The fast-growing market for digital currencies like bitcoin could threaten the economic system as they are unregulated – hence central banks are looking into launching their own
The rapidly growing market for digital currencies like Bitcoin and Ethereum could threaten the economic system as they are unregulated.
The creation of an official UK digital currency could undermine the country’s financial stability and lead to bank runs during economic downturns, a parliamentary report warns.
As a result, central banks like the Bank of England (BoE) are investigating whether they can introduce their own digital currencies or CBDCs.
It is currently working on a digital currency design with the US Federal Reserve, the European Central Bank and the central banks of Canada, Japan, Sweden and Switzerland.
The BoE warns that digitization is changing domestic and international payment systems and governments need to consider how to respond.
However, a report by the House of Lords cross-party Economic Affairs Committee says the UK’s launch of a central bank digital currency (CBDC) could pose “significant risks”.
According to the report, this could pose risks to UK households, businesses and the monetary system for decades to come.
The report states: “These risks include government oversight of people’s spending decisions, financial instability as people convert bank deposits into CBDC during tough economic times, an increase in central bank power without sufficient oversight, and a centralized point of failure that a Target for hostile nation-states or criminal actors.”
They said none of the witnesses who testified, including Bank of England Governor Andrew Bailey and his deputy Sir John Cunliffe, had been able to make “convincing arguments” as to why the UK would adopt a digital currency for need retail.
“While a CBDC may offer some benefits, it could pose significant financial stability and privacy challenges,” the report said.
“We recognize that consumer payment preferences, technological developments and decisions in other countries may improve the case in the future,” it said.
Central banks fear that big tech companies could issue their own digital currencies that could compete with central banks and their control over monetary systems.
Facebook has already announced plans to launch a digital currency called Libra.
Rishi Sunak, Chancellor of the Exchequer, told the committee the Facebook Libra project has prompted the government to ask, “What do we think of a global stablecoin that we have no control over?” What does that mean? How are we supposed to fix this? Should we be worried about financial stability?” He said it catalyzed work on a UK version of the digital currency.
In December 2020, Libra was renamed Diem and its ambitions were scaled back. The then Federal Minister of Finance, Olaf Scholz, described Diem as a “wolf in sheep’s clothing”.
Once established, privately issued digital currencies can enable large tech companies to exert excessive market power and reshape the way payments are made, affecting how the monetary system works.
The Lords said such risks are real, but the UK’s own digital currency “may not be a necessary or complete answer”.
Private corporations or companies big enough to compete with existing payment systems can and should be regulated, it says.
The rapid pace of technological change is driving central banks’ interest in CBDCs, the report said. Over the past decade, a dramatic increase in new forms of electronic payment has resulted in established banks and payment providers in a battle for market share.
An early study by the BoE suggested that among the reasons for adopting CBDCs were avoiding the risks of new forms of private money creation, increasing competition, efficiency and innovation in payments, and meeting future payment needs in a digital economy, as well as coping with them of a decline in cash.
The Lords argued that a decline in case use and rising use of debit and credit cards – trends accelerated by the pandemic – still did not justify the launch of a digital banknote. They argue that there are better ways to improve payment systems with fewer risks.
The introduction of CBDCs by Britain’s strategic competitors may have consequences for Western foreign policy. For example, the SWIFT messaging system improves the US’s ability to impose sanctions. However, in certain countries, such as China, there is a political will to use CBDC technology to create alternatives to the existing international payment system.
Lord Forsyth of Drumlean, Chair of the Lords Committee, said: “The launch of a central bank digital currency would have far-reaching implications for households, businesses and the monetary system. We found the potential benefits of a digital pound, as outlined by the Bank of England, to be overstated or achievable through less risky alternatives.
“We gathered evidence from a multitude of witnesses and none of them could give us a compelling reason why the UK needed a central bank digital currency. The concept seems to offer a lot of risk for very little reward. We came to the conclusion that the idea was a solution in search of a problem.”