As part of its quarterly report, the Bank of England published a thoughtful paper on how the digital pound can become a tool to spur innovation. More importantly, how to design a central bank digital currency (CBDC) to achieve that goal.
It outlines four ways of spurring innovation, including technology, new markets, data and standard setting.
Naturally the central bank is unlikely to come up with a ground breaking technological innovation. That’s not its mandate. However, its actions could encourage tech adoption, and it specifically mentions distributed ledger technology (DLT) as one possibility and privacy enhancing tech (PET) as another. It also believes innovation is enhanced by supporting open source software.
A CBDC requires creating a classic two sided payments market or network. And the Bank of England is planning a Platform model for the digital pound. Key drivers of adoption include incentivizing payment and solution providers to join, which means the business model design is critical. (However, we’d note some jurisdictions plan to mandate participation.)
Regarding data, the Bank sees an opportunity in aggregating anonymized data so analysts can find insights in the economic trends.
Under current design plans, payment providers hold the personal data. However, the Bank is conscious that one or more large actors could dominate and their control of data might inhibit competition. Hence, it is also mulling open banking style data sharing for the CBDC.
Finally, regarding standards, key focus areas are APIs and interoperability. It wants to ensure merchants can adopt (or switch to) any solution without friction. So the process for accepting in-store payments needs standardizing. However, the Bank recognizes it cannot set standards on its own.
Learnings from innovation case studies
Three innovations were provided as examples to glean learnings: the Global Positioning System (GPS) developed by the U.S. military, India’s Aadhar identity system, and the iPhone.
One takeway was that both the GPS and Aadhar use cases show that the private sector can be given the space to innovate organically. “The lesson here for the Bank is to avoid designing the digital pound to support particular, precisely targeted, future innovations or use cases, since it is difficult to predict.” Hence, it is wary of building functionality to target smart contracts or micropayments.
It noted that Aadhar has a deliberately simple design and did not initially target specific use cases, despite pressure to take a different path. This approach allowed the solution to be built quickly and cheaply. So another takeaway is simplicity to let the private sector to develop on top of the digital pound platform.
A third learning from the iPhone was its support of third party applications, which drove its growth and strongly encourage innovation. However, it observed that a platform can kickstart new businesses that can challenge the platform itself. For example, a payment provider might try to change the cost structure.
Hence, the Bank raises the concern “that a digital pound or a stablecoin – becomes so successful that it evolves into a monopoly provider of digital money, crowding out other innovations in this space.”
Meanwhile, the Bank recently conducted a consultation about the digital pound. We explored responses from two financial groups, the IRSG and UK Finance, which believes the digital pound holding limits are too high.
One response from the accounting body ICAEW raised the issue of the comparative disadvantage of a CBDC. The way card based systems are designed provides strong consumer protections, such as the ability to block charges and recourse against fraud. While a CBDC might provide a safe store of value, depending on its design it could be less safe in other respects.