FTI Consulting Public Affairs Snapshot: To CBDC or not to CBDC?

While distinct from the cryptocurrencies we all know, CBDCs are a close cousin of blockchain technologies, relying on a continuously updated database (the “distributed ledger”) that tracks all transactions, and links these transactions to a historical record. Globally, CBDC uptake is dominated by emerging economies, where financial inclusion, resilience and digitisation are key, and remittances play a major economic role. But some of the world’s most advanced jurisdictions are also looking closely at the case for issuing a CBDC.

The European Central Bank has been researching a CDBC since January 2020, and published its consultation results in April 2021. According to Jerome Powell, Chair of the Federal Reserve, the digital dollar is a “high-priority project”. Likewise, Treasury Secretary Janet Yellen thinks the idea is “absolutely worth looking at”. And in the UK, too, there is serious interest in the CBDC project, with last year’s announcement of a new Treasury/Bank of England taskforce to explore a UK CBDC, and a consultation paper from the Bank of England.

Both the Bank and the Treasury are keen to stress that no firm decisions have been made, and they are simply testing feasibility. What we know is that a UK CBDC, or ‘Britcoin’ as some have labelled it, would complement the use of cash and other existing payments systems in everyday transactions: Andrew Bailey, Governor of the Bank of England, recently said “We do not need CBDC for wholesale, because we have real-time gross settlement in central bank money”.

A choir of influential voices sing from the CBDC hymnsheet. The Kalifa review, published by the Treasury in February 2021, recommended the development of a CBDC. The Chancellor acknowledges that CBDCs promote “the adoption of cutting-edge technologies”. And, using the iPhone as an example, Sir Jon Cunliffe, Deputy Governor for Financial Stability at the Bank of England suggests that a CBDC could be the base for future technological innovation. In November 2020, he said: initially “nobody had any idea of the range of uses that (an iPhone) would have” and that “I expect we will see a similar revolution in the functionality of money driven by technology and the private sector”. For some, CBDCs are a technocratically sensible innovation; for others, they symbolise a modern, confident, post-Brexit Britain.

This technological argument for CBDCs is matched by the prudential and monetary policy advantages they bring. CBDCs, the argument goes, reduce the prudential risk exposure of consumers. With CBDCs, a 2008-style scenario with banks facing low liquidity is impossible. When consumers deposit their money with the central bank, the central bank, by default, cannot go bankrupt. This advantage, however, is not unique to CBDC. Stablecoins, which are cryptocurrencies pegged to a real world asset, like the dollar, offer all the technological and prudential benefits without state involvement – and many argue that it should be for private companies rather than the State to bring this new technology to the market.

CBDCs also extend the monetary policy function of central banks. Currently, the BoE, like all other central banks, is reliant on retail banks to pass on its interest rates, with the retail bank free to set its own interest rate on the accounts it offers. With CBDCs, the bank rate could be applied to all CBDC deposits.

There are some interesting political issues at play. CBDC allows central banks to implement unconventional monetary policy, such as negative interest rates, which penalise savers, or helicopter money, when the central bank prints money for consumers with no expectation of being paid back – although this would most probably be a political decision. And given that a CBDC is available to all with a mobile phone, it makes it easier for governments to distribute stimulus and welfare payments – even to the extent of limiting what those disbursements can be spent on. All of these are political as much as economic decisions, and some of them will be controversial.

There are also several risks to CBDCs. One worry is that widespread adoption could lead to a centralisation of risk on the central bank. Currently, payments are processed in a myriad of ways. While interbank transactions are popular, card transactions, particularly those via contactless, are increasingly used. This gives consumers choice, and reduces the impact any one system failing. Were CBDCs to be popular, then the failure of the CBDC system poses more risk than the failure of any single provider. This argument applies to monetary policy too – CBDC may amplify the impact of monetary policy failure, as the central bank has greater control of monetary supply. While giving evidence to the House of Lords enquiry, Cunliffe noted that the Bank has “a mandate on UK financial stability and UK monetary stability”, so therefore “if we introduce a CBDC, it has to suit that mandate”.

Another issue that will have to be faced is a potential loss of privacy – which, in work carried out in the US and Germany and by the ECB, is seen as a highly desired feature. The hybrid CBDC model favoured by the Bank allows individuals to set up accounts with intermediaries, such as banks, who take responsibility for fulfilling Know Your Customer and AML requirements. The intermediaries also process transactions, but the CBDC remains a “claim on the central bank” meaning that it is as secure as cash. The worry is that the central bank’s access to a high volume of commercially desirable transaction data would make them highly vulnerable to cyber-attacks.

The impacts of CBDC adoption are inherently dependent on the design choices central banks make. The Bank of England have made a “prudent assumption”, modelling that 20% of all deposits could move into central bank digital money. The reality will depend on how easy the CBDC is to use. A readily accessible, well-explained currency is likely to fare better than a rushed one, and the first-mover advantage is matched by a first-failure risk.

The hybrid model creates commercial opportunities for firms to be intermediaries between central banks and CBDC users, given that the Bank does not wish to manage retail accounts for the holding of CBDC. These intermediaries could be existing retail banks, payment providers, or even custodian banks, whose experience in holding securities may prove helpful. There is also an opportunity for providers of CBDC infrastructure. A CBDC would be “a major national infrastructure project”, and neither the Bank nor the Treasury necessarily have the knowledge to execute this well. Providers of data and digital expertise may be in demand.

These opportunities will be best realised by those who engage early. As no CBDC decisions have been made yet, there is still time to do so. The upcoming consultation, run jointly by HMT and the BoE, will further assess the case for a UK CBDC, and offers a good opportunity to influence policy. More generally, genuine expertise in the technical requirements for successfully building and launching a CBDC will be in real demand. In the meantime, the Bank’s CBDC Engagement Forum and CBDC Technology Forum will continue to meet.

Ultimately, much will depend on whether consumers are willing to embrace the possibilities that a CBDC offers. The evolution of ancient currencies such as the shekel into the forms of payment we enjoy today has been driven by changing consumer demand, coupled with ease of use. CBDCs may offer the UK a chance for revolution – or end up being merely an interesting diversion. But if the UK does go down the CBDC route, they will want to get it right the first time.