Multiple central banks, including the Bank of England and the European Central Bank (ECB), have declared that their central bank digital currencies (CBDC) won’t be programmable money. A key motivation was to address fears that governments could direct how you spend your money. Russia’s not quite so bothered about launching a programmable CBDC.
So if the smart contracts are not at the base layer, where will they be? Will every bank and payment provider implement their own programmability? Or a better question: who will deploy the programmability function for payments?
These are the sorts of issues that a team at Barclays addresses in a paper exploring the ‘functional consistency’ of money. While the title may sound a little abstract, the content is pragmatic. One of the authors, Dr. Lee Braine, is a member of the Bank of England’s CBDC Technology Forum for the digital pound.
Programmability can significantly improve the functionality of payments. For example, smart contracts can ensure that money is only released on receipt of goods or at a particular time.
Barclays suggests the best institution to house the programmability layer is a financial market infrastructure (FMI). They don’t mention names. Nor do they say whether it would be an existing FMI or a new one, but in the UK, we’d guess it could be Pay UK. That’s because Pay UK operates several payment systems, including BACS and Faster Payments.
Hence, Pay UK is already integrated with payment providers and bank ledgers. If Pay UK hosts the smart contracts you have immediate interoperability across the existing payment systems.
That means smart contracts can apply to both CBDC and commercial bank money, giving them “functional consistency”.
A third type of digital money
When people consider digital money based on fiat currencies, they tend to come up with two options: stablecoins and CBDC. But the third option is tokenized commercial bank money. In fact, commercial bank money doesn’t need to be tokenized to provide programmable payments. HSBC uses a smart contract-based payment solution from Baton Systems that by the end of 2022 had processed more than $4 trillion in transactions. And it doesn’t use tokens.
The thrust of the Barclays paper is how to make a retail CBDC and commercial bank money functionally equivalent to each other with the least effort. Programmability is just one of the functions but the most distinguishing aspect of a digital currency. And it’s the one that commercial bank money currently lacks.
In contrast, most of the other functionalities explored in the paper are features that a CBDC would need to avoid being inferior to commercial bank money. For example, the ability to put a digital pound card into an ATM and withdraw physical cash.
The rationale behind the paper is to avoid fragmenting payments markets and retail deposits. Users don’t want to have different pockets of money that can only be used for certain purposes.
It’s a valid concern because tokenization is already underway in other sectors and offers some stern lessons. Even though asset tokenization is nascent, we’re already witnessing a fragmented approach. Various institutions have launched their own siloed platforms for digital bonds. With digital currency initiatives at an even earlier stage, they can learn from that.