Imagine if the £20 note in your pocket was programmable. It might be a stretch to imagine its potential use or recipient narrowly defined. But the reality is, we already use money-like instruments that have certain restrictions, the most common being vouchers, tickets and store credit. 

Take the example of a retail voucher: it has a monetary value, it can only be spent with a specified retailer or group of retailers and, more often than not, it has an expiry date. In a nutshell, these are similar characteristics to programmable central bank digital currencies (CBDCs). 

In their proposals to date, the majority of central banks (including the Bank of England) have been reticent or outright opposed to programmability. Concerns revolve around the fact that it could have profound implications from a societal perspective, including the natural tension that exists between the freedoms of the individual and the state. While these concerns are certainly valid, the prospect of programmable money does bring with it a number of interesting use cases. 

Imagine, for example, we were back in the midst of the COVID-19 pandemic and the government wanted to support businesses in the hospitality sector. An alternative to the Eat Out to Help Out scheme could have seen the government issue programmable money to individuals that was only redeemable at cafés and restaurants. 

If, say, there were certain regions where the support was especially needed, the state could even restrict redemption to a specific geographic area. If, after issuing the money, a rise in virus transmissions warranted further lockdowns, the programmable money could be assigned an expiry date. All of this could be implemented centrally and almost immediately. 

Use cases could extend beyond helicopter money to monetary policy itself. As we currently face the spectre of inflation, what better way for central banks to dampen demand in the economy than by directly withdrawing money from the financial system? 

This unconventional monetary policy tool would be available in what is known as a Gesell currency. Not only could central banks immediately influence money supply but they could do so in ways that were targeted to those areas where inflationary pressures were the greatest. And if, instead of inflation, the economy was in a slump and there were concerns about the possibility of deflation, the bank could encourage greater consumption by bringing forward expiry dates or air-dropping money into consumers’ accounts.

As with any unproven monetary policy tool, there will undoubtedly be unintended consequences. For example, how attractive to foreign investors (or even domestic) is a currency that can be withdrawn – without notice – unilaterally by the state? Market forces will likely dictate that the most probable outcome is programmability in a very restricted sense or that is only used in extreme circumstances. 

An interesting idea is that the functionality within CBDCs could be used to address society’s ills. What better way to sort out climate change than to assign individuals and businesses a carbon allowance? Transactions could be assigned a carbon emission footprint, alongside their monetary value. When carbon limits for the month are reached, accounts could simply be frozen. 

Similarly, when it comes to poor eating or lifestyle habits, addictions, or political dissent, individuals could be identified and monetary restrictions imposed. Arguably this is all rather dystopian, with echoes of Orwell’s ‘1984’. And for that reason, we are unlikely to see measures of this kind even contemplated, let alone implemented. 

Programmable payments vs programmable money

Instead, what we are more likely to see over the coming months and years is programmable payments. These are distinct from programmable money because they are typically brought about via additional functionality on top of a digital currency. Where programmable aspects of a central bank digital currency might be imposed by the state, programmable payments would typically be entered into willingly by the participants to a transaction and provided by the private sector. 

Programmable payments are enabled through smart contracts. It’s a fancy term for the automatic execution of a payment, contingent on a series of predefined conditions at the outset. 

Trade finance is a good example. At present, if a merchant wanted to acquire stock, it might need to provide the manufacturer with a letter of credit issued by its bank or prefund for part or the entirety of the order, well in advance. With a letter of credit, the merchant’s bank is effectively guaranteeing the manufacturer payment upon confirmation of the receipt of goods. In this scenario, risk management is asymmetrical; the manufacturer has certainty over payment, whereas the merchant carries the risk of goods not arriving and the order being unfulfilled. 

Instead, a smart contract would enable greater certainty between the two parties. An immutable blockchain captures and records fulfilment of contractual obligations and informs the smart contract when the conditions for automatic settlement have been met. Settlement of the transaction and movement of funds only occurs when the individual obligations of each party have been satisfied. 

Within securities trading, the potential for programmable payments is arguably even greater. Smart contracts could enable the simultaneous exchange of legal title for a stock or bond with the receipt of funds, collapsing clearing and settlement times. 

In the retail banking space, smart contracts could help facilitate more affordable lending by introducing a more dynamic approach to repayment of interest and principal. Coupled with artificial intelligence, smart contracts could determine how much a customer is feasibly able to repay in a given month, taking into consideration likely non-discretionary outflows. All of this could be automated. 

Regulators take heed, while the myriad use cases introduce new opportunities, they also introduce new risks. Programmable payments should dramatically change the way we transact for the better. However, the verdict is still out on programmable money.