Digital Pounds - Part 5: Fraud and Friction

HMT and BoE recently launched a consultation on their proposal to introduce a Central Bank Digital Currency, the Digital Pound. Parts 1 and 2 of this series explore the case in favour of implementation, whilst Parts 3 and 4 examine two fundamental risks to the scheme. Part 5 examines two further areas. 

Fraud Detection 

A related issue arises for wallet providers who, according to the consultation, would be responsible for fraud prevention rather than BoE who would simply maintain a central ledger. 

In the current payments model there is a two tier system. Cash payments have close to zero protection — if I wrongly hand over cash to someone the chances of me getting it back are low. In contrast, digital transactions, both bank transfers and card payments are usually insured, either implicitly or explicitly, by my bank or card provider. If I am defrauded I can ask them to reverse the transaction, which they will do if still able. In instances where transactions cannot be reversed I may still be made whole, at the bank or card provider’s own cost. Consequently, payments processors put significant effort into fraud prevention, devoting both money and large volumes of historical transaction data to the challenge. 

The question must surely be asked: will new passthrough wallet providers be able to provide similar guarantees? For small or new firms the answer is clearly no as the costs to reach an acceptable level of prevention will simply be too high. Will using the Digital Pound be more like physical cash, where a payment sent in error cannot be recovered? Or will only the largest financial institutions be competent — and well funded — enough to provide payment services on the new infrastructure without being immediately targeted by fraudsters? The answer from the proposed model is not clear, but needs more consideration before implementation. 

Harmful Practices Enabled By Reduced Friction

The need to use physical cash, or to pass through traditional payment providers, who exercise a pseudo-regulatory role, currently adds friction to transactions. This friction is what the BoE is keen to remove. However, in certain circumstances this friction is helpful in preventing undesirable outcomes. 

• Gambling. Cash withdrawal limits, card freezes & transaction monitoring all provide some checks against problem gambling. Would wallet providers competing for payments business be willing — or able — to provide the same service? 
• Lending. By facilitating transactions — and potentially programmable transactions — outside the existing financial system, new forms of lending will emerge. Are the regulators ready to prevent predatory forms of lending which are built onto the stable, 24/7, no-human-in-the-loop infrastructure?  
• Money Laundering, particularly layering. Transacting large volumes of cash is currently hard, making laundering money more challenging. I cannot show up to a bank with £10k in cash every day for a week without arousing suspicion. However, digital transactions, perhaps routed through various wallets, would achieve  the same effect whilst being much harder to spot. Again, no humans in the loop. 

—

This is Part 5 of a submission in response to HMT’s and BoE’s public consultation. To continue reading Part 6 click here. The further parts are available here.

‍