“The Bluffer’s Guide to Central Bank Digital Currencies”


Exactly what is a “Central Bank Digital Currency”, and why should we be considering it?

This has been written for the wider audience, who will soon find the topic of a digital currency appearing more and more in the mainstream press. We are currently working on a full, detailed analysis of this subject for discussion and engagement with stakeholders.

A CityUnited Project Simple Explainer

The unstoppable progress of digital technology is a fact of life (like death and taxes) which provides both opportunity and risk, but either way it must be managed. 

The digitalisation of financial transactions and their operation and regulation is therefore inevitable. All major central bank currencies, like the £, $, and Euro, will eventually be digitalised and the important thing is that it should be done on our terms.

The platform used to operate a digital currency provides a huge number of competitive advantages compared to the current, hybrid, and interconnected systems that form the backbone of global finance. 

Let’s look at currency generally

A currency is a means by which an asset (which could be tangible or intangible, like a service) is paid for, moving it from one owner to another and is most easily identified in the form of a bank note – in effect a promise to pay by a central bank.

A currency’s value will change against other currencies and it may therefore be held by some as an investment as well as a means of payment. Payments made across a Central Bank’s balance sheet enjoy the status of having achieved ‘settlement finality’ – certainty of payment, in effect.

A bank note is an example of analogue currency.  It has a value, physical presence, and a specific identity with a number. Payments made using bank notes, which are a charge on the central bank’s balance sheet, also satisfy the requirement for settlement finality.

So are we talking about doing away with banknotes – a cashless society?

No.  A Central Bank Digital Currency would not mean the end of physical money.

A bank note would become the physical ‘analogue’ alternative to a digital currency payment and would be used, as long as that were necessary, for payments for assets, services or other financial transactions, as could a normal bank account.

How does a digital currency differ?

A digital currency has the same characteristics: value, an electronic presence and a specific identity. However technology, called Distributed Ledger Technology (DLT), allows for a much cheaper, faster, and smarter experience for users.  It means that the past and current owner of that specifically identified particle of digital currency is recorded, and it can be used to make instantaneous payments, all fully encrypted.

The benefits of digital currency are clear: massive reduction of cost, instantaneous transactions reducing the need for cash holdings, high security and opportunities for real time regulation and supervision, significantly reducing risk in financial and other markets.

This is not the same as ‘crypto’ currencies or Bitcoins

A Central Bank Digital Currency is NOT a ‘crypto currency’ but, like all central bank currencies, has the firm foundation of the backing of such an institution, unlike for instance Bitcoins.

The platform or system that supports the digital currency is also built to handle the vast number of financial transactions that occur daily within the global finance system.  These volumes of transactions would make it impossible for a cryptocurrency to be used in real time because they are just too slow when they try to deal with a large number of transactions.

However Distributed Ledger Technology also provides the means to counteract the obvious risks associated with instantaneous availability of the knowledge (or even prevention) of every transaction in that digital currency.  By means of legally determined and enforceable rules, it can safely limit the knowledge available to different classes of participants, eg Central Bank, regulators, commercial banks, etc, based on proven cryptographic methods that are already in widespread use, tailored for each participant and imposed at the outset.

This knowledge will vary according to the needs of those participants, and would be totally controlled by an appropriate framework of law and regulation.

So what is The CityUnited Project proposing?

The British/sterling digital currency proposed by CUP is a simple ‘wholesale’ model under the control of the Bank of England, involving commercial banks as its intermediaries and based around the current settlement systems such as the activities of its Debt Management Office, and others such as the Bankers Automated Clearing System (BACS) and Crest (the UK based central securities depositary).

It would replace the ageing 20th century technology of the existing systems using existing, established know-how and provide a much cheaper, quicker, and unified system rather than the worn out ‘spaghetti’ of the existing arrangement.  It would specifically provide knowledge of all past and current transactions on that system, but its use outside the BoE would be limited to commercial banks, and would not be available to the latter’s retail and non retail/wholesale customers.

The banks’ third party customer use of the digital currency could then be rolled out in a controlled way once the basic framework, rules and controls had been established.  This approach would continue the banks’ key economic role as financial intermediaries, and ensure that transactional information about individuals, companies, and other legal entities holding bank accounts was totally protected.

Everybody benefits…

Other stakeholders include the UK Government (real time tax and revenue collection), UK regulators (real time regulation), Intelligence Services and Police (real time data to combat crime and protect UK interests), and all service sectors and all businesses through more effective and cheaper cash and resource management and improved regulation.  In short, its implementation would transform the fortunes of the UK and underpin our economic and national security.

Taking on China

China will launch a digital yuan (or renminbi) in 2022, and is already running limited pilots. Unlike the proposed sterling model the Chinese central bank, the People’s Bank of China, would use the state owned commercial banks as agents, rather as the Bank of England uses the Scottish banks.

In other words this would mean that all yuan/renminbi digital currency transactions would have to go across the books of the PBOC, its central bank, or its agent banks.

This could provide the PBOC and its state owned agents – and by inference the Chinese Government – access to total knowledge of all digital yuan transactions across the books of those banks anywhere in China or indeed anywhere in the world.

This would establish a Chinese system of introduction of digital currency.

The proposed, UK-developed, world digital currency system

The UK’s proposed digital sterling system could establish an alternative Western digital currency template in a ‘One Globe, Two System’ world.  It could be cast in an entirely different framework, accepting its inevitability, providing all the direct and a multitude of important related benefits but also with complete control and protection of the rights of and information about all participants, including, eventually, individuals.

It would provide the UK with first mover advantage – bearing in mind the EU’s recently announced plan to carry a digital Euro initiative forward – enabling it to take a global lead in ensuring that such digital currencies are rolled out in the most effective but safest way, recognising the risks associated with their unavoidable ultimate deployment.

It would also reconfirm the Bank of England’s position as a premier league central bank and sterling as a global currency.

– Professor Daniel Hodson, for the CityUnited Project, 19 April 2021