The Rise of the Digital Pound: What It Is and How It Will Impact the Financial World

As the world becomes increasingly digital, the concept of digital currencies is gaining traction. One of the most promising digital currencies is the digital pound. This innovative currency is set to revolutionize the financial world, but many people are still uncertain of what it is and how it works. In this article, we will explore the digital pound in detail and discuss how it will impact the world of finance, whether that be for the good or the bad.

The digital pound is a form of money known as ‘Central Bank Digital Currency’, or CBDC. It is important to note that this type of current is not set to replace cash, nor is it a ‘cryptocurrency’ which is decentralized and issued privately. The Digital Pound would be issued by The Bank of England and have the backing of the Government. This offers stability and it means that your Digital Pound would be just as valuable as the cash in your pocket.

But why not just use cash? Well, the use of cash for payments has declined rapidly over the past decade and continues to do so, falling from 55% of transactions to 15%.
To move with the times, countries are needing to invest in digital currencies to retain financial strength.

When in use, the digital pound would be used for everyday payments, such as in-store and online shopping, and transferring money to family and friends. Both UK and Non-UK residents would pay through a digital wallet, provided to you by participating banks. This wallet can be accessed through smartphones or cards. However, initially, when the digital pound is circulated, there would be a limited amount per user.

Another important thing to note is that as the digital pound is similar to banknotes, interest rate would neither be paid nor charged as it is a means of payment and not a savings product.

Innovative financial technologies present the opportunity for improved provision when it comes to wholesale settlements. So, let’s take a closer look at the five main benefits: transparency, availability, efficiency, atomicity, and access.

1. Let’s start with transparency. The digital pound has the ability to increase financial transparency between firms. Users will be kept informed about the status of their payments and be able to consent to whether they wish for transactions to proceed.
2. When it comes to availability, the settlement service will work on an around the clock basis.
3. This means that there will be maximised efficiency when it comes to making payments, reducing the likelihood of friction between parties.
4. Even when it comes to atomicity, complex transactions containing several actions, the digital pound will make it safer and more efficient through the coordination of movements of funds.
5. Then finally, access. As the use of CBDC grows, the uptake among eligible institutions increases, it will become accessible to more people.

While the digital pound offers these benefits, the aim is not to prevent forms of digital innovation by the private sector. Instead, it is to support financial inclusion and improve cross-border payments. But it may also change the structure of the financial system and increase the UK’s exposure to foreign shocks.

So, CBDC does not come without its risks. It also has the potential to impact banks business models and therefore affect the cost and availability of credit. As both households and businesses switch their bank deposits to digital pounds, there could be repercussions when it comes to financial stability. Banks losing deposits also lose central bank reserves. They may replace them by borrowing in wholesale funding so they can maintain the same level of funding. However, if that wholesale funding is more costly than deposits, banks may decide to increase credit loans or reduce the quantity of credit they are willing to supply, to what extent, we do not know.

Adjustment is key to the process when looking to maintain financial stability. Banks would need the time and the flexibility to adjust to this new financial technology. However, if there is a period of financial stress where demand for digital pounds becomes particularly strong, banks could find themselves unprepared and the risk of lost deposits could be high.

Change can be difficult to get your head around and when it comes to your money, trust is a big factor. With cash, we feel in control of our money. We trust that it is safe with the bank, with the option to withdraw cash at your leisure.

Fragmentation caused by the increase in digital currencies means that people could find it difficult to convert their funds to different types of currency if they are from different issuers or use different systems. Suddenly, things become a lot more complex.

For us to trust the digital pound, the system would need to be both well governed and regulated. It would also need to uphold both monetary and financial stability. This includes maintaining low and stable inflation and stable provision of credit. Therefore, to minimize the likelihood of it impacting banks business models, the digital pound would need to be carefully adjusted into the financial system. Even with this, it still has the potential to impact the conduction of monetary policy and the Bank would need to rectify this by adjusting its design.

There has also been concern over risks to privacy, however, the Bank of England has assured that personal data would not be collected. The Consultation paper claims that a digital pound would have the same, if not stronger, privacy protections as bank accounts. This means that it will protect against counterfeiting and fraud. Also, while personal details would be known to the private sector providing the wallet, like they do with bank accounts today, they would not be known by the Government or the Bank of England.

When the digital pound was announced, Governor of the Bank of England, Andrew Bailey, said “There are a number of implications which our technical work will need to carefully consider. This consultation and the further work the Bank will now do will be the foundation for what would be a profound decision for the country on the way we use money.”

However, just because these obstacles can be overcome, doesn’t mean that the public are convinced. The Bank of England commissioned YouGov and London Economics to carry out market research, to gather public reaction to the idea CBDC. After a short introduction to the concept, they found that just 20% found the concept appealing, with 42% of people remaining unsure and the remaining people having concerns about money becoming less physical and heavily relies on the internet.

The question is, does the digital pound offer value? What do we have to gain? Is it any more reliable than the debit cards and online banking that we use today?

The consultation is open for comments until 7 June 2023. Alongside the Consultation Paper, a Technology Working Paper was also released. This outlines the digital roadmap, the technology and policy terms and the model for the digital pound.

The roadmap to the digital pound being launched consists of three phases.

1. Phase 1: This focuses on Research and exploration, which began in 2022. To proceed, a decision will need to be made on whether investment in further technology is worthwhile.
2. Phase 2: This is when the digital pound is designed, this will be from 2023-2025/26. To proceed, there would need to be major public investment. It would also need to be secure when it comes to legalities, which should be determined based off the design created.
3. Phase 3: Finally, it is time to build, which could happen in 2025 at the earliest. After this, the only questions that would remain would be, should the digital pound be launched?

So, it looks like the earliest year the digital pound could be released is 2025. Though, how well it will be implemented, or if it will be implemented at all, remains unclear.

Work is currently being done on the ‘design phase’ which will look at the technology and policy requirements for a digital pound, so everything is ready to go should they decide to proceed. Private and public sectors will collaborate to create an optimal design for the currency, and the Bank of England will only know whether the digital pound is feasible once this phase is complete. So, it may be that the model will become clearer in the future, as new benefits are found, and challenges are overcome.

While we will have to wait to see the outcome, it might be worth looking at other countries to see their developments. Countries around the world are considering similar proposals.

The U.S being one of these countries, whose central bank digital currency will be issued by the Federal Reserve, acting as legal tender.

Could we be waving goodbye to cash on a global scale?