On 12th March this year, the day after the World Health Organisation formally declared the outbreak of COVID-19 a pandemic and only three days before the end of Mark Carney's term as Governor of the Bank of England (BoE), the BoE released a fascinating discussion paper that was, understandably, largely overlooked by the wider world and so did not get the attention it deserves. The discussion paper explored the opportunities and challenges posed by a Central Bank Digital Currency (CBDC) and invited responses from interested parties. This a clear demonstration that the BoE is ready to embrace technological innovation with open arms, and is part of the trend of central banks to consider the merits of digital fiat currencies.
Money is fundamentally a special kind of IOU in society which serves as a store of value, a medium of exchange, and a unit of account against which to measure the value of goods and services. The two main types of money available to households and small businesses are bank deposits and banknotes. Commercial bank deposits account for about 97% of the money held by households and businesses and carry a form of credit risk – customers needing to make a payment rely on their bank to have sufficient assets to enable a cash withdrawal or enable settlement with another bank, and this carries risk for any deposits in excess of the FCFS guaranteed limit of £85,000. Banknotes issued by the BoE make up the vast majority of physical currency used in the UK economy and are the only form of credit-risk free central bank money that most households and small businesses have access to. Banknotes provide an element of confidence in the banking system as households and businesses know that they can convert deposits to central bank money – a comfort to the reported 10% of Brits that still hide cash in their mattresses.
However, the payments landscape is changing rapidly and the relevance of physical currency is fast declining. Partly this is due to demand as young consumers seek new payment systems that work with smartphones and other devices, partly this is due to ever more advanced digital payment systems, and partly this is due to the rise of e-commerce. According to UK Finance, in the last quarter of 2017, debit cards overtook cash for the first time as the most frequently used payment method in the UK. In 2018, only 28% of payments were made using banknotes, and this is projected to fall to just 9% of payments by 2028. In some ways the dash from cash is welcome – cash is inefficient and according to The Economist in rich countries the minting, sorting, storing and distributing of cash can cost about 0.5% of GDP. Furthermore, the switch to electronic payments makes people and shops less vulnerable to theft, enables retailers to expand their reach to well-beyond their local neighbourhoods, and makes it easier for governments to detect fraud and tax evasion. Nevertheless, the rapid decline of banknote usage risks reducing the BoE's ability to ensure financial stability in the event of crisis, and also risks leaving many people behind, particularly the poor and elderly, as the decline of cash also eats away at the business case for commercial banks to provide cash machines in far flung places.
It is against this backdrop that CBDC is being considered. A CBDC is an electronic form of central bank money that could be used by the public alongside cash and bank deposits. The idea is that the public could exchange the crumpled £5 note found at the back of the sofa for £5 of risk-free digital dosh. In the layered architecture platform model explored by the BoE, a core ledger (read database) would be managed by the central bank to process transactions made using CBDC, while API access would allow third party payment interface providers to handle the customer side of things. While not quite the same thing as a cryptocurrency, and certainly lacking the anti-establishment motivation, CBDC may even use distributed ledger technology and all of the associated clever developments such as smart contracts – it is worth noting that the UK Jurisdiction Taskforce (UKJT), part of the LawTech Delivery Panel, declared in November that cryptoassets can be treated in principle as property and that smart contracts are capable of satisfying the conditions for forming contracts under English Law.
The BoE is not set on any particular design principle, but it is clear that any CBDC must be available 24/7, resilient, scalable, secure, efficient, and adaptable as technology advances. Other advantages of cash to the end user, such as anonymity, have not yet been thoroughly considered, but the advantages of a CBDC to a central bank are clear. As a CBDC will require servers somewhere to retain information on transactions, the ramifications on many aspects of society are likely to be huge.
It is not surprising that several countries are considering getting in on the act. The Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Sveriges Riksbank and the Swiss National Bank, together with the Bank for International Settlements (BIS), announced in January that they had created a group to share experiences as they assess the potential cases for CBDC in their home jurisdictions. Countries from France and Germany to Canada, Russia and Japan have researched CBDCs. Several countries including Thailand and Cambodia have announced their intentions to trial CBDCs. In February, Sveriges Riksbank announced that it would be conducting a pilot project to develop a technical solution for an e-krona based on distributed ledger technology.
By far the furthest down the road to a fully implemented CBDC is China. In the middle of the pandemic in April, China rolled out a homegrown CBDC across four cities as part of a pilot program. This in turn has jerked the US into action – on 30th June the US Senate Committee on Banking, Housing, and Urban Affairs held a virtual hearing on the digitization of money and payments with a focus on CBDC, motivated in part by an as yet unjustified concern for the world dominance of the US dollar.
Inevitably, the adoption of any new technology by central banks will bump up against intellectual property rights. The People's Bank of China has over 80 pending patent applications relating to digital currencies. In contrast, neither the BoE or European Central Bank appear to be filing any patent applications relating to digital currencies. Nevertheless, in the west many large banks and private companies are contributing to the ever-growing number of patent filings for digital currencies and payment systems - Visa even has a pending PCT application concerning the conversion of physical currency to digital cash.
Should the BoE decide to progress with CBDC, the nature of the technology means that in all probability the BoE would own and operate one or more servers on which the underlying core ledger is processed, and so may run the risk of infringing third party IP rights. One would expect a responsible central bank to opt for the best operable system able to withstand the test of time, and not seek to circumvent key patent rights, especially as those patent rights last only for 20 years. Furthermore, the BoE would almost certainly need to partner with private enterprise in order to build the CBDC. Accordingly, some patentees may be sitting on a goldmine in potential license fees, especially if other central banks progress further in their own plans for CBDC.
While it is unclear as yet what the future of CBDC will be, this is an intriguing idea that will not disappear any time soon – you can take that all the way to the bank.
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