The crypto-asset industry

It has been more than four years since our predecessor Committee’s Report called for greater regulation of the cryptoasset industry, and the FCA faces challenges in implementing existing and proposed crypto regulations. It is important that the Government and regulators strive to keep pace with developments, including by ensuring that the Financial Conduct Authority’s authorisations gateway is open and effective, so that potential productive innovation in financial services is not unduly constrained.

While we support financial innovation where there are potential benefits, the extent of the benefits cryptoasset technologies may bring to financial services in the future—and the areas in which the technologies may have the most impact— remains unclear. In the meantime, the risks posed by cryptoassets to consumers and the environment are real and present.

We recommend that the Government takes a balanced approach to supporting the development of cryptoasset technologies. It should seek to avoid expending public resources on supporting cryptoasset activities without a clear, beneficial use case, as appears to have been the case with the Royal Mint NFT. It is not the Government’s role to promote particular technological innovations for their own sake.

Regardless of the regulatory regime, their price volatility and absence of intrinsic value means that unbacked cryptoassets will inevitably pose significant risks to consumers. Furthermore, consumer speculation in unbacked cryptoassets more closely resembles gambling than it does a financial service. We are concerned that regulating retail trading and investment activity in unbacked cryptoassets as a financial service will create a ‘halo’ effect that leads consumers to believe that this activity is safer than it is, or protected when it is not.

We strongly recommend that the Government regulates retail trading and investment activity in unbacked cryptoassets as gambling rather than as a financial service, consistent with its stated principle of ‘same risk, same regulatory outcome’. (Paragraph 52) Regulating Crypto 19

There are some potential benefits to the UK economy from a digital pound. A digital pound could help support innovation in domestic payments, while guarding against some of the risks posed by new forms of private digital money by maintaining public access to a form of central bank money. Innovation brought about by a digital pound could also support the UK’s international competitiveness in payments (and related) technologies, particularly if it is amongst the first major central banks to issue a retail CBDC. The extent of these benefits is unclear, however. Nor is it yet clear that a digital pound is the only (or best) means of achieving them. (Paragraph 29) Risks and challenges from a digital

It is vital that a digital pound does not increase risks to UK financial stability and, were a digital pound to be launched, it could take some time to fully understand the impact on financial stability and the wider economy in both normal and stressed times. To reduce the risk of large-scale outflows from bank deposits into digital pounds, there could be merit in a more cautious approach of a lower initial limit on individual holdings than the £10,000-£20,000 limit proposed by the Bank of England and Treasury, with a view to increasing it over time.

We recommend that the Bank of England and Treasury undertake further analysis on the monetary policy impact of paying interest on the digital pound, and in the meantime ensure that their design work does not preclude the possibility of paying interest on the digital pound.

Strong privacy safeguards would be vital were a digital pound to be introduced. Although the Bank of England and Government state that it is not their intention to be able to access users’ data, it is conceivable that they may in future be tempted to try to make use of such a powerful source of information. It is important to guard against this risk in the fundamental design of the digital pound.

We recommend that any primary legislation used to introduce a digital pound does not allow the Government or Bank of England to use the data from a digital pound for any purposes beyond those already permitted for law enforcement.

We are also concerned about potential misuse of consumers’ data by the user-facing firms that would manage consumers’ digital pound wallets, particularly given that the commercial use of this data could form a key part of the business model for wallet providers, in a way that it doesn’t for banks.

While some consumers may be content to share their personal data with payment interface providers in exchange for digital pound wallet services, there is a risk that consumers do not fully understand how their data could be used, or the implications of doing so. It is vital that it is transparent to users how their data would be collected and used. There must also be clear, usable opt-outs for those that do not wish their data to be collected and used for commercial purposes. To ensure the appropriate 18 The digital pound: still a solution in search of a problem? safeguards are in place, it is vital that wallet providers are robustly regulated from both a prudential and conduct perspective, with strong penalties for those that misuse customers’ data.

It would be important to support financial inclusion to the greatest possible extent through a digital pound were it to be launched, including by exploring the option of offline payments to ensure accessibility by users with limited or unreliable internet connectivity.

The Government and Bank of England must resist the temptation to believe that a digital pound can fix problems it can’t, however, and a digital pound must not make financial exclusion worse. There is a risk that the introduction of a digital pound accelerates the demise of physical cash, causing difficulties for those currently reliant on it. It is vital that efforts continue to be made to support those reliant on physical cash. It is also vital that the Government works to improve digital literacy and inclusion in the UK. The Government and regulators must ensure that any future digital pound wallet providers grant access to at least basic digital pound services for all UK adults. (Paragraph 53) Future decision on whether to launch a digital pound

This report has set out some of the benefits and risks from a digital pound. While there are some potential benefits, their extent is unclear and there are significant risks and challenges to be worked through, particularly in relation to privacy and financial stability. It is not clear to us at this stage whether the benefits are likely to outweigh these risks. Nevertheless, we support the Bank of England and Treasury undertaking further consultative work on the design of a digital pound to enable it to be launched if benefits increase and risks to privacy and financial stability are mitigated. This consultative work could also have wider, indirect benefits for the UK’s competitiveness by furthering the Treasury and Bank of England’s understanding of new payment technologies. It is important, however, that work on the digital pound does not distract the Bank of England from its core tasks of controlling inflation and maintaining financial stability.

The Bank of England has already incurred significant costs from its work on a digital pound, and its further work on the design of a digital pound will require increased expenditure in the coming years. It is important that the Bank of England and Treasury keep control of these costs to avoid spending more than necessary on a digital pound that might not proceed to being built. To ensure transparency around the costs incurred, we recommend that the Bank of England reports expenditure on the digital pound as a separate line item in its annual report and accounts from 2024 onwards.

Building the infrastructure needed for a digital pound would also likely be very expensive, and the eventual decision on whether to launch a digital pound will need to be subject to a rigorous cost-benefit analysis. The Bank of England and Treasury must approach this analysis from a neutral stance—the launch of a digital pound must not be viewed as an inevitable consequence of investing in further detailed design work. The policy question must remain ‘why do it’ rather than becoming one of ‘why not do it’. (Paragraph 60) The digital pound: still a solution in search of a problem? 19

To help ensure a rigorous and balanced approach is taken towards assessing the case for launching a digital pound in future, we recommend that the Government and Bank of England set out in more detail, as soon as possible, the criteria they will use to inform that final decision. (Paragraph 61) 20 The digital pound: still a solution in search of a problem?