1         About nChain

1.1  Founded in 2015, nChain advances the potential of blockchain technology through ongoing research and development of patentable inventions and by offering commercial solutions such as Kensei, a developer-friendly blockchain interface. With one of the largest portfolios of IP and research related to blockchain, we are uniquely positioned to support the Bank of England and HM Treasury in its research for a CBDC design. We have undertaken significant research on the use of CBDC to instill market discipline and explored the divisibility of CBDC and associated implications for central banks.

1.2  A government-backed digital currency protects citizens from the risks of private alternatives and provides investor confidence. CBDC as a digital non-bank store of value thus fulfills the Bank of England’s responsibility to provide accessible money to all. Finally continuous access to CBDC will provide a cheaper and faster way of moving money in the domestic and global marketplace which will increase liquidity, another key concern of central banks.

2         What are the main issues driving central banks to explore CBDCs?

2.1  The Bank of England’s actions are driven by its mandate: price stability and financial stability for the public good. The introduction of private virtual money introduces a threat to economic sovereignty and national security.

2.2  Central banks offering the same capabilities as private digital currency will satisfy customer demand and maintain use of our national currency, the central bank’s key tool for price and financial stability. This also opens-up new Monetary (Policy) Transmission Mechanisms (MTMs) which will allow policy decisions to impact our real economy faster and in an undiluted fashion. A successful CBDC brings opportunities for innovative services atop the new form of national currency and fosters competition in the payments sector.

3         What are the main benefits and risks of a CBDC?

3.1  A well designed CBDC can deliver significant benefits to the UK. The benefits of CBDC are:

               Digital Cash: Central Banks provide money to the public directly in the form of physical cash. As physical cash usage has declined, the introduction of digital cash will provide the same benefits of direct access to cash combined with digitisation and without the need for an intermediary. The latter will contribute to financial inclusion for the 1.3m in the UK that currently do not hold a bank account. It is worth noting this can be in addition to the continued availability of physical cash.

               Resilience: a CBDC can introduce resilience to the payment landscape by building on an open public blockchain that is run independently of any existing banking services.

               Financial privacy: a CBDC as a digital currency provides the inherent privacy properties of cash, in contracts with a bank account transaction. This applies to both purely digital cash transactions and the exchange of tokenised assets and digital cash.

               Immutable Audit: a CBDC built on public permissionless blockchain provides immutability of transaction history and contributes to the prevention of internal fraud & errors, by commercial services and private individuals.

               Increased payment diversity: CBDC can, if implemented correctly, lower the barrier to entry and encourage innovation and competition across the private and public sectors. With CBDC built on an open public blockchain, innovations such as micro and nano payments become possible, introducing new ways to engage with commerce using high volume low costs transactions that are not financially viable under traditional payments methods. These opportunities may bring economic growth.

               Improving cross-border payments: A CBDC built on a scalable, globally accessible, open, public blockchain with high transaction throughput and low fees provides an effective infrastructure for global payment and settlement alongside our existing cross-border payment infrastructure that:

               Additional Monetary Policy Tools: CBDC allow for execution of monetary policy decisions without involvement of an intermediary, improving the speed and effectiveness of decisions, as well as allowing new forms of monetary policy techniques. All of which provides greater control to the Central Bank over price stability and financial stability. The government can enact several different policies, including Keynesian air drops and even negative interest rates.

               Simplified Compliance: The governance model of CBDC allows a pre-emptive approach to transaction execution such that suspicious transactions are instantly visible, and cost of governance oversight is significantly reduced due to the singular nature of transactions (all parties share 1 view of the truth), eliminating reconciliation between participating entities. For victims of crime the ability to access proof immediately & at minimal cost might mitigate the cost of criminal investigation improving vulnerable individual’s access to justice.

               More Innovation: CBDC promotes innovation of services.

               Micro Transactions: Due to the reduced cost of transactions the possibility of micro transactions will spurn new products and services.

3.2  The risks of CBDC are:

               Choosing the appropriate form of CBDC from the current set of options under discussion

               Implementation of CBDC using emerging technology or technology that can’t deliver on the technical and policy requirements

               The new challenges associated with serendipitous innovation

               Speed of adoption

               Identifying and implementing appropriate Governance & Oversight Frameworks for CBDC

               Understanding the impact of new monetary policy tools

               Wallet protection and custodial services

               Recognition of the interdependency of the collective set of technologies in the design

               Competition from private sector equivalent money

               Identify considerations of the current Central Bank Legal Framework

4         Could the proposed benefits of a CBDC be achieved through improvements to existing payment systems?

4.1  Innovations in the digital sector such as pay walls and streaming services could leverage micro and nano payments (less than 1 pence per transactions) to change how users access content. The high cost of traditional payment systems means that users can’t pay for the content they wish to consume, and so are forced to consume all the content for a higher cost. Micro and nano payments will allow users to consume the content they want. These capabilities could be delivered by a CBDC based on a scalable, open public blockchain.

4.2  Existing systems can be adapted to deliver some of the benefits of CBDC, but there are several characteristics of digital cash that will require compromises:

               Financial inclusion: providing citizens with direct access to money is a key driver for cash and CBDC. It encourages financial inclusion by not requiring citizens to have access to financial services. With most of the existing payment systems based on accounts, it becomes extremely difficult for citizens to have direct access to a form of central bank money.

               Financial privacy: by delivering CBDC via existing payment systems, citizens will lose an element of financial privacy if access to CBDC is via intermediaries or third-party systems.

               Micro/nano payments: transactions on existing payment systems are expensive. With the high cost associated with most, if not all, of these payments systems, it no longer becomes possible to deliver a CBDC that supports micro and nano payments which allow for financial innovation and the possible economic/political rewards that brings as mentioned previously.


5         How should the Bank of England and HM Treasury address concerns over privacy and traceability of payments when exploring CBDC design?

5.1  The design for CBDC should mirror physical cash. Therefore, in an optimal design of CBDC using an open public blockchain, the Bank of England would not gather personal information when distributing digital cash to the public. This does not limit the ability for the Bank of England, HM Treasury, or other government agencies to trace payments.

5.2  The appropriate privacy model for CBDC is pseudonymous and leverages the new privacy model introduced by Bitcoin in 2009 because this approach replaces the incumbent model (which is fragile by design) with a robust model that maximises both the privacy value proposition to each user and the state’s ability to monitor activity and enforce the law. As the system scales, privacy of users increases whilst still maintaining traceability.

5.3  Any use of digital cash when involving a 3rd party is bound by the same regulatory demands as with any other form of payment.

5.4  CBDC design incorporating sovereign identity supports KYC, AML, CFT while reducing the misuse of personal information we experience in the market today when using 3rd party services.

5.5  Criminal financial behaviour is addressable using standard legal procedures. A court order acquired with evidence of illicit behaviour enables policing and prosecution by legal means without breaching personal privacy rights.

5.6  A CBDC can operate under the confines of law and regulation and address the key issues with cash and weaknesses in corporate governance, namely money laundering and fraud due to the enhanced audit trail it leaves behind.

6         What effects might a CBDC have on the financial sector?

6.1  Monetary policy and financial stability are not affected by CBDC where the design mirrors physical cash.

6.2  The risks exist when private sector money becomes used widely in the domestic market as an alternative to legal tender, limiting the effectiveness of monetary policy and undermining the credibility of our financial sector. The greatest impact will be on card systems and private ATMs as CBDC becomes less reliant on these mechanisms for accessing and making payments with cash.

6.3  Lack of collaboration or slow progress in reaching consensus, across central banks globally, on how CBDC is used will strengthen use of private sector offerings and poses a risk to our financial sector and the stability of our whole economy.

7         What effect might a CBDC have on competition and innovation in the payments and fintech sectors?

7.1  CBDC creates an ecosystem that fosters competition with big tech firms in the payments market. Gaining a competitive advantage is difficult for smaller, newer firms in the current model. A set of publicly available tools for innovators, customers, and merchants to access, supported by the appropriate regulatory enhancements, will bridge the gap that disruptors are currently faced with.

7.2  The competitive nature of a CBDC ecosystem also supports innovation of micropayments and other capabilities only offered by digital cash due to its quality of supporting embeddable logic. The lowering of fees allows innovators to develop products and services without the fear of payment networks, undermining their business mode creating a more maintainable competitive environment between innovative solutions.

8         How might a CBDC affect monetary policy?

8.1  CBDC can positively affect monetary policy by:

               Supporting a resilient payments landscape; introducing CBDC on its independent infrastructure provides further resiliency through diversification of payments platforms.

               Private money proliferation that threatens the influence of monetary policy is addressed by a CBDC direct to the public.

               Payment competition, efficiency, and innovation via publicly owned and accessible financial systems offered by the Bank of England

               Meeting future payment needs in a digital economy; legislation will be required for emergent microtransactional business models.

               Improving the availability and usability of central bank money, which will help the state provide its social safety net.

               Addressing the consequences of a decline in cash and forming the building block for better cross-border payments-allowing for likeminded national actors to consider system standardizations and their resultant efficiency benefits to form a part of trade negotiations.

               Enhancing monetary policy; providing new, real-time insights into the economy. The current monetary policy toolkit could be improved with better real-time systems enabled by CBDC for analysing the impact of monetary policy in the economy compared with the expected impact. Additionally, retail CBDC has the potential to improve performance of both conventional and unconventional monetary policy tools under certain assumptions.

               Identifying financial risks early and in real-time; CBDC on an open public blockchain allows for the implementation of powerful new features for risk reduction including automatic monitoring, automatic audit and event driven taxation that can improve economic stability.

               Incentivises lower risk practices; an interest-bearing CBDC can improve financial stability by incentivising commercial banks to prefer fixed-term deposits rather than current accounts. Interest-bearing CBDC has the potential to increase the competition on retail money markets, forcing commercial banks to insure themselves against greater volatility of the general public’s liquidity preference by relying more on fixed-term deposits. Since fixed-term deposits penalise premature withdrawal of funds, such a structural change in the banking business model can improve financial stability.

9         How might a CBDC change the Bank of England’s role and responsibilities?

9.1  The bank of England’s role will remain the same while sterling is used to pay salaries and make payments. If an alternative private money takes hold, in favour of UK’s CBDC, then the power of the bank to influence price stability and financial stability with the current monetary policy tools does not work.

9.2  Engagement with other Central Banks is key for international finance.

9.3  Our view is that the Bank of England will continue to play a pivotal role in managing currency and the monetary policy of the United Kingdom.

9.4  Introducing a digital form of cash could introduce new responsibilities for the Bank of England, depending on the design. These will range from distribution of cash, to providing support to users and adhering with regulation.

10    How should HM Treasury and the Bank of England engage with the public on the research and development of a CBDC?

10.1        The Bank of England and HM Treasury introduced the CBDC Task Force in April 2021 alongside the CBDC Engagement and Technology Forums. The Engagement Forum includes senior stakeholders from industry, civil society, and academia to help Bank of England and HM Treasury understand the practical challenges of designing, implementing and operating CBDC.

10.2        CBDC directly impacts the entire UK population and thus quantitative data, such as surveys, is necessary to analyse a change of this scope. There are demographic challenges to this engagement:

               The way the public engage with technology is generationally specific, due to the rapid advancement of consumer tech and payment methods in the last 50 years.

               Different socio-economic groups will have different requirements of CBDC, for instance the retired may see different challenges/opportunities than those in employment.

10.3        As such feedback must cover this diversity in the affected population.

10.4        The Bank of England and HM Treasury should also consider building awareness around CBDC. Investing in educational material and publishing through a variety of channels is key in helping the public understand CBDC. By building this awareness and educating the public, the Bank of England and HM Treasury will have a more effective feedback mechanism to help understand the views and perspectives of the users of the CBDC.

10.5        It is important that the HM Treasury and the Bank of England continue to share the thinking and design of CBDCs as they evolve with the public.

11    How might CBDCs affect the economic foreign policies or geopolitical influence of different countries and economic areas? Are there implications for the effectiveness of economic sanctions?

11.1        In the domain of foreign aid and charity, a CBDC offers opportunities for innovation. If citizens in locations that have been designated to receive either charitable or foreign aid were provided a CBDC wallet it would be possible to make CBDC transfers direct to them that could be exchanged to local currency with immediate finality. This would allow our government, charities and even the public to directly contribute to citizens in affected areas. It would also give our public confidence that aid is directly reaching recipients in disaster and aid zones and a sense of direct contribution to the lives of those that they see suffering.

11.2        Another benefit of this approach is that it could bypass corruption in the aid system. However, care must be given to relations with the national actor to which the aid is targeted. Agreements might need to be reached and policies put in place at an international relations level to ensure any donations are compliant with the recipient nations financial and tax requirements/responsibilities.

11.3        In short, the CBDC could go direct from a charity or UK citizen to the wallet of a citizen in need. There are political and legal implications of this capability that must be considered.

11.4        In the domain of international financial activity there are opportunities using a CBDC to enhance detection and suspension of suspicious financial activity. This will help counterparties in their compliance and investigation responsibilities.

11.5        Non-compliant or suspicious international transactions will be identified when they are made by CBDC programmed logic. The fees from suspicious transactions can automatically be deposited in a separate holding account, until the matter is resolved. The counterparties will receive their fees upon resolution.

11.6        Currently the model provides counterparties with their fees prior to any investigation. As such they have limited incentive to investigate suspicious transactions beyond their compliance requirements. There have been documented cases of these investigations being de-prioritised such as those in the FinCEN papers which involved many UK businesses. Under a CBDC model with automatic notification and fee suspension private financial institutions are incentivised to investigate to unlock their fees as is their responsibility.

11.7        The UK along with other Central Banks are currently working to ensure a cohesive set of principles in the design of a CBDC. This bodes well for addressing the above scenarios and many others.

15 October 2021