The Bank of England and the finance ministry said a central bank digital currency (CBDC) was likely to be needed later this decade as they launched a new consultation for the design of such a system.
"While cash is here to stay, a digital pound issued and backed by the Bank of England could be a new way to pay that's trusted, accessible and easy to use," finance minister Jeremy Hunt said in a statement.
"That's why we want to investigate what is possible first, whilst always making sure we protect financial stability."
BoE Governor Andrew Bailey said the implications of a digital pound - including privacy issues - had to be considered.
"This consultation and the further work the Bank will now do will be the foundation for what would be a profound decision for the country on the way we use money," he said.
Prime Minister Rishi Sunak asked the BoE to look into the case for a CBDC when he was finance minister in 2021.
Other central banks, such as the U.S. Federal Reserve and the European Central Bank, are also considering launching their own CBDCs and 11 countries have already launched them.
Unlike cryptoassets, the digital pound would be issued by the central bank and not the private sector and its value would be fixed.
Under Britain's proposals, individuals would not hold accounts directly with the BoE. Instead they would have accounts with private digital wallet providers, which would provide digital pounds over public infrastructure.
Officials said a digital pound, while offering services similar to those already available to consumers, would avoid the risk of competing, non-interoperable systems operated by tech giants or banks and would drive future innovation.
The idea of CBDCs gathered momentum after Facebook proposed in 2019 a crypto-asset called Libra that would have pegged its value to a basket of currencies. It was eventually shut down.
The new head of innovation at the Bank of International Settlements, a forum for central banks, told Reuters in an interview published on Monday that CBDCs would face geopolitical limits.
China has conducted the largest cross-border CBDC trial to date.
Britain would impose initial restrictions on how much CBDC individuals or businesses could hold as a precaution to avoid the risk of unsettling the financial system, the BoE and finance ministry said.
BoE Deputy Governor Jon Cunliffe is due to give a speech on Tuesday to update the finance industry on the BoE's CBDC work.
(Writing by William Schomberg and David Milliken; Editing by Tomasz Janowski)
