The Bank of England (BoE) issued a consultation paper on the digital pound in February this year. If the proposals go ahead, the BoE would i) issue digital pounds (i.e. a digital form of cash, with a direct claim on the BoE) to individuals and businesses via pass-through wallet providers and ii) build and operate a new retail payment system so that end users can make payments using digital pounds.
Should this go ahead, it would be a major new infrastructure project in the UK. Under the current design proposals, it would also amount to the BoE entering the market for retail digital payment systems – competing with large private providers such as Visa and Mastercard.
Kairos Economics has responded to the consultation. You can find our full response at the end of this blog. The key messages from our response are:
Increasing competition in retail payments is a worthy motivation for the digital pound.
- The market for retail payments between consumers and businesses in the UK is concentrated. Credit and debit cards account for 88% of retail payments and Visa and Mastercard share 99% of the market for card payments.
- Emerging market reviews by the Payment Systems Regulator (PSR) indicate a high cost to end users of payments using card networks. The digital pound and accompanying retail payment system proposed by the BoE and HMT may be particularly well-placed to exert competitive pressure on cards.
- Under the current ‘pass-through wallet’ design, Payment Interface Providers (PIPs) may not be part of the existing group of payment service providers that participate in incumbent card schemes. This may help to mitigate the effect of commercial incentive blockers that have historically led to the preservation of the status quo and limited the uptake of alternative retail payment methods, such as Open Banking payments (which use interbank payment systems).
To achieve the objective of increasing competition in retail payments and to promote the uptake of the digital pound more generally, subsequent phases of the digital pound roadmap will need to consider:
- The value proposition to end users on both sides of the market (i.e. merchants and retail consumers) for retail payments made using the digital pound versus cards. Where there are gaps in the value propositions (such as functionality, consumer protections, rewards, trust and consumer awareness, for example), the BoE will need to ensure that the digital pound design will create an environment whereby there can be sufficient commercial incentives for PIPs to fill these gaps in the value proposition;
- The design options for a value transfer mechanism from the merchant side to the consumer side of the market (such as whether ‘interchange-like’ fees are necessary and if so, how they should be implemented, for example); and
- How and to what extent the risk of the PIP market consolidating around Big Tech incumbents (should they enter) should be mitigated, by working closely with the CMA’s Digital Markets Unit (DMU) on measures such as mandatory third-party NFC chip access by Apple.
The consultation doesn’t cover commercial models for the digital pound payment system (i.e. how the BoE will fund the upfront and ongoing costs of issuing the digital pound, and building and operating the core ledger and payment system).
This needs careful consideration during subsequent phases of the roadmap, in particular:
- If the BoE decides not to recover its costs by charging private providers, then demonstrating compliance with subsidy controls for the payment system services may be required. Here, collaboration with the CMA’s Subsidy Advice Unit (SAU) may be helpful.
- If the BoE decides to charge PIPs for use of its payment system services (as is typically the case for other payment systems), then a pricing framework for the BoE as PSO will be required that considers price structures and levels, given the impact that input prices for PIPs could have on digital pound uptake and market dynamics.
- The merits and demerits of alternative funding models may be worth exploring during subsequent phases. For example, raising funds via the offering of tokenised digital assets that are linked to the performance of the digital pound to end users could align end-user incentives with digital pound adoption.
It will be important to consider the substitutability of: i) payments made using the digital pound and the BoE’s proposed payment system, with ii) payments made using existing forms of money (i.e. commercial bank money or physical cash) and other UK payment systems, when determining which use cases for the digital pound to prioritise.
In particular, certain use cases for the digital pound could have significant substitutability with payments provided by BACS, the Faster Payments System (FPS), the future New Payments Architecture (NPA), and Open Banking Payments that are facilitated by these systems. Should the digital pound capture market share from these alternative payment systems, this could have knock on effects for their commercial viability, and in-turn, the net benefits to consumers and businesses of the various UK payment initiatives that are underway. Whilst an empirical analysis of the benefits of different use case combinations across UK payment system initiatives has yet to be carried out, we hypothesise that prioritising the consumer to business retail use cases for the digital pound is likely to yield the greatest net benefit to UK consumers and businesses.