Fintech enables a centrally controlled digital currency

Stablecoins are the less popular sibling of cryptoassets. They are different, as they are a method of payment rather than an investment or asset. Tied to an underlying asset, they are inherently more stable than crypto as an asset. With a stablecoin, the price is designed to be tied to a cryptocurrency, fiat money, or exchange-traded commodity (such as precious metals or industrial metals). They are currently a small part of the total crypto market, worth around $130 billion, which is about 5 percent of the market. That said, their size has doubled since 2020.

Stablecoins have so far been limited to crypto payment systems, with an emerging and experimental use case seen in wholesale financial market players and large enterprises. Yet there is another facet of stablecoins emerging; their potential use by central banks to create a central bank digital currency (CBDC).

A CBDC will integrate into existing payment systems used by financial institutions and will be relatively risk-free; backed by a central bank, such as physical notes and coins. According to the Atlantic Council (an independent think tank), some 87 countries were exploring issuing a CBDC as of March 2022. Less than two years earlier, in May 2020, only 35 countries were considering a CBDC. But now 14 countries, including India, China and South Korea, are in the pilot phase of their CBDCs and are preparing for a possible full launch. Nine countries have now fully launched a digital currency.

Britcoin is the UK’s potential CBDC. It is still in a nascent and theoretical stage of development with lots of talk but not much action so far. However, its establishment is feasible and is thus well on the radar of the Bank of England, having been discussed in several speeches and the subject of a discussion paper back in 2020. A central bank digital currency task force was established in 2021 and the Bank of England is currently in the consultation phase for to see if a case for a Britcoin can be made and what its scope will be. The bank is working with Asos, Spotify and PayPal among others to consult its CBDC Engagement and Technology forums with the aim of making any Britcoin operational and technologically robust. It is believed that the latter part of the decade would be the earliest date for the launch of a UK CBDC.

However, a framework for e-money through the Electronic Money Regulations 2011 and the Payment Service Regulations 2017 provides a basis for payment firms in the UK. Although this is not explicit for stablecoins, it is a good basis because the framework can be relatively easily applied to stablecoin issuance, and the provision of wallets and custody services, according to a government paper published in early April 2022.

Britcoin seems to have some support as well. In a 2021 speech, Tom Mutton, fintech director at the Bank of England, outlined the intention: “The CBDC would make central bank money available to the public, in digital form, for the first time. Crucially, if introduced, CBDC would complement – ​​rather than replace – cash and bank deposits.”

Siobhan McArdle, CEO of L3COS, the fintech company behind an enabling operating system, says: “In many ways, CBDCs will work very similar to the fiat currencies we use today. They will be minted by a central bank or government and then distributed on a number of ways. Like fiat currencies, only a limited amount will be minted to maintain and regulate its value.”

A Britcoin can be a positive thing. The most obvious advantages are the low costs and transaction speed – especially when it comes to cross-border payments.

There are also benefits for the central bank. Especially when issuing emergency funds instead of printing money to buy up government bonds or other securities, as is the case today with quantitative easing (where there is a need to lower interest rates by increasing the money supply). Again, using a Britcoin would be cheaper and faster than physically printing money.

However, Britcoin could be bad news for commercial banks. The Bank of England’s deputy governor for financial stability, Sir Jon Cunliffe, said in November 2021 that if a CBDC was introduced, 20 percent of deposits could move out of the commercial banking system as a result.

Yves Longchamp, head of research at SEBA Bank, explains: “There is an argument that says if you had a Britcoin account with the Bank of England, why would you want to have an account with a commercial bank. That said, central banks are not set up to hold deposits or lend directly to consumers, so it is likely that Britcoin will be used in much the same way as cash or electronic money. The central banks, instead of pumping money electronically into the system, will pump it digitally.”

McArdle says this is not bad. “It is true that having secure private wallets would make the traditional function of personal banking redundant. But in a digital economy, banks must develop and serve other purposes apart from being cash depositories. Banks can also join the L3COS platform and be part of the fintech revolution happening around them by offering more agile, market-led and innovative financial solutions,” she comments.

If nothing else, a Britcoin would promote choice, which is increasingly important as consumers become more demanding and have higher expectations of their financial service providers. So whether they want to use a private digital currency, a publicly issued digital currency by the Bank of England, or indeed a mix of the two, at least they can choose.

High standards, especially around transparency, are likely to be high on the list of must-haves. Speaking in October 2021, Cunliffe said: “Cryptotechnology offers the prospect of further transformation in the way we pay and the use of money as a means of transaction. However, the development of large-scale general purpose stablecoins cannot be allowed to come at the expense of lower standards or higher risk to financial stability. Regulators must ensure that the standards applicable to current systemic payment systems apply equally effectively to any systemic or likely systemic payment system using stablecoins.”

McArdle explains the importance of transparency: “While the transparency of a blockchain-based CBDC greatly benefits regulators, it allows individuals to hold businesses and governments accountable. If regulated, individuals could be able to see where banks are investing and what transactions central government officials are making – decisions that are increasingly important in today’s world.”

An example of this would be the ability to enforce financial sanctions or regulate financial institutions. “The use of CBDCs will provide a transparent account of where money is, where it is held and where it comes from. The governing bodies will be able to set rules that can automatically stop an entity from making illegal transactions,” says McArdle.

In which one? Money podcast in October 2021 Mutton said: “The use of data may be relevant to certain public policy objectives. The most obvious is to avoid financial crime, avoid money laundering. And we must consider the circumstances in which data can be used with appropriate protection by the appropriate authorities where necessary for the purposes of law enforcement.”

A high degree of control and openness also gives rise to the question of control and programmability. What is positive in one area is negative in another.

A central facet will be the privacy of individuals. Cash is untraceable – the Bank of England produces money but does not track it. But unless a privacy layer is introduced, the same cannot be said for a Britcoin, and in theory it would be easy, if not ethical, to use private data for control or other purposes. This is unlikely to happen in the UK, where there are high ethical standards and financial stability, but conceptually it is possible.

Programmability is a particular problem area. This would mean that a Britcoin could be programmed to only be spent on certain things, or spending limits could be set. The obvious example is with government benefits, but it could extend to healthy food, environmentally friendly choices or anything else that the government was keen to push at any given time. Anonymity, as with banknotes, would be one way to deal with this.

Longchamp comments: “A security layer would be a positive thing. Individuals would have to go through some kind of gateway security, but then become anonymous once inside the system – in the same way that nightclubs have doormen, but once inside the system , individuals are not identifiable. It would be a financial whitelisting system to access the liquidity pool inside. That way you know all the other users are clean as well, but that would be the extent of it.”

McArdle adds: “Anonymity can be programmed into a digital ecosystem. For example, with L3COS there is an opportunity to transfer the voting system to a digital format, which can be done completely anonymously and will solve many accessibility problems around voting and vote counting, as it can all be facilitated through the platform. “

This relates to digital identity, where every individual and entity has a digital identity, much like a persona in a game like ‘Fortnite’ which is linked back to the username and login. So everyone can trade with security and transparency. Each digital identity will be linked to the individual’s own unique wallet, which houses their CBDCs, along with any other assets they may have. With full traceability regarding people’s digital holdings, CBDCs can be safely implemented, audited and therefore fully regulated.

McArdle sums up: “In a properly run and regulated ecosystem, CBDCs can indeed be programmed to follow a set of rules, but this is not entirely wrong. Recent events highlight one of the main advantages of this. The sanctions against Russia have led to many institutions and businesses have reanalyzed their KYC (‘know your customer’) data to check compliance. However, any verified data can be used to immediately flag the entities and individuals of interest and freeze assets where necessary. In in addition to this, it will ease the risk for many institutions and individuals, as the platform can also automatically stop a non-compliant action.

At the end of the day, all stakeholders, individuals, businesses and governments have a lot to gain from the adoption of CBDC. But as with all things in life, only if implemented within a strong governance structure.

Longchamp says: “This is quite a long way from becoming a reality. Implementation and use will take time – perhaps a generation – and so it’s time to get things right and move this from something theoretically possible to making it a genuine alternative to cash.”