This post is a representation of the response sent to the Bank of England in regards to their discussion paper ‘New forms of digital money’, which was published on 7 June 2021.
The role of money in the economy
How might new forms of digital money affect money and credit creation? Are there channels beyond those explored in this paper?
The introduction of new forms of digital money will lead to the coexistence of three forms of fiat currency: cash, commercial bank money, and new forms of digital money (which may be further subdivided into CBDC and privately issued systemically important stablecoins, should a CBDC be introduced). In the Digital Pound Foundation (DPF)’s view, public interest will likely be less in the potential for a central bank backed form of digital money, and more in the potential anonymous aspects of such a development. Since the Bank has already said that any form of digital money will not be anonymous, digital money as envisaged in this paper is likely to be more of an alternative to commercial bank e-money than to cash, with the exception of financial inclusion requirements (bearing in mind that people do not necessarily transact in cash out of choice, but also due to exclusion from the banking system for whatever reason). Its primary appeal to the public will therefore lie in fact that it is smart (programmable etc) e-money, much like a smarter form of commercial bank or EMI-issued e-money, and that it is fully backed by the central bank with no FSCS limit.
We therefore agree with the Bank’s assessment of the potential impact for commercial bank money, its creation and the wider effect on lending and financing activities. However, we do not see this as necessarily a blocker to the adoption of new forms of digital money. The new forms of money are no stand-alone freak of monetary innovation. Money is a servant of a greater force: value interaction. It is not the driver.
In our view, the driver now is the digital revolution. And one of the most powerful forces for change within that revolution is the mechanism by which something is exchanged for something else. The new mechanism – indeed the revolution itself – was only made possible by the computer and by the internet. Together they spawned a host of new ‘technologies’ (artificial intelligence, digital identity, robotics, bionic adaptation, blockchain, algorithmic disciplines, quantum computing, privacy parameters ….). As a result, even the things that are being exchanged are changing. Assets are being fractionalised, adapted and qualified in ways never before possible. The entire exchange process is undergoing change.
Enterprises across the world have therefore been working on new infrastructures to support what is becoming, in effect, a new operating system. Early models include the service constructs of the new marketplaces (Amazon, Alibaba, WeChat, Facebook et al.). More far-reaching infrastructure work stretches beyond even those. On top of that, the digital revolution and the new operating system which it is breeding has the capacity to restore and reinforce the common good, and to better reflect our changing and much-needed attitudes to value, particularly the ways in which value is impacted by environmental and social outcomes. Money is rightly adapting to facilitate this metamorphosis. Our view is that any commentary on new forms of money must sit within this new, all-enveloping construct.
Public policy objectives
How important is direct access for the general public to central bank money in a digital world? Choose from the following:
- Very important
- Somewhat important
- Not important
Explain your reasoning for your answer to question 2, and your thoughts on the question more generally.
We believe that access to public money is of fundamental importance to maintaining trust within the UK’s banking system. Despite the rise of commercial bank money and the corresponding decline in cash usage, cash remains an intrinsic part of the money ecosystem and millions of UK citizens still depend on using it for a number of reasons. A more radical shift towards greater use of private money could result in a system whereby some members of society are left behind due to the focus of the private sector on more commercially advantageous customers. We note as well that financial inclusion is a key priority area for the Bank, and maintaining access to public money is a means of ensuring that such policy objectives can be delivered. Furthermore, public money represents a fundamental policy delivery mechanism for the government.
As a digital form of public money, a “Britcoin” or CBDC, however, could have significant benefits for the public and act as a potential differentiator and accelerator of innovation for a global Britain. As noted in the Discussion Paper, unlike cash, a digital CBDC could enable micropayments or otherwise be “programmed” for specific uses to support government aims, including macroeconomic and social policy delivery, and also to facilitate an improved transactional relationship and experience between individuals, businesses and the state. Accessing digital money usually requires no more than a smartphone. This type of technology could bring many of the unbanked or underbanked into Britain’s financial system for the first time.
While we agree that the public should continue to have access to central bank money, we also believe in the importance of providing consumers with choice. Privately issued digital currencies, including stablecoins, may provide advantages that a CBDCs cannot. We also acknowledge and support the need to have appropriate safeguards in place to ensure that privately issued coins and stablecoins do not destabilise the financial system.
We do anticipate a rise in tokenised sterling currency in the form of stablecoins or e-money tokens, and believe a single, regulated form of systemic stablecoin, issued by regulated financial institutions and interoperable / redeemable will be important to the UK, as the programmable nature of stablecoins can deliver efficiencies and foster innovation in the payments space.
The core issue, we feel, is public confidence. A “Britcoin” would benefit from the legitimacy of the Bank’s backing, and interchangeability between commercial and central bank issued tokenised currency would boost consumer confidence. There may also be use cases and needs where central bank issued money is preferred, particularly for existing heavy users of cash.
On a general note, if the decision is taken to implement a central bank digital currency, we would anticipate the need for an extensive transition and education programme in place for the general public. The Bank will need to clearly articulate the benefits and implementation considerations around a CBDC, including how its characteristics, benefits and risk profile compare with other privately-issued stablecoins so as to ensure informed decision-making by the consumer, and the market infrastructure required to support this. The Bank should also consider the information channels to be used, including appropriate public bodies that can be used to provide advice.
This will represent a fundamental change to the financial infrastructure/industry and clear understanding by the public will be vital.
Do you agree with the Bank’s view on protection and privacy? What would you regard as a minimum set of protections? Choose from the following:
- Strongly agree
- Strongly disagree
Explain your reasoning for your answer to question 3, and your thoughts on the question more generally.
We agree that existing regulation would seem to rule out fully anonymous models of digital currency. We believe that the existing regulation (which may need updating to include new forms of money in its scope) is appropriate, customer data being held according to purpose, and in line with UK GDPR, with data access maintained for purposes of combating fraud, money laundering and terrorist funding. This may include the network level aggregation of payment data under secure conditions to combat fraud and money laundering along payment chains, analogous to the financial crime solutions provided by Vocalink today.
As the FCA would govern conduct, we are confident in their enforcement of existing regulations related to privacy.
However, in the world of digital cash (stablecoin or tokenised e-money), consideration must be given to:
- Use cases where a customer is known to the issuing authority but acting anonymously (e.g., paypal-like transactions). Does this give rise to new considerations?
- Security. As a bearer’s instrument, theft may or may not have a higher % likelihood than with forms of bank account hacking, but with today’s digital money issued by commercial banks, the ability to block an account is a trust provided by a commercial bank. Consideration must be given to the alternative scenario where the theft of a stablecoin or tokenized e-money account results in a complete transfer of ownership
As the BoE acknowledges, widespread implementation of either a CBDC or stablecoin will involve a range of actors (e.g., the issuer (including the central bank in the case of a CBDC), the wallet provider, the sender and recipient, and any third-party intermediary) which creates a host of data and privacy concerns. We recognise that controls are needed to ensure full compliance with AML/CFT rules – (and that either a CBDC or stablecoin is not used for illicit purposes).
At the same time, we believe that maintaining user privacy is key to ensuring continued confidence and trust in money and payments. Bearing this in mind, we have a number of general privacy concerns as they pertain to unhosted wallets:
- There is a difference between knowing your customer and knowing your customer’s customer or counterparty. Any regulations implemented should be careful not to extend protections beyond the point of workability.
- It is unclear whether third-party Payment Interface Providers would be able to comply with such a rule.
- It may not ultimately be possible to glean the information desired (e.g., the fact that an individual has access to a private key does not mean he/she maintains exclusive control over that key).
- The costs associated with designing and maintaining such a system may be prohibitive to all but the largest businesses (i.e., such a requirement could stifle innovation).
We note that HM Treasury is currently consulting on changes to current AML/CTF rules and call for any changes to be proportionate to what is required under the current fiat system and consistent with FATF guidelines.
What steps could be taken, and by whom, to help promote interoperability of new forms of digital money with other payment systems, and thereby foster a competitive environment?
A key challenge with respect to this ambition is the lack of interoperability even between existing UK payment systems. From a message perspective, BACS runs on Standard 18, whilst CHAPS runs on SWIFT, and the other infrastructures run on ISO8583 (Faster Payments/cards/ATM). It could make sense, therefore, to place all payment infrastructures, including both privately issued stablecoins and any new central bank digital currency, on a single messaging standard. However, the current state of the New Payments Architecture illustrates the challenge of achieving this and so this may be a valuable moment to step back and consider the future state of all the payments architectures in the UK.
The DPF believes that interoperability must be a common cause across both public and private sectors to succeed, and with the goal of reducing friction in the digital money ecosystem. A fundamental issue is that of “fungibility”. Today, a physical pound is at par value to a digital pound issued by a commercial bank. With respect to digital cash, the question is how a stablecoin is funded, and whether a deviation from par value results in a deterioration of fungibility. These issues will be addressed to some extent through the prudential models in place for issuers of private stablecoins, but must also be addressed through interoperability.
With respect specifically to stablecoin interoperability, the DPF envisages an ideal environment in which financial institutions are not compelled to adopt a specific technology in order to issue or process stablecoins, but rather, analogous to Open Banking, the boundary of the financial institution is a standardised API, including interoperability mechanisms and supporting the screening and authorisation of payments. This environment would allow issuance of stablecoins by financial institutions (and other regulated firms), which could be paid in / redeemed at any other institution and linked to existing settlement mechanisms such as RTGS, thus providing a seamless experience to the consumer (as is the case with commercial bank money today).
Technology is another consideration. Will issuers of digital money – including the Bank – utilise centralised or decentralised technology platforms? Due consideration must be given as to how different types of digital money platform may be supported in an interoperable ecosystem. With respect to decentralised platforms in particular, it is important to bear in mind that, whilst financial market participants are beginning to adopt such platforms, their use is still at an early stage.
Consideration should also be given to the global picture around standardisation. Initiatives such as the adoption of ISO20022 (including the SWIFT standardisation project), the BIS Nexus project and similar cross border faster payments projects may also provide synergistic opportunities. There is a plethora of new initiatives across the payments industry and this may well provide an opportunity to work with other central banks and global agencies to adopt a more united approach.
DPF members are active participants in the ISO initiative looking at the international standardisation of DLT and blockchain technologies, of which sub-group 7 concerns interoperability.
The IETF (Internet Engineering Task Force) initiative concerns interoperability between digital currency and digital asset networks, and is standardising a protocol for gateway between networks to operate to create seamless interoperability. DPF members, alongside MIT, CSIRO, IBM, Hyperledger, Intel and others, are working to create the internet standard for interoperable digital asset gateways, ODAP (Open Digital Asset Protocol).
With respect to cross-border payments and interoperability between CBDCs, the recent BIS work in this area may provide useful models for cross-border collaboration.
Implications for macroeconomic stability
Can respondents identify any other significant risks to economic stability from new forms of digital money even when stablecoins are adequately regulated?
The introduction of appropriate and proportionate prudential and conduct regulation for the issuers of stablecoins, and specifically systemically important stablecoins, will largely mitigate the potential systemic risks posed to the financial and economic system from these new forms of digital money.
Nevertheless, we do see other economic risks arising from systemically important stablecoins, particularly in the event that the UK chooses not to implement a CBDC and instead relies on private issuers for the introduction of functionality and benefits associated with new forms of digital money. These risks could give rise to a loss of monetary sovereignty, with corresponding economic impact to the UK as a global player.
Systemically important stablecoins, particularly when backed by central bank money, so concentrating significant holdings of central bank money in a single issuer, could present a potential threat to the national monetary sovereignty policy of individual jurisdictions and to the ability of the Bank to deliver the UK government’s monetary policy objectives. More importantly, the rapid development by the People’s Bank of China in this area, as well as their plans for a global payments network in the next five years, suggests that the UK needs to carefully consider its own economic and political strategy within the global context. A CBDC may well give it leverage in both these areas.
The failure of a single large stablecoin provider could leave retail and wholesale customers facing financial pressure on a massive scale, leading to potential government intervention. However, policy and regulations that allow for a diversity of funding sources and commercial bank participation in the accountability toward digital cash holders could mitigate such risks in part or in whole. We note that the tokenised economy may likely provide more clarity as to who are the claimants in the event of potential insolvency of any regulated financial institution.
Do respondents have any other concerns over the ability of banks and markets to adjust to the introduction of new forms of digital money in addition to those identified?
The introduction of new forms of digital money at the systemic level will be challenging not only for banks to adjust from a funding perspective, but also when integrating into the emerging ecosystem as service providers.
It is likely that financial institutions will wish to begin undertaking activities and providing services around new forms of digital money, both public and private. Furthermore, financial institutions may well turn to new forms of digital money as a means of making and accepting payments and settlements. In the absence of some form of interoperability, the effort required to adapt and to integrate will be significant and could result in some upheaval to the market, particularly where some firms embrace and prepare for change and are able to maintain a competitive edge, whilst others (perhaps due to resource constraints) may not be so fortunate. It is notable as well that many banks whose business models may be most sensitive to the introduction of new forms of digital money and the accompanying transformative potential for the market, will be traditional British banks. (Newer digital / challenger banks and fintech providers will also need to adjust, but will likely be an advantage given their forward-looking business models and better ability to adapt to technological change).
Banks and other market participants will need to assess the impact of new forms of digital money on their own internal front-to-back payment and accounting systems, applications and platforms, in order to ascertain changes required to support holding of and access to digital money wallets and / or accounts, and processing of digital money payments. A key challenge will be around the support of real-time settlement of payments, and the impacts this will have not only on technology and operations, but also on those business models that are dependent on the interest accrued on funds held before being released for settlement. Liquidity management practices may need to be reviewed. In the short term, traditional securities could be utilised, with more innovative solutions, such as digital money-settled bonds, being adopted at a later stage. New liquidity options will require both system and process changes to accommodate both traditional and digital securities and cash settlement.
It is also important to note that it will not just be payment systems that will be affected, but other instruments which require settlement including equities, bonds and derivatives. All of their applications will also have to be updated. This will include custodians, clearing houses and central securities depositories (e.g. CREST).
The regulatory environment
Do respondents think there are any other features of the banking regime that need to be reflected in the regulatory model for stablecoins?
The key features of prudential regulation seek to promote the financial resilience and operational resilience of the banking system and its competent firms.
In our view, the current banking regime exists to ensure the financial and operational resilience of the financial system, and to ensure that both consumers and the wider economy are adequately protected from the systemic risks arising from financial institutions that are both heavily interlinked with each other and with the economy, as well as ensuring that they are treated appropriately based on their level of sophistication, by institutions that act with integrity.
The prudential aspects of the banking regime promote this financial resilience, via the requirement for banks to meet internationally developed and recognised standards around capital adequacy and liquidity, and to have recovery and resolution plans in place. Over the past few years, operational resilience has increasingly come to the forefront of regulators’ minds and is implemented in requirements for firms to have in place appropriate business continuity and disaster recovery plans.
Conduct regulations set expectations around governance, individual accountability of senior leaders, and provisions for AML / KYC / financial crime and consumer protection (including participation in the deposit guarantee scheme). The DPF believes that such features should be present in the approach to regulating systemically important stablecoins as well, regardless of whether they are backed using a bank model (deposits + HQLA).
Notwithstanding the above, we observe that not all stablecoin backing models will have the same risk profile as that of a banking institution, which is by definition and deposit taking, fractional reserve lender. Therefore, the way such regulatory principles are applied to the specific risk profile of an individual issuer should be appropriate to the level of risk introduced by that specific issuer.
The most appropriate regulatory model for each potential type of issuer will be easier to assess once the full operating structure and frameworks have been explored and preferred options identified. A risk framework needs to be fit for purpose and proportionately reflective of the risk exposure from a variety of perspectives including market stability, customer protection and general conduct of business. The risk exposure will vary depending on a number of characteristics, for example how the stablecoins / e-money tokens are backed; whether they are tradeable or simply payment instruments and the level of due diligence and customer suitability deemed appropriate for the instrument type. It will also depend on the wider business model of the issuer – for example, do they wish to lend or rehypothecate assets held for the purpose of backing the stablecoin?
With that in mind, it seems sensible to present a spectrum of possible regulatory models and whilst an objective of regulation is not necessarily to drive innovation, it is nonetheless a very important consideration that must be fully taken into account as well. We acknowledge that a full regulatory overhaul would be daunting and burdensome for both regulators and the industry. We would therefore recommend a full and thorough gap analysis of the current regulatory framework to identify where additional requirements are required and to focus on these shortfalls through extensions or adaptations to the existing models. We would expect that the Bank’s proposed consultation for a regulatory model would identify those areas in need of scrutiny.
Do respondents agree with the Bank’s assessment of the four possible regulatory models for stablecoins? Are there other models the Bank should consider? Choose one of the following:
- Strongly agree
- Strongly disagree
Explain your reasoning for your answer to question 10, and your thoughts on the question more generally.
The DPF recommends that stablecoins should not be regulated in such a way that the requirements pre-ordain the stablecoin backing model. Rather, a range of options should be available to issuers of stablecoins – based on existing regulatory regimes as well as novel regimes – such that issuers may adopt the regime most appropriate for their own specific model. Over-prescriptive regimes will inevitably stifle competition in this important emerging sector.
As a starting observation, it will be important to firstly consider the distinctions between stablecoins, existing e-money tokens and commercial bank money, and to recognise that the differing characteristics result in different risk profiles.
Client fund protections are an example of the implications of the differing characteristics. The paper refers to the importance of backing assets for stablecoins that always cover the outstanding coin issuance in order to achieve such protection; however, through e-money tokens, the same outcome can be achieved through the safeguarding and daily reconciliation regime as required under the current e-money regulations, whilst through the banking regime, the same outcome can be achieved via the holding of HQLA and / or deposits.
For certain types of stablecoins, it could then be challenged as to why a different regime is necessary. Would e-money tokens be regulated in the same way as the stablecoin, for example? If the answer is yes then the challenge is two-fold – (i) why is the existing e-money regime no longer considered fit for purpose within this context and (ii) the resultant perception that e-money tokens are higher risk than traditional e-money. This would not be a technology neutral approach and could potentially stifle innovation if the regulatory requirements are sufficiently higher so as to be seen as a deterrent to operate within the market.
Likewise with the current payments regime that already adequately regulates the use of e-money as a payment instrument – the suggestion that the FPC approach to regulate stablecoins could sit alongside the existing Bank’s payments regime makes sense if the approaches are aligned; however it creates unnecessary confusion and frustration for e-money token issuing firms offering payment services could arise should they be caught within the broader definition of ‘stablecoins’ with different regulatory requirements applied. Some of the existing E-Money regulation could be extended to cover stable tokens as it provides a framework for value, redemption and claims on the issuer, all of which are key to stable tokens. Reuse of such a framework with the necessary extensions and adjustments may prove more efficient than creating a new body of regulation from scratch.
With respect to banking, similarly we should look at the extent to which a banking regime could apply to some issuers of systemically important stablecoins who wish to hold non-cash reserves, such as HQLA. As the Bank has noted, the banking regime could then be tailored or scaled in an appropriate manner to better suit the risk profiles of non-bank stablecoin issuers who do not wish to engage in fractional reserve lending (as opposed to those who may wish to do so).
Given the large uncertainty around a new steady state and risks identified during any transition to new forms of digital money, are there any other reasons for imposing limits? How should such potential limits be structured?
The DPF understands the Bank’s concerns with respect to a potentially rapid, unmanaged and unmitigated transition to systemically important new forms of digital money, particularly where this is led by private issuers of stablecoins. As such, the imposition of proportionate, appropriate and, importantly, time-bound limits to the amount and usage of privately issued systemically important stablecoins would seem to be reasonable. Limits on transmission and velocity could work well as a temporary measure, enabling the Bank and the wider market to understand the impact of new forms of digital money on the market structure and flows of money. These could take the form of transaction limits, or limits on individual holdings.
A tiered system could be implemented, based on the extent to which a consumer segment might, by virtue of its size and nature of its activities, have the potential to impact the banking / financial system through its choice to hold new forms of digital money as opposed to commercial bank money. Such a tiering system would not necessarily align with the existing classifications of retail vs. professional, and could also take into account the type of financial services under consideration. It should be noted as well that more positive incentives can be used to retain some deposits (e.g. savings) in commercial bank money, by offering more appealing interest rates, for example, or more possibilities for offsetting savings against debt.
We would stress however that such limits must be applied consistently and regularly reviewed, to avoid any potential for stifling innovation or competitiveness in the UK in the interests of incumbents. Throughout this Discussion Paper, there has been a recognition and acceptance of the transformational potential that new forms of digital money may bring to the financial system and to the wider economy and society. The aim of any limits should be to manage the risk associated with such a transition, as opposed to stifling the transition itself