How a digital pound could work alongside cryptocurrencies

The UK, like many other countries has developed a plan to create a central-bank digital currency (CBDC). A digital pound is a form of online cash that can be used for daily payments. The digital pound would not pay interest, like some standard savings accounts (or current accounts), but could improve access to financial services.

Recently, the Bank of England proposed a framework that would govern how a digital currency would function. The Bank of England has proposed a timeline to introduce a digital pound by 2025. You have until the 7th of June 2023 to let the bank know what you think about its plan.

The success of the UK CBDC depends largely on whether or not the benefits of having a digital currency are greater than the costs associated with creating and deploying the infrastructure required to support the new system of payment.

CBDCs have many benefits, including increasing financial inclusion and making it easier for UK's unbanked 1.2 million residents to sign up for banking services. The government could use the online wallets to transfer "fiscal transfers", such as tax subsidies and support payments, to households or businesses.

The Bank of England is currently proposing a digital pound, but it also seeks answers to certain questions. It is important to know how it (or if) could coexist with other digital currencies, such as cryptocurrency assets. The bank has suggested several models that could reduce the systemic risks in the crypto industry and increase the banking options available to UK consumers.

Read on to learn more about stablecoins. A blockchain expert explains

Stablecoins are specifically mentioned in the CBDC consultation document of the Bank of England. They are digital assets issued by private companies instead of a government, as opposed to traditional currencies. Stablecoins are digital currencies that are not like bitcoins. Instead, they have a value pegged to an asset such as the US dollar or British pounds. But what about a virtual pound?

Stablecoins can complement digital pounds

The bank discusses the overlap of what a stablecoin or digital pound can offer. The bank argues that they could "coexist", in a mixed payment economy. It compares it to the way we currently use cash and bank account in the same payment system, pointing out that technology advancements such as ATMs have made coexistence easier over the years.

According to the bank, stablecoins must be "fully backed by high-quality liquid assets" to complement a digital currency. The bank adds:

Stablecoins would, unlike the digital pound and regardless of its backing asset, be a liability for the private sector issuer, rather than a claim against the central bank. This means that they would be private currency, similar to commercial bank deposits https://www.gpucoin.net.

The report also proposes a model where these assets would be "held exclusively by the central bank", adding this would make stablecoins "economically comparable to the digital pound", and reduce financial risks.

If digital currency is used to support a stablecoin then the issuer will provide holders with stablecoins based on digital pounds. These tokens can be used for domestic and international payments as well as cryptocurrency trading. These private forms would be based on the blockchain which makes payments more convenient and cheaper. Stablecoins have been used in some countries to hedge against inflation, macroeconomic instability and other risks.

Regulating cryptocurrencies

It could be beneficial for the crypto-industry as well. Stablecoins are currently managed by private organisations or banks that are not audited and regulated. A stablecoin that is backed by digital pounds in a central bank account would be more transparent and reliable. The central bank can regularly audit the reserves of stablecoin providers. Legislators can also set capital requirements. For example, they could mandate that a certain percentage of the issuers’ reserves be held in the central bank account.

Stablecoins are not without risk: excessive capital requirements can affect their profitability. They can earn money by holding assets that are linked to Treasury bonds or other assets with interest.

A digital pound-backed stabilitycoin issuer, on the other hand, would not be likely to earn interest from its account with the central bank. A typical bank, such as Lloyds, has a reserve account at the central banks that earns a base rate. However, the Bank of England is unlikely to give the same type of account to a stablecoin issuer. This would mean being subject to the exact same regulations which could have an impact on the flexibility that crypto assets providers value.

Mobile banking. Woman with smartphone and digital wallet. Credit card on table. Top view

Digital wallets are available. Prostock-studio/Shutterstock

Stablecoins that are backed by digital currencies held by the central bank would certainly be able to address some of these systemic problems surrounding this type crypto asset. In the last year, the value of a major stablecoin fell. It usually happens when an event in the market prompts holders of stablecoins to rush to redeem their holdings, and the issuer is unable to fulfill so many redemptions all at once.

The central bank would hold a certain percentage in liquid digital currency reserves to ensure that issuers had enough funds for redemptions and withdrawals, while also maintaining the value of the coin against the digital pound. Even if the issuer were to fail, a central banking institution could provide insurance for stablecoin holders to protect their assets up to a certain amount.

It is possible for digital assets and stablecoins to coexist, and even complement one another. A digital pound would also shed light on the increasing role of private money within the economy. This would make the financial system safer while also encouraging financial inclusion.