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Bank of England considering digital currency, how does it work?


The Bank of England and the HM Treasury have recently announced plans on proposing a Central Bank Digital Currency.


Although the announcement has put the idea to light, the central bank states that it does not necessarily mean that it will be implemented.


The Bank of England stated that it will review the idea with major stakeholders, individuals who would have an interest in the currencies creation if it is a good idea.


The list will likely include various analysts, financial institutions and especially the UK government.


But what is a Central Bank Digital Currency (CBDC) and what would its creation mean for the UK economy?


In a way, a Central Bank Digital Currency is basically the same as the pound, just digital.


The BBC states that if issued by the bank, the currency would act alongside cash and bank deposits rather than replacing them.


The CBDC currency will be somewhat anchored towards the pound, for example, £10 in CBDC will always be worth £10.


But what actually will the CBDC do? Is it a form of cryptocurrency owned by the Central Bank? Or will it eventually replace the physical pound?


From the sounds of it, the CBDC sounds like somewhat of a cryptocurrency, but instead, it is owned by the Central Bank.


Cryptocurrency refers to coins such as Bitcoin and Etherium which have grown in popularity as young investors see them as an attractive asset to purchase due to their limited supply.


However, this brings us to the sort of “issue” with cryptos, they were originally intended to be used as coins meant for anonymous transactions, now they are more of an asset that individuals invest into.


For this reason, the CBDC could turn into this weird hybrid between currency and asset, but, if £10 in CBDC will always be £10, then this may not be the case.


This is where the similarities between a CBDC and Bitcoin blur, cryptocurrencies have a limited supply and are anonymous by nature, however, a CBDC will be controlled by a central body.


This means the central bank will be able to choose the amount of the currency in circulation and will also be able to track payments much more easily, especially if the method becomes favoured over cash payments.


So, if we move to a CBDC based economy, the likelihood is that the majority of payments would be cashless, in fact, we could even get to the point where pretty much no goods or services can be bought with the original, physical pound.


If this occurs, pretty much all transactions made within an economy, the ones using the CBDC, will be traceable, consequently, the underground economy may decrease.


This is because it will be much harder to make cash-in-hand untraceable payments, if the whole economy runs on a digital currency, nobody will trust the original pound as there is no use for it.


However, that does not mean illegal activities will cease to exist, individuals who operate in counterfeit goods or illegal substances may use different methods of payment such as cryptocurrencies to stay anonymous.


Nevertheless, a CBDC would be an effective way of somewhat reducing the underground economy, its introduction would also make sense as transactions become much more reliant on technology.


The number of contactless payments has drastically increased due to the pandemic, and, banks are also beginning to favour online banking methods, so, a CBDC makes sense as it fits with the increasingly technological future.


However, the Bank of England knows that some are not tech-savvy enough to know how to use online banking which is why in their announcement they stated that if a CBDC is introduced, it would not entirely replace the pound.


Another reason why the Bank of England decided to make this declaration is to ensure the stability of the British Pound, if the bank announced that we are completely changing currency, the likelihood is that confidence in the British pound would plummet.


This would be terrible for the UK economy as if nobody is confident in the new currency, foreign nations would likely not want to trade, or more specifically, buy products from the UK.


This would significantly widen the current account deficit, further increasing the amount of money leaving the economy.


So, the Bank of England has made the right decision to ensure that our trading partners do not lose faith in the British Pound by suggesting that the introduction of a CBDC would be much more gradual rather than instant.


This method of implementation will also allow the Bank to test the waters in an effort to ensure the currency actually works, and, if it is a success, we will likely see a much more efficient method of exchange in the near future.

 

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