--- begin forwarded text Date: Tue, 19 Dec 1995 13:42:20 +0700 (GMT+0700) From: Patiwat Panurach <pati@ipied.tu.ac.th> To: ecash@digicash.com Subject: Economics of Digital Money. (part 2) MIME-Version: 1.0 Sender: owner-ecash@digicash.com Precedence: bulk Reply-To: ecash@digicash.com The Economics of Digital Commerce: An analysis of Digital Cash, ElectronicFund Transfers, and eCash (the second part wasn't included for some reason) The advantages of Electronic Checking over paper checks include Savings of time. The instantaneous updating of account balances allows all the financial players a greater deal of financial flexibility. There is no clearing period for transactions to be finished. This allows large cost reductions and more opportunities in cases of large-sum arbitration, and allows even pedestrian players to have a great deal of financial freedom. Also considerable is the savings in time. Checks no longer have to be cashed and purchased at bank branches. Reduction in paper handling costs2. Universities are not overwhelmed with paper checks at the beginning of each term; banks aren't faced with unmanageable lines of people at every payday; governments don't need large check printing and mailing facilities; fewer trees are sacrificed. No bounced checks. Being simultaneous, the receiving of the certification and the debiting and crediting of the accounts assures that no certification can be made without having funds to back it up. This could be done through an automatic check of account status before the certification is issued. This is similar to the checking of the credit limit before credit card transactions are finalized. Flexibility. Electronic checking is an extremely broad and generic field. It is used, in some form or the other, worldwide. Nearly all types of transactions can be conducted by using electronic checking. Electronic checking bypasses the physical weaknesses of physical checks. But it is still, in its essence, a check. A critical weakness of this is privacy. All transactions must pass through the banking system3. Furthermore, the banking system is obligated to document the details of every transaction that passes through it. What is to prevent the bank from selling or leaking such information to others? This precludes a possible infraction of personal civil liberties. Such was the case of Winai La-onsuwan, the man who was formally known as the monk Yantra. His illicit adventures in an Australian brothel were documented via American Express receipts4, and such evidence was critical in defrocking him. An even more frightening scenario would be if governments would demand access or control over the electronic checking, or over electronic checking records. What would permit them from instantly forbidding, say, a pregnant woman from buying cigarettes? Electronic checking systems could conceivably be a tool of "Big Brother" in gaining control over individual lives. As payment systems using electronic checking become more pervasive, is it necessary sacrifice the privacy and undocumentability of Cash? Many feel5 that cash also has a role as an electronic payments system. Such a "digital cash" (as it is called by many adherents) would have to have the essential characteristics6 of cash from the consumers perspective: Anonymity. The buyer pays the seller. Nobody, except the seller knows the identity of the buyer or the details of the transaction. In cases were the buyer uses a sufficiently sophisticated pseudonym system, not even the seller knows the identity of the buyer. Besides those of the 2 agents, there is no record of the transaction taking place. The certification of payment is the payment. There is no transfer between accounts that banks could analyze to discern the exact flow of funds. Liquidity. Digital Cash must potentially be accepted by all concerned economic agents as a method of payments. For example, in the Global Internet, the largest meta-network in existence, this would involve a significant proportion of internet merchants accepting a digital cash, if it is to be more than an ìelectronic play-moneyî. In many pilot projects, there must be a large threshold of affiliated merchants that are willing to participate in accepting digital payment for the system to be successful. On the institutional side, digital cash holds many advantages over existing fiat money (cash). These mainly involve the physical weaknesses of cash. First, Cash is highly risky to robbers. Cash must be kept in secure vaults and be guarded by security guards. The more cash is held, the greater the potential risk is. Secondly, cash has high transport costs. Because physical mass is proportional with the amount of cash held, large amounts of cash are difficult to store. It has been estimated that money handling costs of transporting cash in the US amount to over 60 billion US$ a year7. Lastly, the advent of high- quality color copiers and counterfeiting methods8 make government stores of cash insecure. It has been rumored that the United States Government waged economic warfare against Iraq during the Persian Gulf War by flooding the country with expertly counterfeited cash9. Digital Cash could conceivably have many forms. These might include: Prepaid Cards. Buyers could buy prepaid cards that will be accepted by special sellers. For example, phone cards act as surrogates for coins in the payment of public phones. The weakness of phone cards as digital cash is in the liquidity of the medium: no one would accept a 100 Baht phone card for the payment of a meal. Electronic road toll payment systems also suffer from the same weakness. Recent pilot projects conducted in Australia by VISA show more promise. Prepaid and rechargeable cards are accepted at the point-of-sale of a variety of merchants. Furthermore, to increase the systemís acceptability, the cost of point of sale terminals is subsidized by VISA. It is now possible to pay for a beer at the bar and a hotel bill with the same card10. Proposals for incorporating cash functions into multipurpose ìsmart cardsî have been announced by the EMV (Europay, Mastercard, Visa) consortium11. This would allow many functions like SIMM, ATM, encryption/decryption, and digital cash to be fitted onto a single card. Purely Electronic Systems. Purely electronic digital cash would be devoid of physical form. This would make it useful for network and internetwork transactions where the buyer and seller are physically apart. The payment would take place by electronically deduction of digital cash from the buyer and sending it to the seller. The actual transfer of digital is usually encrypted so that only the intended recipient (the seller) could make use of the cash. However, methods of anonymity and security must be in place, as to not turn fully electronic systems into electronic checkings systems. In all its forms, digital cash is not always cash. If, say, a financial institution were to issue the digital cash, the creation of digital cash could simply be considered a withdrawal from that financial institution. Similarly, the financial institution would be obliged to credit user accounts for deposits of digital cash. The digital cash would not have to have any real funds to back it, other than any legal reserve limit for the original deposits. Digital cash could just be considered as ìcashî on calculations of money supply. M1= 1+ Currency/Deposits X MB LRR+ (Currency/Deposits) + (Excess reserves/Deposits) when Currency encapsulates cash, coins, and digital cash. Withdrawing digital cash reduces the amount of deposits that the financial institution could use to extend loans, thus reducing any dynamic effects money creation effects upon M1. If, on the other hand, a non-financial firm were to issue digital cash, it would simply be a purchase of 1 unit of digital-cash with 1 unit of physical-cash. It could only be backed up by the willingness of merchants in accepting digital cash as a unit of payments. This second type of digital cash is inherently riskier for the consumer than the former. It is actually more analogous with ìcouponsî than with ìcashî. Furthermore, redeeming paper cash for privately issued digital cash does not effect any transformation upon the monetary conditions of the economy. Buying this type of digital cash does not affect the money creation process; there is no decrease in the economyís loan creation capacity. After considering the conceptual and theoretical aspects of electronic checking and cash, it is now time to look at a real world example of electronic payments: eCash is an open standard12 electronic payments system developed by the Digicash Company and currently the being implemented by the Mark Twain Bank of Missouri, USA. Conceptually, eCash is a type of ìdigital cashî, offering high levels of privacy and security. Its current implementation by the Mark Twain Bank is not exclusive - any bank licensing Digicashís eCash protocol could become an intermediary in the eCash scheme. To undertake transactions13, both buyer and seller would have to have deposits in the ìWorldCurrency Accessî accounts of the Mark Twain Bank. ìWorldCurrency Accessî accounts are claimed to be conventional money market accounts14; however, they do not pay interest nor have a fixed maturity period but are insured by the FDIC. The buyer must instruct the Mark Twain Bank to transfer funds from his ìWorldCurrency Accessî account into his ìeCash Mintî. This Mint is a personal buffer account. Funds in the Mint are no longer deposits of the bank, and they are not insured. At any time, the buyer can order his computer to remotely interface with his Mint and withdraw funds from the Mint into the buyers hard disk drive on the buyers personal computer. The format of the funds is now completely electronic: a series of zeros and ones that is cryptographically secure and unique. It might be useful to consider the funds in the Mint and in the buyers hard disk as being electronic in an ìelectronic walletî. To make the payment, the buyer encrypts the appropriate amount of eCash with a suitably secure encryption protocol15 and sends the eCash to the seller. The eCash can be sent to the seller by any data communications medium, e.g., email, ftp, shttp. Ironically, eCash can even be saved onto a disk, and the disk sent to the seller. Or it can be printed out onto paper, and the printed copy sent to the seller. The seller receives the eCash and after decryptizing it, stores it into his computer. This can then be sent to the Mint, and transferred into the sellerís ìWorldCurrency Accessî account. The net result is a decrease in the buyerís funds and an increase in the sellerís. eCash is private: although the Mark Twain Bank will have records for each eCash withdrawal and deposit16, it is impossible (mathematically impossible17, not just computationally difficult or improbable) to trace any subsequent uses of that eCash. If the userís hard disk drive should ìcrashî, the eCash is lost forever18. But although eCash is purely electronic, and can easily be copied, it is impossible (again, mathematically impossible, by the explicit design of the eCash protocol specification) to use any eCash twice19. Given its nature, eCash must be considered to be cash from the monetary standpoint. eCash withdrawals from the userís account are leakages from the money creation process, in the same way that cash withdrawals are. If a userís WorldCurrency Access account had $100 in it, and $50 was withdrawn as eCash, only $50 (minus any legal reserve limit and excess reserve) could be lent out to others. Conversely, a $50 eCash deposit would give the Mark Twain Bank $50 (again, minus any legal reserve limit and excess reserves) to lend out. Now let us examine some common tendencies of all types of electronic payment. First is the long term trend to increase velocity of money flow in the economy. As the growth of the credit card industry (actually a subset of electronic funds transfer) has shown us, increased convenience of payment is a large factor in increasing the number of payments made. As electronic payments become more widespread for the consumer, we might expect a similar long term trends of increased price level and output through velocity. Also, the disembodiment of cash also tends to give illusions as to its value. Transforming money from bills in your wallet into charged electrons in you hard disk is probably a greater abstractative leap than the transformation from gold coins to fiat currency. As another evolutionary step in the development of money, we might expect consumers to reexamine there conceptions of money, cash, and value. Another significant impact has stemmed out of research into the root of interest gaps in the money market. Citicorp has claimed that around 2/5 of the interest charged on a consumer finance loan is in branch delivery and management costs. This cost could be reduced substantially with increased adoption of electronic means of payments. It has been estimated that the interest differentials in the money market could be drastically reduced with adoption. After examining these three electronic payments systems and there impacts, it should be noted that no single system is ìbestî. Which system is adopted depends largely on the needs of the transaction and the agents. On the consumerís side, survey data20 shows that the single most important factor is wide acceptance of the system. Thus it may be that any system, whether it is formally standardized and secured or not, could gain market dominance and remain in that position by virtue of its ad-hoc standard. Sellers would use it because most customers use it; customers would use it because most sellers use it. The main channel for competition would not be in price of the system, but in gaining exclusive rights to the point of sale of a large number of merchants. This environment would make electronic payments widely available in a relatively short time span, but is not exactly conductive to diversity or technological advancement. This would be analogous with the entrenched tri- opoly of Visa, Mastercard, and American Express in the credit card market. An alternative to this situation might be the wide adoption of an open standard electronic payment system. In this case, any intermediary would jointly adopt an inter-operatable system, whereby the client of one system could transparently conduct transactions with any other seller whoís intermediary uses the same system. This would be similar to the openness and competition in Thailand's ATM system, where the 2 main ATM consortiums (ATM Pool and BankNet) support an open system. The holder of a Bangkok Bank ATM card can withdraw money from, say, a Thai Farmers Bank ATM. Such an open electronic payment system would have several advantages over a proprietary electronic payment system. Choice. Users could be given better choice and services. Since there could be several intermediaries vying for the same open market, they would have to use a policy of differentiation. Such a structure would bring about a monopolistic competition type market, the "market" being the market for open-standard electronic payments. Hopefully, this differentiation would be for the benefit of users. Policy. Government policy implementation would be less ambiguous. Generally, the fewer heterogeneous systems there are to regulate, the more effective government policy would be on each system. This is because each system would need a specific interpretation of the applicable laws. Since in most nations, the legislative process can't enact new laws with high speed, the "applicable laws" tend to be arcane and controversial. Combined with the constrained capacity of the state, this might cause an ambiguous period of years before systems can be finalized. The ambiguity during this period can kill of enthusiasm for new systems, leading confused agents to return to conventional paper methods of payment. It could also lead to market distortions, as misguided governments could give anti- competition concessions to single firms. Simplicity. Open standard electronic payments systems would provide a consistency in payments from the users side. It is a general design principle in computer-human interaction engineering that consistent interfaces are synonymous with the efficiency of the system. Survey data21 has shown that simplicity is the second most important aspect that is looked for in an electronic payments system. Thus the consistency of an open standard would contribute to its wide adoption. Despite the advantages of open standard electronic payments systems, it is also likely that a variety of standards could simultaneously gain market acceptance. This would not be through conventional price competition, but rather by seeking niches in the market. For example, it is highly likely that some form of electronic cash system will gain a market niche due to its strong point of unquestionable privacy. Besides the easily targetable markets of "socially deviant" products like pornography (one of the most popular products of the Global Internet) or weapons design (the users of which tend to be very paranoid), it would also gain acceptance from users who are uneasy with the fact that each and every one of there transactions would be documented by the banking system. Fear of such information getting into the hands of the few (or the hands of the state) will most probably cause users to move to a more private system. Such concerns for privacy and fear of powerful corporations have crystallized into the cypherpunk and cyberpunk movements, small but vocal special interest groups who are often listened to by governments22. Other niches might include government subsidized ones for the payment of various state benefits. The United States Department of Nutrition has already implemented an advanced ìVirtual Food Stampî system in New York City23. Groceries with a large portion of low-income customers are required to install electronic payment systems at the point of sale. Customers can buy there groceries without using cash, there being an automatic transfer of funds from their food stamp account to the groceries account. This system reduces long lines at government offices, eliminates the black market in redeeming food stamps for cash, and significantly reduces the shuffling of paper of all parties. This system is used by 500,000 people and is favored over the old system by 94% of them. Like any new technology, it would be impractical to think of the status of electronic payments as clearly defined. Although the technology has existed for decades to implement many systems, they have just begun to permeate into the everyday consumerís lives. The number of merchants accepting eCash numbers less than a hundred. Card based electronic cash systems have only been implemented in pilot projects in a handful of cities over the globe. Never the less, the trends of modern commerce, driven by the weaknesses of traditional payments systems, point to the eventual rise of electronic payments. It is just a matter or time and spirit. Footnotes 1 from J. C. Wood and D. S. Smith ìElectronic Transfer of Government Benifitsî Federal Reserve Bulletin V.77 N.4 April 1991 2 D. Gleason as quoted by S. Levy ìE-Money (That's what I want)î Wired V.2 N.12 as archived in http://www.hotwired.com/wired/2.12/features/ emoney.html on the internet 3 via Regulation E implementing the Electronic Funds Transfer Act of 1979 (15 U.S.C. 1693) as quoted in J. C. Wood and D. S. Smith, op. cit. 4 from the news group soc.culture.thai 5 As can be seen from the atmosphere of various sites on the internet. Most explicit is the cypherpunks mailing list at cypherpunks@toad.com 6 These characteristics, and the mathematical theories that underpin them were developed over several years in the cypherpunks mailing list and the future culture mailing list at futurec@uafsysb.uark.edu 7 S. Levy op. cit. 8 S. Levy op. cit. 9 heard from the future culture mailing list, op. cit. 10 S. Levy ìThe End of Money?î Time 6 Nov 1995 P.38-44 11 announced in the cypherpunks mailing list 12 details of the protocol and messaging system were publicized in the internet at http://www.digicash.com/ecash/protpublish.html 13 described in the eCash/Mark Twain Bank FAQ at http://www.marktwain.com/digifaq.html and the eCash FAQ at http://www.digicash.com/ecash/faq.html 14 This is claimed in the eCash/Mark Twain Bank FAQ. But the same document also states that WorldCurrency Access accounts do not earn interest and have no fixed time periods. 15 PGP public key encryption is a highly popular defacto standard due to its high security and its zero price. 16 This is to conform with conventional banking laws concerning the documentation of transactions. 17 D. Chaum ìShowing credentials without identification: transferring signatures between unconditionally unlikely pseudonymsî (Springer-Verlig, Berlin) p.946-64 (Conference: Advances in Cryptology-AUSCRYPT '90 International Conference on Cryptology. Proceedings, Sydney 8-11 January 1990) 18 Just another incentive to backup data 19 the eCash protocol specification at http://www.digicash.com/ecash/ protpublish.html 20 from the internet money survey conducted by the Management School at Imperial College. Archived at http://www.tu.ac.th/thammasat/pati/money.survey.results 21 See fn. 20 22 The Electronic Frontier Foundation has had close links with the Clinton Administration. The Cypherpunks mailing list catalyzed public protest that eventually brought down the government supported Clipper Chip 23 See J. C. Wood and D. S. Smith, op. cit. ------------------------------------------------------------------------------- Patiwat Panurach Whatever you can do, or dream you can, begin it. eMAIL: pati@ipied.tu.ac.th Boldness has genius, power and magic in it. m/18 junior Fac of Economics -Johann W.Von Goethe ------------------------------------------------------------------------------- --- end forwarded text ----------------- Robert Hettinga (rah@shipwright.com) e$, 44 Farquhar Street, Boston, MA 02131 USA (617) 958-3971 "Reality is not optional." --Thomas Sowell The NEW(!) e$ Home Page: http://thumper.vmeng.com/pub/rah/
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