The Shape of things to come
The shape of things to come: innovation in payments and money − speech by Sir Jon Cunliffe Given at Innovate Finance Global Summit, London Published on 17 April 2023
In his speech, Jon Cunliffe looks at four areas where the tokenisation of money is now being explored. The first is stablecoins used for payments, the second is the tokenisation of commercial bank deposits, the third is the next stage of the Bank of England’s work on issuing a Digital Pound and the last is the Bank’s work to ensure to ensure these new forms of money are robust and uniform. Speech Thank you for inviting me here today to talk about the ‘shape of things to come’. I want to concentrate my remarks today on payments and money – how we pay for things and what type of money we use. These once dusty and forgotten corners of the financial system have been transformed in recent years. And there are good reasons to believe that even more radical change is on the horizon. I will talk today about developments within in the UK, but much of the trends and the possibility of further technological advances that I will cover are relevant for cross-border payments which have lagged far behind the developments we have seen in recent years in domestic payment systems. And which merits a speech all of its own. I should start however with a health warning. Central bankers are very used to forecasting the economic future. It is at the heart of what we do. And I can say from experience that, despite the masses of data and our complex mathematical models, it is not an easy task. The future, as the last few years of pandemic and war have shown us, rarely behaves as it should. However, forecasting the direction and pace of technological innovation - and, crucially, the way it will interact with social and economic trends - is an even more hazardous enterprise. Much lauded innovations prove to be dead ends or fail to be adopted. Unheralded ones emerge at speed. And often it is the unforeseen combination of a number of technological advances that generates radical change. Against that background, public authorities, like the Bank of England, that are charged with maintaining financial stability and with the regulation of the financial system need to be forward looking, for two key reasons. The first is that while we cannot be certain how new technologies and social and economic trends will play out, we need to have thought through in advance how the risks might need to be managed and, where the likelihood of major change is high, have the regulatory frameworks and powers in place. Playing regulatory catch up with new technologies once they become established and adopted at scale can be very difficult – as some of the experience in recent years with social platforms and other big techs has demonstrated. And it generates uncertainty for innovators.
The second is that we want competition and innovation in financial services – it can increase efficiency, functionality and resilience. Setting out the regulatory approach allows those who want to innovate by providing better products and services to understand the risks that need to be managed as they develop those products. It also ensures that innovation is not simply competing by taking higher risks. This approach has been a key element in the evolution and adoption of innovation in payments in the UK in recent years. Against the background of increasing digitalisation of everyday life, the combination of technological advance and appropriate regulatory frameworksfootnote - both to foster competition and to manage risks – has transformed the way we pay. It has also stimulated the growth of the UK Fintech sector which is now the second largest in the worldfootnote.
Contactless’ card payments are now used by close to 90% of people and make up almost a third of all payments in the UK, Nearly a third of UK adults use mobile payment apps such as ApplePay or GooglePay. Seven million consumers and three-quarters of a million SMEs are using Open Banking products. Several digital only challenger banks operate in the UK providing competition and innovation to the UK banking sector. These changes have not only transformed the way people pay but also the type of money they pay with. Two types of money circulate in the UK today. The first is public money’, money issued by the Bank of England in the form of physical cash; the second is ‘private money’, issued by commercial banks in the form of electronic bank deposits. Until relatively recently, the great majority of everyday transactions in the UK were made in publicly issued money, notes and coin. Electronic transfers of commercial bank money tended to be reserved for higher value transactions. However, as the cost of electronic money transactions has come down and the functionality increased, and as our daily lives have become more digitalised, commercial bank electronic money has come to dominate payments in the UK.
Card payments surpassed cash as the most commonly used form of retail payment in 2016. By 2021, 85% of payments were made electronically (either through cards or bank transfers). However, as the experience with contactless and mobile payments shows, innovation in payments will continue as new technologies and business models develop. The ability to transact in cash, of course, remains very important to a substantial part of the population and often to the most vulnerable. And cash is clearly an important store of value for many in times of stressfootnote. The Bank of England has been very clear that it will continue to issue cash as long as there is any demand for itfootnote. But the recent trend away from publically-issued, Bank of England, physical money and towards electronic money issued by private sector banks is very clear. And we should expect that trend to continue for a number of reasons.
First, and most obviously, what I have called the digitalisation of everyday life will continue. The growth of internet commerce or use of banking and payments apps, for example is forecast to grow/unlikely to stop. Second, there are further developments in train within existing payment systems, infrastructure and regulatory frameworks. These include Pay.UK’s development of the New Payments Architecturefootnote. The Bank of England is well advanced in the build and implementation of a new central bank real time payment system (RTGS), the central rail of the current UK payments infrastructure. This renewal programme will increase resilience and access, and offer wider interoperability, improved user functionality and strengthened end-to-end risk management of the UK’s High Value Payment System. As announced this morning, the government and regulatorsfootnote will expand the Open Banking framework through making improvements on API performance, improving the provision of information sharing to third party providers and working towards additional functionalities, such as variable recurring payments. Third, and looking a little further into the future, over the last decade a set of newer technologies have emerged which may have the potential for a further transformation in payments. I am referring here to technologies that have been pioneered and refined in the crypto world, such as tokenisation, encryption, distribution, atomic settlement and smart contracts. These developments have been much hyped of course, and one could not say it was a certain bet that they will be as transformative as some have claimed. But some have already begun to find their way into conventional financefootnote and there is a great deal of experimentation and development going on, both in the crypto world and in conventional finance. They offer the prospect of what is loosely called the ‘tokenisation’ of financial and other assets – including the ‘money’ that is used to settle - and thereby a more extensive, faster and more secure programming/automation of transactions. And they offer new ways to record the ownership and the transferring of ownership, of assets - again including the transfer of money – which we generally call ‘payments’. One can certainly think now of possible use cases for such functionality. In the world of wholesale financial transactions, for example, they may make it possible to cut out intermediaries and make trading and settlement instantaneous. In retail payments, for example, they may enable functionality like micro-payments and more flexible programming of money for everyday uses. But perhaps more important may be the use cases we cannot see at present. A good illustration of this is the expansion of use cases for the smart phone which I am reasonably sure has far exceeded anything that could have been imagined when the first iPhone and apps were introduced in 2007. At launch the iPhone had just 15 apps, the app store opened the following year with around 500 apps which has grown such that today it holds over 2 million. The potential tokenisation of money and development of new ways of transferring it in transactions has major implications for the Bank of England. It is not just that we are responsible for ensuring that payment systems work seamlessly and without disruption in the UK, crucial though that is for financial stability. It is also, and more fundamentally, because we are ultimately responsible for ensuring that each of the monies circulating in the UK – and at present we have around 800 private banks, building societies and credit unions issuing moneyfootnote - are both robust and uniform. By robust, I mean that users can have confidence that the money will be useable and accepted in transactions. By uniform I mean denominated in the same currency unit – Sterling – and seamlessly exchangeable for any other money in circulation on demand and without loss of value. Against that background, I want to look at four areas where the tokenisation of money is now being explored. The first is stablecoins used for payments, the second is the tokenisation of commercial bank deposits, the third is the next stage of the Bank of England’s work on issuing a Digital Pound and the last is the Bank’s work to ensure to ensure these new forms of money are robust and uniform. The emergence, in the world of crypto assets of so-called stablecoins is at the forefront of developments in the tokenisation of money. Stablecoins broadly comprise a digital financial asset that purports, by one means or anotherfootnote, to maintain a stable value, a ledger system, usually a distributed ledger, for recording and transferring ownership. These are supported by exchanges for trading the coins and custody arrangements for storing them. At present, they are issued by a variety of non-bank entities. So far their use has been confined to facilitating trading and other transactions in the world of crypto assets but there are proposals to introduce them for other payment purposes in the economy and for cross border use in competition with money issued by commercial banks and conventional payment systemsfootnote. Stablecoins offer the possibility of greater efficiency and functionality in payments. But they currently sit outside most of the regulated framework and it is extremely unlikely that any of the current offerings would meet the standards for robustness and uniformity we currently apply both to commercial bank money and to the existing payment systems that transfer commercial bank money between the parties to a transaction. The Financial Services and Markets Bill will give the Bank powers to regulate operators of systemic payment systems and systemic service providers using “digital settlement assets”, including stablecoins that are used, or are likely to be used, for payments, at systemic scale in the UK. It will also give the FCA powers to regulate the issuance and custody of fiat-referenced stablecoins for conduct and market integrity. We and the FCAfootnote plan to consult later this year on the regulatory frameworks we will apply to stablecoins.
The Bank of England’s regulatory framework, in line with the legislation, will cover the issuance of stablecoins which are used for payments at systemic scale, the systems for transferring the coins, and also extend to systemic service providers such as custody wallets that are an intrinsic part of the stablecoin arrangement. It will give effect to two expectations for systemic or likely to be systemic stablecoins that have been set by the Bank’s Financial Policy Committee. First, that payment systems that use stablecoins should be regulated to standards equivalent to those applied for traditional payments. And second that stablecoins used as money for payments should meet equivalent standards to those provided by commercial bank money. It will follow the guidance on the relevant international standards set last yearfootnote, including the requirement that the coins should be redeemable from the stablecoin arrangement, in fiat money, at par value and on demandfootnote. This matches the requirement for commercial bank money and is crucial both to ensure confidence in the coins and their uniformity with other sterling money. Systemic stablecoins will need to be backed with high quality and liquid assets to be able to meet these expectations and standards, as set out by the Financial Policy Committee.footnote These could include either deposits at the Bank of England or very highly liquid securities, or some combination of the two. We are currently considering which of these options is most appropriate. In doing so, we will need to take two important considerations into account. The first is that, unlike commercial bank money which is protected by deposit insurance up to £85,000, it will not be possible – initially at any rate – to give stablecoin holders industry funded protection against failure of the coin. This reinforces the need to ensure that the backing assets are at all times of sufficient value to meet redemption requests. And it also highlights the potential role of capital requirements. The second consideration is that the underlying objective of the legislation and the ensuing regulation is to open further the frontier for safe and sustainable innovation and competition in payments. Stablecoin business models should in general reflect this and be grounded in improved payments efficiency and functionality rather than in maturity transformation. There are other important questions to be resolved, such as whether there should be limits, initially at any rate, on stablecoins used for payments. While, from a public policy perspective, we want competition and innovation in payments we need to guard against rapid, disruptive change that does not allow the financial system time to adjust and could therefore threaten financial stability. The risks to financial stability from the development of digital money issued outside the banking system has been the subject of extensive analysis. The Bank of England’s assessment is that over time, the financial stability risks should be manageable including risks from the impact on the banking systemfootnote. But we cannot know for certain the extent and the speed at which payment stablecoins might be adopted and we may well need limits, at least initially, to ensure we avoid disruptive change that could threaten financial stability.
Another important question will be whether the requirement to be redeemable in fiat money, on demand and at par and the backing asset model will be sufficient to ensure uniformity of sterling stablecoins with each other and with other forms of sterling money. This will depend to some extent on whether there are frictions in the redemption and interchange process. It has been suggested that ensuring the uniformity (or ‘singleness’ of money) requires that all transactions between different monies settle ultimately in central bank money across the books of the central bank. While it is not clear to me that this should be the case, it is clearly an issue that should be considered carefully in the design of the regulatory regime. Finally, on stablecoins, it is important to emphasise that powers in the Bill and the Bank’s regime will be for stablecoins used for payments. A digital representation of an asset with a generally stable value could be used for other purposes. It could offer a return as an investment product akin to a money market fund. Or it could be part of the credit creation process, with the loans issued in the form of stablecoins. Neither of these models is likely to fit within the regulatory regime for payment stablecoins, though they may fit within other regulatory regimes. In the first case, to be acceptable as a means of payment at systemic scale, stablecoins will be required to meet redemption at par on demand which is inconsistent with an investment product. In the second case, the issue of liquid liabilities that can be used as money in return for illiquid debt obligations is the banking business model and issuers of tokenised money who wish to pursue credit creation will need to be regulated as banks. This brings me to the second area, the issuance by commercial banks of new forms of digital money to be used on new payment rails – in the form of ‘tokenised’ bank deposits. These might offer some or all of the functionality and efficiency claimed for stablecoins, allowing banks deposits to compete better with non-bank payment coins. Some banks in the UK and in other jurisdictions have been exploring and investing in the development of tokenised deposits as settlement assets on new forms of ledger (eg DLT). The majority of this effort appears to have centred on wholesale as opposed to retail financial transactionsfootnote, though there are signs that attention is now being given to tokenisation of retail depositsfootnote. In regulatory terms, the tokenisation of bank deposits is a much simpler proposition than non-bank stablecoins. Bank deposits are already uniform, robust money in the UK – indeed they account for 85% of the money in circulation for retail purposes and are generally acceptable for wholesale transactions. We have a comprehensive regulatory regime, deposit insurance and resolution and insolvency procedures to protect bank depositors. Commercial banks settle between each other in Bank of England money which helps to reinforce uniformity. Nonetheless, the tokenisation of bank deposits raises some important questions. Currently, money issued by a commercial bank can only be held by someone that has an account at that bank. It is not directly transferable from one holder to another unless both parties have an account at the same bank. In order to transfer money from the holder of an account at one bank to the holder of an account at another bank, there needs to be a transaction between the two banks which ultimately settles in Bank of England money across our books.