In an earlier article in this column, I dug into the premise behind Central Bank Digital Currencies (CBDCs) in an attempt to try and understand how these new digital instruments align with the two-tiered banking system we have come to depend on for over 400 years. In the process I gained a new appreciation for the relationship between private money (the money in our bank accounts) and public money (issued by the Central Banks) and how the ability to redeem private money into Central Bank currency as well as to acquire Central Bank public money in times of stress is critical for the stability of the modern financial system.
By the end of that article, I concluded that there was no real need for India to roll out a central bank digital currency. Since we already have a highly efficient fast payments system in UPI, any of the benefits that CBDCs could offer are either already available to us or capable of being provisioned with a little bit of additional engineering.
Future of Money
In a recent speech that he delivered at the Monetary Authority of Singapore, Agustin Carstens, the General Manager of the Bank for International Settlements, called for a fundamental reimagining of the existing financial system - and by extension of all of global commerce.
Central Banks are, he argued, the guardians of public trust in money and therefore have an obligation to envision what the future of money should look like. If the future is digital then the digitisation of money has to be an important part of our vision for this future. While this would, in the context of public money, likely mean CBDCs or something like that, in order to describe a complete solution we have to find a way to extend this concept to private money. According to Carstens, the way to do that is through the tokenisation of the deposits of private money that are currently held in the accounts of commercial banks.
What this would immediately mean is that there would be two separate digital ledgers - one for CBDCs and another for tokenised deposits. However, because these systems are digital we can, Carstens argues, connect them to each other through a unified ledger on which both public and private digital money can interact - unlocking new efficiencies that were impossible until now.
We could, for instance, use smart contracts to leverage the composability inherent in such digital systems to enable novel features like micro-payments and the automated transfer of consideration between internet of things (IoT) devices. Once money itself is programmable and capable of digitally interacting with tokenised assets, it should be possible for us to automate entire sequences of commercial transactions that currently depend either on manual intervention or the participation of a host of different intermediaries at various stages.
This would eventually enable simultaneous and near-instant payments and the easy settlement of transactions both within the country and across borders. And once the technical underpinnings for this have been realised, we will likely see a host of other use cases that we have not even begun to imagine, spring into existence.
To explain how this might work, Carstens describes how the traditional escrow process could be re-imagined on the unified ledger. Through the use of smart contracts, we could, when the escrow is invoked, programmatically lock funds in the buyer's tokenised deposit so that it is placed on hold until the payment is triggered. Once the escrow conditions are achieved a digital instruction could be sent to the smart contract indicating that money can now be transferred to the seller. Once initiated, settlement can be achieved instantly via digital central bank money.
What makes this idea even more interesting is the fact that once we tokenise private money deposits, nothing stops us from extending that same approach to all sorts of other ledgers — eventually adding them to the unified ledger. While it is easy to see how this could apply to assets like securities that are already transacted almost exclusively in dematerialised formats, it could easily extend to more traditional ledgers like those for moveable property and real estate.
By tokenising all these assets, transactions that involve them will take place faster, at lower cost and with greater transparency. This in turn will improve certainty in title and confidence in the commercial system as a whole — while making it possible to automatically carry out a host of transactions that are impossible today without an army of intermediaries.
A New Approach to Governance
All of this is of particular interest to me because the implementation of tokenisation at scale across the entire commercial ecosystem is an opportunity to transform governance. A unified ledger will digitise every single aspect of commercial transactions - not just the payments but also the very assets that are their primary subject matter. If we can layer on top of this, carefully designed smart contracts, it will be possible for us to programatically describe every last element of our commercial transactions.
Once this happens, regulators will be able to embed compliance directly into the smart contract so that instead of parties having to subsequently take additional steps to report compliance, it can be automated in the normal course of the execution of the transaction.
Not only will the reduce the cost of compliance, it will allow regulators to dynamically calibrate their responses for the benefit of those they are legally obliged to protect.