The digital pound – a direct threat to democracy and financial freedom

Executive Summary

The Bank of England, in coordination with HM Treasury, will likely press ahead with plans to introduce a ‘digital pound’ within the next 3-5 years. The reasons for doing this are purportedly benign, but there are elements of the plans which are concerning as they represent latent opportunities both for future governments, and for private actors, to intrude on our financial freedom.

Since there are few identifiable benefits of introducing the digital pound (certainly when weighed against the risks to civil liberties) the project should be abandoned as it represents the unnecessary introduction into the political economy of a major threat to financial freedom. If it goes ahead, it is important that the legislative framework enacted in advance of the introduction of the digital pound is structured in such a way as to ensure that this new form of money poses smaller, rather than greater, risks. It is also important that physical cash remains a viable alternative – not just in terms of maintaining financial access, but also in terms of ensuring its continued usefulness in daily transactions so as to serve as a failsafe. 

Background

The Bank of England (the ‘Bank’) describes itself as ‘looking at the case’ for a Central Bank Digital Currency (‘CBDC’), which it would call the ‘digital pound’.

This would be a digital form of cash which would be exactly equivalent in value to banknotes. It would be issued by the Bank, with holdings being recorded on a core ledger which the Bank would operate anonymously. Access to the ledger to make transactions would be managed by intermediaries generally referred to as Payment Interface Providers (PIPs), who would operate ‘digital wallets’ for users.

The word ‘wallet’ is a misnomer in that it really a gateway or pass-through, by which the individual user accesses the core ledger to make transactions. When engaging in a transaction, the user would interface with his or her wallet to direct the payment of digital pounds, but the actual transaction itself would be recorded on the ledger by the changing of holdings accordingly.

The digital pound, if introduced, will have the following noteworthy features:

• It will not be remunerated, meaning it will not bear interest;
• Holdings will initially be limited – likely to £20,000;
• User data will be unavailable to the Bank but not to PIPs, who will be expected to comply with existing Know-Your-Customer (KYC) obligations and anti-money laundering regulations;
• Its primary use cases will be in retail, rather than wholesale, contexts

The Bank has given two main reasons as to why it thinks the introduction of the digital pound will be necessary. The first is that it will purportedly promote innovation and choice. The second is that it will allow central bank or ‘public’ money in the UK to retain its status as an anchor for monetary stability in the face of lower cash use, increased adoption of cryptocurrencies, and the possible appearance of privately issued retail stable-coins.

These different drivers may, it is thought, result in a fragmentary payment landscape, with the result being that monetary sovereignty would be compromised – in other words, that monetary policy levers would lose their effectiveness. The availability of the digital pound as, essentially, another (digital) form of cash would in this view support the uniformity of money.

The Bank, together with HM Treasury, is now in the process of moving to the design phase of the digital pound, having issued two consultation papers (on the digital pound and its technological aspects) in 2023, and received responses.[1]

In their own recent response to the main digital pound consultation in January 2024, the Bank and HM Treasury stated that it is too early to make a final decision on the digital pound’s introduction, but that the Bank will now go about building ‘the necessary skills [and] technical capability’ to introduce it if and when such a decision is made.[2] This suggests that there is a strong likelihood that the decision will be positive.

This assumption is bolstered by the observation that the Bank is hardly alone among central banks around the world in setting out plans to issue a digital currency: at the time of writing, 134 countries and currency unions (the Eurozone being chief amongst the latter) are also ‘exploring the option’.[3]

The issue

The introduction of the digital pound represents what can be thought of as a latent risk to financial freedom, and indeed to freedom itself, since the availability and utilisation of money is so central to the exercise of autonomy in a market economy.

It is by no means certain that financial freedom will be restricted either through the design of the currency itself or the means by which it will be regulated. However, the architecture of the digital pound suggests that circumstances in which the currency itself could be manipulated for political ends could easily emerge. This creates what can be thought of as a latent risk in the political economy – one which has the potential to be catastrophic, in its consequences for freedom, if realised. Since a potentially catastrophic risk should be averted even if the likelihood of its realisation is low, there is a strong argument in itself that it would not be prudent to create a digital pound. If it is to be introduced, the level of risk should, it goes without saying, be minimised insofar as it is possible to do so.

This latent risk manifests itself in three broad areas: programmability; ‘de-walleting’; and quasi-compulsion, each of which is considered below.

It must be mentioned that there are other risks associated with CBDCs in general, such privacy concerns and threats to financial stability arising from potential disintermediation of the financial system, but these risks will not be addressed here except to observe that they further support the case for not pursuing the development of a digital pound at all.

Programmability

The retail form of the digital pound is intended to be programmable, meaning that it could be programmed to be only spendable in certain amounts, with certain retailers, on certain items, at certain times, on the occurrence of certain events, and so on. This also means that it could be programmed to bear a negative interest rate, or to lose its value if it is not spent within a certain timeframe, so as to boost spending.[4]

The programmability of the digital pound is said to be necessary in order to facilitate certain legitimate use cases, such as smart contract or escrow functionality, or even parents programming their children’s money so as not to be spendable on sweets.[5] The Bank has made clear that its intention is for programmability to only be user-initiated. It has also stated that neither it nor the government will engage in programming of the digital pound. If programming does take place, it is intended to be carried out by the PIPs who operate the digital wallets through which individual users will interact with the Bank’s core ledger for transactions. The Bank has suggested that there will be a ‘robust regulatory framework’ in place to ensure that programming will only happen on user request.[6]

Despite the Bank’s assurances, however, the fact that the digital pound will be in principle programmable obviously represents what was earlier called a ‘latent risk’, since there is no guarantee that the intention to only permit programming on the basis of user consent will hold indefinitely. Particularly at times of real or perceived crisis there is a tendency for emergency powers to be used to override pre-existing intentions. It is also the case that ‘user consent’ or ‘user-initiation’ may itself be effectively coerced by making such consent or initiation a requirement for use of a digital wallet by a PIP, or by burying the ‘giving’ of consent within dense and lengthy sets of terms and conditions.

This risk to financial freedom posed by the potential programmability of the digital pound could manifest itself in various ways. For example, a future government or regulator may, through delegated legislation or licensing requirements, require PIPs to program digital pounds to achieve a political goal of some kind – such as to limit consumption of a particular type of product or service, or to limit transactions of a particular type, or with a particular provider.

A future regulator may require PIPs to impose a duty to require consent from users for certain programmability functions at sign-up, or PIPs may do so of their own volition. Or the Bank may decide to require digital pounds to bear a negative interest rate or to lose value if they are not spent within a particular timeframe, as a tool of unconventional monetary policy – particularly during a severe recession.

It is important to point out that any form of digital currency, such as bitcoin, is in theory programmable, and that the use cases put forward for programmability with respect to the digital pound are all realisable through those other currencies. The crucial difference with respect to the digital pound would be its centralised nature – since all holdings would be contained on a ledger owned by the Bank of England, and since the only way for users to access their holdings would be through a PIP, it would be a relatively straightforward matter to deploy the programmable potential of the currency for political ends. This, in our view, is highly likely.

This risk is not, of course, imminent, and it bears repeating that the Bank and HM Treasury have sought to reassure the public at every stage of consultation that the intention is that programmability will only ever be user-initiated. Intentions can, as history has shown, change. It is important, therefore, that a government which has a strong interest in securing financial freedom sets the legislative agenda for Parliament such that the risks in question are less likely to become manifest in future.

De-Walleting

A related concern is that PIPs may, as commercial banks currently do in some circumstances, ‘de-bank’ (the suggested term is ‘de-wallet’) customers on the basis of political discrimination or for some other reason.

This is not, strictly speaking, a risk posed by the design of the digital pound itself, but is a feature of the architecture within which it is intended to be used. Since anyone wishing to use digital pounds will have to enter into a contractual relationship with an intermediary (a PIP), that usage will obviously be contingent on the behaviour of that intermediary and how it exercises whatever contractual right to terminate it possesses. This means that there is a pressing need to deal in advance with any risk that PIPs will engage in the practice of ‘de-walleting’ in a similar fashion to the manner in which high street banks have been revealed to ‘de-bank’ customers for political reasons.

Quasi-compulsion

It seems likely that the concept of a digital pound will not be popular amongst the public. The take-up for CBDCs around the world have not been very enthusiastic so far, and in almost all cases they have been very small.[7] It is to be hoped that if such circumstances prevail in the UK, both the Bank and HM Treasury will simply either wind up the project or allow it to subsist as a niche element of the economy.

These scenarios are less likely, though, than efforts being undertaken to ‘nudge’ take-up. These may be relatively benign right now (such as advertising campaigns) but could become more hard-edged.

For example, it is not difficult to imagine a scenario emerging in which benefits, or state pensions, are made payable only in digital pounds so as to encourage the currency’s use. This was indeed suggested implicitly by some respondents to the Bank and HM Treasury’s 2023 consultation, with ‘government-to-person’ or ‘G2P’ payments such as subsidies, stimulus pay-outs, pension payments, relief payments and Gift Aid being recommended to be made in digital pounds ‘to support a sense of trust and encourage its adoption’.[8]

This quasi-compulsory take-up would by definition restrict choice.  It would also be an amplified threat to financial freedom if done in conjunction with the programming of the currency to inhibit or encourage certain types of spending, thinking or the purchasing of particular classes of products. It is indeed not difficult to imagine that the payment of benefits could mandated to be made through digital pounds in the guise of a means of encouraging ‘financial inclusion’, and that such digital pounds will be programmed so as not to be spendable on, for example, tobacco, alcohol, sugary foods, and so on.

Taken together, these latent risks to financial freedom far outweigh whatever benefits the digital pound will purportedly realise. The argument that the digital pound will boost innovation is not persuasive. Most, if not all, of the use cases suggested for the digital pound are achievable with commercial bank money or private digital currencies. Indeed, the UK already has a highly innovative and efficient system for making digital payments.

Likewise, the argument that the digital pound will be necessary to maintain the uniformity of money is not particularly plausible. It is difficult to imagine what incentives would lead the public to abandon the pound sterling at large scale in favour of privately issued stable-coins or crypto assets and it is not clear in any case why this would be undesirable, except perhaps from the Bank’s perspective as the maker of monetary policy. As long as cash circulates in the economy, the perfect interchangeability of public money and commercial bank money will remain.

When other risk factors that are not the subject of this paper are taken into account (such as the significant national security risk of potentially creating a single point of failure for payments, the potential for theft via hacking, and so on) the case for the project begins to look very weak. This means that it should not be pursued at all – or, if it is to be pursued, that every step should be taken to diminish the risks in question.

This cannot be done perfectly, as the very existence of a programmable digital currency held on the central bank’s core ledger is almost by definition an invitation to authoritarianism. A government with a strong interest in securing financial freedom should at the very least ensure, well in advance of the introduction of such a currency, that any attempt to deploy it to achieve authoritarian ends will face as many hurdles as possible.

Recommendations

The digital pound, or any other form of CBDC, should not be introduced in the UK.

If the digital pound is to be introduced, a government with a strong interest in securing financial freedom should consider enacting the following measures, justified in more detail below:

1. PIPs should be required as a licensing condition to always maintain programmable and non-programmable functionality with regard to digital pounds, so as to ensure that there is genuine consent for programmability from the user, and that users are never required to ‘opt in’.
2. Similar protections as those encoded in the Payment Services (Contract Terminations Amendment) Regulations 2024 should be extended to PIPs or other operators of digital wallets for accessing the Bank’s core ledger.
3. In the longer term, a ‘right to pay in physical cash’, similar to that which has been proposed by Norges Bank, the central bank of Norway (an English-language precis is available),[9] and which is likely to be followed in the near future in Sweden,[10] should be enshrined in UK law.

Norges Bank’s proposal is to make clear in statute that a consumer has a right to pay in physical cash and that this cannot be ‘contracted away’ where goods or services are offered to the general public at a physical location. This would appear a sensible approach to adopt in the UK and should likewise be done through the enactment of primary legislation.

Argument

The measures recommended above are justified on the following grounds:

1. PIPs should be required as a licensing condition to always maintain programmable and non-programmable functionality with regard to digital pounds, so as to ensure that there is genuine consent for programmability from the user.

Consumer contract literature has shown beyond doubt that when users sign up to terms and conditions for an online service they typically do not read, and have little understanding of, the meaning and import of those terms. This is often referred to as the ‘no-reading problem’.[11] To gain so-called consent for programmable functionality from users by including it within standard terms and conditions would, therefore, be trivially easy within the context of the PIP-user relationship. PIPs must therefore be required to make available a standard service, on the basis of which digital pounds will not be made programmable, as a requirement to be granted a license – and must also be required to make the choice of whether to allow programmability obvious and meaningful to the user with a choice whether to opt in being mandatory.

1. Similar protections as those encoded in the Payment Services (Contract Terminations Amendment) Regulations 2024 should be extended in advance to PIPs or other operators of digital wallets for accessing the Bank’s core ledger. The same arguments for the current government’s response to the ‘de-banking’ phenomenon apply within the context of the digital pound, where the most significant relationship is not between the customer and bank but the user and the operator of the digital wallet through which the user interacts with the core ledger (i.e., the PIP). PIPs may very well become subject to precisely the same incentives which encourage ‘de-banking’ by high street banks. It is essential that ‘de-walleting’ is made functionally impossible in advance of the digital pound’s introduction.
2. In the longer term, a ‘right to pay in physical cash’, similar to that that proposed by Norges Bank, the central bank of Norway (an English-language precis is available),[12] and which is likely to be followed in the near future in Sweden, should be enshrined in UK law.

There is a very strong argument for retaining the provision of cash services as a redundancy against problems with, or attacks against, digital payment services. Indeed in this respect, the retention of physical cash as a viable payment method must be seen as a critically important national security imperative. An ongoing commitment by government to ensure that there remains a right to make retail payments in cash below a certain price threshold would also be a crucial component of retaining financial freedom. If the latent risks associated with the deployment of the digital pound do materialise, then the ability to make ordinary retail transactions in cash could be an important failsafe.

The intention in Norway seems to be to make clear in statute the consumer’s right to pay in physical cash and that this right cannot be ‘contracted away’ where goods or services are offered to the general public. The UK should consider introducing a similar requirement, certainly on purchases below a certain value which is set at a realistic level that reflects typical household expenditures. This would not only bolster the government’s existing commitment to make sure that there is access to cash, but also to make sure that access to cash is meaningful in the sense that there remains a realistic option of using it for everyday transactions.

These recommendations to some degree raise concerns about state interference with market forces, but the ‘de-banking’ scandal has revealed that there are circumstances in which market actors can become captured by dominant political preferences. This makes regulation a requirement.

Conclusion

It is important in particular that, since the digital pound is intended to become an important public service by the Bank and HM Treasury, concerns about state intervention do not interfere with the project of ensuring that the new currency is not used in ways that are restrictive of financial freedom.

Debate which pays true heed to democratic principles and the education of policy makers and parliamentarians will be central in ensuring that if and when the digital pound is introduced it is not deployed as a means of social control.

7 May 2024

The Centre for Digital Assets and Democracy Limited

 

David McGrogan, fellow:  [email protected]

Claire Cummings, founder: [email protected]

Jennifer Ewing, head of strategy: [email protected]

www.cfdaad.co.uk

 

[1] The two consultation papers are: Bank of England and HM Treasury, The Digital Pound: A New Form of Money for Households and Businesses? (available at https://www.bankofengland.co.uk/paper/2023/the-digital-pound-consultation-paper), and Bank of England and HM Treasury, The Digital Pound: Technology Working Paper (available at https://www.bankofengland.co.uk/paper/2023/the-digital-pound-technology-working-paper).

[2] Bank of England and HM Treasury, Response to the Bank of England and HM Treasury Consultation Paper – The Digital Pound: A New Form of Money for Households and Businesses (available at https://www.bankofengland.co.uk/paper/2024/responses-to-the-digital-pound-consultation-paper), p. 18.

[3] The Atlantic Council tracks developments internationally here: https://www.atlanticcouncil.org/cbdctracker/#:~:text=130%20countries%2C%20representing%2098%20percent,advanced%20stage%20of%20CBDC%20development

[4] It must be mentioned that Central Banks around the world have been keen to distance themselves from such suggestions. See, for example, Bank for International Settlements, Central Bank Digital Currencies: Foundational Principles and Core Features (2020) (available at https://www.bis.org/publ/othp33.pdf), p. 8.

[5] This was cited explicitly as a benefit of the digital pound by Sir John Cunliffe, then-Deputy Governor of the Bank of England for Financial Stability, in a 2023 interview (available at https://news.sky.com/story/britcoin-bank-of-england-seeks-views-on-economic-impact-12327110).

[6] Bank of England and HM Treasury, supra note 2, p. 30.

[7] Central Banks which have introduced CBDCs at the time of writing are those in Ecuador, the Bahamas, Jamaica, the East Caribbean Currency Union, China and Nigeria.

[8] Bank of England and HM Treasury, supra note 2, p. 45.

[9] Norges Bank, ‘The Right to Pay Cash’ (2023) (available at https://www.norges-bank.no/en/topics/notes-and-coins/the-right-to-pay-cash/).

[10] Government of Sweden, The State and the Payments (2023) (available at https://www.regeringen.se/contentassets/c01377cf65424cf0b12addf64c04374a/english-summary-the-state-and-the-payments.pdf).

[11] I. Ayres and A. Schwartz, ‘The No-Reading Problem in Consumer Contract Law’ 66 (3) Stanford Law Review (2014) 545.

[12] Norges Bank, supra note 9.