Programmability for Money: Leveraging Blockchain Technology

Discussions of financial technology and payments in recent years have started to include the notion of "programmable money," though the exact meaning of this term is often unclear and interpreted differently. The different perspectives in its definition could be due to ambiguity in the particular underlying technology or set of features to be a part of a programmable money system, and lack of overall consensus on these aspects.?Traditionally, when we think about money, we think about fungible assets. For example, "One dollar = one dollar". The above can also be applied to CBDCs (Central Bank Digital Currencies), where the central bank will “program” the parameters around supply and other characteristics. To some extent, this is what we have seen with native cryptocurrencies, where the minting and burning process is coded into the protocol, enabling stability around their monetary policies.

According to the Bank for International Settlements (BIS), over 80% of central banks are experimenting with CBDCs. CBDCs are close to being widely introduced and many complex matters have been discussed in financial circles. These include developing secure infrastructure, questions around governance. This includes how to balance transparency with anonymity and mitigating adverse economic impacts. As public digital currencies rapidly transform from theory to reality, there is one important feature that needs to be examined: programmability [1].

But what is the big deal with programmable money? Don't we already have systems in place for making digital payments? Programmable money has two key concepts: [1] They behave more like digital content (peer-to-peer and free service) which is published on web servers, that can be open and interoperable leveraging the internet; and [2] For the first time we have building blocks that exist on the internet that can run on networks (leveraging Blockchain) that is developed based on codes (i.e. smart contracts) which can go up on the internet, censorship-resistant and is a breakthrough technological paradigm.

Defining “Programmable Money”

The German Bundesbank defines programmable money as “a digital form of money which the user can program to follow an inherent logic for a predefined purpose, based on the attributes of the digital money itself.” [2] Whereas the Federal Reserve in the US has defined programmable money as two natural components which includes money as a digital form, with a mechanism for specifying the automated behaviour of that money through a computer program (this mechanism is termed "programmability" [3].?

Peter-Antonius Bramm (Global head of Central Banks at SAP) was recently quoted in Forbes stating that there has been a recent global movement among governments, social media platforms, and central banks to develop digital currencies and has further highlighted the growing interest in money being programmable [4].?

“Programmable money relies on the internet, making it much easier and accessible to use across previously siloed systems,” said Bramm. “Instead of navigating fragmented organisational and payment provider sites, digital currency would allow frictionless payments at the precise moment goods were received through machine-to-machine payment [4].”

Naturally, any form of programmable currency will eventually transform existing financial application software (including accounts payable and receivable, not to mention supply chain management and payroll). Bramm [4] also stated that it is not just about new efficiencies from merging information directly with processes and payment, machine-to-machine payments herald entirely new business models.

When examining programmability, it is important to highlight the distinction between programmable money and programmable payments which is often confused in literature. The two terms are often used interchangeably, but there are clear differences. Programmable money is designed with in-built rules that constrain the user. These rules could mean that money expires after a fixed date or its use is restricted to a certain set of goods. This would affect digital currency acceptance and has obvious legal implications [1].

Classification of “Programmable Money”

We can classify programmable money via three novel utilities over other forms of money:

• A. Store of Value — cryptocurrencies may offer a novel, non-sovereign store-of-value
• B. Privacy — a better way to do offshore banking and store assets
• C. Smart Contracts — code that can own, transfer, and manipulate money will result in better derivatives, lending, escrow, securities, REITs, insurance, and other instruments

Many observers and writers have offered differing interpretations and discussion of potential use cases of programmable money (Lewis, (2020), Koning (2020), and Bechtel et al (2020). References to programmable money typically describe it as being enabled by distributed ledger technology (DLT) or blockchain systems, this is not universally the case, and the term remains ill-defined (Lee, 2021).?

Blockchain came to prominence as the digital ledger technology for the crypto-currency known as Bitcoin. This programmable money has been a double-edged sword to the world. On one hand, it proved the feasibility of a self-regulating, global, digital, peer-to-peer payment network, operating without a trusted third-party intermediary (such as a bank, credit card company or payment company). On the other hand, Bitcoin has tended to promote the perception among an increasingly digital populace that banks are no longer necessary [5].

Two natural components for the definition as highlighted earlier is the mechanism for specifying the automated behaviour of that money through a computer program (this mechanism is termed "programmability") and a digital form of money. However, it is not clear whether these components alone are sufficient for a definition, given that various combinations of similar technology for payments automation have existed for decades. The advent of public blockchain cryptocurrencies that the term "programmable money" became common parlance which is why confusion still exists in the definition of programmable money. Programmable money should be examined in the context of tokens [5].?

Several reports have identified various payment solutions: conventional payments, private crypto-tokens and stablecoins as well as central bank digital currency and tokenized commercial bank money. As conventional payment systems do not have the technical capacity to integrate the payment process into smart contracts, they are reaching their limits in terms of meeting future needs. By contrast, the need for 24/7 payments in real time can already generally be met at the current juncture using instant payments. Many crypto-tokens and stablecoins have the technical capacity to settle the cash leg of a large number of DLT applications. However, they are seen as unsuitable in practice due to their volatility and limited interoperability [9].

Before we drive into more detail about the function and possibilities of tokens or programmable money and understand what programmable money actually means, let’s first define what a token actually is. The term token is derived from the Latin term “T?cen”, which means symbol. Tokens are nothing more than a blockchain-based abstraction that can be owned and represent assets, currencies and right of use (Blockchance, 2022). Examples of a token can be voting access or ownership rights to a resource.

Different Types of Tokens

The different types of tokens that currently exist include:

There are four known ways to map a FIAT currency on blockchain technology (Blockchance, 2022). These options are continuously gaining more and more relevance and traction across the globe and are being experimented on in several countries at the moment (see below):

• CBDC = Digital Central Bank Currency: This form of currency is issued by central banks as legal tender (refer to my earlier articles available on my LinkedIn article).
• sCBDC = Synthetic Central Bank Digital Currency: This currency is issued by commercial banks or e-money institutions. This currency is not a legal tender, but is 100% backed by central bank reserves.
• DLT-based commercial bank money: This is also issued by commercial banks, but is only partially backed by central bank reserves compared to sCBDC. (Fractional reserve system).
• DLT-based commercial bank money: This currency is issued by e-money institutions and is fully backed by e-money in an account.

As we can see from the above types of programmable money types, there are a variety of different applications of money in the world of blockchain technology. Which cryptocurrency or CBDC is the right one, everyone has to decide individually and depends on the application that one wants to use the “money” or “token”. Here it becomes clear how digital money differs from physical money.

Many consumers believe that money should move as easily as email. A growing number of articles debate whether the current banking system or even banks themselves are becoming obsolete. Many people believe that if banks were cut out as intermediaries, payments could be simpler, autonomous and instantaneous. A number of these articles describe the following principles for ideal digital money. The first is that money should be intrinsically connected to the internet, unconstrained by geography or institutions. Second is that foreign exchange should be immediate. Third is that all transactions should be free. The thinking goes that if sending messages using email is free, why shouldn’t sending money also be free?

Although the principles of digital money are valuable and achievable, banks will continue to play a key role in the global financial system and economy established by central authorities. These authorities’ direct banks to allocate funds from savers to borrowers in an efficient, fair and equitable manner. Banks also will continue to perform critical everyday operational tasks such as verifying identities, monitoring transactions for fraud, preventing money laundering and filing suspicious activity reports to government and law enforcement. These activities are invisible to most retail consumers of banking services (IBM, 2018) [5].

Unlike the custodian and correspondent models, the digital asset model addresses clearing and settlement on a single network. It has been popularised by the design principles of Bitcoin and appears to offer the most disruptive potential. Under this model, payment instruction history, along with an immutable transaction ledger, and the means for settlement, are combined onto a single network. The digital asset model provides an integrated network for initiating transfer instructions and a native asset to settle those transactions near real-time. Because the settlement asset or digital currency is a purely digital instrument, near real-time foreign exchange becomes just another step within a composite transaction. All of the steps, from payment instruction to clearing, to settlement and foreign exchange, can be encapsulated into a single atomic transaction that is executed in near real-time.

Blockchain as a means for Programmability

While a broad range of use cases have been predicted for blockchain, the most valuable use cases for cryptocurrencies are forms of programmable money. Programmable Money delivers currencies, banks, and financial instruments with new utility and potential value in the trillions of dollars. One facet of successful public blockchain systems that may provide some clarity is how they closely link digital value and programmability in a single system that only functions properly when both are present. In traditional financial technology systems, digital money is typically defined by database entries. Any "programmability" offered for this money, whether internally to the entity maintaining the database or exposed to its customers via an application programming interface (API), involves another technology system built separately from that database and then connected in some fashion [5].?

While newer cryptocurrency systems also use a database (often in the form of a blockchain data structure), a key difference is that the records in such blockchains either directly incorporate some programmable script (as Bitcoin records do, for example), or sit alongside a general programming functionality within the system that allows for direct manipulation of those records (the model used by Ethereum, among others). In both designs, the value represented in those systems and the programmability of that value are tightly integrated. There is no notion, for example, of "bitcoins" without an associated script governing their spending conditions, whereas a traditional ledger could certainly hold digital records of money without offering a programming interface to those records [5].

What is powerful is the use of smart contracts that can be as simple as ‘send money on Friday’ or complex as extremely advanced functions such as ‘building interest rate market with advanced parameters. This sets up a rapid evaluation of what is possible with programmable money. With traditional systems, adding programmable logic is slow and difficult to do. With smart contracts, communities can build on what is being developed (‘money Lego bricks’), and all is built on itself and this results in new applications emerging in this open, financial sandbox environment. These smart contracts run on internet-based public operating systems, where anyone can act and interact with them as a shared good (machine enforced public network).?

Let's take an analogy to explain how this works, when you deposit money in a bank account you don’t know the financial processes and operations that go into that process that creates a financial product. There are massive amounts of operations and work behind the scenes to create this whereas a smart contract on blockchain is a tool to create financial products. The difference is you can see exactly how it operates, the community can audit it, and you can see all of the logic and expectations that come with it. The advantages here are that they are extremely transparent and predictable and in the long term, economic activity could shift to this new technological paradigm.?

Numerous blockchain experiments for international payments have been conducted in recent years. All of them fall into three design patterns: the custodian model, the correspondent model, and the digital asset model (see Figure 2). The custodian and correspondent models are well represented within today’s existing payments networks. These models are used by large foreign exchange settlement firms that support daily net settlement of major banks around the world.?

They also are used for vast correspondent messaging networks that support payment instruction routing and clearing. Applying blockchain technology to either of these models can offer incremental innovation to existing functionality. However, it has been claimed that blockchain doesn’t offer the transformational change that Bitcoin has inspired.

Blockchain technology enables programmable money. Crypto and blockchain platforms are optimised to move slowly and never break, a uniquely good fit for use cases involving money. programmable money solves previously unsolved problems (highlighted below):

• Seizure-Resistant Store of Value — cryptocurrencies are cryptographically secured, seizure-resistant, non-sovereign digital assets. We can now transfer $10 million in one hour between countries for a fee of $2 without a bank.
• Privacy — new cryptographic techniques such as zk-SNARKs enable true privacy and anonymity. Private coins enable crypto equivalents to private banking ecosystems. Many banking and insurance businesses will take advantage of these privacy-preserving technologies.
• Smart Contracts for Financial Services — smart contracts are software eating contracts. Instruments for derivatives, securitization of assets, lending, escrow, and insurance can now be expressed as software code. These smart contract platforms will often have strong regional network effects due to their interaction with regulation and regional norms.

One bank that has led the way for leveraging blockchain technology is J.P. Morgan. Their industry-leading product was seen as a first-of-its-kind innovation: J.P. Morgan developed the technological banking infrastructure using Onyx, the world’s first blockchain-based platform for payments transactions, and applied the technology to Siemens’ business use cases to address real-world pain points [7].?

“There has been talk of programmable, real-time payments for years, and using J.P. Morgan’s proprietary Onyx Programming Language, this has now become a reality” [7].

J.P. Morgan has also highlighted that programmable payments can facilitate an automated process, which responds to real-time events, which is not quite applicable under the current monetary system. Following pre-programmed rules, payments are initiated any time conditions are met, removing the need for human intervention to discover, calculate and confirm the required conditions needed before a payment can be executed [7].

They have further highlighted that "consumers are moving into the are world of programmability through the JPM Coin" (Umar Farooq, Head of the bank’s Onyx suite of applications). “Actually, programming what money can do for you, whether it’s conditional payments, whether it’s things like tax assessments. That’s all-very rule based and, in the past, you would have had to send specific instructions to a bank like JPMorgan. We increasingly want you to be able to program these things, and actually tell the money what to do.”

But according to Farooq, it’s only the beginning. Applying dollar-pegged stablecoins, or emulating cryptocurrency generally, was never the plan for JPM Coin (which, to be clear, is not available to retail investors nor traded on any crypto exchange) (11). That desire helps explain why JPMorgan chose to build its various blockchain projects on Ethereum (albeit a bespoke version of it) five years ago. Now the second-largest blockchain as measured by the market cap of its native token, ether. Ethereum was designed specifically to enable complex “if this, then that” programs (known as smart contracts) that were hard to do on Bitcoin, which was built for the straightforward task of transferring digital cash from A to B [11].

The Challenges

With its benefits, there are undeniable challenges that lay ahead for programmable money. It is argued that programmable money via CBDCs can be essentially be viewed as programmable cryptocurrencies that run on blockchains, they could potentially be “programmed against you” at the whims of the centralised authority behind them [6]:

“If for whatever reason you say the wrong thing, because you know we’re seeing censorship increasing, then that money can essentially be programmed to be used against you [Cointelegraph, 2022].”

Notably, such concerns around financial censorship have been especially prevalent with crypto in general of late, with the recent Tornado Cash debacle, which saw the United States Treasury sanction both Ether (ETH) and USD Coin (USDC) addresses associated with the Ethereum-based privacy tool [6].

In addition, when examining stablecoins, which are algorithm-based cryptocurrencies, they have also seen their value plummet of late. Even big names such as Bitcoin have thus far failed to establish themselves as broadly used means of payment, and people at the very highest level are now dismissing them as unviable stores of value. European Central Bank (ECB) President Christine Lagarde went so far as to say that they are “worth nothing” [8].

These unique features of programmable money through smart contracts have also allowed the rapid creation of a large and complex crypto ecosystem where smart contracts have a high degree of control. Arguably this ecosystem has not worked very well [11]. The first large scale investment strategy run by a smart contract, the distributed autonomous organisation (DAO), ended in major fraud. A wave of security-like “token” issuances in the initial coin offering (ICO) craze also has led to large scale waste and even larger frauds. More recently a complex series of pyramid scheme-like investments called DeFi (decentralised finance) have grown up and has tainted the good work being undertaken in the blockchain community.

As described by David Gerard (LSE, 2920) as “a worked example of the hazards of programmable money — incomprehensible financial derivative instruments, bots front-running everything a human does, hackers stealing everyone’s money through badly-written code is still a prevalent risk that needs to be further examined and thoroughly assessed” [11].

Despite much criticism, CBDCs may offer developing nations more macroeconomic stability in comparison to decentralised currencies, according to IMF Managing Director Kristalina Georgieva, as CBDC’s would have the “backing of the state” and would of course be regulatory compliant.

In addition, programmable money has been spurred in part by growing competitive threats from sovereign nations intent on global growth, as well as big tech platforms looking to monetize enviable user bases, central banks see programmable money as a viable option [4]. Central monetary institutions are aware of the growing role of big tech in this space but are apprehensive about the monetary transmission impacts that are associated with such new forms of money without appropriate regulation.

Furthermore, tokenized commercial bank money and CBDCs are thought to bring the greatest functional benefit in terms of settling programmable payments. The development of both payment forms, which is still pending, offers sufficient scope to comprehensively take into account the need to implement programmable payments. Both options are particularly well-suited settlement solutions for programmable payments on account of the expected credibility of their issuers and their use within a binding legal framework.

The universal acceptance of any payment solution hinges on technological interoperability and robust IT infrastructures. We need to further highlight the need for monetary stability as a key criterion for new payment solutions to be accepted to enable programmable money to foster and grow.

Conclusion

There is growing interest in the potential of programmability, as it would offer myriad uses. Motivations among stakeholders are varied, but its introduction would offer benefits on a large scale [10]. In order to be able to anticipate and meet the demand for programmable payment solutions, trigger solutions could conceivably be used in the near future. Such solutions could integrate conventional payment systems into the settlement of smart contract-based transactions. While limitations are to be expected in terms of the extent to which they can be implemented and applied, they have the advantage of being quick to develop [9].

Algorithm-based cryptocurrencies remain highly volatile, making them unpopular with regulators and unsuitable for day-to-day payment needs. We have seen stablecoins that are backed by assets with real value but not regulated failing to live up to their promise in times of crisis but we will see further innovation and development in this space to shore up how they could function in the near future.

Digital central bank currencies (CBDC) for the general public, meanwhile, are a monetary policy hot potato and give rise to stability risks. The future thus belongs to digital currencies issued by regulated providers, such as tokenized book money from banks, or special-purpose currencies, e.g., those used within trading systems for settlement purposes.

There is also growing acknowledgement of the increased interest in decentralised means of payment with new functionality and that, if central banks and supervised intermediaries do not satisfy this demand, others will.? This is advocated by regulators for the growing need for centralised programmable money which is why we have seen initiatives such as ECB’s project for a Digital Euro, which is currently still in the exploratory phase [8].

As we prepare to usher in a new paradigm shift in global payments, diligence is critical. The introduction of programmable CBDCs offers great opportunities, but the risks are considerable.

Citations:

1. https://www.omfif.org/2021/07/cbdc-systems-should-focus-on-programmable-payments/
2. https://www.algorand.com/resources/blog/programmable-money-smart-contracts-make-money-better
3. https://www.federalreserve.gov/econres/notes/feds-notes/what-is-programmable-money-20210623.html
4. https://www.forbes.com/sites/sap/2021/03/25/as-programmable-money-emerges--central-banks-ramp-up-for--tokenized-economy/?sh=72b6a73ec402
5. https://www.ibm.com/downloads/cas/WVJNWYO4
6. https://cointelegraph.com/news/programmable-money-should-terrify-you-layah-heilpern
7. https://www.jpmorgan.com/solutions/treasury-payments/insights/programmable-payments-automation-becomes-reality
8. https://www.swissbanking.ch/en/news-and-positions/news/programmable-money-as-a-public-good-sba-stepping-up-efforts
9. https://www.bundesbank.de/en/press/press-releases/rising-demand-for-programmable-payments-855266
10. https://www.gi-de.com/en/spotlight/payment/benefits-of-programmability-to-cbdc
11. https://finance.yahoo.com/news/remember-jpm-coin-next-step-090000036.html
12. https://blogs.lse.ac.uk/businessreview/2020/09/14/do-we-need-programmable-money/