The Bank of England has published a One Bank Research Agenda Discussion Document. The aim is to open up the Bank’s research agenda, so that it can learn from external contributors, and “crowd-source solutions to key policy questions“. The Agenda has five themes, including: “Theme 5: Central bank response to fundamental technological, institutional, societal and environmental change” – a theme which “takes a longer-run perspective, raising questions around how fundamental change might affect central banking over a longer horizon’.

The Bank’s introduction to Theme 5 acknowledges that “Digital currencies … may reshape the mechanisms for making secure payments, allowing transactions to be made directly between participants. This has potentially profound implications for a financial system whose payments mechanism depends on bank deposits that need to be created through credit. Similarly, technology has enabled the emergence of new business models, such as peer-to-peer lending and crowdfunding, which create alternative sources of finance for both individuals and businesses“.

The Bank’s more detailed comments are not altogether flattering: “The emergence of private digital currencies … has shown that it is possible to transfer value securely without a trusted third party. While existing private digital currencies have economic flaws …, the distributed ledger technology that their payment systems rely on may have considerable promise. This raises the question of whether central banks should … make use of such technology to issuedigital currencies” themselves (emphasis supplied – note that the Bank seems to be contemplating the issue of a digital fiat currency, rather than the issue of a virtual cryptocurrency, as some reports have suggested).

If the Bank issued a digital currency, it could be used to enable interbank settlements. The Bank’s digital currency could also be made available more generally in the same way that notes and coins are made available today. However, the Bank would need properly to understand the impact this would have on (for example) the existing payment systems and bank deposits, before doing so. The Bank would also need to be satisfied that: (a) it would be able to control its currency; (b) the system was secure against systemic attack; and (c) the remuneration structure that encouraged participation in the relevant distributed ledger system incentivised honest participation, without leading to socially inefficient over-investment in transaction verification.

In theme 5, the Bank notes that digital currencies also raise systemic, prudential and conduct regulatory issues:

  • The systemic issue is developing the protocol … which govern[s] how a technological system works. The first question is whether a protocol for a central bank issued digital currency could be developed at all”;
  • The prudential issue is focussed on wallet and currency-exchange service providers: “…they would not be offering to hold funds on their own account, [so] the prudential regulatory issues would probably be different from the conventional focus on capital and liquidity requirements at existing banks“; and
  • The conduct issues would be concerned with the “Know Your Customer” and anti-money laundering obligations that regulators would expect wallet and exchange providers to meet.

Theme 5 also includes a brief look at crowdfunding, peer-to-peer lending and other sources of alternative finance. “While the alternative finance sector is … small … it is growing rapidly. If this … is sustained, the sector may change the way in which consumers and businesses understand and manage their finances, and the way in which they use traditional banks and insurers. These developments raise questions about the optimal business models for the provision of financial services … More generally, the changes that may arise from technology-enabled alternative finance could have implications for all areas of central bank policy, including monetary policy, microprudential policy and financial stability policy. For example, they could alter the transmission mechanism of monetary policy … And if they grow sufficiently, they could be a source of macroprudential and microprudential risks, with potential implications for regulation“.  This prompts the Bank to ask itself a number of interesting questions, including: “How might a shift towards alternative finance change the way in which new money is created and distributed through an economy? … Would a shift towards alternative finance change the way in which households and businesses respond to changes in monetary policy? How might growth in alternative finance change the business models of prudentially regulated banks and insurers? What implications would this have for macroprudential and microprudential regulation? [and] Could the distress or failure of a technology-enabled alternative finance provider have implications for financial stability?”

At first blush, this looks like the re-emergence of the “unreliable boyfriend” – until now, the Bank of England had only taken a cursory look at Bitcoin and digital currencies before dismissing them as too small to matter for now (see our client alert about the regulation of virtual, digital and crypto-currencies for more detail about this). But even the most unreliable boyfriend can become reliable when he gets to know you better. And the Bank  is at least now prepared to take a more detailed look. As you’d expect from the Bank, it’s taking an academic approach first; but at least that shows it’s serious.  The Bank is also asking for feedback, debate [and encouragement]. If you’d like to give it, the e-mail address for Theme 5 replies is: OBRAtheme5@bankofengland.co.uk