Latest / Monetary Policy Explained with Fexingo: Central Banks, Money Supply, and Interest Rates / How Central Banks Design Digital Currencies for the Public
Transcript
- Lucas: So the Bank of England recently released the technical specifications for its digital pound pilot, and one number really jumped out at me: thirty thousand transactions per second. That's the throughput target. To put it in perspective, that's roughly ten times what the UK's faster payments system handles today. Luna: That's a massive leap. And this is the retail version, right? The one meant for everyday people, not just banks settling with each other? Lucas: Exactly. This is a retail central bank digital currency, or CBDC. The Bank calls it the digital pound for person to person payments, online shopping, maybe even tap to pay at a coffee shop. The pilot isn't a live launch yet, but it gives us the clearest picture yet of how central banks are thinking about the design trade-offs. Lucas: If walking through the economy with us has made something click, the way these episodes stay ad-free is listener support. You can find us at buy me a coffee dot com slash fexingo. It's a simple way to keep the conversation going without any sponsored interruptions. Luna: Yeah, and it genuinely makes a difference. We hear from listeners who say this show helps them make sense of policy decisions that affect their daily lives. That's exactly why we do it. Lucas: So back to the digital pound design. One of the most interesting choices is the tiered access model. Essentially, there's a holding limit of twenty thousand pounds per person. If you want to hold more, you'd need to provide extra identity verification, and there's a hard cap. Luna: Twenty grand seems low for a wealthy individual. Is that to prevent a bank run scenario, where people pull money out of commercial banks en masse? Lucas: That's exactly right. The Bank's biggest fear is disintermediation. If the digital pound were too attractive, people might shift all their deposits from commercial banks into the central bank's digital wallet. That would shrink bank balance sheets and potentially reduce lending. The tiered limit is a guardrail. Luna: But how do they prevent the limit from being a hassle? If I'm a small business owner and I need to receive payments, twenty thousand might be too restrictive. Lucas: Good question. The Bank has proposed a 'reverse waterfall' mechanism. Imagine your digital wallet is linked to your current account at a commercial bank. If an incoming payment would push your digital pound balance over the twenty thousand limit, the excess automatically flows into your linked bank account. So the limit applies to the central bank wallet, not your total money. Lucas: That design is clever because it keeps the CBDC as a medium of exchange, not a store of value. You're not meant to hoard digital pounds; you're meant to spend them. The reverse waterfall ensures the limit never actually blocks a transaction. Luna: Right, so it's a payments tool first. But what about privacy? The Bank of England has said they won't see individual transaction data, but the wallet providers will. Who are these wallet providers? Lucas: The Bank is designing a two-tier architecture. Tier one is the central bank's core ledger, which only records wholesale transfers between wallet providers. Tier two is the user-facing layer, run by private firms: banks, fintechs, maybe even non-banks. Those providers handle know your customer checks and transaction monitoring. Lucas: So the central bank sees only aggregated flows, not that you bought a latte. The wallet provider sees the latte. That's similar to how cash works now: the central bank issues the notes, but the corner shop doesn't report every sale to Threadneedle Street. Luna: But with cash, there's no digital trail at all. Here, the wallet provider still has a record. Is there any offline capability being planned—like a physical card that stores value for places without internet? Lucas: The Bank's pilot specifically includes an offline feature. They're testing a model where a card or a phone can store a limited balance, say two hundred pounds, that can be spent without an internet connection. When you go online again, the transactions sync. This is crucial for financial inclusion in rural areas or during outages. Luna: That's a big deal. I remember when the ECB first floated the digital euro, there was pushback about privacy and surveillance. How does the UK approach compare to what the eurozone is doing? Lucas: The ECB is further along in some ways. They've already completed a two-year investigation phase and are now in a 'realisation phase.' Their design also includes a holding limit, but they've proposed a lower one—around three thousand euros per person. And they've faced more political friction, especially from Germany and Austria, where cash is culturally sacred. Lucas: The ECB has also been more explicit about programmability. They want the digital euro to allow conditional payments—like a welfare benefit that can only be spent on food. That's controversial because it blurs the line between a payment instrument and a policy tool. Luna: I can see why that would make people nervous. But isn't that the whole point? Central banks could use programmability to implement monetary policy directly, like expiring money to stimulate spending during a deflation. Lucas: Theoretically, yes. But the Bank of England has explicitly ruled out any form of 'expiring money' or negative interest on digital pounds. They want it to be as close to digital cash as possible: no interest, no expiry, just a secure means of payment. The ECB has been more cagey—they haven't ruled out programmability entirely. Luna: So we have two major central banks taking slightly different paths. Which design do you think will become the global standard? Lucas: It's early, but I'd watch the Chinese model. The digital yuan is already live in pilot cities, processing transactions for millions of users. It's more centralized—the People's Bank of China can see individual transactions if needed. That's a nonstarter for most Western democracies, but it shows the technology works at scale. Lucas: The Bank of England and ECB are trying to build something that preserves privacy and limits central bank power over individuals. That's harder. The reverse waterfall and tiered access are elegant solutions to the trade-off between usability and financial stability. If they pull it off, it could become a template for other countries. Luna: And what about the timeline? When will I actually be able to open a digital pound wallet? Lucas: The Bank has said a potential launch is still 'several years away.' The pilot runs through 2026, and then there'll be a legislative phase. The UK government would need to pass a law authorizing the digital pound. Realistically, we're looking at 2028 at the earliest. Lucas: But the pilot itself is important because it forces the Bank to answer hard questions about liability, fraud, and cybersecurity. For instance, if someone hacks your digital wallet, who's on the hook? With cash, if it's stolen, it's gone. With a CBDC, the central bank might be expected to reimburse you. That's a huge shift in risk allocation. Luna: And that's probably why they're moving slowly. One design flaw could undermine trust in the entire financial system. Lucas: Exactly. The digital pound isn't just a new payment method. It's a new form of money, issued by the state. If people lose confidence in it, that could spill over into confidence in the currency itself. So the Bank is being methodical. Lucas: One more design detail I find fascinating: the 'no interest' feature. By not paying interest on digital pounds, the central bank ensures they don't compete with bank deposits as a savings vehicle. But some economists argue that's a missed opportunity to have a monetary policy tool that reaches households directly. Luna: Right, because if the central bank ever wanted to stimulate spending, it could cut the interest rate on digital pounds into negative territory, effectively charging people to hold them. That would be incredibly powerful—and incredibly unpopular. Lucas: Exactly. The Bank of England has said they want to avoid that entirely. But the fact that they've designed the system to allow it in theory means the option is there if a future crisis demands it. The technology doesn't constrain the policy choices; it enables them. Luna: So the digital pound could be a Trojan horse for more aggressive monetary policy down the line, even if the Bank says it won't be. Lucas: That's the worry for some critics. But for now, the focus is on getting the basics right: a reliable, private, fast payment system that works for everyone. If they can deliver that, it will be a genuine public good. Luna: And if they can't, we're stuck with the current system, which isn't perfect but works. So the bar is high. Lucas: It's the highest bar in financial infrastructure. And that's why watching these pilots unfold is so interesting. Every design choice reveals what central banks value most.