In this three-part blog series, our experts offer their views on what can firms do to become 'CBDC-ready', the benefits of a CBDC to UK consumers and businesses, and the Technology Working Paper (TWP), discussing the key Technological features that the CBDC must be equipped with.
In recent years, much has been written about digital currencies’ ability to facilitate financial inclusion, improvements to the payments system, and reductions in transactions costs.1 The Bank of England’s (“the BoE”) Consultation Paper2 and Technical Working Paper3 have contributed to accentuating this existing hype in the market and the media. However, one could argue that these claims are not substantiated enough to confidently predict meaningful benefits. For example, transaction costs are already very low for retail users of payment services; and financial inclusion for those outside of digital channels remains an unlikely prospect. What tangible benefits can UK customers and businesses expect from a UK CBDC?
As digital payment and payment service experts, we understand the wider effects a retail CBDC could have in the UK. We believe the key opportunities for UK customers and businesses that would arise with the arrival of a digital pound could be found in the following three themes:
1. Lowered financial fraud risks when making digital payment
2. A more streamlined tax system for the self-employed
3. Greater focus from payment services firms on providing safer access to excellent user interfaces
Lowered financial fraud risks when making digital payments
We believe the advent of CBDCs will decrease the initial risk of and subsequent consequences of financial fraud. In 2021, financial fraud totaled £730 million in the UK, 84% of which came from payment card and Authorised Push Payments (APPs) fraud alone.4 Financial fraud is a serious issue because not only does it deal a devastating blow to its victims who find themselves with a hole in their wallets, but it also has a pronounced impact on the UK. It perpetuates crime, facilitates terrorism financing, increases risks to the UK’s security and harms the wider UK economy with increased cybersecurity costs, lower growth and fewer tax revenues collected. With a centralised digital pound, the BoE’s assumed heightened ability to track payments and control individual currency tokens facilitates the better prevention of financial fraud and crime, as well as enabling the restitution of CBDC funds fraudulently appropriated. While it has not yet clarified the full liability model, the BoE will ultimately have to guarantee the certainty of its digital funds.
A more streamlined tax system for the self-employed
Secondly, implementing a CBDC grants the State the opportunity to reshape the tax system for self-employed businesses in the UK, which currently concerns 4.3 million people.5 The latter are required to make a “payment on account”, namely pay half of their tax returns upfront on 31st January and then on 31st July of each year, 6 leading to them incurring huge costs at one time. This issue is particularly salient for SMEs since, due to their small size and inability to access financial resources, they are often disproportionately affected by negative cash flows.7 71% of SME owners report being worried about their business’s cash flows.8 Widespread adoption of a digital pound could facilitate the creation of a PAYE-type tax system overlay service for UK self-employed businesses to pay income tax, VAT and potentially other transaction-related taxes because of the programmability and rich-data a CBDC provides. This would have to be an overlay, as the BoE recently reaffirmed that programmable functions would not be used without users’ full consent. Not only would this incentivise reluctant businesses to use the BoE’s CBDC, but it would also improve their financial position because it would spread their tax payments more equitably throughout the year.
Greater focus from payment services firms on providing safer access to excellent user interfaces
Existing e-money firms and other non-banking payment services firms not covered by the Financial Services Compensation Scheme (“FSCS”) are held back by the perception they are higher risk than traditional banks – simply because of the lack of FSCS cover.9 This makes them less appealing to customers regardless of any other benefits, such as the overall customer experience. With a CBDC, the counterparty risk and the need for the FSCS is removed. This would liberate such firms to compete on other benefits that they are more suited to, such as digital innovation and providing the best customer experience. Greater focus in the industry on the provision of excellent user interfaces and on tailoring services to individuals in the UK will foster a more innovative environment as new practices are adopted. The proposed new regulatory roles (PIPs/ESIPs) demonstrate that the BoE understands the reduced oversight that will be required for firms using its digital currency.
The BoE, the financial services industry and the media have reported on a need for adopting a digital pound. However, aside from obvious benefits it provides to the State and unevidenced claims on financial inclusion, improving the current payments system’s efficiency and reducing transaction costs, to date, we have seen little on true benefits. There are tangible reasons for UK customers and businesses to use a CBDC, and these should be explored further. Three key opportunities stand out: lowered financial fraud risks, support for a new tax system overlay service for self-employed businesses, and safer access to new UX/UI-focused financial services provided by new and existing fintech companies. While we cannot state that these benefits outweigh the equally hyped risks of a CBDC, we believe the BoE should not undermine these opportunities in its adoption.
[1] How is the "world's most advanced central bank digital currency" progressing? | LSE Business Review, How would a UK digital pound operate and what would it mean for cash? | Financial Times (ft.com) and What is the Digital Yuan (e-CNY)? (qpsoftware.net)
[2] The digital pound: a new form of money for households and businesses?
[3] The digital pound: Technology Working Paper (bankofengland.co.uk)
[4]Annual Fraud Report 2022_FINAL_.pdf (ukfinance.org.uk)
[5] Self employment in the UK 2022 | Statista
[6] Payment on Account: What Is It and How To Pay It? | Crunch
[7] Why is cash flow management important? - Experian UK
[8] Ibidem
[9] Using payment service providers | FCA
