In the world of digital currencies, a new term has been making the rounds – ‘Britcoin‘. This catchy moniker is used to describe a Central Bank Digital Currency (CBDC), a centralised digital currency that is quite different from decentralised ones such as Bitcoin. But what exactly is a CBDC, and should we be concerned about it?
To understand what a CBDC is, we first need to understand the difference between physical cash and the cash in your bank account. Then, we need to understand the difference between these and a CBDC, which is kind of like an account with the Bank of England itself.
When you pull out a £20 note, you’ll find a quote that says, “I promise to pay the bearer on demand the sum of twenty pounds.” Whilst seemingly insignificant, this quote is a reminder of when money was backed by gold. It signifies the government’s liability, an IOU, to you, the citizen. This meant that under the gold standard, the citizens of the British economy had a direct claim on the state. In other words, if you went to the Bank of England with £20, they would have to convert said money to gold.
However, in the modern economy where money is simply backed by trust, the scenario is different. If you were to go to the Bank of England with a £20 note, they would technically have to honour their obligation by repaying you not in gold but with another £20. But if you attempted the same strategy with money held in an electronic bank account, the Bank of England would not have to honour the obligation. This is because, while physical (public) money in the economy gives you a direct claim on the state, private money is a claim on private institutions – commercial banks.
All private banks from Halifax to HSBC will see your savings as a liability on their balance sheet. If you want to take that money out, these banks must produce it on demand. In other words, private banks have an obligation to you, another IOU. You place your trust in the bank to hold your money. While the FSCC does insure £85,000, the government is largely absent from this transaction.
With 95% of money being private money, there is little public money out there. The transition to an increasingly digital world will only reduce its usage and will potentially destabilise the monetary system.
The Bank of England aims to avoid this by introducing a CBDC by allowing UK citizens to create a bank account with the Bank itself through a ledger system. This ledger, known as the ‘core ledger‘, would be the central infrastructure for the CBDC, recording all transactions involving the digital currency.
However, individual users wouldn’t interact directly with this core ledger. Instead, private sector companies, which could include banks or approved non-bank firms, would integrate into this central infrastructure. They would provide digital ‘pass-through’ wallets to end users, acting as the interface between the Bank and the users. These wallets would pass instructions from the user to the core ledger, enabling transactions.
In essence, the user’s holdings of digital pounds would be recorded anonymously on the Bank’s core ledger to safeguard their privacy, and the wallet would simply facilitate the interaction between the user and the core ledger. With a CBDC, you would effectively be banking with the central bank, albeit through a private company’s digital wallet.
Now, because the Bank of England issues its own currency, it cannot run out of money. This means that with a CBDC, you, the citizen, could store as much digital cash in a CBDC wallet as you wish without worrying about bankruptcy. However, like cash, CBDCs carry no interest, meaning there is a tradeoff associated with this decision. Yet, this no-interest property could significantly affect monetary policy and financial stability. The Bank considers that the ease of switching to a CBDC could make bank runs more frequent. Yet, this could also serve as a more stringent acid test for banks, ensuring they maintain robust financial health to meet all on-demand cash requirements.
A CBDC could also impact the transmission mechanism, particularly when it comes to the zero lower bound. A CBDC, being digital, has more functionality than cash and could potentially reduce the constraints of the zero lower bound. If banks were to offer negative or meagre interest rates, customers could potentially choose to move their money into CBDC wallets instead.
While it is crucial to consider the implications for the wider financial system, it is important to note that CBDCs are still in the early stages of research. As such, the Bank acknowledges that many of the outcomes and effects of CBDCs are speculative at this point. What is certain however is the fact that a CBDC is a digital form of public money designed to always be available. So, would you bank with the Bank of England?