Bank of England Describes Future Payments
Sir Jon Cunliffe, Deputy Director Financial Stability at the Bank of England (BoE), has spoken about innovation in payments and money, focusing on the impact and opportunities offered by tokenisation, including the future of cash 1.
New forms of tokenisation are coming in payments in the form of stablecoins, commercial bank deposits and, perhaps, the Digital Pound. The BoE needs to ensure that these new forms of money fit the key criteria of existing forms of money, robustness and uniformity. By getting regulations and standards right, the Bank also gives certainty and clarity for those seeking to innovate.
If central banks, armed with appropriate powers, can get the regulatory framework right, then risks can be managed. If new advances drive radical change ahead of the regulatory framework being in place, it can be extremely hard, and disruptive, to catch up. It is important that the market does not compete by taking higher risks.
If innovation and competition can be managed well, then increased efficiency, functionality and resilience can be delivered for payments.
Recent innovations
Examples of the UK adopting innovations can be seen in the introduction of contactless payments, which has led to nearly 90% of Britons using them and nearly a third of payments being made contactless. Equally nearly a third of people use mobile payment apps. Seven million consumers and three quarters of a million small and medium-sized enterprises use open banking. The UK has a number of digital only challenger banks.
The result of lower payment costs and increased functionality has been a move from the predominant use of cash to payments using commercial bank money. By 2016 more retail payments were made using cards than cash and by 2021 85% of payments were made digitally.
Despite that, the BoE is clear that cash is important for vulnerable groups in society and for resilience. It is committed to providing cash while there is a demand.
Innovations in the pipeline
Digital payments will grow even further and Pay.UK (the recognised operator and standards body for the UK’s retail interbank payment systems) is introducing the New Payment Architecture programme. The BoE will introduce a new Real Time Gross Settlement (RTGS) system next year with increased resilience, access, interoperability, user functionality and end-to-end risk management.
The open banking framework is being extended with improvements on API performance, the provision of information sharing to third parties and technology changes that allow developments such as variable recurring payments.
The emerging technologies are tokenisation, encryption, distribution, atomic settlement and smart contracts. These have the potential to allow more extensive, faster and more secure payments through programming and the automation of payments. They also offer new ways to record ownership and the transfer of the ownership of payments.
For wholesale payments, this could make trading and settlement instantaneous. For retail payments, it might allow micro payments and flexible programming of money in everyday use.
While some may think this unlikely, perhaps the introduction of the iPhone may give pause for thought. In 2007 the iPhone was launched with 15 apps. In 2008 there were 500. Today there are over 2 million.
Robust and uniform money
The UK has about 800 private banks, building societies and credit unions issuing money that is robust, users can have confidence that the money will be useable and accepted in transactions, and uniform, denominated in the same currency unit – sterling – and seamlessly exchangeable for any other money in circulation on demand and without loss of value.
The new forms of payment will need to have these characteristics.
The plan for stablecoins
Stablecoins are a digital financial asset recorded on a ledger system and with exchanges used to store and trade them. Currently stablecoins are not issued by banks, they are not regulated, and they lack either robustness or uniformity.
The UK’s Financial Services and Markets Bill will give the BoE power to regulate them, defining stablecoins as digital settlement assets. They will be allowed to operate at a systemic level and fiat-referenced stablecoins will be possible.
The BoE will require standards equivalent to traditional payments and commercial bank money. They will need to be redeemable in fiat money, at par value and on demand. This means they will need to be backed by high quality and liquid assets. They will not be covered though, by deposit guarantee.
Stablecoins should increase innovation and competition resulting in more payment efficiency and functionality rather than maturity transformation. There is a risk of moving too fast. Frictions in the redemption and interchange suggest to an ultimate settlement in central bank money.
The BoE is looking at regulation for payment rather than investment or credit creation using stablecoins. Redemption at par would be inconsistent with investment products. If stablecoins are to be used for loans, then the exchanges will need to register as banks.
Tokenised bank deposits
Tokenised bank deposits (TBD) could offer some or all of the functionality and efficiency claimed for stablecoins, allowing bank deposits to compete with non-bank payment coins.
To date TBDs have been considered for wholesale payments, but can they be used for retail payments?
Today account to account payments, if they take place for accounts at the same bank, are direct. If the accounts are not held at the same bank, then payment settlement is made through the BoE. TBDs could go direct, but offering deposit insurance will be hard when the tokens are held on wallets rather than in accounts. Anti Money Laundering is also a potential issue. Smart contracts may offer a solution.
The final thought is that understanding the difference between TBDs and stablecoins will be hard for consumers.
Digital Pound
Today cash anchors the value and robustness of all monies. As cash use decreases it will become less usable in transactions, for example for e-commerce, and there will be a need for an at par digital equivalent.
Whatever the digital equivalent is, it will need to be designed to keep competition open. There is a risk that a few large internet platforms and markets could become dominant. As a result, the Bank has adopted a ‘platform model’. It envisages running the digital settlement and central transfer system with the private sector providing wallets and consumer facing payment services.
Issues of privacy and financial stability were not covered but the BoE is currently consulting about both.
Wholesale transactions
Wholesale transactions are to be settled in central bank money to the maximum extent possible. For the Boe this is not ‘whether’ but ‘how’ to do settlements of tokenised transactions in central bank money.
The BoE is exploring three options:
- Tokenised wholesale money and central bank reserves with a ledger for transfers
- A trusted private sector network to hold an account with the Bank and tokenise the reserves operate the ledgers and transfers within that account
- A tokenised ledger synchronised with the new RTGS system.
Final word
The Bank of England has neatly described the changes coming and the need for central banks to respond. A useful summary, particularly of the need for a digital currency.
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