The creation of an official UK digital currency could undermine the country’s financial stability and lead to a run on the banks during economic downturns, a Parliamentary report has warned.
The rapidly growing market for digital currencies such as Bitcoin and Ethereum could threaten the economic system because they are unregulated.
As a result, central banks such as the Bank of England (BoE) are investigating whether they can launch their own digital currencies or CBDC’s.
It is currently working with the US Federal Reserve, the European Central Bank’, and the central banks of Canada, Japan, Sweden and Switzerland on a digital currency design.
The BoE warns digitalisation is transforming national and international payments systems and governments must consider how to respond.
However, a report by the all-party House of Lords Economic Affairs Committee said the introduction of a central bank digital currency (CBDC) could pose “significant risks” in the UK.
It could pose risks to UK households, businesses and the monetary system for decades to come, the report says.
The report stated: “These risks include state surveillance of people’s spending choices, financial instability as people convert bank deposits to CBDC during periods of economic stress, an increase in central bank power without sufficient scrutiny, and a centralised point of failure that would be a target for hostile nation state or criminal actors.”
Digital currencies: What are they?
The best known cryptocurrencies are probably bitcoin or ethereum. They are digital assets that can be transferred electronically between users without intermediaries or oversight of banks and governments.
How do you know how much is in your account?
Transactions are usually stored on a decentralised ledger known as a “blockchain”. It allows users to confirm and record transactions so assets can be traced. Unlike conventional banking there is no need for a central clearing body.
Can you spend it like cash?
No. The pound is a widely accepted means of exchange. A store of value as well as a unit of account. Cryptocurrencies are often traded as speculative assets, rather than used to make payments..
What about stablecoins?
These are said to bridge the gap between cryptocurrencies and regular currencies. They are designed to be used more easily to purchase goods and services and their market value is pegged to a currency, usually the US dollar. Examples include Tether and USD Coin. Some are popular ways of trading digitally.
Are these any different from ‘digital banknotes’?
A Central Bank digital currency (CBDC) differs from the privately issued Bitcoin in that it would be backed by a central bank. A CBDC would be a form of central bank electronic money able to be used to make everyday payments. The UK Government has not yet decided whether to introduce a CBDC but others already have including the Bahamamian Sand dollar and Nigeria’s e-Naira.
They said none of the witnesses who gave evidence, including the Bank of England Governor Andrew Bailey and his deputy Sir John Cunliffe, were able to make a “convincing case” for why the UK needs a retail digital currency.
“While a CBDC may provide some advantages, it could present significant challenges for financial stability and the protection of privacy,” the report found.
“We recognise consumer payment preferences, technological developments and other countries choices may enhance the case in the future,” it said.
Central banks are concerned that big tech companies could issue their own digital currencies which could compete with central banks and their control of monetary systems.
Facebook has already announced plans to launch a digital currency called Libra.
Rishi Sunak, Chancellor of the Exchequer, told the committee the Facebook Libra project prompted the Government to ask: “What do we think about a global stablecoin that we are not in control of? What does that mean? How should we regulate that? Do we have to worry about financial stability?” He said it catalysed work around a UK version of digital currency.
In December 2020, Libra was rebranded as Diem and its ambitions were scaled down. However, Olaf Scholz, then Germany’s finance minister, described Diem as a “wolf in sheep’s clothing”.
Once established, privately issued digital currencies may enable big tech companies to wield excessive market power and reshape how payments are made, affecting how the monetary system works.
The Lords said such risks were real, but the UK’s own digital currency “may not be necessary or complete response.”
Private groups or companies big enough “to compete with the existing payments systems can and should be regulated,” it says.
The rapid pace of technological change is driving central banks’ interest in CBDCs the report says. In the past 10 years a dramatic increase in new forms of electronic payment with the result that established banks and payment operators face a challenge for market share.
An early study by the BoE suggested that among the reasons for adopting CBDC’s were avoiding the risks of new forms of private money creation, increasing competition, efficiency and innovation in payments as well as meeting future payment needs in a digital economy as well as addressing a decline in cash.
The Lords argued that a decline in the use of case and the increased use of debit and credit cards – trends accelerated by the pandemic – still didn’t justify the introduction of a digital banknote. The argue there are better ways of enhancing the payments systems with fewer risks.
Once established, privately issued digital currencies may enable big tech companies to wield excessive market power and reshape how payments are made, affecting how the monetary system works
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 Lords 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.”