Future of Finance


Programmable Money Part I The Summary

Programmable Money Part I The Summary

Programmable money is one of the technologies to have emerged from blockchain. In fact, its origins in the trustless promise of primitive blockchain are not hard to discern. It is, in essence, tokenised cash controlled by a smart contract rather than a bank or central bank.

Click here to see the discussion of Programmable Money Part I on February 9


Money is a social construct. Whatever people are prepared to accept in payment counts as money, so what matters is not money per se but how payments are made.

Programmable money is best understood as a conditional form of payment. Conditional payment is not new. The precedents include direct debits, cheques and credit default swap payments.

What is new is “smart contracts,” the self-executing code that actualises the conditions associated with particular payments.

Examples that fit this description of programmable money are hard to find, but there is no shortage of speculative examples as to how programmability might be applied.

They include linking payments to the delivery or provenance of goods; automatic re-stocking; payment of energy bills according to consumption; and remittance of indirect taxes at the point of sale.

It is also speculated that programmable money could reduce the cost of cross-currency payments by circumventing correspondent banks, through direct connection of national payment systems.

Conditionality can render programmable money non-fungible and illiquid by comparison with fiat currency or most forms of a central bank digital currency (CBDC).

Making a CBDC programmable has some advantages. It would enhance financial inclusion by facilitating direct payments to individuals and make it easier to inflate and deflate the economy.

However, a programmable CBDC would also alter the prevailing division of labour between central banks and commercial banks and raise profound questions about privacy and liberty.

A programmable CBDC could, for example, give central banks control over the provision of credit and equity capital, the means to punish and reward different types of social behaviour and the power to exclude citizens from participation in the economy at all.

Since KYC, AML, CFT and sanctions screening already give governments powers to monitor individuals and transactions, a programmable CBDC would not represent a large extension of State power.

In the long term, the numbed of crypto-currencies is likely to reduce to a smaller number of programmable private commodities. These will co-exist alongside programmable CBDCs.

The determining factor in the evolution of both types of programmable “money” will be what they are used for, and by whom they are used. Regulators can assist a safe evolution of both.

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Money does not exist. What does exist is mechanisms for transferring value from one person to another, such as notes and coins or the crediting of bank accounts by electronic transmission, in a form that enables the payee to transfer value to someone else in turn. Money is just the measuring rod, or unit for accounting for the value transferred.

Programmable money is not a new concept

Programmable money is not new. Since money was digitised decades ago, it has been programmable in multiple ways, from automatic direct debits, through cash flows in derivative transactions such as Credit Default Swaps (CDS), to operation by central banks of the Real Time Gross Settlement (RTGS) systems that settle net payments between commercial banks in central bank money.

What is new about programmable money is the “smart contracts” (though these are not contracts but code that self-executes when certain conditions are met) intrinsic to certain forms of crypto-currency. In other words, programmable money can be defined as conditional payment.

Conditionality is the defining characteristic of programmable money

Attaching conditions to payment has the interesting consequence that programmable money is not fungible money in the way that fiat currency is. Non-fungible money cannot work like a bank deposit, which is lent out many times over by banks, so increasing the supply of (commercial bank) money through the syllogism that every loan creates a deposit.

This process is not fundamentally disrupted by crypto-currencies and other digital assets so long as they are purchased with fiat currency and the seller places the fiat currency back in the banking system. Replacement of fiat currency by digital assets might make it impossible for banks to manufacture commercial bank money through the extension of credit.

A CBDC is the likeliest replacement for the fiat currencies of today

Likewise, a Central Bank Digital Currency (CBDC) which is not distributed by the commercial banks would effectively turn the central bank into the sole provider of bank accounts and credit. Some CBDCs, such as that being piloted by the Eastern Caribbean Central Bank (ECCB), will operate this way because there are no commercial banks.

Even where there are commercial banks, a CBDC is likely to displace some commercial banking activity. Both inter-bank payments and securities transactions, for example, are settled in central bank money already, and a CBDC is likely to expand the range of activities that settle in central bank money. As a result, the range of activities open to commercial banks once a CBDC is in issue will be narrower.

A CBDC which disintermediated commercial banks from providing accounts and dominated the provision of credit raises profound questions about the distribution of power in a society. President Andrew Jackson closed the central bank of the United States in 1833, for example, because it refused to make advances to his political allies.

A programmable CBDC has advantages

A central bank armed with a programmable CBDC would given a government a power to decide which companies or individuals were worthy of raising short term credit, or long-term debt, or even equity capital – especially if it was allied to a centralised system of corporate and personal digital identities (digital IDs).
This can have advantages, particularly in terms of combating the twin evils of inflation and deflation by adding to or subtracting from the quantity of money in circulation, or by imposing negative interest rates to encourage spending, or by distributing welfare or furlough payments directly to citizens, but also in terms of financial inclusion.

In India, the national digital identity system is already making it easier for the central bank to issue cash directly to citizens, rather than solely via bank accounts operated by commercial banks (though the digital ID system was also hacked). In Nigeria, to take another example, national identity cards are being used as pre-paid credit cards.

A programmable CBDC also has disadvantages

But a CBDC that was programmable could also be used for more sinister reasons. It could, for example, reward good behaviour and punish bad behaviour by citizens. It could even exclude individuals from participating in the economy at all (the “social credit” system in China is analogous). So it represents a threat to personal privacy and civil liberty.

However, this outcome is not specific to programmable money. All non-cash transactions are electronic already, and the only difference between the police investigating transactions in a tyranny and a democracy is that the police in a democracy operating to the rule of law must obtain a warrant.

A programmable CBDC would not mark a large expansion of State power

Money launderers, terrorists and sanctioned states and individuals are already locked out of the financial system by Know Your Client (KYC), Anti Money Laundering (AML), Countering the Financing of Terrorism (CFT) and sanctions screening laws and regulations. Large transactions, such as paying for a house, are difficult for consumers to complete without being asked about their sources of funds.

In fact, because at present KYC, AML, CFT and sanctions screening risk is held by banks, it is not uncommon for respectable citizens to be denied access to the banking system or even have their bank account closed, because the banks err on the side of caution. Part of the appeal of crypto-currency is not simply its highly secure, cash-like anonymity, but the fact it can exist outside the banking system.

Nor is the invasion pf privacy and the erosion of liberty confined to government. Amazon, Facebook, Google, Microsoft and Uber, all gather, use and sell a great deal of personal information. Familiarity with this fact does not amount to consent, but consumers seem less uncomfortable trading personal information for free services from corporations than sharing data with governmental bodies to obtain, say, a digital identity. Libertarians warn that that the boundaries between governments and large corporations are more porous than they appear.

Programming money to direct social behaviour – making it impossible, for example, to spend a CBDC on tobacco – is also intrinsically difficult to police. The money could be spent on an approved purchase instead, which could then be used to obtain the tobacco.

Programmable money could be used to make cross-border payments more efficient

Programmable money could be used to expedite cross-border payments, though not in its present form, which still necessitates translation of crypto-currency into fiat currency via the familiar combination of domestic RTGS systems accessed by correspondent banks.

The average number of correspondent banks involved in cross-currency payments is 2.6, so some correspondent banking chains are extended. One reason for this is the reduction in the number of correspondent banks, because fewer banks are prepared to incur the KYC, AML, CFT and sanctions screening risks of handling payments across borders.

Direct links between RTGS systems could reduce the cost and increase the speed of these arrangements but might not represent an improvement on the existing cross-currency netting system operated by CLS.

There is a long list of conditional payment propositions to programme

But all these possibilities remain theoretical. There are as yet no extant applications of programmable money. However, there is no shortage of ideas that can be programmed into digital money.

They include linking payments to data about deliveries (receipt, quantity, quality, discounts); making payment contingent on the provenance of goods; invoices that self-execute on receipt of goods or services; linking payments to re-stocking or switching on devices via the Internet of Things (IoT); the possibility of micro-payments at affordable cost (e.g. for reading articles or selling personal data); automatic routing of sales tax payments to the tax authority at point of sale; automatic payment of energy bills by usage; raising capital by issuing programmable money instead of equity; turning invoices or purchase orders into tradeable assets; paying export finance on receipt of assurance about transaction status; and payment versus Payment (PvP) cross-currency payments.

Almost all such use-cases reduce to making payment conditional. This is nothing new. Even the humble cheque drawn on a bank – still a popular form of payment in the United States – can, if the payer writes the name of the payee and crosses the cheque, can be “programmed” to ensure it is cashable by the payee only and no one else. An implication is that programmable money can reduce the incidence of theft and fraud.

Private programmable monies are likely to co-exist alongside programmable CBDCs

Private forms of programmable money are likely to co-exist alongside CBDCs, although in smaller numbers than exist today. The current list of crypto-currencies has more than 8,000 entries, and there are more than 200 sovereign states theoretically capable of issuing a CBDC.

The number of both crypto-currencies and CBDCs is bound to diminish over time, chiefly as a result of specialisation. Domestic payments and cross-border payments are the two obvious use-cases, while Bitcoin is emerging as a store of value and a hedging instrument.

A likely scenario is that crypto-currencies will be used not as money but as commodities, with CBDCs being used as money and private sector intermediaries programming it. Conditional payment may well prove more useful in capital markets transactions with predictable cash flows than in day-to-day retail payments.
An infrastructure to support such a division of labour is emerging. In the United States, the Office of the Comptroller of the Currency (OCC) agreed in January and February 2021 to license the first two digital asset-only custodian banks (Anchorage and Protego). Developments of this kind can be expected to shorten the time-lapse that occurs between a crypto-currency transactions being agreed and settlement taking place.

Views differ on whether regulation should lead or follow the development of programmable money

An open question is whether it will be necessary to regulate peer-to-peer activities between crypto-currency investors of the kind familiar from the ICO and DeFi bubbles. One view holds that the bubbles are driven by regulatory arbitrage designed to circumvent investor protection. Another view holds that crypto-currencies were never money but always securities, and that regulation was slow to catch up with this fact.

Likewise, optimists see the DeFi bubble as an experimentation in various forms of “open finance” while detractors see it as a series of pyramid schemes. Some say crypto-currencies may not even be susceptible to regulation, because regulators tend to regulate intermediaries not investors. A more conservative view is that every crypto-currency scheme is run by someone, and they can be regulated.

Indeed, it can be argued that regulators should be looking to get ahead of developments in the crypto-currency markets to bring the innovations spawned by the ICO and DeFi bubbles within the scope of regulation before something goes wrong, so the benefits can be enjoyed with reduced risk.

Questions to be addressed at the next Programmable Money discussion
1. Do we need blockchain-based programmable money or can we accomplish what we want and need with existing technologies?
2. Are there any concrete examples of programmable money in use?
3. Where should the boundary be drawn between central banks and commercial banks in the programmability of a CBDC?
4. How can programmable money cut the cost of cross-currency payments?
5. How should private programmable monies be regulated?

If you would like to participate as a panellist please contact Wendy Gallagher at wendy.gallagher@futureoffinance.biz
If you would like to participate in the audience please let us know below or contact Wendy Gallagher on the email above
If you would like to participate as a sponsor please contact Valerie Bassigny on valerie.bassigny@futureoffinance.biz