Blockchain, Society and Digital Pound

This article is written in the context of the seminar with a similar name taking place at the University Business School in Edinburgh, UK, in which we are participating. It elaborates on the theme while also addressing global dynamics.

The Digital Pound representative image; AI generated using Bing

The fintech revolution is infectiously catching up with all corners of the globe, and United Kingdom is no exception.

If we were to pick one reason that looks to be driving this paradigm shift, it would be blockchain technology.

The emergence of Central Bank Digital Currencies (CBDCs), a notion that has taken hold around the globe and is now progressively spreading its impact to the UK, is the most significant step in this change.

As a privileged participant in the initial roundtable discussions initiated by the Bank of England, we at Redeem Technologies, have been actively engaged in consultations and the documentation surrounding this groundbreaking endeavor.

Now, we are proud to announce our participation in the upcoming seminar, “Blockchain, Society, and the Digital Pound,” scheduled for Wednesday, 4 October at the University of Edinburgh Business School.

Against this background, I am pleased to bring this article that explains the connotation of the theme of the seminar and our take on it along with the wider discussion on the hot topic.

Introduction

Blockchain technology stands to ignite the fintech revolution with its fresh concepts of transparency, decentralization, security, and programmability.

Within this realm of possibilities, Central Bank Digital Currencies (CBDCs) have emerged as one of the most promising applications of blockchain technology, and the United Kingdom is charting its course finally to chatch up with this fast moving global phenomena.

Understanding CBDCs

At its core, a CBDC represents a digital rendition of a nation’s fiat currency, issued and governed by the central bank.

In the context of the UK, it is referred to as the Digital Pound.

It is crucial to note that CBDCs carry the crucial endorsement of governments and generally share many of the fundamental traits of traditional cash, very unlike cryptocurrencies like Bitcoin.

Differences with Traditional Cash and Cryptocurrencies

The degree to which a Central Bank Digital Currency (CBDC) differs from traditional physical currency or cryptocurrencies such as Bitcoin depends on how each country’s central bank designs and implements the CBDC.

However, here are some key differences and potential differentiating factors that may apply to CBDCs:

1. Central Bank Oversight: CBDCs are issued and regulated by the central bank of a country, providing a high level of oversight and control compared to physical cash or decentralized cryptocurrencies, which operate independently of any central authority.
2. Legal Tender: CBDCs are typically recognized as legal tender, just like physical cash. This means they must be accepted for transactions within the country, while cryptocurrencies are not always accepted as legal tender.
3. Government Backing: CBDCs have the backing of the government and central bank, instilling trust in users. In contrast, cryptocurrencies are decentralized and not backed by any government or central authority.
4. Exchange Rate Stability: Many CBDCs are designed to maintain a stable exchange rate with the national fiat currency, reducing the volatility often associated with cryptocurrencies like Bitcoin.
5. Regulation and Compliance: CBDCs are subject to regulatory frameworks and anti-money laundering (AML) and know-your-customer (KYC) requirements, making them compliant with existing financial regulations. Cryptocurrencies may operate in a more decentralized and less regulated environment.
6. Anonymity and Privacy: CBDCs can vary in terms of privacy features. Some CBDCs may offer enhanced privacy, while others may be designed with greater transparency and traceability. Cryptocurrencies like Bitcoin often offer a higher degree of privacy but may also face regulatory scrutiny for this reason.
7. Infrastructure: CBDCs rely on established financial infrastructure, including banks and payment systems, which can facilitate their adoption for everyday transactions. Cryptocurrencies often require separate infrastructure and may not be as widely accepted.
8. Cross-Border Transactions: CBDCs may be designed to facilitate cross-border transactions and international trade more effectively than physical cash or cryptocurrencies, which can face challenges related to exchange rates and international regulations.
9. Smart Contracts: Some CBDCs may incorporate smart contract functionality, enabling programmable money for automated transactions, which is a feature not typically found in physical cash.

Again, all the above differences need to be factored in with the design elements and the implementation methods of the CBDC. That is the reason the CBDC of one country might be quite different from that of another country. As the concepts evolve and its implementation becomes more universal, the differences shall become better defined and understandable.

The Promise of a CBDC

However, CBDCs has the potential to usher in a myriad of benefits on full implementation, including:

1. Financial Inclusion: They can act as a safe and efficient entry point for the unbanked and underbanked, allowing for greater financial involvement.
2. Streamlined Cross-Border Payments: CBDCs have the potential to ease cross-border transactions by lowering costs and shortening settlement times.
3. Enhanced Security and Transparency: Robust security features embedded in CBDCs can amplify financial transparency, offering a safer avenue for transactions.

Navigating Challenges

However, while the Digital Pound presents a tantalizing vision, it is not without its challenges.

Before discussing the design and implementation challenges, let me point out some fundamental issues of concern:

1. Privacy issues — how to balance the need for privacy vis-a-vis preventing financial crime
2. Cybersecurity risks — unauthorised access to digital wallets; identity and access mechanism
3. Impact on traditional banking — financial stability (money laundering, financial terrorism, bank runs), monetary policy (bank disintermediation concerns, monetary interventions)
4. Regulatory changes — existing laws shall require tweaking to adjust the vagaries of CDBC

These four concerns are pivotal considerations to address.

Striking the right equilibrium between privacy and regulatory oversight is paramount.

And then there are some peculiar technical challenges arising from design and implementation of CDBC.

1. Scalability: CBDCs need to be able to handle a large number of transactions per second. This is a challenge for any distributed ledger technology (DLT), but it is especially important for CBDCs, which could be used by millions or even billions of people.
2. Interoperability: CBDCs need to be interoperable with existing payment systems. This means that users should be able to use their CBDCs to pay for goods and services from merchants who do not accept CBDCs directly.

Types of design and implementation in other countries’ CBDCs

There are two main types of CBDCs: retail CBDCs and wholesale CBDCs.

1. Retail CBDCs: Retail CBDCs are designed for use by the general public. They can be used to make payments for goods and services, and to store value.
2. Wholesale CBDCs: Wholesale CBDCs are designed for use by financial institutions. They can be used to settle payments between banks and other financial institutions.

CDBCs around the globe

The UK isn’t traversing this transformative path alone.

Countries across the globe, including China, Hong Kong, Singapore, and India, have either already launched or are piloting their own CBDCs.

Notably, India took the pioneering step of introducing the Digital Rupee in December 2021, currently in the pilot phase with plans for broader implementation by the Reserve Bank of India.

Let’s see briefly the extent of these implementations and the types of design being done.

• China: China is currently piloting a retail CBDC, called the digital yuan. The digital yuan is designed to be a complement to cash, and it can be used to make payments at participating merchants and to withdraw cash from ATMs.
• Sweden: Sweden is currently piloting a retail CBDC, called the e-krona. The e-krona is designed to be a replacement for cash, and it can be used to make payments at participating merchants and to withdraw cash from ATMs.
• The Bahamas: The Bahamas is the first country to launch a fully functional retail CBDC, called the Sand Dollar. The Sand Dollar is designed to be a complement to cash, and it can be used to make payments at participating merchants and to withdraw cash from ATMs.
• Singapore: Singapore is currently exploring the development of a wholesale CBDC, called Project Ubin. Project Ubin is designed to improve the efficiency and security of cross-border payments between financial institutions.
• India: India has launched the Digital Rupee.

Of the above, only Singapore is pursuing the wholesale design while the rest are currently piloting the retail design.

There are a number of reasons why Singapore is pursuing a wholesale CBDC design.

Singapore being a financial center and major center for cross-border payments, a whole CDBC makes perfect sense as it shall make the payments efficient and secure.

Second, a wholesale CBDC could help to reduce the risk of financial instability.

Third, Simgapore believes that a wholesale CDBC might promote innovation.

The other countries on the list are pursuing retail CBDCs for a different set of reasons. For example, China is piloting a retail CBDC to reduce the use of cash and to promote financial inclusion. Sweden is piloting a retail CBDC to make payments more efficient and convenient. The Bahamas launched a retail CBDC to improve financial access for its citizens.

UK’s Digital Pound

As the UK charts its journey into the digital realm of the Pound, and brings in the Digital Pound, several key recommendations should guide this transformation:

1. Transparency and Engagement: Government and the Bank of England should uphold transparency and active engagement with stakeholders, fostering trust and aligning the Digital Pound with user needs.
2. Prioritizing Privacy and Security: Privacy and security should be non-negotiable cornerstones in the design and implementation of the Digital Pound. Strong encryption and robust security measures are imperative defenses against cyber threats.
3. Interoperability: Collaboration and interoperability with other CBDCs and existing payment systems will facilitate seamless cross-border transactions while mitigating the risks of fragmentation.
4. Assessing Impact: An astute evaluation of the Digital Pound’s potential impact on traditional banking services is vital to ensure stability within the financial system and safeguard consumer interests.
5. Accessibility: How to make the the digital pound easily accessible to all users, irrespective of income level, technical expertise or internet connectivity. This may involve developing different types of wallets and payment solutions.

A Transcendent Potential

In closing, it shall not be an exaggeration to suggest that a Digital Pound can reshape the financial landscape of UK besides enormously benefitting society. .

However, it needs to tread with caution, follow proper recommendations by experts, learn from experiences and setbacks from round the globe, and navigate inherent risks and challenges in this ambitious endevour

Disclaimer: The author is Cofounder and Chief Operating Officer of Redeem Technologies, Edinburgh, UK