A Bank of England central digital currency would have ‘far reaching consequences’ - including risk of state surveillance

Derek du Preez Profile picture for user ddpreez January 13, 2022 Audio mode
Peers on the House of Lords Economic Affairs Committee have said that any central bank digital currency is potentially a ‘solution in search of a problem’

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(Image by Gerd Altmann from Pixabay )

Any central bank digital currency (CBDC) developed by the Bank of England would pose significant risks and have far reaching consequences - including state surveillance of people's spending choices - according to a new House of Lords report released today. 

Whilst a CBDC is different to privately issued cryptocurrencies - such as Bitcoin - the decline in cash payments and the digital innovation happening in the financial sector is spurring governments to consider the possibility of digital currencies. There is also growing concern that big tech companies could issue their own digital currencies, enabling them to accrue excessive market power. 

Over 90 central banks are exploring CBDCs, which would be a form of electronic money issued by a central bank that could be used by households and businesses to make payments - essentially, it would create a ‘digital banknote'. 

However, peers on the House of Lords Economic Affairs Committee have said that a CBDC could be a ‘solution in search of a problem' and have far reaching consequences for households, businesses, and the monetary system for decades to come. IT could also pose significant risks, depending on how it was implemented. 

The Bank of England and HM Treasury have created a Joint Taskforce to explore the possibility of a CBDC, but no final decision has yet been reached. However, whilst the Economic Affairs Committee notes that consumer payment preferences and technological developments may enhance the case for one, it has said that it has yet to hear a convincing case for why the UK needs a CBDC. 

Lord Forsyth of Drumlean, Chair of the House of Lords Economic Affairs 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.

The core issues

Whilst the Committee is currently against the idea of a CBDC, it does note that there are some arguments for its creation. For instance, the threat of big tech - such as Facebook/Meta - creating their own alternative and proving popular enough to compete with the current traditional monetary systems in place. 

However, the Committee adds that whilst this is a risk, it would be better to regulate companies and payments systems - rather than competing. 

Equally, whilst payments made via debit and credit cards - including digital wallets - has accelerated (particularly during the COVID-19 pandemic), cash continues to be widely accepted in the UK; and the Committee's report notes that "it is not obvious that the properties of CBDCs would satisfy the demand for cash, which is valued for its physical properties and the privacy that it can provide". 

Importantly, the report released today notes that any CBDC would have implications for the UK's monetary system. It notes: 

If a CBDC is introduced, it is inevitable that some people will transfer money out of their bank accounts and into CBDC wallets. This process is known as disintermediation, but it is unclear how much might take place, and will depend ultimately on how a CBDC is designed. 

Without safeguards, such as limits on the amount of CBDCs individuals can hold, financial instability could be exacerbated during periods of economic stress as people seek to replace bank deposits with CBDC which may be perceived as safer. 

Equally, whilst there are some design options that would provide some privacy safeguards, the Committee believes that technical specifications alone may be insufficient to counter public concern over the risk of state surveillance. We've seen time and time again how the state has rushed through technology projects, only for them to be withdrawn over the public's privacy fears - so this isn't an unwarranted concern. 

One potential advantage for households and businesses could be that a CBDC system further spurs innovation and competition in payments, possibly leading to a reduction in card fees paid by merchants. But beyond that, the Committee found few other compelling reasons for its introduction for consumers and organizations. 

Cross-border payments were also flagged as a potential opportunity, as they are currently expensive and slow. However, a CBDC would still have to comply with oversight frameworks, national laws and international technical standards, which "are a long way from being agreed". Equally, cross-border payments are already improving because of innovation in the fin tech sector and a great deal of international collaboration is underway to make them more efficient - the Committee argues that it may be better to continue to pursue this route, instead of adopting a whole new system. 

International factors

The Committee does recognize, however, that the reliance on the US dollar and the SWIFT messaging system, which supports cross-border payments, has enhanced the US's ability to implement sanctions. Reducing this reliance on the US dollar is often a motive behind countries' ambition to create a CBDC. 

The report states: 

In the short term, barriers to bypassing the US-dominated international payments system remain formidable. Complex agreements on standards, design and governance would have to be agreed by all countries concerned. However, agreements between small groups of countries could be negotiated more quickly, and it is apparent that there is political will in certain countries, such as China, to create alternatives to the existing international payments system. 

This trend could erode the US dollar's sanctions leverage. We recommend that HM Treasury's Office of Financial Sanctions Implementation assesses whether similar risks exist for sterling and the euro.

However, risks remain. Firstly, individual CBDC accounts could be compromised through weaknesses in cyber security. Second, the centralized CBDC ledger, which would be a critical piece of National infrastructure, would inevitably be a target for attack from hostile state and non-state actors. The Committee notes that any CBDC would need to be adaptable enough to manage emerging security threats and technological change. 

If a CBDC did get the go-ahead though, there could be opportunity for the UK on the global stage. The report states: 

The UK is well placed to lead on developing international standards for CBDCs. It would derive most long-term benefit by ensuring global standards and rules on governance, privacy, security, and interoperability are compatible with the national interests of the UK and its allies.

My take

My instinct tells me that the UK will go ahead with this, as will many countries across the globe. However, it is always a huge red flag to me when a project in search of a problem gets the go-ahead, particularly when there are so many high profile risks involved. Introducing a central digital banking system should be thought through over years and years, not rushed through simply because it can be. Too much is at stake to make big mistakes in this area. 

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