Complexity is the enemy of U.K.'s digital currency

A lot of inertia can build over the course of 327 years, which is how long the Bank of England has existed.

It's the sort of history that fosters a lot of patience for Antony Welfare, who is contributing to an effort to digitize the U.K.'s currency.

"The U.K. has one of the oldest and most complex financial systems in the world. It's served billions of people and processes trillions [of pounds] and is one of the most important systems for the international economy. It's hard to change that," said Welfare, an executive director at NEM Software, and an author and technologist who specializes in blockchain. Welfare is working with Her Majesty's Revenue and Customs and The City of London on a task force that will inform the Bank of England of the risks and use cases of a digital Pound.

The effort is trying to determine how a central bank digital currency will exist alongside traditional policy and management, which has existed at the BofE in some form since 1694.

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"I used to ask myself why these central bank currency projects were so slow," Welfare said. "But these projects are trying to do four or five different things. If you look at the [EU], there are 27 countries, they all have to agree on what they're doing and how. That's going to be really complicated. I've also worked with central banks in Latin America on this, and it's a lot easier because the complexity of the existing system isn't there."

The U.K. task force has produced a research report detailing the technology use cases and benefits of a CBDC. Monetary sovereignty; streamlined payments for businesses, government and consumers; financial inclusion; and enabling the transformation to a digital economy are all among the uses of a digital currency or a reason to create one. These tasks and concerns exist presently, according to Welfare, but digitizing currency can make transactions easier and more widely available.

"The expense of cash is part of it," Welfare said. "And despite what most people think, disbursement is easier with a CBDC."

He referenced a U.K. government program that attempted to give money to self-employed people near the start of the pandemic as an example.

"That was hard to do and a bit of a mess," Welfare said. "With a CBDC the government would have been able to do that with a push of a button. That would have sent funds directly into a digital wallet."

Central bank digital currencies have become part of the vernacular for dozens of countries, yet there's still very little that has materialized in real-world use. Beyond a couple of markets in or near the Carribean, most notably the Bahamas, most of the projects are in pilot, proof-of-concept or feasibility studies. In a recent interview with PaymentsSource, Circle CEO Jeremy Allaire referred to CBDCs as a "set of ideas."

What's lighting a fire under central banks are two digital currency projects, feeding the monetary sovereignty portion of the U.K. research report Welfare helped write.

One concern is the Chinese digital yuan, which has raised alarms that China's central bank could gain dominance over traditional currencies, particularly threatening the U.S. dollar's status as the world's top reserve currency.

China's digital yuan is considered to be ahead of other central bank currencies, far enough along to be running pilots with Starbucks and McDonald's — with more tests planned for the 2022 Winter Olympics in Beijing. At a time when most other major CBDC projects are in the research stage, companies in China such as e-commerce giant JD.com are starting to pay staff in China's digital currency.

"A digital currency could be used in trade negotiations … 'if you want to trade with me, you have to use digital currencies,'" Welfare said, adding the trade ramifications of digital currency are being considered more by the U.S. than the U.K. at this point. "And it is easier to pay in digital currency."

Yet the digital yuan has challenges. China's project has raised privacy concerns in two directions: consumers who fear giving too much information and merchants who distrust too much anonymity. There's also some question in China as to whether the digital yuan is a threat or an ally of the private financial services industry. Ant and Tencent have promoted their work on the digital yuan, while independent analysis views the digital currency as competition to Alipay and WeChat Pay.

Private-sector digital currencies appear to be a larger concern to Europe and the U.S. than China's central currency.

Welfare said it took "days" for the U.S. congress, for example, to call for regulations and hearings after the Facebook-affiliated stablecoin Diem (then Libra) was announced, and the stablecoin has faced political pushback for most of the past two years. "The [central banks] saw Diem as a threat, and there's concerns about how it can be used for good and bad in the future," Welfare said.

The next year will be important for the dozens of CBDC projects, given the expected formal launch of the digital yuan, the growth of private sector stablecoins such as Circle and moves fromfinancial institutions to build technology that connects consumers to CBDCs.

Writing forPaymentsSource, Todd McDonald, co-founder and partner at the R3 blockchain consortium, said 2021 will "be the year that CBDCs move off the whiteboard. The initial excitement around CBDCs is into real world uptake from central banks, driven further by the current cryptocurrency boom in bitcoin and Ether."

Welfare did not provide a timeline for the U.K.'s CBDC project, which like most of the world's projects is expected to take several years. The next step is to build common regulations and rules that would allow the digital pound to take shape, and to start tests along the lines of a recent pilot in Lithuania, which is using a fintech sandbox to test the LB Coin in different environments to see how businesses and consumers would use a digital currency, and how it can exist alongside traditional currency.

"LB Coin is a real coin that did real things, so you see how people work with it and how banks work with it," Welfare said. "You can find an architecture that works."