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This article was originally published in Issue 4 of Finance Derivative and can be accessed here, on page 10. 

Digital currencies: The next big financial experiment?

Manoj Mistry, Managing Director, IBOS Association

The mid-1990s saw Britpop emerge as an upbeat form of music to underpin a short-lived phenomenon, known as Cool Britannia. In the 2020s, cryptocurrencies are the phenomenon du jour. The response from the UK Treasury and the Bank of England (BoE) is perhaps seeking to achieve some degree of coolness for Central Bank Digital Currencies (CBDCs) with the term Britcoin: a potential digital currency backed by the UK’s central bank reserves. The Bank’s governor, Andrew Bailey, recently told a House of Lords (HoL) committee that a reserve-backed digital currency could result in 20% of commercial deposits shifting to Britcoin.

Bailey’s committee address followed hot on the heels of another recent announcement by the BoE: that it is set to launch a consultation on a digital pound. Such a move would certainly herald a significant financial experiment for the UK. Through a consumer-focussed lens, we increasingly see digital banking as becoming a dominant and necessary force in our day-to-day lives, as well as in the activities of companies, both large and small.

None of this should come as any surprise given the surge of interest and uptake in digital banking during the pandemic. Nevertheless, the BoE is cautious, as central banks tend to be. It is acutely aware that while a digital pound would create significant opportunities, it may also pose equally significant risks – for both individuals and businesses – as well systemic risk thanks to the volatile nature of crypto assets.  But in theory, the concept of a Britcoin would eliminate such risks since it would be underwritten by the central bank as the lender of last resort.

Developing a digital pound, and creating an environment in which it can operate safely, will take time. Through understandable prudence, the BoE is therefore not minded to move rapidly. In starting a consultation next year on plans for launching a Britcoin, the Bank has cautioned that no such central digital currency would be available before 2025. Before then, the groundwork has to be laid which guarantees that stability and certainty will prevail.

Inevitably, the centrepiece will be a legal and regulatory framework which can provide both of these things. Accordingly, there will be a slew of new policy proposals that need to be stress-tested before they can be implemented. Beyond changes in policy development, a significant body of regulation will also be needed to passed in order to counteract the potential and very real risk of fraud, money laundering, and hacking.

Regulators worldwide have been busy cautioning their citizens over the inherent risks of crypto assets. In the US, the SEC chairman, Gary Gensler has not minced his words in a variety of speeches, invariably concluding that the crypto market will not mature without regulatory oversight. In more understated language, The Financial Conduct Authority (FCA) recently launched a campaign aimed at investors designed to help them understand the risks associated with digital currencies.

Internationally, there have been a number of interesting developments. Nigeria recently launched the eNaira, becoming the latest country to launch a digital currency. Meanwhile, China has launched a trial for the eYuan and an electronic Euro is expected to be launched by 2025. More controversially, El Salvador has short-circuited the entire CBDC process by adopting Bitcoin as legal tender, i.e. a legal national currency. BoE Governor Bailey described this decision as “a concern for consumers” in view of its volatility.

Despite the obvious risks, not least the inherent volatility, digital currencies do offer a distinct upside that make them attractive to consumers and corporates alike, providing them with an efficient and low-fee option for domestic and international payments.

Much effort is being made to develop a new financial infrastructure in London, which currently bisects Silicon Valley at the top and New York in third place when it comes to the number of FinTech start-ups. This is part of the engine room which continues to drive London, and by extension, the UK, as the dominant financial services player in Europe. Although the European Central Bank (ECB) would have to regain approvals from all EU Member States in terms of Britcoin, the UK would continue to position itself at the forefront of financial innovation should that happen.

It is arguable that the past two years of frenetic crypto growth have exposed central bankers: they have been caught sleeping at the wheel and not doing enough to keep pace. Looking ahead, they need to act quickly to introduce CBDCs if we are to have any hope of maintaining democratic control over our money and the banking system which ultimately underpins it.