Bank of England outlines path to digital pound

Comment

A clear thread running through these latest publications on a digital pound is the scope for more innovation in the UK payments landscape and how that innovation can help to boost economic growth - a key priority for the Government. In addition to the benefits to the UK payments industry, this movement towards making a decision on the digital pound keeps the UK firmly in the global conversation on the development of digital currencies. Maintaining a position of relevance concerning central bank digital currencies is important for the global influence of the BoE given the trend towards their adoption – as at September 2024, three countries had launched a digital currency, with another 44 pilots underway.

As explained in the Progress Update, the proposed public-private model for the digital pound tasks the public sector with providing and operating the infrastructure, allowing the private sector to focus on producing innovative products, optimising the consumer experience and identifying commercial opportunities. Payments and fintech firms should also be heartened to learn the Design Note emphasises the importance of ensuring that the availability, security and performance requirements of any future digital pound infrastructure "do not unduly impact commercial viability". With the launch of the Digital Pound Lab technology sandbox due this year, interested firms should be ready for more experimentation around potential use cases and business models for the proposed digital pound.

What’s happened?

The BoE's publication of the Design Note signals the start of a movement from research and positioning to beginning to articulate what a digital pound would look like and how it would operate. The Design Note sets out deliverables for the BoE in relation to developing the design of the digital pound. As a reminder, the BoE and HM Treasury have been in the "design phase" to explore the policy and technological framework for a potential digital pound since 2023, as set out in the BoE’s 2023 consultation paper and associated response (please see our article on this development here). The 2023 consultation paper received more than 50,000 responses, and the BoE wants to test potential designs before making a concrete proposal. A key theme of the responses received was the importance of trust, so the BoE wants to test the functionality and security of any digital pound in a controlled environment before releasing to the public.

These publications are the next stage in the government's commitment to continue with the design phase of the digital pound, as set out in the National Payments Vision ("NPV") (see our article on the NPV here). However, as in the NPV, the Progress Update makes clear that "no decision has been made on whether to proceed with a digital pound". The current position is that this decision will be taken after the design phase has been completed in a few years' time, and would require parliamentary approval through the introduction of primary legislation, before which there would be a further public consultation.

The announcement that the Digital Pound Lab will be launched during 2025, made in the Progress Update, is a stepping up of the BoE's practical engagement with the digital pound. The Digital Pound Lab will provide a technology sandbox to enable experimentation of API functionality, proposed use cases and potential business models for PIPs and ESIPs. Through such experimentation, the technical viability and commercial feasibility of different designs and uses can be explored. The BoE will seek to engage with businesses and other stakeholders around the Digital Pound Lab experiments, with the Progress Update expressing a particular interest in "existing payment needs and pain points".

The importance to the BoE of a central bank digital currency is highlighted in the Bank of England Agenda for Research, 2025-2028, published on 8 January 2025. This document sets out five aspects of the UK economy that the BoE intends to conduct research into over the next three years, each listing four "priority topics for 2025". Questions around the potential impacts of a central bank digital currency are mentioned throughout, including its effects on "monetary transmission, financial stability and financial innovation" and on "traditional banking".

Proposed model for the digital pound

Building on the BoE's 2023 consultation paper on a retail central bank digital currency (see also our analysis of the January 2024 consultation response here), the Design Note sets out that the digital pound would be a form of sterling, issued by the BoE for retail use on a "public-private platform model". This envisages that the BoE would build and run the ledger, with regulated private firms conducting all engagement with users, thereby taking advantage of the stability and equity of public-sector provision as well as the innovation and risk-taking of private sector delivery. It also encourages co-operation between the public and private sectors to develop uses and solutions, as well as facilitating the transfer of knowledge and skills between the sectors. Legislative safeguards would be put in place to ensure that neither the BoE nor the Government are able to access users’ personal information or control how the money is used.

The BoE explains that the rationale behind this design is to encourage private sector innovation by giving access to a range of firms, whilst ensuring that the digital pound would be exchangeable with cash and bank deposits, thereby maintaining the singleness of central bank money. Public confidence in the ability to make one-for-one exchanges between all types of central bank and private money at all times is a key outcome identified in the Progress Update.

Access would be granted to two types of private firms - Payment Interface Providers ("PIPs") and External Service Interface Providers ("ESIPs"). PIPs facilitate the processing of online payments, whilst ESIPs are non-payment firms that provide adjacent services, e.g. business analytics or fraud monitoring. These firms would have access to the digital pound infrastructure (e.g. via an application programming interface ("API")) and provide digital pass-through wallets to communicate instructions from customers to the core ledger and provide a mechanism for users to hold and use digital pounds. Such firms would never be in possession of the funds, which would always be a direct liability of the BoE.

It is important to note that the BoE's current proposal is for a retail central bank digital currency, and that the Design Note does not apply to, or refer to, a digital pound for wholesale use. In the 2024 discussion paper on its approach to innovations in money and payments (the "Discussion Paper"), the BoE proposes a programme of experiments to explore the feasibility and merits of issuing a digital pound for wholesale use. Further, the BoE is participating in Project Agora, a joint initiative involving seven major central banks and a large number of private-sector financial institutions which, amongst other things, plans to test tokenised central bank money in a wholesale context. However, experiments proposed in the Discussion Paper also consider alternatives to a wholesale digital pound, including "synchronisation". Synchronisation involves structuring a transaction such that the cash is transferred on the RTGS system but the asset concerned is transferred on an external system. The two legs must be mutually conditional to eliminate the risk of one party reneging. See our analysis of the Discussion Paper here.

The design phase

The BoE reiterates in the Design Note and the Progress Update that the design phase of the Digital Pound consists of four workstreams:

1. creating the blueprint of a proposed model and design of a digital pound;
2. producing proofs of concept and running experiments on the technological feasibility of different design choices;
3. holding a national conversation (i.e. an ongoing programme of engagement by the BoE and HM Treasury with relevant stakeholders); and
4. ongoing assessment to evaluate the costs and benefits of a digital pound, in order to assess whether or not to proceed to the build phase.

The blueprint must be completed first, as this will initially be used to guide the other workstreams. Once all of the workstreams are underway, they will operate in an interconnected fashion, with developments in one informing the others. The Design Note is the first of its kind published by the BoE in relation to the design phase of the digital pound, and is intended to identify the key components that the BoE and HM Treasury will explore when developing the blueprint.

The blueprint for a digital pound 

The blueprint is subdivided into a further four components:

1. Product strategy and vision

At a high level, this is concerned with articulating the digital pound proposal, including how it would assist with meeting policy goals and benefit the UK economy. The strategy and vision will sit above the other three components and inform their design and implementation.

The BoE's 2023 consultation paper listed two main motivations for developing a central bank digital currency. Firstly, continued access to and use of central bank money in the interests of ensuring continued monetary and financial stability. Secondly, promoting efficiency, innovation and choice in the UK payments system. These align with the NPV, which also emphasised fostering innovation and financial stability.

To realise the motivations behind the digital pound, the BoE has three aims: (i) to provide the digital pound as a public good that is trusted, secure and part of the monetary framework in the same way as cash, (ii) to ensure that the digital pound can be widely used and is as quick, easy and secure as other retail payment methods, and (iii) to facilitate an open, dynamic and innovative payments system with a variety of payment options and complementary services being developed and offered.  

The BoE envisages an incremental product vision for a digital pound, with the intention of developing a strategy that includes a roadmap of ‘day one’ features, as well as the phased delivery of future features.

2. Scheme and regulation

The blueprint will set out how the digital pound would be used by different actors in the economy, the terms that would govern its use as well as how such terms would be supported by regulation, legislation, standards and policies. This involves considering a wide range of questions to better understand its commercial and operational impact, such as the responsibilities of public and private sector actors, whether users can have multiple accounts, and the scheme for fraud compensation. Guiding design principles will be to reduce frictions and support innovation in digital pound services, make roles and responsibilities clear to participants, define high-level principles and standards for services using the digital pound, foster a consistent and predictable operating environment, protect consumers, and be sufficiently flexible to accommodate future developments in the payments space.

In the interests of simplicity and regularity, the BoE plans to "align our approach with existing payment frameworks where possible, avoiding duplication and keeping things consistent".

The key areas identified by the BoE are:

• Regulatory and policy. All participants in the digital pound ecosystem would be subject to regulatory frameworks covering payments, data protection and privacy, with the aim of ensuring sufficient risk management and consumer protection. The blueprint will not provide the detail of these regulations – which would be subject to further development including necessary consultation and cost benefit analysis – but will set out intended outcomes, areas for focus and key features.
• Scheme outline. Clear standards, procedures and expected behaviours for participants in the digital pound ecosystem will be provided, taking into account industry and international practices, frameworks and controls. This will be at a high level and will inform the detailed scheme rulebook, to be developed at a later date.
• Users and use cases. The design of the digital pound would enable third parties to innovate and develop a range of services for merchants and consumers. The BoE will set out core use cases to test its design choices. The list of use cases will grow over time as new ideas are developed and tested. The Progress Update reports that the BoE has started the analysis of payment needs and use cases, considering whether these can be solved or improved using different designs of a digital pound. Experiments are currently being set up in the newly-created Digital Pound Lab (see Next Steps below for more information) to test the feasibility of potential uses.
• Intermediaries. The blueprint will set out the minimum capabilities required for intermediaries in order for them to deliver digital pound services as well as the expected service standards. Part of this will be mechanisms to ensure an acceptable level of interoperability with other forms of money and integration with other payment systems, existing and future. The Progress Update singles out interoperability with the UK RTGS system as a necessary requirement, and interoperability with foreign systems as a desirable feature to facilitate cross-border payments. The rules for intermediaries will be set according to the public policy risks, which will be controlled through regulation, and the operational risks, which will be controlled through the scheme rules to be developed by the BoE.
• Market development. The BoE will consider how the design of the digital pound would impact the commercial opportunities for service providers and how to create an environment conducive to innovation. Innovation is one of the key outcomes highlighted in the Progress Update, emphasising that the digital pound ecosystem should be designed to encourage a diverse range of payment options (e.g. account-to-account payments, in line with the NPV's emphasis on Open Banking) to develop and enable new entrants into the payment services market. The BoE presents three forms that innovation may take: (i) lower costs and increased convenience, (ii) new activities or business models, and (iii) greater financial inclusion. Examples such as Pix in Brazil and the Unified Payment Interface in India demonstrate how the public sector can foster innovation by providing payments infrastructure.

3. Technology

The technology component of the blueprint will set out the proposed requirements to enable digital pound transactions. This requires considering:

• the design of the technology platform for the core infrastructure;
• the solutions the private sector needs to access the core infrastructure and ensure its use throughout the ecosystem; and
• how the digital pound can be integrated with existing payments technologies.

The blueprint is not intended to be a complete analysis of the technical requirements, but should demonstrate the feasibility of the digital pound by providing analysis of: the technical means and standards for use and acceptance of the digital pound in a retail context; the delivery of services by intermediaries, such as wallet providers; the necessary data flows and technical specifications within the digital currency ecosystem; and how the core ledger itself would operate in a resilient and secure way. The infrastructure must be flexible to account for emergent technologies and technological obsolescence in an ever-changing digital landscape.

4. Operations

The blueprint will also outline how the digital pound infrastructure would be operated and maintained, setting out the functions and services necessary to ensure the digital pound is secure, resilient and always available. Key considerations include:

• governance and risk management for both the public sector delivery of the core infrastructure and the private provision of services to users – it is worth noting that one of the outcomes set out in the BoE’s July 2024 Discussion Paper (reiterated as Outcome 4 of the Progress Update) highlights the importance of infrastructure providers in the retail payments space having sustainable financial models and making continual investments in resilience;
• a development approach to ensure the service is progressively enhanced going forwards;
• what intermediary services may be required and the support that such service providers may require from the BoE or other parties;
• technology operations, including capabilities to guarantee continuous operation of the digital pound, even in the event of external shocks or required maintenance; and
• cybersecurity.

The BoE emphasises the importance of "ensuring that availability, security and performance requirements do not unduly impact commercial viability."

Engagement

The Progress Update refers to the national conversation on a digital pound as being something that will be opened more widely in the future. Currently, the BoE is focussed on engagement with "specialist stakeholders" who it has judged to have particularly useful contributions to make to the technical design phase.

In addition to the 2023 consultation and January 2024 consultation response (see above under Blueprint), the BoE has engaged stakeholders through its CBDC Engagement Forum, made up of senior figures from financial institutions and civil society groups; CBDC Technology Forum, made up of members from financial institutions, universities and technology firms; and CBDC Academic Advisory Group, run in conjunction with HM Treasury. The Digital Pound Lab will become a hub for expert advice, replacing the CBDC Technology Forum which will be wound down, although no dates have yet been provided for this.  Additional expertise may be incoming with the first Transatlantic Regulatory Exchange, an international secondment program for senior experts in emerging payments and digital assets at the BoE and New York Department of Financial Services, announced on 13 January. 

Authored by Roger Tym, Dan Park, Virginia Montgomery, Christina Wu and Sinéad Meany.