28 June 2020
CryptoUK (CUK) welcomes the opportunity to comment on the Bank of England’s (BOE) Discussion Paper: Central Bank Digital Currency: Opportunities, challenges and design (“the Discussion Paper”).
Below are the collective responses from our members and chairperson to 15 of the 35 questions posed by the BOE. We appreciate this discussion paper is focussed on a retail CBDC and will focus the answers accordingly.
7.2 Understanding the impact of CBDC on payments
1. How could CBDC be designed to support a more resilient payments landscape in the UK?
One of the ways in which resilience is achieved in wholesale banking payments, is through netting. This achieves amongst other things, a reduction in both settlement and credit risk. We believe businesses that make multiple payments would benefit, if say there was an automatic netting system, of which a CBDC could facilitate. For illustration imagine that “Small Business A” makes 10 payments a day to “Bank A” and receives 5 payments per day from “Bank A”. A small business netting system, much like a Central Counterparty (CCC) could reduce inherent risks by netting the businesses 10 payments to 5. This has the potential to be scaled up across all commercial banks facing the merchant.
2. How could CBDC be designed in a way that improves the efficiency and speed of payments, while also facilitating competition and innovation?
Many of our members are or have been involved with the FCA sandbox. We feel that tendering some of the CNBC technical architecture to experts in the private sector, facilitated through the safe sandbox environment would foster competition and innovation. Much like how the private sector uses hackathons for such innovation and competition.
3. How could CBDC be designed to meet future payment needs? How might future innovations and evolutions in technology (e.g., the Internet of Things (IOT) change these needs?
A key opportunity for CBDC’s are micropayments (i.e., payments made for very small amounts), including cross-border micropayments. Currently, the transaction costs associated with fiat micropayments are too high to support their execution. The big banks only see economic potential in extremely large volumes. A CBDC would be suitable to facilitate micropayments cross border with benefits including speed, scalability, energy efficiency and cost.
Let’s envision a scenario where a UK resident is living pay-check to pay-check. It would improve the residents cashflow, if for example they could make small (fractional payments) for such services as their utilities, rental costs, transport etc. As opposed to current norms of monthly payments, they could be weekly or daily for example.
We could go further and use the IOT example. Energy in the home could be paid for on a kilowatt per hour (KWh) consumption basis. Or let’s say my income is inconsistent. Rather than commit to a monthly contract where I pay a sum of monies up front. The flexibility of financial management for a sporadic income would be improved, if payments for a streaming service occurred at the exact time and duration of consumption, for example.
5. Does CBDC pose other opportunities or challenges with respect to the payments landscape that we have not discussed?
Please refer to our answer to question 1 in regards a CCP.
Also, we believe that a CBDC could be used in specific segments of society and industry sectors. Perhaps those sectors that are highly regulated or prone to abuse, crime or manipulation. In healthcare the payment of prescriptions supported by the government could be automated, effectively eliminating the paper prescription, for example.
8. How could CBDC be designed to complement other public and private sector
initiatives to improve payments in the UK?
The financial action task force (FATF) recommendation 16 “Travel Rule”, as I am sure the BOE appreciates, impacts the crypto industry in a big way. I refer the bank to one initiative that we are involved with, that is seeking industry wide solutions to ensure compliance with all AML and CTF directives. Please refer to Inter-Vasp Joint Working Group.
7.3 Understanding the impact of CBDC on monetary and financial stability
12. What opportunities could CBDC provide to enhance monetary or financial stability?
In regards the setting of interest rates. Could the BOE not tailor the rates they offered to particular segments of the UK demographic? For example, offer retirees a higher rate on CBDC deposits in a low annuity environment. Also, a multi-step rates policy could address other difficult areas of the economy, such as first-time house buyers. Not wishing to get to embroiled in the discussion of free market versus intervention at the state level. However, some level of bank disintermediation could be a good thing for the broader economy and thus financial stability. As over the past few decades these and other issues have not been solved.
13. How much demand would there be to hold CBDC? How would that demand vary depending on the economic design choices outlined in this paper?
It is hard to know at this stage what demand would look like. As mentioned, the rolling out of a CBDC should be done piecemeal (specific industry sectors / demographic) and also tested in a sandbox equivalent. Also, the BOE would have the capability to manipulate demand, through their current monetary toolset and or other new innovative developments that programmable money would bring.
14. To what extent might CBDC lead to disintermediation of the banking system? How would the degree of disintermediation vary with different economic, functional and technological design options outlined in this paper? How would different degrees of disintermediation affect the stability of banks and the rest of the financial system?
As the BOE mentions in the discussion paper the disintermediate of the banking sector, through deposit balances moving from commercial banks into CBDC, could have implications for the balance sheets of commercial banks and the Bank of England, the amount of credit provided by banks to the wider economy, and how the Bank implements monetary policy and support financial stability.
Many of the early pioneers in the digital asset industry would take the libertarian view that banks should be disintermediated. Hence the catalyst for the creation of Bitcoin in 2009 (first client released Jan09) post the financial crisis that many felt was created by the banking sector.
We at CUK would advocate for a slower managed approach, however, do feel that some
form of disintermediation would benefit the UK economy and wider society in general.
A scenario we believe has potential is as follows. Could the BOE replenish the lost funding from deposits (banks liabilities) in the short term (stepped approach) to commercial banks? Would the consumer choose a risk-free loan to the central bank at a lower rate (zero), than lending to commercial banks at a higher rate? Could the BOE
then lend to the commercial bank at a higher rate? This interest margin revenue could
be used by the BOE as a safety fund for future economic shocks. In this scenario the
BOE replaces the commercial bank as deposit taker and at the same time ensures the
banks remain funded. This CBDC funding model could be priced at differing
programmable levels, to ensure the business models of the banks are not disrupted,
leading to increased lending cost to wider society.
17. How could CBDC affect the portfolio of unconventional monetary policy tools available to the central bank? How effective would a remunerated CBDC be in relaxing the effective lower bound on monetary policy?
Back in early the 2010’s the financial markets general view of the potential for zero rates
for sovereigns was one of scepticism. With the total global sovereign debt at $13 trillion with a yield of zero or lower, this has become the new normal for investors. With rates at historic lows and what most economist believe that low to zero bound rates will exist for the medium to long run, we believe the BOE should have the tools to address this. Whether your believe in a contrary thought, in respect to monetary expansion as acting deflationary, we at CUK believe that using a CBDC as a programmable tool, will allow the BOE to achieve its mandate during economic cycles, to better ensure financial stability through faster execution times (through rate changes) and additional new tools, at their disposal.
7.4 Functionality and provision of CBDC
19. What are the advantages and disadvantages of this public-private payments platform approach? What alternative approaches might be considered?
Our members agree that creation of a public-private payments platform approach in which the BOE builds the core ledger, while private sector firms “provide overlay services that extend the functionality of CBDC could prove an effective model. The more open and extensible the payments platform, the more utility it will deliver.
22. What kind of overlay services would be most useful? What functionality would a CBDC core ledger need to provide to enable these?
A layered model in which simple functionality and certainty in non-functional areas (e.g., security) can be delivered by the core system, while innovative, rich services are delivered by other components and organisations can provide a long-term strategic ecosystem which meets the broad promise of CBDC initiatives.
Introduction of simple functions – such as cryptographic conditions – will enable additional agile layers and participants to develop more complex capabilities like programmable money and smart contracts, as well as transactional interoperability with external processes. Tight-coupling of these more complex functions with the core system should be avoided to better promote future innovation, competition and efficiency across the entire ecosystem, with further layers building differentiated applications relevant to all stakeholders.
25. What is the appropriate privacy model for CBDC? Is it necessary, or feasible, to replicate any of the privacy aspects of cash?
We at CUK believe in certain levels of anonymity in any payments network. We also appreciate the need to ensure compliance in such arears as sanctioned countries and financial crime. A CBDC could ensure a “best of both worlds” approach, in so far as a de minimis value could be programmed into the system, where the sender and recipient are anonymous. Furthermore, larger payments would require this information (please refer to the travel rule in question 8) and so a trigger value could be added to the design. This could further be extended to identifying the source of funds, from say a blacklisted wallet before settlement occurs. In sum, a CBDC would enhance financial due diligence on global scale therefore, increasing financial stability.
7.5 Technology, infrastructure and further innovation
29. The core ledger for this model of CBDC could be centralised or operated through a consensus-driven distributed approach. Which is the optimum approach, and why?
Our members feel that the decision to balance a centralised versus decentralised system is highly depended on a number of factors. With a centralised core ledger, the Bank has absolute control, with a decentralised one, it can set the rules absolutely at the start, but can rely on others to enforce the rules through consensus.
Ultimately this decision, as you mention in the outline will be the one that best ensures the bank’s core mandate of financial stability. We highlight the below considerations in working through this decision.
Security and integrity of the network – how will the CBDC solve the double spend challenge? With a central ledger, it can do so by validating every transaction, no consensus needed. With a decentralised ledger, it will require a decentralised consensus mechanism, where multiple validators validate each transaction.
Censorship – what actual and perceived censorship control over the ledger does the Bank wish to exercise? With a central ledger, the Bank can prohibit or change any CBDC transaction or user of CBDC it wishes. Even with privacy and other legal and technical safeguards, this comes with “Big Brother” risk. This risk still exists if the Bank runs decentralised consensus on a permissioned DLT network where it can change the rules with the same control as with a central ledger. However, the Bank could also consider a permission-less DLT network where the rules are very difficult to change – this protects the network from outside influence in the future, and it would preserve the rules for the CBDC network with certainty for years to come. The Bank takes its independence seriously, and this would ensure its CBDC network remains independent and resistant to
any future external pressures to make changes that stray away from the original purpose and objectives of the CBDC. Rules can be added or mandated for smart contracts using the CBDC, so the Bank would still have tools to keep control of the CBDC network.
Revocability – what are the finality/revocability rules for a transaction and does the Bank require a role in applying or monitoring them?
31. What are the key use-cases for programmable money?
As mentioned in the outline a CBDC allows for increased inclusivity. This is a keyobjective for CUK, to bring the underbanked into financial inclusion. We believe that digital assets can and will facilitate this. We also believe that there is no limit to the potential use cases of programmable money in society. The main use cases include, but are not limited to micropayments, interest rate bearing (positive and negative yields), b2c commerce, b2b commerce, cross border payments, central bank swap lines and government support initiatives.
In regard to government programs (e.g. covid support) a citizen could have an account at the BOE, the bank could quickly facilitate financial support ensuring the funds go to the right person much faster than using, say the banks to issue government backed support loans, where a time-lag could exist.
35. What other future technology and digital economy innovations should we be factoring into the potential design of CBDC? How might these impact the future demands placed on CBDC, and potential approaches to designing a CBDC?
We refer you to questions 1, 8, 12, 14,15, 25 and 31.
Other considerations we would like to bring to the BOE’s attention, are as follows.
Interoperability – the design should allow for the flexibility for the CBC to interact in the current payment system in a seamless fashion. For example, one can use an ATM or a commercial bank to switch between fiat and CBDC as required with zero friction. Also, the GBP CBDC could move into another CBDC issued overseas, if the user wanted to buy travel money for example.
Digital identify – While digital identity use cases are much wider than those needed for payments, a CBDC would therefore benefit from a digital identity solution that allows wallets from multiple providers to enable authentication, authorisation and payment addressability. This should extend to the identity of individuals, organisations and devices and objects, from small tags to drones to ships, satellites and aircraft to support programmable payments in the internet-of-things.