The use of physical currency for transactions is plummeting globally, so why is the U.K. so tentative with its own central bank digital currency?

British society is both civil and democratic, so it wasn’t unexpected that the government of the United Kingdom would “consult” the public before signing off on a digital version of the British pound. The response it received may have been surprising, though.

The public canvassing conducted jointly by His Majesty’s Treasury and the Bank of England between February and June of 2023 drew some 50,000 responses, and it unleashed a “public backlash,” according to The Telegraph — a U.K. newspaper — with “widespread public concern about privacy as well as anger over the possible consequences for cash.”

Not only could a digital pound, dubbed “Britcoin,” be used to surveil U.K. citizens, respondents feared, but it could also potentially destabilize the U.K. financial system because the digital pound would be easier for depositors to move out of commercial banks in times of crisis, promoting bank runs.

This latest pushback comes as many in the crypto sector continue to view central bank digital currencies (CBDCs) with suspicion — or as clumsy government attempts to snuff out private money, including decentralized cryptocurrencies.

Amid these concerns, it’s worth digging deeper into some of the public concerns brought to light in the most recent U.K. consultation. Are privacy and stability issues really a substantial risk for CBDCs in advanced Western economies? On the plus side, can state-issued digital currencies potentially advance financial inclusion? And are they really designed to put cryptocurrencies out of business?

Staying at the ‘forefront of technological change’

One can begin by asking why a digital pound is even needed, as some British parliamentarians recently asked. “In an increasingly digital society, the U.K. needs to keep pace with the speed of innovation that’s happening in the payments sector,” Ian Taylor, head of crypto and digital assets at KPMG UK, told Cointelegraph. “The Bank of England’s consultation into a proposed CBDC is a sensible approach to keep the UK at the forefront of technological change without committing yet to the substantial investment needed to roll out a digital pound.”

Others agreed that the U.K., like many countries around the world, is struggling to come to grips with an increasingly cash-free economy. “The government is attempting to strategically place itself to allow the use of digital currencies so it is able to compete with other regions on a global stage,” Cardiff University professor Nicholas Ryder told Cointelegraph. The biggest obstacle to a digital pound “would be public demand and whether we end up with a cashless society,” he added.

Still, good intentions probably won’t allay privacy concerns. With a CBDC, the government could arguably generate “vast amounts of data that would allow anyone — from government to third-party companies — to develop extensive profiles on the public and snoop on their spending more than ever before,” Susannah Copson at Big Brother Watch, told The Telegraph.

One of the project’s developers even cautioned that a digital pound “could be used to check shoppers’ ages or nationalities.” However, the developer also said that a digital pound would still be “more private than holding a bank account,” though not cash, according to the newspaper.

A real danger?

Concerns over a loss of privacy in commercial transactions with a digital pound are not entirely overblown, Annabelle Rau, financial regulatory lawyer at law firm McDermott Will & Emery, told Cointelegraph. “Like any form of digital currency, a CBDC would inherently have some level of traceability, which could increase surveillance.”

Still, with the right design and regulations, privacy can be maintained to a significant degree. “For instance, privacy-enhancing technologies, such as zero-knowledge proofs or differential privacy, can be incorporated to protect user identities and transaction details while still enabling regulatory oversight,” Rau added.

Eswar Prasad, Tolani senior professor of trade policy at Cornell University and author of the book The Future of Money, told Cointelegraph that a CBDC could indeed entail the loss of anonymity relative to the use of cash, “but central banks that are experimenting with CBDCs are adapting new cryptographic technologies to provide transaction anonymity, at least for low-value transactions.” 

Risk of ‘deposit flight’?

Critics from the City of London, the U.K.’s financial hub, warned that a higher limit on Britcoin holdings — e.g., 20,000 pounds per individual — could destabilize the traditional banking system by facilitating bank runs or “deposit flight”’ from commercial banks.

But is this really a risk? “If a digital pound can be withdrawn instantly during times of economic instability, it could exacerbate financial crises,” said Rau.

Moreover, recent events, like the collapse of several regional banks in the United States following deposit flight, “have shone a spotlight on the heightened risks of bank runs in our increasingly digital financial landscape,” she added.

Holding limits could safeguard against such dangers, Rau conceded, but stricter limits on Britcoin holdings could, in turn, dampen public enthusiasm for the digital pound. “The optimal balance would likely involve a combination of limits, insurance schemes and regulatory oversight,” she added.

Cornell University’s Prasad agreed that CBDCs could elevate the risk of deposit flight from commercial banks in times of perceived crisis, adding:

  “Preventing this possibility by capping the balances that can be maintained in CBDC digital wallets seems reasonable, but could also limit the use of a CBDC and hinder its widespread acceptance.”  

Expanding access to financial services

Then there is the matter of financial inclusion, traditionally a big argument used in favor of CBDCs, especially in emerging markets.

In its February consultation paper, the U.K. government stated that financial inclusion “means that everyone, regardless of their background or income, has access to useful and affordable financial products and services such as banking, payment services, credit, insurance, and the use of financial technology,” declaring it an “important priority.”

According to Rau, “A retail ‘Britcoin’ could potentially boost financial inclusion, but the degree to which it would do so in the U.K. is debatable.” After all, the U.K. already has high levels of financial inclusion, with most adults having access to a bank account.

That said, “CBDCs could still enhance financial services for the underserved or those who prefer digital transactions. It could simplify transactions, reduce costs and provide access to digital economic participation to those who are still excluded from traditional banking,” she added.

An attempt to preempt crypto?

Not all view central bank digital currencies as benign instruments of inclusion, however. Some in the crypto community see CBDCs as an attempt to snuff out private money, including decentralized cryptocurrencies like Bitcoin (BTC). After all, one heard almost nothing about CBDCs until Facebook unveiled its Libra stablecoin proposal several years back.

“The emergence of decentralized cryptocurrencies such as Bitcoin, as well as stablecoins, has certainly catalyzed central banks’ interest in providing their own digital currencies, particularly as the use of physical currency fades away,” noted Prasad.

That said, “CBDCs are not necessarily intended to snuff out private digital currencies, but are seen as a way to keep central bank money relevant for retail and peer-to-peer transactions in a world where the use of physical currency for such transactions is plummeting.”

CBDCs may pose some competitive challenges to decentralized cryptocurrencies, added Rau, but it’s unlikely “that their primary purpose is to ‘snuff out’ such currencies.”

Sovereign governments are thinking more about digitizing their economies, not about threats from Bitcoin and other cryptocurrencies. Cardiff University’s Ryder largely agreed. CBDCs represent “an attempt by governments to enter the market, to offer a more enhanced product by ways of regulation,” while Rau further added:

  “Moreover, the introduction of a CBDC could potentially legitimize the broader concept of digital currencies, which could indirectly benefit cryptocurrencies. That said, the relationship between CBDCs and private digital currencies will largely depend on specific regulatory decisions made in the future.”  

In any event, the full-scale launch of a digital pound is still many years away — if ever. According to the Atlantic Council’s CBDC Tracker, a U.K. CBDC is still in its research stage — the least advanced CBDC development level. 

It would still have to pass through a proof-of-concept stage — where Brazil, Russia, Turkey and some others now stand — and a pilot stage (France, China, Canada) before reaching actual launch (the Bahamas, Nigeria and a few other small countries). Even the decision on whether to move forward with a digital pound is “some years” away, the Bank of England’s deputy governor said in June.

‘A social decision’

Overall, “The benefits and challenges of introducing a digital pound need to be carefully considered,” KPMG UK’s Taylor said. Factors to take into account include “the fine balance between the inevitable decline in physical cash, the importance of ensuring as an economy we are being financially inclusive, and the current lack of consumer protection in the digital assets market.”

How long might all this take to achieve? Could it be accomplished before the end of the decade? “We are still a few years off until trials commence,” said Taylor. “The government’s objective is to ensure we are innovative and continue to lead the world on payments.”

“Striking a balance between privacy and necessary regulation — for important reasons like preventing money laundering — is a challenge all digital currencies face,” added Rau.

Perhaps the last word here belongs to Prasad, who identified the challenges involved in creating a central bank digital currency in a 2021 article, which arguably explains why economies in the U.S., the U.K. and elsewhere are proceeding so carefully:

  “A digital dollar could threaten what remains of anonymity and privacy in commercial transactions — a reminder that adopting a digital dollar is not just an economic but also a social decision.”