[NEWS]

Washington Post: Monday, October 21, 1996 CyberCash: Change Is Good, They Bet By David S. Hilzenrath Somewhere in cyberspace, shrouded in anonymity, someone surfed to the World Wide Web site for Virtual Vegas last Friday and saw casino betting tips for sale for 50 cents. With a few clicks of a computer mouse, using software called a "wallet," the surfer ordered the tip sheet. Almost instantaneously, the gambling advice crossed the Web to the buyer's computer, and payment traveled to the Web site in a new form of electronic money known as CyberCoin. When Virtual Vegas settles its accounts, the encrypted CyberCoin payment will be converted into a 42-cent deposit in the business's bank account. Its bank and the buyer's bank will share a fee of 2 cents, and CyberCash Inc., the Reston company that issued the electronic money, will cut itself in for 6 cents. Mere pennies -- but multiply the transaction by a zillion here and a zillion there and someday the company could be making real money. One of the Internet's hottest and most speculative stocks, CyberCash has emerged as the early front-runner in a race to handle the pocket change of electronic commerce, many merchants and analysts say. In the process, CyberCash could help transform the way people do business on the Internet, making it easier to buy and sell inexpensive items such as individual news articles, pictures, video-game plays, computer software, recipes, jukebox selections -- or odds on the third race at Belmont. "When the Internet comes into its own, and it will come into its own, then CyberCash and its competitors will have provided a key mechanism for going from worldwide chaos to worldwide commerce," said Ira Morrow, a financial services analyst for the Gartner Group. It's big talk about a tiny company that in the first six months of this year had only $ 37,705 in revenue and has yet to show a profit. Moreover, the company is one of many betting on an explosion of on-line commerce that more than a few savvy observers say may never come. "Are people really going to want to do real commercial transactions on the Internet? A lot of us involved in this aren't sure," said Sholom Rosen, vice president of emerging technologies at Citibank and point man for the bank's experiment in Internet currency. "There's more smoke out there than there is fire right now . . . more hype than there is reality in the marketplace." Until about two weeks ago, some analysts considered CyberCash's prospects to be tenuous at best. Then Netscape Communications Corp. agreed to package the CyberCash wallet with its Netscape Navigator software, by far the most widely used "browser" for surfing the Web. Suddenly, CyberCash appeared more plausible. "CyberCash, with the Netscape deal, has emerged with some kind of a leadership position . . . some clear viability," said Kris Tuttle of SoundView Financial Group, a technology research firm. CyberCash introduced a system for secure on-line credit card payments in 1995, but by its own account it will be just one of many players following a standard approach in that arena. It is also developing a system for on-line check payments. But it is CyberCoin, which debuted on Sept. 30, that holds the key to CyberCash's fortunes -- and the greatest potential to shake things up in cyberspace. With CyberCoin, the company is trying to facilitate purchases of 25 cents to $ 10, transactions typically too small to be made by credit card. The system could allow Internet merchants to charge for things they have been giving away, or to charge nominal tolls for visiting Web sites. It could allow virtual vendors to charge "by the sip" instead of by the bottle, as some industry analysts say -- for example, to eliminate costly subscription fees for on-line publications when the reader only wants a single story. "It seems to be the answer everybody's been looking for to make small-amount purchases on the Internet," said Ned Barnett, marketing director of HealthWorld Online Inc., which plans to use CyberCoin to sell chapters of books and brief audio recordings about nutrition and health on the Internet. The folks at Virtual Vegas agree, but their own receipts should temper such enthusiasm. As of Friday, Virtual Vegas, based in Venice, Calif., had rung up just 48 CyberCoin transactions for a grand total of $ 40.05 in sales. Only a dozen merchants are currently equipped to accept CyberCoin payments. Another 33, including the Los Angeles Times, have signed up to use the system. Netscape won't begin distributing the wallet software to consumers until next year; in the meantime, it can be downloaded for free from CyberCash's Web site, www.cybercash.com. But to CyberCash co-founder and chief executive William N. Melton, it's a fairly good bet. And Melton has a history of good bets. In a prior life, he created VeriFone Inc., building it into the world's largest provider of credit-card terminals, which retailers use to verify transactions. He serves on the boards of America Online Inc. of Dulles, the world's largest on-line service, and Transaction Network Services of Reston, which manages a network that connects retailers and credit card processors. Melton, 54, grew up on a farm in Nebraska, where he and his brother and mother tended to the cows and pigs and chickens. His father, a Methodist minister, died when he was 7. As a boy, he dreamed of being a truck driver, he said, because the trucks that rumbled through Nebraska represented freedom. At West Mar College in LeMars, Iowa, he majored in psychology before going to Honolulu for graduate work in Chinese language and philosophy. He spent five years in Asia, traveling to Taiwan, Vietnam and Japan, and returned to Hawaii fluent in Mandarin. In 1993, practicing venture capital with his own money, Melton watched the growth of the Internet and saw its "revolutionary and transformative power," he said. He envisioned a need for a kind of VeriFone for the global computer network, an automated on-line payment system. "Most of the banking world at that time was not paying attention to this new [Internet] phenomenon, and most of the people in the Internet were not paying attention to payments. And so there seemed to be a gap that needed to be filled," he said. Melton also perceived a gap in his knowledge of the Internet, and sought out Daniel C. Lynch, now chairman of the CyberCash board, to fill it. Lynch, 55, one of the Internet's pioneers, had already made a fortune of his own by creating and selling Interop Co., which ran Internet trade shows. Lynch also served on the board of UUNet Technologies, the Internet services company recently bought by MFS Communications. Early in his career, as a computer programmer for the U.S. Air Force, Lynch wrote software for missile-tracking radars. But in the early 1970s he decided that was "a boring game" because "the offense has it all over the defense," he recalled. Now, Lynch relaxes by working on his own vineyard in Napa Valley. Melton and Lynch found each other through their mutual interest in bionomics, the philosophy espoused by author Michael Rothschild in a 1990 book by that title. Bionomics views the economy as organic and evolutionary, like a rain forest, and doubts the power of governments or other institutions to direct it. The two entrepreneurs became sponsors and directors of Rothschild's Bionomics Institute. Rothschild describes Melton and Lynch in contrasting terms. "Bill is a man of few words. To me he's sagelike, just very wise," Rothschild said. Lynch "is both a mathematical wizard, a hyper hyper techie guy, the super-geek, if you will . . . and the ultimate party animal." They met for breakfast one morning in October 1993, and Melton told Lynch about his ideas. By the time Rothschild arrived, late for the meeting, the two were planning a business. Initially, they financed the venture themselves. "We're two guys that could write checks for millions of dollars, and if we lost, we lost," Lynch said. "We were going to shake the world up." As the company developed, they watched the share prices of publicly traded Internet upstarts, such as Netscape, rise to stratospheric heights. By last winter, it was their turn to play. CyberCash issued stock on Feb. 15, raising $ 44 million from the public and $ 15 million from Japanese investor Softbank in a private deal. Initially priced at $ 17, the stock has since traded between $ 24.75 and $ 63.50 and closed at $ 33 Friday. Melton's $ 4.7 million investment in the company is now worth $ 75.5 million on paper, and Lynch has turned $ 2 million into $ 25.6 million. What made the offering all the more remarkable was not only that CyberCash was losing millions of dollars at the time, but that it had yet to take in a penny of revenue. "That was a bit of a rush, wasn't it?" Lynch said. Today, CyberCash has about 190 employees and offices in Redwood City, Calif., and Bangalore, India, where labor costs for programmers are much lower than in this country. The CyberCash strategy is to distribute its system to the masses through alliances with banks, credit card-processing firms, makers of Internet software for businesses and consumers -- such as Netscape, Oracle Corp. and Sun Microsystems Inc. -- and service providers such as CompuServe. CyberCash decided early on that it was better off cooperating with banks rather than competing with them. "We knew that the Internet was going to so challenge all of . . . life's assumptions that we were not interested in asking consumers to also leave the safe haven of their current banking relationships," Melton said. The company wants banks to put their names on the CyberCash wallet and offer it to their customers. So far, it has forged relationships with dozens of financial companies, including First Union Corp. and First Data Corp., the nation's largest credit card processor. To accept CyberCoin payments, merchants must use a bank allied with the company, but consumers can establish CyberCash wallets using any bank or credit card company. The consumer begins by in effect buying CyberCoin currency -- up to $ 20 at a time. This is done by transferring funds from a credit card or checking account to a bank account controlled by CyberCash. Encoded digital currency is placed on the storage disks of the us er's computer, and is transmitted over the network when purchases are made. Merchants then redeem the digital currency for the conventional kind via electronic networks run by CyberCash and the banking system. In this closed loop, the digital money can be spent on ly once before being cashed in. That distinguishes CyberCoin from other forms of electronic money that can circulate endlessly and anonymously like traditional cash or "bearer instruments" issued by governments. It also reduces the danger that CyberCoin would be counterfeited or used for money-laundering, major concerns of law enforcement authorities who are closely studying the emerging electronic money systems. When consumers shop with CyberCoin, they do so under a veil of cryptographic confidentiality. They hold electronic "keys" that can unlock the code. With a subpoena, the government could compel users to surrender the keys, which would make it possible to trace their purchases. But unless the user surrendered the key, the most CyberCash could do to assist law enforcement would be to stop encrypting transactions for that person. That's CyberCash's attempt to balance the government's police interests with the consumer's privacy interests. "There are no easy answers in this area," said Raymond Kelly, the Treasury Department's undersecretary for enforcement. "We think electronic money is good for the country and the world. But there [are] still many outstanding issues" for policymakers to consider, Kelly said. The final pillar of CyberCash's strategy is to rely on software, which can be easily transmitted over the network, rather than hardware add-ons to a computer. Some alternative approaches would employ devices such as stored value cards -- plastic cards embedded with computer chips. Those systems -- roughly akin to Metro farecards -- would also require users to attach card readers to their computers. Some analysts predict that smart cards eventually could dominate the market, but CyberCash believes that software solutions will spread faster. The CyberCash wallet could be adapted to work with smart cards, but at a reduced level of profitability, Melton said. For all its progress, CyberCash has also missed opportunities, one former executive said. It failed to forge a relationship with America Online's 6.2 million-member service. "Shame on me for that," Melton said of his unsuccessful run at AOL, but he added that as a member of its board he was unwilling to push AOL too hard. CyberCash has yet to build an alliance with Microsoft Corp. For a long time it didn't even try, because Melton thought it should wait until it had more to show for itself. Former marketing vice president Magdalena Yesil questioned that judgment. "Putting your head in the sand doesn't get you away from trouble," she said. "It actually allows the trouble to get bigger." Perhaps most seriously, the company has yet to recruit many merchants to accept CyberCash payments. "As a consumer, what do I do with this thing?" Yesil asked rhetorically. "It's like somebody giving me Turkish liras in California." CyberCash's closest competitor, an Amsterdam company called DigiCash, requires consumers to open accounts at designated banks, and it has enlisted only Mark Twain Bank in the United States. Other competitors may soon appear, though. Citibank is working on its Electronic Monetary System. Melton's old company, VeriFone, is readying on-line card readers. And Digital Equipment Corp. promises it will launch a service called Millicent, with much lower transaction charges than CyberCoin's. Before long, these companies may count their fees not in pennies, but in fractions of pennies. Then, zillions of transactions won't ensure profitability. It will take bazillions to get there. FEWER MIDDLEMEN, BIGGER MARGIN The chief executive of Virtual Vegas sees products such as CyberCoin as nothing short of "revolutionary," and he says the proof is the cards -- blackjack cards, to be precise. The Virtual Vegas Turbo Blackjack computer game sells in stores for $ 29.95. But with CyberCoin, Virtual Vegas is selling it on the Web for $ 2.95, a tenth of the price. And CEO David Herschman says he could make more money doing it. Each $ 29.95 CD-ROM version of the game yields a profit of about $ 4.50 after deducting the retailers' and distributors' share of the price; production, packaging and shipping costs; sales commissions; and unpaid accounts. By contrast, each $ 2.95 copy of the game paid for with CyberCoin and delivered over the Web costs Virtual Vegas about 26 cents, yielding a $ 2.69 profit. At the Web price, Virtual Vegas could sell many more copies, Herschman said. "The profit margin is huge," he said. "We make it once and . . . we could sell that from here to eternity." HOW A CYBERCOIN TRANSACTION WORKS 1. CyberCash Inc.'s electronic wallet software is downloaded from its Web site at http://www.cybercash.com to a user's computer. The user fills the wallet with money by transferring funds from a checking account or credit card to a bank account controlled by CyberCash. The actual money stays in the account until after a purchase has been completed. To fill the wallet from a checking account, users must mail in a voided check. CyberCash then loads the wallet with digitally encrypted symbols representing the allotted money in the bank. 2. To buy something, the consumer clicks the PAY button on a participating merchant's Web site. The code for the money is verified by CyberCash. The electronic product -- such as an on-line document or news article -- is transferred to the user's computer. The code for the money is transferred from the user's wallet to the merchant's electronic "cash register." The user's wallet logs all transactions. 3. When the merchant empties the cash register of its coded payments, CyberCash transfers the actual money to the merchant's bank account from the account where it was holding the consumer's funds. CyberCash deducts a transaction fee from the merchant's payment. The fee is split among CyberCash, the consumer's bank and the merchant's bank. 4. The user can return unspent funds to a checking account, but not to a credit card. American Banker, 10/23/96 Phone alliance may rival banks in electronic cash A smart card alliance of five telephone companies could raise competitive obstacles to banks that desire to control electronic cash transactions. US West Communications, GTE, Bell Canada, PTT Telecom Netherlands, and Telekom Malaysia announced formation of the Global Chipcard Alliance at the CardEx 96 conference this month in the Netherlands. Additional members are welcome. Oracle Corp., the data base software giant, plans to join, said US West. The alliance wants to create an open standard to allow any smart telephone card to operate in any pay telephone network. Some partners' cards are already interoperable -- for example, GTE cards work in telephones installed by US West and vice versa -- and alliance members may have the power to affect technology in the banking and payments field. Though phone card standards are its initial target, the alliance could view electronic purses and other chip card applications as viable opportunities. The major bank credit card associations have produced a smart card standard called EMV, for Europay, MasterCard, and Visa. It is designed to assure that merchants' terminals accept all compatible cards. The chip card group could incorporate EMV into its operating standard. --- Dr.Dimitri Vulis KOTM Brighton Beach Boardwalk BBS, Forest Hills, N.Y.: +1-718-261-2013, 14.4Kbps