Exploratory work on a digital euro has been underway for more than a year, yet in some ways the UK’s early digital pound proposals are more defined.

The global race to develop central bank digital currencies (CBDCs) is heating up, with more than 100 countries currently exploring the potential for digital base money, according to the International Monetary Fund. In Europe, both the Bank of England (BoE) and European Central Bank (ECB) have thrown their respective hats into the ring and are moving ahead with preliminary research into the launch of retail CBDCs.

On February 7, the BoE and UK Treasury published a joint consultation paper on the digital pound, offering the clearest indication yet of London’s thinking around a future CBDC. Although the document, together with an accompanying technology working paper, are exploratory in nature, the initial considerations around hot-button issues like privacy, functionality and financial system stability are all signposted.

The view from Frankfurt and Brussels, meanwhile, is less clear, although the European Commission is expected to advance a legislative proposal on the digital euro in the first half of 2023. Nevertheless, a number of documents have been published by the ECB in recent months that, together with public statements from euro area officials, offer some insight into the conceptual underpinnings of a euro-area CBDC.

End-user privacy key

Notably, both projects have a number of commonalities. These include a commitment that any CBDC design would exist alongside physical cash and not replace it. Moreover, both projects have, to date, emphasised the need to maintain the data protection and privacy of the end user. In the UK’s consultation paper, it is noted that a digital pound would be “at least as private as current forms of digital money”. This would be achieved through payment interface providers identifying and verifying users, with neither the BoE nor the government having access to personal data.

Similarly, the ECB has committed to a digital euro that will provide a level of privacy that is equivalent to existing electronic payment offerings. But Christine Lagarde, the bank’s president, has also raised the possibility of a more flexible privacy regime. In a November 2022 speech, she noted that “it would be desirable to depart from this baseline in certain circumstances,” by potentially giving the digital euro “cash-like features” to augment privacy standards for low-value, low-risk payments.

There are broad similarities in other domains, including a commitment by both projects to avoid CBDCs that permit government or central bank-guided programmability (i.e. the idea that the currency can be ‘programmed’ to be used within certain conditions e.g. to pay for specific services). In the UK’s case, however, the door is left open for programmability from private sector participants through mechanisms like smart contracts. The joint BoE/Treasury consultation paper highlights the potential benefits for the end user, with “programmability, smart contracts and or micro payments” potentially driving demand for the digital pound.

Underlying tech unclear

But neither the digital euro project nor the digital pound consultation paper have shed any light on the technology that could underpin either CBDC. Though the BoE refers to some possibilities in its technology working paper, including blockchain and distributed ledger technology, it is likely to be some time before the question is resolved. This lack of detail, particularly from the UK project, in light of the hundreds of pages contained in its consultation papers, is a source of frustration for some market participants.

“I think that they are playing it too safe. I understand that it’s a difficult decision to make, but they are there to make that decision. So, I think that having a view on whether they are completely ruling out blockchain or DLT or not, is something that I was expecting from that consultation paper,” says Jorge Lesmes, banking director at NTT DATA UK & Ireland.

Holding caps

Meanwhile, a number of key differences are emerging between the digital pound and its euro equivalent. Chief among them is the suggested unit holding cap. In the UK consultation, an individual limit of between £10,000 and £20,000 is proposed. With a cap of £20,000, the BoE reckons 95% of income-earners in the country would be able to use the digital pound wallet to get paid, without frequently breaching the cap. At the lower level of £10,000, it is thought that 75% of income-earners could use the digital pound to cover their income and pre-existing balances.

This thinking deviates markedly from the ECB’s potential approach, which is considering a much lower unit holding figure. “The difference that really stands out is the personal holdings cap. The ECB has not formally communicated anything but the figure of €3000 has been floating around for years now. Yet the Bank of England is considering a £10,000 to £20,000 cap, which is quite a lot more,” says Teunis Brosens, ING’s head of regulatory analysis.

“It’s a fundamentally different approach because the BoE is prioritising the development of a usable product with financial stability as a secondary objective. In the ECB’s case, financial stability is its key focus because it doesn’t want to drain too much funding from the banks.”

UK will not preserve currency status quo

This distinction is reflected in the UK consultation paper, where it is noted that the BoE will not “seek to preserve the status quo structure of the financial system or to protect any business model within the commercial banking sector from the impact of technological innovation and competition”. This addition is striking, in that it underlines the UK’s stance toward change and innovation and that the authorities are prepared, to some extent, to endure the consequences of this disruption.

“The BoE is emphasising that it wants to build a usable product and that it won’t hold back just because it might affect the banks. It’s basically saying that it is prepared to break stuff,” says Mr Brosens.

The UK consultation paper references a 2021 impact analysis, in which it evaluated an assumed migration of 20% of commercial bank retail deposits to digital money alternatives. Under this scenario, the BoE determined that bank lending rates would increase by about 20 basis points, with a high degree of uncertainty.

“The question for the BoE is: are you really confident the impact will indeed be so benign? And even if it is, what does a structurally higher bank dependency on wholesale funding mean for financial stability, knowing that wholesale funding is more volatile?” says Mr Brosens.

For the ECB, with a lower probable unit holding cap, other challenges are likely to arise. “The ECB’s starting point of prioritising financial stability can make trying to build a usable product very complex. What if an incoming payment is above the cap? It has to think about automatic defunding and automatic transfers, among other issues. It gets it into a whole lot of complications,” says Mr Brosens.

Interest-bearing CBDCs?

The relationship between limits on unit holdings and potential financial stability concerns also feed into considerations around whether the digital pound and digital euro will be remunerated; essentially, if they are interest-bearing or not. According to the UK’s consultation paper, there appears to be little need or appetite for the digital pound to be remunerated. The BoE provides a number of reasons for this, including that its basic vision is to replicate a banknote in digital form.

The BoE also suggests that by not remunerating the digital pound, it would remove the competitive element with traditional bank accounts and reduce the impact on the banking sector. “I think in some sense that’s because the BoE recognises the kind of macroeconomic implications that could emerge if it were a remunerated CBDC, in terms of deposit flight and deposit volatility,” says Rhiannon Butterfield, principal, payments and innovation, at UK Finance.

Meanwhile, there are early signs that limits on individual holdings of digital euros would be accompanied by “disincentivising” remuneration above a certain threshold. In a June 2022 speech, Fabio Pannetta, executive board member of the ECB, suggested that both tools would be applied, with larger positions of digital euro attracting more punitive rates. But the ECB’s official commentary on this issue indicates that no decision has been made on these thresholds, and that alternative options could be explored.

Communicating and co-creating

These and other issues will be ironed out over time. But for both central banks, the importance of engaging with private sector stakeholders, market participants and the wider public will be a vital ingredient in the success, or otherwise, of their respective CBDC projects. Despite the embryonic nature of the work conducted by both the BoE and ECB, a gulf is emerging in terms of their outreach and communication efforts.

In particular, the UK central bank has been praised for the way in which it has engaged with the wider financial services industry to develop its consultation paper. “The BoE has been incredibly transparent. It has been open [to outside ideas] and UK Finance has been part of the CBDC discussions all the way through. So, there’s been a lot of co-creation in this space, which I think is incredibly helpful,” says Jana Mackintosh, managing director, payments and innovation at UK Finance.

The ECB, meanwhile, has come under fire for a perceived failure to communicate its thinking, and its intentions, in a consistent manner. Although documentation exists, and public comments from senior ECB figures have become more frequent in recent months, some critics suggest this communication has been haphazard. Despite this, the euro area’s apex bank did conduct a public consultation on the digital euro that concluded in January 2021, in which it received a record-breaking level of engagement and feedback.

Yet recent missteps have not helped the ECB’s cause. In February, eurozone central bank governors convened in Finland to discuss the digital euro, without releasing an agenda. “There was no agenda, it was not clear what was being talked about. And that it could have the effect of making people question what they’re building there,” says Bernhard Blaha, chief executive of the People’s SCE at eCredits, a decentrally governed organisation that manages products and services on the eCredits blockchain.

But even if the ECB’s outreach efforts have been lacking, a significant shift appears to be underway. “I think now the ECB is starting to realise that there could be a real backlash against the digital euro coming from citizens because of a lack of awareness. There is this need for more awareness. And I think that now it wants to speak to civil society, and maybe it needs a bit of help from civil society to spread that awareness,” says Vicky Van Eyck, executive director of Positive Money Europe, a not-for-profit research and campaigning organisation.

“I think people need to see the added benefits [of a digital euro] to their lives. They need to see how it will make their lives easier.”

Based on official estimates and statements, and assuming both projects advance, a digital pound could launch by around 2030, while a digital euro could potentially launch in 2027.