Lord Sarfraz is a Conservative member of the House of Lords and a Member of the Science and Technology Committee.
Today in the House of Lords, I will be speaking about a digital pound. Specifically, on this occasion, I will be asking the Government what assessment it has made of a UK Central Bank Digital Currency (CBDC).
There is already much thinking that has already gone into this. The Bank of England’s CBDC discussion paper, published last year, started the ball rolling for a digital pound.
A digital pound, backed by the Bank of England, could be a major win for individuals and businesses. With a digital pound, held in an electronic wallet, many bank fees could be eliminated, and foreign currency exchange risks substantially reduced. Importantly, such a currency could compete with Bitcoin’s market share, which currently stands at approximately US$1 trillion. It is estimated by the FCA that 1.9 million adults in the UK already own cryptocurrencies, and this number is growing.
A successful digital pound will need to be built with the right technology. The Bank of England has several options, including using a decentralised distributed ledger, like other cryptocurrencies. However, the very principle of “decentralisation” will not come naturally to any “central” bank. Most importantly, central banks will need to work with each to ensure their various CBDC’s operate on the same technology standards. Otherwise, we will have the same problem we have with fiat – a pound note doesn’t fit in a US vending machine.
Other countries are already forging ahead with plans for a digital currency. Japan’s Central Bank has launched a one-year digital currency trial this year. Furthermore, this week the Chinese government has officially started to issue digital yuan to 750,000 recipients. Other central banks around the world are also experimenting with digital currencies of their own. There are already several GBP-pegged stablecoins in the market. We now need to pick up the pace on a Bank of England issued digital currency.
Alongside issues of supply, there is clear demand for stable digital currencies. Tether, a stablecoin pegged to the US dollar, already has a US$45 billion market cap. However, CBDC’s will not mark the end of Bitcoin, nor should that be our objective. Bitcoin will still be the “people’s digital currency”, uninfluenced by central banks or governments. Without the success of Bitcoin, we would never have been thinking about a digital pound in the first place.
The rationale for the emergence of a digital pound is that the current banking system has several drawbacks. Over the past few decades, commercial banks have diversified their revenue sources. As a result, “non-interest income”, mostly in the form of bank fees, have become an important source of income. Bank fees are charged on all sorts of things – account maintenance, overdrafts, cashier checks, reference letters, returned cheques, and wire transfers to name a few. There are entire online comparison sites helping consumers navigate bank fees.
Individuals making or receiving overseas payments, and those travelling overseas for both business and pleasure, get hit especially hard. They are faced with foreign currency losses (often twice during a trip – on departure and return), foreign ATM fees, traveller’s cheques issuance fees, fees for sending or receiving money, and fees for overseas transactions. Similarly, businesses that are buying and selling overseas, have to manage foreign currency risks and pay substantial transaction fees.
While some challenger banks are doing a good job reducing transaction fees, many still earn considerable non-interest income. They would say, quite rightly, that regulatory and compliance costs have skyrocketed, which result in the need to find additional sources of revenue.
A digital pound could be even more powerful when combined with smart contracts. Take the example of trade finance. In today’s archaic system, international trade is entirely dependent on banks, without whom costly letters of credit – the principal instrument in import and export – cannot be opened. Letters of credit were used by the Medici Bank in the 14th century, and are still in use today. A smart contract, programmed into a digital wallet, could mean importers and exporters could use their digital pounds to conduct trade without banks.
Any solution afforded by the emergency of a digital currency would be part of the UK’s burgeoning fintech sector. The UK has already established a strong fintech sector and it could become even stronger. It has built on the UK’s historic strengths in financial services, which contributes an estimated £132 billion to the UK economy, corresponding to 6.9 per cent of the economy. The UK’s fintech market generates over £11 billion in annual revenues, and claims 10 per cent of market share globally. It is no surprise that 71 per cent of all British people interact with at least one fintech, which is higher than the global average of 64 per cent.
The Kalifa review reported in late February proposed five key recommendations. One of those was focused on creating a new regulatory framework for emerging technology, and this would include virtual currencies. The report’s author explained: “Fintech is not a niche within financial services. Nor is it a sub-sector. It is a permanent, technological revolution, that is changing the way we do finance.”
Fintech has already brought benefits for people in everyday life, and the UK has become a particularly strong hub for its development. Looking ahead, a digital pound could bring benefits for both consumers and businesses and the UK must move faster in exploring the mechanics and regulatory system of such an innovation.