At the Singapore Fintech Festival (SFF) 2022 last November, Deputy Prime Minister Lawrence Wong announced that Singapore would be evaluating the use of purpose bound money (PBM) as part of the Monetary Authority of Singapore (MAS)’ Project Orchid.
First unveiled at SFF 2021, Project Orchid is an initiative by MAS to explore the foundational technology infrastructure and technical competencies necessary to issue retail Central Bank Digital Currencies (CBDCs) in Singapore.
How a PBM works is simple. Rules — otherwise known as a smart contract, such as the purpose and beneficiaries of the PBM — will be embedded within a medium of exchange to define its usage. These rules will be retained even when the PBM is transferred, for example, through donations to charity, and ensures that funds will be used for their intended purposes.
MAS’ Project Orchid whitepaper identified four promising areas for the application of PBMs in Singapore, which include simplifying the existing government voucher system, facilitating government payouts, disbursing grants, as well as streamlining the commercial voucher system.
The usage of PBMs in these instances can solve Singaporeans’ key pain points and address gaps in these areas, but it’s not all rosy. PBMs are laden with their owns risks as well.
From cybersecurity risks to privacy issues, even the World Bank is aware that introduction of CBDCs will bring about perils — which is why countries need to adopt a plan to prevent and mitigate these risks, or consider alternatives to CBDCs.
In Singapore’s context, here are some potential issues that may arise and measures that MAS is working towards to ensure that Singaporeans can reap the benefits of CBDCs.
Creating an accessible currency for a wide spectrum of users
The Singapore dollar (SGD) is a payment instrument that is easily accessible and can be utilised by almost anyone without requiring special devices or technical knowledge. The currency has been specially designed to take into account the needs of the wide spectrum of users, including the visually
In addition to this, cash can be used by consumers and merchants to make purchases without transaction fees, aside from handling and storage costs.
To compete with cash, the design of a CBDC needs to prioritise the accessibility of the digital currency to a wide spectrum of users, particularly of disadvantaged groups such as low income individuals or people with disabilities, just like how the SGD is currently accessible to a wide community, as cash is phased out as a medium of exchange.
Hence, this would require MAS to retain significant control over the design of a CBDC. For instance, enabling offline functionality for the CBDC would give greater access to digital payments to individuals without subscriptions to mobile data networks.
MAS could also ensure that the retail CBDC is offered at no cost to use, just like cash, and is compatible with cheap, easy-to-use hardware, to avoid reliance on the latest smartphones or a high level of technical literacy.
Besides that, MAS would also have to consider that Singapore has an ageing population. By 2023, it is expected that one in four Singaporeans will be aged 65 and above.
Retaining control over transactional data
Transactions made with cash ensure that privacy is maintained as there are no centralised records of its holdings or transactions.
The substitution of cash towards CBDCs and programmable money would mean that this privacy will be compromised, and there would be fewer options for consumers and merchants to retain control over their transaction data.
Electronic payments also generate an extensive trail of data, which is increasingly being harvested and utilised by firms.
According to a McKinsey report, payments providers have access to a treasure trove of data, which can be used by these firms to generate insights such as consumer spending behaviour. The data harvested from consumers can also be monetised by the payments firms.
Hence, to alleviate concerns surrounding privacy, MAS seeks to design CBDCs that would preserve the privacy of Singaporeans, albeit not as anonymous as cash.
A well-designed CBDC can actually preserve users’ privacy by granting them the ability to retain control over whom can access their transaction data and how it can be used, thus offering significantly stronger consumer protection than current digital payment methods.
For example, advances in privacy-preserving technologies such as zero-knowledge proofs can be integrated into CBDCs to protect transaction privacy while preserving the ability of third parties to audit transactions. The integration of this cryptography into CBDCs can even achieve cash-imitating levels of privacy.
Meanwhile, some programmable money implementations such as the proof-of-concept for retail CBDCs by the European System of Central Banks, are testing out CBDCs that allows for some degree of privacy where value transfers can be entirely anonymous and only require more information when the transaction value across above a certain threshold.
Aside from these technologies, new legal provisions can also be enacted by the government to further limit MAS’ access to personal transaction data and ensure the privacy of Singaporean consumers. MAS is currently studying issues revolving CBDCs and privacy carefully.
Abroad, other countries such as Switzerland are developing pilots for a version of CBDCs that can protect user privacy.
Currently, the Swiss National Bank is working with David Chaum, creator of the Bitcoin predecessor eCash, on Project Tourbillon — a CBDC designed for privacy-focused central bank money, which is bound to be completed mid-2023.
Malicious attacks and single points of failures
Blockchains, once seen as “unhackable” technology which power cryptocurrencies, has seen a multitude of attacks this year. As of August this year, cybercriminals have stolen over US$$1.4 billion, according to blockchain analytics firm Chainalysis.
These malicious attacks won’t stop there.
Smart contracts, which are bound to PBMs, might be a target area of malicious actors who seek to exploit vulnerabilities in the smart contract code to drain funds or to manipulate the market.
To prevent these malicious attacks, aside from reviewing the code of the smart contract itself, MAS would need to do a thorough review of the PBM’s information security process, which includes its full development and deployment lifecycle.
In addition to this, as CBDCs utilise blockchain technology, all transactions made with CBDCs must be conducted while connected to the internet at some point. This connectivity is their single point of failure and the reason CBDCs cannot be a 100 per cent secure, which makes the digital currency more vulnerable to cyber attacks.
Currently, the experimental nature of the initial phase of Project Orchid — which involves a restricted group of trial participants and merchants and limited low value transactions — does not include an in-depth security review. MAS will only be looking into security recommendations in the subsequent phases of Project Orchid.
Bank runs and financial crises
The introduction of CBDCs into Singapore’s payments ecosystem would bring about implications to the banking sector and threaten financial stability.
During times of financial stress, the confidence in the banking system is generally lower and there is a greater risk of systemic bank runs.
Bank runs are essentially a self-fulfilling prophecy. During a bank run, large groups of people withdraw their money from banks simultaneously based on fears that the institution will become insolvent — pushing the bank into actual insolvency.
These runs have occurred throughout history, from the Great Depression to the 2008 housing market crash. In recent times, individuals and firms have run from troubled banks by transferring their deposits to more stable banks within the domestic banking system, or by purchasing safe assets such as government bonds (electronically) using their deposits.
The issuance of a CBDC in Singapore may exacerbate the number of banks experiencing a run in times of distress if the CBDC or programmable money has features that make it more attractive than existing run assets such as deposits at the safer banks, tax accounts or cash.
During times of crisis, money could shift out of banks into digital cash at unprecedented speed and scale which will subject banks to liquidity strains that exceed the buffers provided for by existing regulatory safeguards such as the Liquidity Coverage Ratio covered in Singapore’s Banking Act.
According to the Bank for International Settlements, during times of crises, transfers from bank deposits into CBDCs would have lower transaction costs than cash withdrawals (through ATMs or waiting in line at physical bank branches), which will provide an incentive to depositors to convert their deposits to CBDCs.
Aside from crises, if people held a significant portion of their deposits in the form of digital SGD even during stable periods of time, it would considerably reduce banks’ ability to make loans.
Ravi Menon, managing director of MAS explained at SFF 2021 that these risks can be managed by designing CBDCs with sensible safeguards, such as stock and flow caps on the amount of digital Singapore dollars that anyone is allowed to place with MAS.
Fragmentation and closed payment ecosystems
In addition to these issues, MAS also has to ensure that programmable money is designed to be interoperable across different platforms — wallets, payment systems and rails — to ensure that this does not lead to fragmentation and the creation of closed ecosystem of providers.
“Interoperability is prerequisite for CBDCs to be fully operational, and to be an efficient solution compared to what already exists,” said Florence Lubineau-Henric, head of central banks coverage at BNP Paribas in Paris.
For example, MAS’ Project Orchid allows PBM recipients to access and use their PBM tokens from a government provided or commercial wallet provider of their choice through the development of an open-sourced technical framework for PBMs.
To ensure that the adoption of PBM acts in the interest of the public, the government has also partnered different organisations such as Grab, StraitsX and OCBC to issue the PBMs.
Despite Singapore’s efforts in creating an interoperable payments ecosystem, with multiple countries and private institutions developing their own digital currencies based on different technologies, standards and protocols, the global CBDC ecosystem is at risk of becoming fragmented — leading to multiple ‘digital islands’ springing up across the globe.
These independent digital islands will also be detrimental to consumers. The providers of CBDCs and PBMs will take on a monopolistic behaviour, and consumers will end up needing to onboard various systems or pay exorbitant fees to intermediaries to complete a transaction.
This is why developing a method for transactions to flow between different CBDC constructs and platforms will be critical. According to Swift, a bilateral solution between two countries could be a solution to this, but is not scalable and would be unmanageable if applied globally.
Instead, what would work to connect CBDC networks and existing payment systems would be a multilateral interoperability mechanism, which will enable CBDC transactions to flow across borders in a seamless and frictionless way. This is something that MAS is currently working on with select international partners under Project Ubin+.
As part of Ubin+, MAS is exploring cross-border interoperability across digital currencies based on distributed ledger technology (DLT) and non-DLT payment systems with more than 17 other central banks in SWIFT’s CBDC Sandbox.
MAS does not see the need to implement a CBDC in Singapore
According to Atlantic Council, 114 countries, which represent over 95 per cent of global gross domestic product (GDP) are exploring a CBDC. Among these countries, 60 of them are in an advanced phase of exploration into the new payment medium.
What’s more is that 11 countries have fully launched their digital currencies, with Jamaica being the latest to launch its CBDC, the JAM-DEX, in hopes to reach its unbanked and underbanked population.
The need to implement CBDCs heavily depends on the economic requirements of countries. In some cases, CBDCs can be an important tool for financial inclusion. For example, CBDCs may provide assistance to countries where geography is an obstacle to physical banking.
In other cases, a CBDC could be an essential backup in the event that other payment instruments fail. For instance, the Eastern Caribbean Central Bank extended its CBDC pilot to areas struck by a volcanic eruption last year.
Despite MAS’ foray into CBDCs, the central bank still believes that there is no pressing need for the digital currency in Singapore. There are “neither strong reasons for or against a retail CBDC in Singapore,” said Ravi Menon, the managing director of MAS at SFF 2021.
Several other central banks have taken the same stance towards CBDCs, such as the US Federal Reserve, Bank of Canada, and Reserve Bank of Australia.
At the end of the day, Project Orchid is a way for Singapore to build its digital capabilities, and for MAS to issue a retail CBDC if the need arises.
Featured Image Credit: Shutterstock