UHY Ross Brooke Chartered Accountants

How could Central Bank Digital Currency (CBDC) benefit the UK?

AI, crypto and technology specialist accountants

We’ll be looking at the pros and cons of a Central Bank Digital Currency, but before we dive in too deep too quickly, let’s understand what CBDC is.

What is CBDC and what’s the difference between Bitcoin and CBDC?

We’ll use Bitcoin as an example of digital currency, because everyone has heard of it, but Bitcoin and CBDC (Central Bank Digital Currency) are two very different types of digital currencies.

Bitcoin was created in 2009 and is a decentralized digital currency that operates on a peer-to-peer network without a central authority. It is based on blockchain technology, which is a public ledger that records all transactions made using Bitcoin. Bitcoin can be bought and sold on cryptocurrency exchanges, and it is not backed by any government or central bank.

CBDC is a digital version of a country’s fiat currency (e.g. dollars, euros, yen) which is issued and backed by the central bank. CBDCs are centralized, meaning they are issued and controlled by a central authority, such as the Bank of England. CBDCs are not based on blockchain technology, and they are intended to be legal tender, which means they are recognized as a valid means of payment by the government. They are designed to be a secure and convenient way for people to make payments and store value, similar to cash but in digital form.

The main differences between Bitcoin and CBDC are therefore:

  • Bitcoin is decentralized and not backed by any central authority, and is not legal tender.
  • CBDC is centralized and backed by a central bank, and is intended to be legal tender.

Pros and cons of a CBDC for the UK

Should the Bank of England introduce a Central Bank Digital Currency, there are likely to be both advantages and disadvantages; often at polar ends of either aspect.

Financial inclusionCBDCs can make it easier for people who are unbanked or underbanked to access financial services. Since they can be stored and transacted using digital wallets on mobile phones or other devices, financial services become more accessible to those who do not have access to traditional banking services.    A CBDC may not be widely adopted if it is not seen as a convenient or secure form of payment, potentially limiting its effectiveness as a means of exchange.

Payment system efficiency  Transaction times and costs may be reduced. Payments made with CBDCs can be settled instantly and securely, without the need for intermediaries such as payment processors.Implementing and maintaining a CBDC could require significant investment in technology and infrastructure, potentially leading to high operational costs.
Monetary policy effectiveness  CBDCs could help central banks to implement monetary policy more effectively by giving them more direct control over the money supply. The central bank can directly issue and control the amount of money in circulation, potentially making it easier to stabilize the economy and manage inflation. (They can already do this through traditional methods of quantitative easing, although CBDC implementation should be much swifter).Some would argue that the central banks already have too much control over inflation and money supply which causes its own problems.

Financial stability  CBDCs could potentially enhance financial stability by reducing the risk of bank runs and other financial crises. By providing a safe and secure digital form of money that is backed by the central bank, CBDCs could reduce the likelihood of bank failures and other systemic risks. Naturally this only works if consumers trust the currency and this holds true whether it is held as paper, coins, gold or virtually (in a paper passbook or a crypto wallet).

CBDCs could potentially undermine the role of traditional financial institutions such as banks, leading to financial disintermediation and potential instability in the banking system. Could this result in significant job losses?

If a CBDC is not pegged to another currency, it could be subject to exchange rate risks, which could impact the value of the currency and the economy. Naturally this already applies to traditional ‘paper’ money.
Data collection and analysis  CBDCs could provide the central bank with more detailed data on economic activity and financial transactions, which could help inform monetary policy decisions and enhance the effectiveness of financial regulation.

Many people hold cryptocurrencies in the desire to avoid third party tracking and user privacy could be compromised by giving the central bank access to all one’s financial transactions. Where does the bank stop and the state start?   A CBDC could be vulnerable to hacking and other cyber threats, potentially leading to financial losses for individuals and systemic risks for the financial system.  

While there are undoubtably advantages to the Bank of England launching a Central Bank Digital Currency, one could argue that the disadvantages currently outweigh them. As we have seen with Brexit, the significant changes to existing laws and regulations required, leading to legal and regulatory challenges will not render such progress swift nor controversy-free.

We’ll be watching closely to see what happens in the future. Until then we’ll be looking after all our clients who engage in both the deregulated and centralised finance world, in whatever space they feel happier in.

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