Central banks worldwide are actively exploring the concept of a central bank digital currency (CBDC) to complement physical cash and traditional banking systems. India’s central bank and regulator, the Reserve Bank of India (RBI), aims to balance innovation, security, and regulation while developing a CBDC framework to offer financial inclusion, secure digital payments, reduced cash management costs, and real-time transaction monitoring benefits. The combination of CBDCs, regulated stablecoins, and smart contracts could serve as the medium of exchange in the digital asset ecosystem. However, the utility and programmability features of digital money require further discussion to ensure they don't compromise its function as a medium of exchange and its fungibility.
Understanding programmability
Smart contracts are digital agreements that facilitate secure and transparent transactions, eliminating the need for intermediaries by automatically executing predefined conditions. For instance, smart contracts have immense potential in the insurance sector, particularly in expediting and simplifying the claims process. In the case of life insurance, policy terms can be encoded into a smart contract. When a death certificate is provided as an input trigger, the smart contract automatically releases the payment to the designated beneficiaries.
Smart contracts are digital agreements that facilitate secure and transparent transactions, eliminating the need for intermediaries by automatically executing predefined conditions.
The emergence of digital currencies has generated interest in programmable money, which allows digital currencies to be programmed for specific purposes. However, implementing this idea faces numerous real-time challenges.
While modifying digital currencies' properties and conditions could hinder their acceptance as a medium of exchange, reprogramming all existing currencies for new conditions would be impractical. Creating multiple versions of digital money with uniquely programmed logic is an alternative, but it risks fragmenting liquidity and reducing fungibility. Therefore, it is essential to explore diverse programmability models to maintain fungibility while expanding the potential of digital money. Such innovations could enable seamless exchange and ensure the viability of digital money as a medium of exchange in the ever-changing and diverse digital economy.
Money with purpose
Clarifying the distinction between programming currencies and programming payments is crucial. While not entirely groundbreaking, the concept of programmable payments has existed for quite some time. Programmable payments execute transactions at the fulfilment of predetermined conditions. For instance, the banking system widely embraces basic forms of programmable payments, such as standing orders or direct debits, which are activated through specific transaction events or predefined thresholds.
In a nutshell, programmable money involves customising the properties and behaviour of the underlying currency, enabling it to be programmed according to specific requirements. On the other hand, programmable payments focus on automating and customising the execution of payment transactions by utilising smart contracts or predefined rules. The potential to apply sophisticated preprogrammed rules to payments automatically and achieve interoperability across all network-connected devices is highly enticing. It represents an anticipated innovation with a significant future appeal.
The banking system widely embraces basic forms of programmable payments, such as standing orders or direct debits, which are activated through specific transaction events or predefined thresholds.
Applying programmable logic to currencies is thus a novel innovation made possible by the emergence of digital currencies. CBDCs must embody the essential attributes of physical money, as the evolution of programmed digital currencies makes it imperative to uphold the fundamental principles of value and fungibility.
The Monetary Authority of Singapore (MAS) whitepaper introduces the concept of purpose-bound money (PBM), which aims to retain the fundamental characteristics of money while opening doors to programmability. The purpose-bound money design can be envisioned as a digital currency comprising an underlying store of value serving as collateral, encased within a layer of programmable conditions. This design allows using existing digital money for different purposes without altering its intrinsic properties. Once the programmable conditions are fulfilled, and the purpose-bound money serves its intended purpose, digital money can be used without limitations. By retaining control over digital money, the issuer avoids fragmentation and ensures digital money retains its characteristics.
Conceptually, purpose-bound money provides a common framework regardless of the type of underlying digital money, depending on its acceptance, value, and usability. Thus, it is essential to carefully consider the reserve assets, regulatory implications, and compliance requirements associated with digital money. For instance, CBDCs, tokenised bank liabilities and stablecoins offer different levels of guarantees and are subject to different regulatory oversight than private digital currencies.
New opportunities
The continuous exploration of programmable money paves the way for novel use cases, particularly as it diminishes the role of intermediaries. One compelling application emerges in e-commerce, where programmable currency holds promise. In the typical online shopping experience, consumers often face the requirement of making upfront payments for desired products, which are then dispatched for delivery. Consumers and merchants employ various arrangements to address concerns around non-delivery and payment risks. Credit cards and pre-payment methods provide safeguards for merchants, yet consumers may remain vulnerable.
Purpose-bound money emerges as an alternative solution, instilling confidence in merchants and consumers as it ensures fund transfers upon fulfilling service obligations.
Conversely, cash on delivery may reassure consumers but leaves merchants uncertain, particularly when dealing with perishable goods that cannot be repurposed. Purpose-bound money emerges as an alternative solution, instilling confidence in merchants and consumers as it ensures fund transfers upon fulfilling service obligations. This intersection of programmable money and e-commerce holds tremendous potential for reshaping transaction dynamics in the digital landscape.
Another emerging application could be found in cross-border payments, a rapidly evolving landscape. Cross-border transactions are subject to various policy and regulatory frameworks, encompassing capital flow management, macro-prudential policies, anti-money laundering (AML) and combating the financing of terrorism (CFT) standards. Adhering to these measures entails substantial costs and processing delays. However, incorporating existing policy requirements as conditions within purpose-bound money systems can automate compliance checks, significantly reducing costs and enhancing cross-border payments efficiency. Furthermore, such a compliance-by-design approach could foster regulatory and policy interoperability, aligning with the G20 roadmap's objectives to enhance cross-border payment systems.
Assessing innovation
The extensive development of CBDCs worldwide highlights a growing obsession with digital currencies. However, undue control of organisations or governments over individuals through digital currencies evokes unsettling visions of a dystopian future. While the possibility of governments exploiting these mechanisms and regulating people's lives cannot be dismissed, it is still speculative.
Programmable payments have already demonstrated value, benefiting businesses, societies, and individuals. Initial scrutiny reveals that programmable payments have the potential to achieve similar outcomes as programmable money, albeit through a different internal mechanism.
Programmability is in its early stages, and it is essential to differentiate between programmable payments and programmable money, as the latter is a recent development often misconstrued. Concerns arise regarding money programming, as it risks compromising its inherent characteristics. The purpose-bound money project has taken proactive steps to alleviate such concerns. By clearly separating the roles of the purpose-bound money creator and the digital money issuer, the system ensures that no single entity has full control over the issuance and usage of money. Such demarcation effectively limits the amount of data held by individual institutions to only what is essential for their authorised functions. Though the purpose-bound money project has made significant progress in addressing these concerns, widespread acceptance remains uncertain.
Programmable payments have already demonstrated value, benefiting businesses, societies, and individuals. Initial scrutiny reveals that programmable payments have the potential to achieve similar outcomes as programmable money, albeit through a different internal mechanism. Nevertheless, it is crucial not to overshadow or impede the progress and exploration of programmable money.
It is important to perceive programmability for what it truly represents—an experiment exploring the potential applications of digital money for specific purposes. The adoption of such a system by countries already equipped with CBDCs or other digital currency issuers remains uncertain. Nevertheless, this endeavour provides invaluable insights into simplifying transactions and settlements at the core of monetary operations, free from intermediaries. Central banks and digital currency issuers worldwide can glean valuable knowledge from this experiment. However, this does not imply that all efforts must be dedicated solely to programming digital currencies. A prudent approach involves identifying practical applications and striking a balance between programmable currencies, programmable payments and traditional physical currency tailored to address the specific challenges.
Sauradeep Bag is Associate Fellow at the Observer Research Foundation
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