Today the cross-party Lords Economic Affairs Committee published its report, ‘Central bank digital currencies: a solution in search of a problem?’
The report concludes that there is no convincing case for why the UK needs a central bank digital currency (CBDC). The committee found that while a CBDC may provide some advantages, it could present significant challenges for financial stability and the protection of privacy.
A CBDC is different to a crypto asset such as Bitcoin, which is privately issued and not backed by any central party. A CBDC would be a form of central bank electronic money that could be used to make everyday payments – in essence a ‘digital banknote’. The Government has not yet decided whether to introduce a CBDC.
If a CBDC is introduced, it is inevitable that some people will transfer money out of their bank accounts and into CBDC wallets. Without safeguards, such as limits on the amount of CBDC individuals can hold, financial instability could be exacerbated during periods of economic stress as people seek to replace bank deposits with CBDC which may be perceived as safer.
To prevent their use in large-scale criminal activity, any CBDC system could not support anonymous transactions in the same way that cash can be spent anonymously. While there are design options that would provide some privacy safeguards, technical specifications alone may be insufficient to counter public concern over the risk of state surveillance. The Bank of England risks being drawn into controversial debates on privacy.
A CBDC could enable central banks to conduct forms of unconventional monetary policy more easily. While the Governor of the Bank of England told the committee that he did not see a CBDC as a way to implement monetary policy, the committee noted that his successors may disagree. Such measures may increase the Bank of England’s role and influence in the economy and any changes to the Bank’s monetary policy toolkit should be scrutinised carefully. The committee recommended that the Joint Taskforce publishes its assessment of the potential for monetary policy via a CBDC in its 2022 consultation to assist this scrutiny.
The introduction of CBDCs by the UK’s strategic competitors may have consequences for western foreign policy. For example, the SWIFT messaging system enhances the US’s ability to implement sanctions. However, there is political will in certain countries, such as China, to create alternatives to the existing international payments system using CBDC technology.
Lord Forsyth of Drumlean, Chair of the House of Lords Economic Affairs Committee, said:
“The introduction of a UK central bank digital currency would have far-reaching consequences for households, businesses, and the monetary system. We found the potential benefits of a digital pound, as set out by the Bank of England, to be overstated or achievable through less risky alternatives.
“We took evidence from a variety of witnesses and none of them were able to give us a compelling reason for why the UK needed a central bank digital currency. The concept seems to present a lot of risk for very little reward. We concluded that the idea was a solution in search of a problem.”
The Committee’s other key findings and recommendations include:
There are two main security risks posed by a CBDC. First, individual accounts could be compromised through weaknesses in cyber security. Second, the centralised CBDC ledger, which would be a critical piece of national infrastructure, would be a target for attack from hostile state and non-state actors. While no design can guarantee absolute security, any CBDC system will need to be adaptable to emerging security threats and technological change, including fast-developing quantum computing.
There may be some benefits from the introduction of a ‘wholesale’ CBDC for use between financial institutions. While the wholesale operations of the monetary system are already efficient, a CBDC may help to further enhance efficiency in securities trading and settlement, but further exploration and experimentation are necessary. The committee recommends the Joint Taskforce consults on the use case for a wholesale CBDC alongside its 2022 retail CBDC consultation.
The case for a digital pound may change in the future and therefore the Government and Bank of England could derive most benefit now by taking action to shape global standards which suit the UK’s values and interests, for example with regard to privacy, security and operational standards.