The responses are currently being analysed, but concerns have been raised around the potential to further undermine the use of physical cash or money, the risks of programmability and the threats to individual privacy.

This article considers how the concerns might apply to the current financial system or what might be different.

Decline of cash

Although we have been using physical items as money for thousands of years, its form and nature has changed over the years. Two of the most significant changes have been its conversion from items viewed as inherently valuable (eg cowrie shells or gold coins) to fiat money (including cash in the form of coins and notes), and the development of bank accounts.

Given the desire to retain cash it is strange to now think that we were once weary (even frightened) of using paper money, such that its current form is relatively recent. While paper money has been around for over a millennium (it was in use by the Song Dynasty in the eleventh century), the current form of ‘fiat’ money did not come into being until the early 1970s.

The fear was rational and to some extent the reason why remains. Fiat money has no intrinsic value beyond a country’s ability and willingness to honour the money it has issued. Printing money and inflation (as seen in Weimar Germany in the 1920s and more recently Zimbabwe in the early 2000s) can rapidly erode its value, while governments can also demonetise (ie withdraw the money in issue). And countries regularly demonetise – generally for good reasons such as wear and tear (eg the introduction of UK polymer notes), or that low denominations are no longer practical (the UK withdrew the decimal half-penny in 1984), or to combat crime.

Historically, people trusted gold or silver coins – or rather the value of gold and silver within the coins (notwithstanding widespread clipping and adulteration of the coinage by unscrupulous rulers). Who would want paper money with no inherent value or coins minted in base metals? Who would trust their rulers given their records?

To combat early abuses and the perceived risks of fiat money, countries adopted the gold standard, whereby paper money was a written promise to pay a specified amount of gold. This was finally abandoned in the early 1970s and for the last fifty years we have had a pure fiat monetary system.

Today cash represents only around 5% of the total stock of UK money. The other 95% is in the form of bank accounts (commercial bank money), which is considered as money as it can be converted into cash at the same value and can be readily used to make payments. A bank account is however a private debt owed by the bank to the account holder, and (absent the Financial Service Compensation Scheme) repayment depends upon the bank not suffering losses and failing.

Over the last sixty years or so credit cards, on-line payments, e-money have been introduced and gained wide acceptance and trust as means of electronic payment alongside having a bank account. As a result, cash payments have declined from 54% to 14% of all payments in a decade.

But the decline in cash is a real concern and gives rise to a risk of financial exclusion. Cash payments were only 14% of all payments in 2022, according to UK Finance, but that still represents 6.4bn transactions; and a significant number of UK adults do not have a bank account (1.2m per the FCA’s 2021 Financial Lives Survey). While the number without a bank account may decrease in time, there may always be a significant number that rely on cash because, for example, they do not have access to the technology required for digital payments. Moreover, the affected individuals are likely to be the more vulnerable members of society. Recent experience from the cost-of-living crisis also suggests some people like cash to help manage their budgets.

To deal with the concerns, the Government has committed to retain cash for those who need it, while the largest banks and building societies have made a similar long-term commitment. The risk, however, is that the enhanced efficiency of digital payments means there is an insidious shift away from cash, as seen with the decline in bank branches and ATMs, and the increased number of outlets that only accept debit or credit cards.

A digital pound diversifies the money supply and provides for a more resilient system. The same is true of physical money or cash, which does not rely on electricity or the internet for its usage. Regardless of perceived demand, some form of cash should perhaps always be retained.

Programmability

This concern revolves around whether governments should have the ability to control your spending, or how much control they should have, in terms of what, where and when you can spend your money.

We considered programmability of the digital pound in a previous article, which noted there may be benefits, such as enforcing prohibitions on certain expenditure that might be detrimental to society or individuals (eg managing a gambling habit).

Elements of programming or similar effects can, however, be found today which means we do not now have complete freedom to spend as desired. Some programming is necessary to ensure money can function efficiently. For example, governments define what is legal tender, and as noted above, they can demonetise. Governments can however go further, as they are the writers of the rules by which societies and economies operate.

While in the UK, old bank notes are exchanged for new with no economic cost and we are typically told well in advance, that need not be the case. When India demonetised 86% of its cash in 2016, there was no forewarning (old notes ceased to be valid from midnight on the day of the announcement), there was a time limit for converting old notes to new, and there was a risk of paying tax if it could not be proven that the old notes were from a taxed source.

Governments have in the past implemented capital controls to restrict money flows. Adjusting the cost of money (interest rates) influences where it is spent. In the current rising interest rate environment, debtors paying higher charges are potentially forced to cut back their spending on goods and services. A new wealth tax could be implemented – where money in the form of bank accounts could be an easy target.

Generally, however, the digital pound seems to increase the ability, through enhanced flexibility and ease, with which the authorities could influence or control how money is spent. While it is not the position of the UK authorities that they will program the digital pound to control an individual’s spending, in part as it may undermine confidence in the new form of money, there is possibly a heightened risk of future temptation.

Privacy

The holder of cash is anonymous, but the holder of a UK bank account or a credit or debit card is not. 97% of the adult population has a bank account, while there are over 160m credit and debit cards in issue, and 86% of UK payments are non-cash according to UK Finance. A significant proportion of the population are therefore already leaving a trail of their financial transactions.

Banks and card companies capture a considerable amount of payment and other transactional data and have been doing so for years. The growth in internet and digital payments has only increased the volume of data available to them.

The data is not shared with the government but is used by these private organisations to sell further services, and with increased processing power and enhanced data analytics will be used in ever more creative ways. Open banking is then about sharing this data with others who might want to monetise it. On the other hand, Central Banks should have no commercial interest in accessing our data.

Currently we put our trust in these private organisations to keep our data secure and that they do not use it in unethical ways. The existence of the Data Protection Act 2018 suggests, however, that the market may not be so inclined if left to its own devices.

As the data is already caught, it is not beyond the powers of the authorities to put in place measures whereby the data is shared with them, as seen with recent proposals for the Data Protection and Digital Information Bill under which banks would be compelled to share data on welfare claimants with the Department for Work and Pensions (the aim being to combat fraud and error within the welfare benefit system).

Nevertheless, as the government is committed to maintaining cash, the degree of privacy afforded by the monetary system might not change substantially for the foreseeable future. You will still be able to buy those jelly babies incognito.

Going forward

While at present there may be few obvious use cases for the digital pound, a real benefit is further diversification of the money supply, which should make it more resilient to stresses.

Moreover, planning for a digital pound is a prudent action. There are concerns and risks associated with the introduction of the digital pound that need resolving. Some are technical, such as ensuring the security of the system. Others are ethical or societal, which are just as important and need to be addressed, notwithstanding they may apply to the current monetary system. The financial system is substantially based on trust and confidence. In the absence of dealing adequately with peoples’ concerns, there will be little trust in the digital pound which may impede its adoption and potential effectiveness.