How would a UK digital pound operate and what would it mean for cash?

The government and the Bank of England say a digital pound is “likely to be needed” in the future and have started work on its detailed design.

Ministers and officials are worried that cash use is declining rapidly: physical money accounted for 60 per cent of transactions as recently as 2008, but now only 15 per cent.

To ensure efficient payments systems in the future, the Treasury and BoE are now consulting on a digital version of banknotes, which could be introduced in the second half of the decade.

How would a digital pound work?

A digital pound issued and guaranteed by the BoE would sit in wallets on smartphones or specially designed smart cards provided by private companies, which could be commercial banks or technology groups.

These wallet operators would in turn have access to the BoE’s payments infrastructure, including a core ledger, to provide digital pounds to users. This all means that people would not have bank accounts with the BoE.

One digital sterling would be the worth the same as one physical pound. A digital pound would not pay interest, and the BoE has also promised not to impose a negative interest rate, equivalent to a charge to hold money.

Operators of digital wallets would have to hold user data securely. The BoE would receive only anonymised information on transactions involving digital sterling.

The wallet operators would carry out various know-your-customer and anti-money laundering checks similar to those done by banks on customer accounts.

Law enforcement agencies could ask for information from wallet operators in the same way they can seek access to bank accounts.

Will there be big changes to how electronic payments function?

No. Payments involving a digital pound would be very similar to those of today using debit cards, credit cards, payments with smartphones or payment services such as PayPal.

A digital sterling would seek to ensure payments systems such as these still exist in the future because wallet operators would have access to the BoE’s infrastructure.

A key ambition in the preparatory work being done by the Treasury and BoE is defensive.

Officials hope that a digital pound would stop the formation of “walled gardens” in which it is difficult to send money between operators of different payment systems.

This was the case in China with Alipay and WeChat Pay until recently. Some western technology companies are also interested in issuing payment tokens for their platforms.

The BoE also wants a digital pound to ensure payments are still denominated in sterling, thereby ensuring monetary sovereignty.

A digital sterling would be quite different to a cryptocurrency such as bitcoin, which has no intrinsic value and is better described as an investment. It will be more similar to stablecoins, a class of cryptocurrency that is pegged to underlying assets in order to keep its value steady.

Officials say they do not foresee a digital sterling would be programmable by the BoE, which could allow it to control how money was spent and where. However, wallet operators could allow consumers to set limits on their spending themselves.

One key question still to be answered is how offline payments will function, both for those who are not comfortable with digital services and in areas where internet connectivity is limited.

Is cash going to be scrapped?

Ministers and the BoE say no, and that cash will always exist. But while demand for cash is still high, its use in transactions is plunging, and at some point this trend will raise questions about how physical banknotes are being hoarded but not utilised.

A piece of government legislation going through parliament includes some provisions to preserve access to cash. But in the future, if the number of users of cash continues to fall, ministers’ stance on physical banknotes might change.

How will all of this affect commercial banks?

On a day-to-day basis, the idea is for banks to operate seamlessly alongside a digital pound.

But there is a concern that if a bank lost the confidence of its customers, it would be much easier to convert deposits into digital pounds than physically remove them from the financial institution. This could make bank runs more likely.

The government hopes the Financial Services Compensation Scheme, which guarantees customers’ deposits in bank accounts up to a value of £85,000 will help maintain confidence in commercial banks.

But to further address this risk of bank runs, Sir Jon Cunliffe, BoE deputy governor, said there would be an individual limit on holdings of digital sterling of between £10,000 and £20,000.

The conundrum that officials are contending with is that the lower the limit, the less danger there is to commercial banks. But that in turn would mean less use of digital pounds for transactions.

If there are few obvious changes, what is the point?

Officials have struggled to answer this question clearly. Privately they say it is important to keep their options open given the future of digital currencies and use of cash is unclear.

Funding the detailed design of a digital pound and relevant infrastructure is not expensive for the Treasury and BoE, and the decision on whether to press ahead with implementation is due to be taken in 2025.

Pressing ahead with preparatory work on a digital sterling is similar to taking out insurance against an uncertain world in which the payments landscape becomes much less customer friendly than the one of today.