling, a digital currency that responds to the needs of civil society as discussed earlier and not simply the dreams of technologists.

The launch of digital currency will be a once-in-a-generation change in the way that money works, so it is very important that the Bank of England, the European Central Bank, the Federal Reserve, and everyone else take the time to work out exactly how it should work and make sure that it is implemented correctly. There is no burning platform, as they say: we do need digital currency but we don't need it tomorrow and it's much more important to get it right than to get it quickly.

About David G. W. Birch

David G. W. Birch is an author, advisor, and commentator on digital financial services. He is an international keynote speaker and recognised thought leader in digital identity and digital money.

David is the Principal at 15Mb Ltd., his advisory practice, and Global Ambassador for Consult Hyperion, the secure electronic transactions consultancy. He is the Non-Executive Chairman of Digiseq Ltd and holds a number of other board-level advisory roles with companies in Europe and the USA including Tillo, PaymentWorks, Au10tix, and YourSafe.

He is an Honorary President of EEMA, the European e-ID Association, a Senior Research Fellow at King’s Business School in London, and a Digital Fellow at the University of Exeter Business School’s DIGIT Lab.

Before helping to found Consult Hyperion in 1986, he spent several years working as a consultant in Europe, the Far East, and North America.