Fintech enables a centrally controlled digital currency

Stablecoins are the less popular sibling of crypto assets. They are different, as they are a payment method rather than an investment or asset. Pegged to an underlying asset they are inherently more stable than crypto as an asset. With a stablecoin, the price is designed to be pegged to a cryptocurrency, fiat money, or exchange-traded commodities (such as precious metals or industrial metals). They are currently a small part of the overall crypto market, worth around the $130bn mark, which is about 5 per cent of the market. That said, their size has doubled since 2020.

Stablecoins have thus far been confined to crypto payment systems, with an emergent and experimental use case being seen in wholesale financial market players and large corporates. Yet it is another facet of stablecoins that is emerging; their potential use by central banks to create a central bank digital currency (CBDC).

A CBDC would integrate into existing payment systems used by financial institutions and would be relatively risk-free; backed by a central bank, like physical banknotes and coins. According to the Atlantic Council (an independent think tank), some 87 countries were exploring issuing a CBDC as of March 2022. Less than two years prior, in May 2020, just 35 countries were considering a CBDC. But now, 14 countries, including India, China and South Korea, are in the pilot stage with their CBDCs and preparing for a possible full launch. Nine countries have now fully launched a digital currency.

Britcoin is the UK’s potential CBDC. It is still in a nascent and theoretical stage of development with lots of talk but not much action so far. However, its establishment is feasible and is thus firmly on the radar of the Bank of England, having been discussed in several speeches and the topic of a discussion paper back in 2020. A Central Bank Digital Currency Taskforce was created in 2021 and the Bank of England is currently in consultation phase to see whether a case for a Britcoin can be made and what its scope would be. The Bank is working with Asos, Spotify and PayPal, among other companies, to consult on its CBDC Engagement and Technology forums with the aim of making any Britcoin operationally and technologically robust. It is thought that the latter part of the decade would be the earliest date for the launch of a UK CBDC.

A framework for e-money through the Electronic Money Regulations 2011 and Payment Service Regulations 2017 does, however, provide a foundation for payment firms in the UK. Although this is not explicitly for stablecoins, it is a good foundation because its framework could be relatively easily applied to stablecoin issuance, and the provision of wallets and custody services, according to a government paper published in early April 2022.

Britcoin does seem to have some support too. In a 2021 speech Tom Mutton, fintech director at the Bank of England, outlined the intention: “CBDC would make central bank money available to the public, in digital form, for the first time. Crucially, if introduced, CBDC would complement – rather than replace – cash and bank deposits.”

Siobhan McArdle, chief executive at L3COS, the fintech company behind an enabling operating system, says: “In many ways, CBDCs will work very similarly to the fiat currencies we use today. They will be minted by a central bank or authority and then distributed through a variety of means. Like fiat currencies, only a limited amount will be minted to maintain and regulate value.”

A Britcoin could be a positive thing. The most obvious benefits are the low costs and the speed of transacting – particularly when it comes to cross-border payments.

There are also benefits for the central bank. In particular when issuing emergency funds instead of printing money to buy up government bonds or other securities, as is currently the case with quantitative easing (where there is a need to lower interest rates by increasing the money supply). Again, using a Britcoin would be cheaper and faster than physically printing money.

However, Britcoin might be bad news for commercial banks. The Bank of England’s deputy governor for financial stability, Sir Jon Cunliffe, said in November 2021 that if a CBDC was introduced, 20 per cent of deposits could move out of the commercial banking system as a result.

Yves Longchamp, head of research at SEBA Bank, explains: “There’s an argument saying that if you held a Britcoin account with the Bank of England then why would you want to hold an account with a commercial bank. That said, central banks are not set up to hold deposits or lend directly to consumers and so it’s likely that the Britcoin would be used in much the same way as cash or electronic money. The central banks, instead of pumping money electronically into the system, will pump it digitally.”

McArdle says this is no bad thing. “It’s true that having secure private wallets would make the traditional function of personal banking redundant. However, in a digital economy, banks need to evolve and serve other purposes outside of being cash depositories. Banks can also join the L3COS platform and be part of the fintech revolution happening around them by offering more agile, market-led and innovative financial solutions,” she comments.

If nothing else a Britcoin would promote choice, something that is increasingly important as consumers become more demanding and have higher expectations of their financial services providers. So, whether they want to use a private digital currency, a publicly issued digital currency by the Bank of England, or indeed a mixture of the two, they could at least choose.

High standards, particularly around transparency, are likely to feature high up the list of must-haves. In a speech in October 2021 Cunliffe said: “Crypto technology offers the prospect of further transformation in the way we pay and the use of money as a means of transaction. However, the development of stablecoins for general-purpose use at-scale cannot be allowed to come at the cost of lower standards or higher risks to financial stability. Regulatory authorities will need to ensure that the standards that apply to current systemic payment systems apply equally effectively to any systemic or likely to be systemic payment system using stablecoins.”

McArdle explains the importance of transparency: “While the transparency of a blockchain-based CBDC is of huge benefit to regulators, it equally allows individuals to hold businesses and governments accountable. If regulated, individuals may be able to see where banks are investing, and what transactions key government officials are making – decisions that are increasingly important in today’s world.”

One example of this would be the ability to enforce financial sanctions or regulate financial institutions. “The use of CBDCs will provide a transparent account of where money is, where it is being kept, and where it has come from. The governing bodies would be able to set rules that could automatically stop an entity from making any illegal transactions,” says McArdle.

In a Which? Money podcast in October 2021 Mutton said: “The use of data can have relevance to certain public policy objectives. The most obvious one is avoiding financial crime, avoiding money laundering. And we will have to consider the circumstances in which data might be used with the proper protections by the right authorities where it is necessary for the purposes of law enforcement.”

High levels of control and transparency also give rise to the issue of control and programmability. What is positive in one area is negative in another.

A key facet will be the privacy of individuals. Cash is non-traceable – the Bank of England produces money but then does not trace it. But unless there is a privacy layer introduced, the same cannot be said of a Britcoin and, in theory, it would be easy, if not ethical, to use private data for control or other purposes. This is unlikely to happen in the UK, where there are high ethical standards and financial stability but conceptually, it is possible.

Programmability is a particular area of concern. This would mean that a Britcoin could be programmed to only be spent on certain things, or spending limits could be set. The obvious example is with state benefits but that could extend to healthy eating, environmentally sound choices, or anything else that the state was keen to push at any given time. Anonymity, as with banknotes, would be one way of dealing with this.

Longchamp comments: “A security layer would be a positive thing. Individuals would need to pass through some sort of gateway security but then become anonymous once inside the system – in the same way that nightclubs have bouncers but then once inside individuals are not identifiable. It would be a financial whitelisting system to gain access to the pool of liquidity inside. That way you know that all the other users are also clean, but that would be the extent of it.”

McArdle adds: “Anonymity can be programmed into a digital ecosystem. For example, with L3COS, there is a possibility to transfer the voting system into a digital format, which can be made completely anonymous and would solve many accessibility issues around voting as well as vote counting, as it can all be facilitated through the platform.”

This relates to digital identity, where every individual and entity has a digital identity, much like a persona in a game like ‘Fortnite’ that is connected back to the username and login. So, everyone can transact with certainty and transparency. Each digital identity would be connected to the individual’s own unique wallet, which houses their CBDCs, alongside any other assets they may have. With full traceability regarding people’s digital holdings, CBDCs could be safely implemented, audited, and therefore fully regulated.

McArdle summarises: “On a properly run and regulated ecosystem, CBDCs can indeed be programmed to follow a set of rules but this is not all bad. Recent events highlight one of the main benefits of this. The sanctions against Russia have led many institutions and businesses to re-analyse their KYC (‘know your customer’) data to check that they are compliant. However, any verified data could be used to immediately flag the entities and individuals of interest and freeze assets where necessary. Further to this, it would ease the risk for many institutions and individuals, as the platform could also automatically stop a non-compliant action.”

At the end of the day, all stakeholders, individuals, businesses, and government have much to gain from the introduction of CBDCs. But as with all things in life, only if implemented within a strong governance structure.

Longchamp says: “This is quite far off becoming a reality. Implementation and uptake will take time – maybe a generation – and so there is time to get things right and move this from something that is theoretically possible to making it a genuine alternative to cash.”