Globally people are progressively shifting away from cash and adopting digital payments in their day to day life. In the last decade or so, the UK has seen a significant surge in mobile banking, contactless cards and fintech platforms such as Apple Pay and PayPal. However, the dependence on private businesses presents challenges of access as well as control. Central Bank Digital Currencies (CBDCs) are government backed digital currencies that function on centralized platforms, catering to retail for individuals as well as financial institutions. The CBDCs have been examined by 134 countries with a key focus on improved security, accessibility and effective regulations with China leading the way with E-Yuan and The Bahamas taking some significant steps with their Sand Dollar. 

The UK scenario and Bank of England

The Bank of England Governor stated that although the country will be a pioneer in digital currency, its adoption will not be swift. Private players are moving faster than expected, the UK government needs to act faster and bring in specific regulations such as legislative guarantees and  for seamless implementation. 

According to a recent study by the BOE with 50,000 individuals, it was discovered that people are split between being overly cautious and those who are engaged. Some individuals even feared having control over their own finances, the ability to access cash, and maintaining privacy. 

While the question remains: ‘Are there adequate protections in place to address data-related concerns,’ the HM Treasury has assured that strict security measures will be implemented to prevent unauthorised access to individuals’ financial information by the Bank of England or other authorities. However, the UK government has yet to confirm its plans for launching a digital currency through the central bank.

China and Bahamas are leading the way

The electronic yuan has been introduced in large cities such as Beijing through lottery distribution, such as the 2021 Beijing lottery, which distributed 40 million yuan to 200,000 residents. Alipay and WeChat Pay, however, are digital platforms challenging its dominance.

In the Sand Dollar of the Bahamas, inclusion is promoted, and banking accessibility problems are dealt with in outlying areas. Yet a USD one million government giveaway was insufficient to keep account activity up and prevent 160,000 accounts from being sedentary. Technology and consumer understanding have slowed progress.

On one hand China has demonstrated the positive impact of government backing, whereas the Bahamian example demonstrates a CBDC cannot thrive without robust financial institutional support as well as sufficient infrastructure. These examples demonstrate how important it is for institutions to be involved and for the public to have trust in order to ensure adoption in the UK.

Relevance to the United Kingdom

The UK, being a major player in the global economy, should learn from the errors made by the early adopters like China and The Bahamas. The UK could prevent falling into the identical pitfalls by promoting cooperation between established financial institutions and effective user education. A universally acknowledged state-backed digital currency could ease private financial ecosystems known as “walled gardens” and paved the way for the electronic pound. These steps will not only help in strategic improvements to boost financial inclusion, interoperability, and customer loyalty, but also solidify the UK’s position as a global leader in innovation.

Impact on business

A well implemented CBDC may also change business operations – for instance – the medium-sized and small enterprises (SMEs), which account for close to 60% of employment and contribute around 50% to the UK’s GDP. Instant, low-cost transactions could enable the sector to reduce reliance on traditional banks and expensive intermediaries. Currently companies are paying 1.5 % to 3 % on card payments as the transaction costs. With CBDC in place, these charges may be reduced or even eliminated in future. Though an electronic pound is going to require global cooperation with other CBDCs and international regulators. Without interoperability businesses might be trapped within regional financial systems. The switch to CBDCs might also incorporate compliance costs to businesses – notably the smaller ones or the underbanked businesses – that are not in the position to present a brand new payments system. A CBDC might decrease exchange rate volatility and cross border transaction costs for global trade making it possible for UK companies to exchange much better. 

For an electronic pound to succeed, it must be business-friendly, easy to adopt, and offer clear advantages over the existing financial system 

Challenges to Solve 

A CBDC cannot simply be approved by regulations alone; it necessitates a comprehensive transformation of financial systems, technology, and economic structures. Financial security is a significant concern. If consumers transfer a large amount of money from commercial banks to secure CBDC wallets, they could potentially lose a significant source of funding and may face challenges in providing loans quickly. If things go really badly, this could worsen credit shortages, lead to higher loan expenses, and slow down economic growth. 

Another overlooked concern is the technological systems as well as security measures in place. A failure of the CBDC system would erode trust in the financial services industry. The risks of a cyberattack are enormous. Central banks are facing significant pressure to implement highly secure measures that are as strong as those used by the military, in order to prevent any potential compromises.

By implementing CBDC, we generate digital tokens while enhancing payment infrastructure, linking businesses, providing financial education to institutions, and ensuring compatibility with global markets. The crucial issue is if the necessary infrastructure is going to be built, which is going to necessitate a significant investment of funds. What advantages does a Central Bank Digital Currency offer compared to the costs associated with introducing it?

The central banks’ newly introduced digital currency has to comply with laws regarding anti – money laundering as well as counter-terrorism financing, consumer protection, financial privacy, and international legal frameworks. If a Central Bank Digital Currency does not have a well-defined legal framework, it may lead to confusion as well as disorder instead of stability. A CBDC could be seen as causing disruption, but it would not be truly transformative unless these challenges are overcome.

Privacy Discussion

A highly contentious discussion is currently taking place regarding central bank digital currencies, with governments contemplating the possibility of linking individual transactions to these currencies. This has sparked concerns about potential risks to financial autonomy. Having transparent transaction records could potentially lead to worries about heightened scrutiny, limitations on financial freedom, and the risk of assets being frozen quickly, unlike with cash where transactions are untraceable. However, doubts persist regarding the assurance of central banks that electronic ledgers would safeguard personal information. If this data held significance, transaction logs could be utilized to track customer habits, restrict expenses, or curtail financial autonomy. 

Governments have the potential to save significant amounts of money each year by putting into action transparent financial practices to combat fraud, tax evasion, along with illegal transactions. So, the simple question is, what happens after this? Do privacy and security outweigh each other? To prevent fraud, ensure various levels of anonymity — for smaller transactions that are kept secret and for larger transactions that are subject to auditing. While transactions are securely protected using different cryptographic methods, the identities of users are kept confidential. If CBDCs are mismanaged, they may push individuals towards decentralised cryptocurrencies. CBDC will achieve a balance between currency control and transparency when it becomes a digital currency. 

The digital pound does not come about simply from its presence or how it was created, integrated, or perceived. Creating a CBDC can enhance the effectiveness of financial operations, increase stability in the financial system, and bring transactions up to date with modern technology. There are numerous risks that need to be addressed, such as disintermediation risk in the banking sector as well as concerns related to cybersecurity. The UK believes that having a digital version of its currency is important for conducting business, maintaining financial stability, and participating in global economic networks. A CBDC may become a costly duplication if it fails to earn public trust and demonstrate unique advantages when compared with current alternatives. The digital pound should ultimately assist individuals rather than rule them, granting them financial freedom instead of imposing restrictions.