The Bank of England is considering a crytpo/digital pound. In a report published on 13 January 2022, the House of Lords Economic Affairs Committee raised concerns. Laith Khalaf, head of investment analysis at AJ Bell looks at the benefits and risks of a digital currency.
It seems the Lords Economic Affairs Committee is not too keen on the idea of Britcoin, but that won’t stop the Bank of England looking into it. The Lords committee is right to highlight the risks of introducing a digital currency, but if the Bank of England doesn’t create a digital pound, the private sector might.
The best known cryptocurrencies like Bitcoin are currently too volatile to provide a functional means of exchange, but more recently developed stable coins, pegged to traditional currencies, could open up a new financial frontier. In theory that might wrestle some control of the UK monetary system away from the central bank, which could pose its own dangers. Not to mention the risk that other countries which introduce digital currencies could find themselves with a leg up in the technological arms race.
Britcoin is best thought of as a digital version of a bank note, which is a token that carries a certain value in pounds sterling. People don’t hold large sums in paper money because it’s more convenient and secure to hold cash with commercial banks, but unlike a stack of tenners, Britcoin would be both easy to manage and safe to store. That’s because rather than residing in your wallet or under a mattress, digital pounds would sit in an account with the Bank of England.
It’s true that a digital pound could cause widespread disruption in the banking sector if it is introduced, as well as increasing the chance of a run on commercial banks in times of financial stress. If consumers were to adopt Britcoin in large numbers, that could mean a big shift of money out of deposit accounts, which are a key source of funding for commercial banks to lend into the economy. In order to persuade customers to stick with them, banks might have to increase the interest rates on offer on deposits, which would then be passed onto borrowers like mortgage holders, in order to preserve bank margins. Or they may have to end free banking, and start charging for basic services in order to make up for lost profitability. Or the lower availability of funding could mean less appetite by banks to issue loans, which could restrain economic growth.
The central bank could choose to pay no interest on Britcoin, in order to limit its appeal and dissuade savers from switching their bank deposits across. However, balances would be held directly by consumers with the central bank, and so wouldn’t be subject to the risk of a commercial bank going bust, and being unable to return their deposits. That extra security means savers would be willing to accept a lower amount of interest, a bit like they might with NS&I products. So in a low interest rate environment, even if Britcoin pays no interest, savers might still flock to it because the added security would be worth more than the measly interest they could get from their current account. That’s particularly the case for individuals with large amounts of cash that exceed the £85,000 compensation limit in the event of a UK bank default.
In times of financial stress, the availability of a secure store for pounds and pence with the central bank could in an extreme case facilitate a run on commercial banks. During the financial crisis, huge queues formed outside Northern Rock, as account holders rushed to withdraw their cash balances as banknotes, despite the risk associated with stuffing cash under the mattress. If savers could simply switch money into a secure digital account with the Bank of England, with just a few taps on their mobile device, that could mean huge sums fleeing high street banks at the first whiff of trouble in the sector. Such a run on deposits would increase the chance of a bank collapsing, and could undermine financial stability in the UK. The Bank of England could limit the amount of digital pounds individuals could hold in order to mitigate this problem.
There are definitely some potential benefits to Britcoin, for instance facilitating cross border payments, without the eye-watering fees often levied by high street banks. The digital currency would also almost certainly require a supporting infrastructure from the private sector in its interaction with customers, which would be an opportunity for fintech firms. It could also offer an alternative to card payments for online retailers, reducing the risk of provider outages and delays in receiving payment.
A digital currency could also facilitate micropayments, which could become more economical if the digital currency is successful in driving down transaction charges. This could be useful for low value commercial transactions, opening up the potential for customers to pay small amounts of money for a fleeting service, like reading a solitary news article instead of paying a monthly subscription. A digital pound could also allow money to be programmable, so that transactions occur if certain conditions are met. This could in theory include smart electric meters automatically settling bills based on usage, the automatic payment of taxes at the point of a transaction, or taxpayers claiming immediate tax refunds on pension contributions.
However, these potential benefits do need to be weighed up against the risks. Particularly when you also consider that any sweeping financial innovation is likely to be a rallying cry for scammers, who will flock to the scene of any confusion to misappropriate funds wherever possible. A digital pound certainly looks worth investigating, and could ultimately deliver considerable benefits to consumers, but the central bank needs to tread very carefully indeed.