We must not let the Chinese get too far ahead. The UK must be at the forefront of the development of central bank digital currencies to cement the City’s competitive position post-Brexit. So says a new think-tank, the CityUnited Project, which is backed by such Eurosceptic luminaries as former Chancellor Lord Lamont.
The group’s founder and chair Daniel Hodson is probably right that the momentum towards digital currencies is unstoppable — however much the Bank of England insists that no decision has been taken to go ahead with a digital pound. He is also probably right that it would bolster London’s position as a global financial centre if the UK can be one of the early adopters. But City firms should be careful what they wish for. For many, a digital currency could be a very mixed blessing.
There is little argument that a digital pound could bring big benefits for users of financial services. It would provide households and businesses with a new risk-free form of central bank money that the Bank of England says could be designed to underpin a cheaper and quicker electronic payment system. It would enable the private sector to create services that support greater choice for consumers.
“As well as providing more advanced functionality, these services might meet future payment needs by enabling programmable money, smart contracts and micropayments,” said the Bank in its discussion paper on digital currencies. Sounds great for customers. But the more successful the digital currency is as a risk-free store of value and as a payment mechanism, the more of a potential threat it will be to established financial services companies.
For a start, inevitably there will be some substitution away from cash and bank deposits to the new digital currency. This could hit commercial bank funding and affect the amount of credit that banks could provide. At times of financial stress, the impact could be acute. The digital currency could also compete with money market funds, thus further squeezing their dwindling margins.
It would threaten the fat revenues that the banks and other established intermediaries make from payments and also the money fintechs have been making from bypassing some of the inefficiencies of the current systems.
The Bank highlights better cross-border payments as a key potential benefit from the digital pound. This will presumably challenge those fintechs such as Wise (formerly TransferWise) that offer improvements over the extraordinarily expensive payment and transfer services from banks.
Some observers believe that a move towards central bank digital currencies could ultimately bring big reductions in the overall cost of financial intermediation, and so in the revenues of the financial sector as a whole.
But the industry optimists point to the work of Thomas Philippon, a finance professor at New York University’s Stern School of Business, who has shown that the cost of intermediation has remained remarkably stable at about 2% since the end of the 19th century despite wave after wave of new technologies.
While some costs, such as share trading fees, have fallen dramatically, the industry has managed to compensate by stimulating increased volumes and offering improved products. In some markets, firms have been able to hold on to the cost savings rather than passing them on to customers.
Haydn Jones, a blockchain specialist at PwC, says that while a digital currency would pose a threat to many firms’ current businesses, it would also offer a host of new opportunities, particularly because of its programmable nature. This will allow conditionality to be built into the currency so that, for example, a payment to a supplier triggers a value transfer automatically once delivery conditions are met.
The big opportunity for the capital markets would be the development of digital securities underpinned by the digital currency. Traded constantly and settled immediately these could have all kinds of features embedded in them. This would bring huge changes for the chain of intermediaries from trading venues to custody services and Jones says there will inevitably be some “Kodaks” that fail to adapt: “There will be winners and losers.” But the creative and adaptable nature of the City should mean that overall this is a big opportunity for UK finance.
Although it is a revolution that will take many years, Jones agrees that it will make a big difference for the City if the UK is among the first big countries to introduce a digital currency.
Many commentators have suggested that when it comes to central bank digital currencies, it is more important to “get it right” than to “get it first”. But there is a balance to be struck. There will be a cost to being late. Chancellor Rishi Sunak has expressed excitement at the idea of “Britcoin”. It remains to be seen if his enthusiasm extends beyond the odd Tweet.
To contact the author of this story with feedback or news, email David Wighton