From: Robert Hettinga <rah@shipwright.com>
Date: Tue, 4 Jun 1996 16:11:46 +0800
To: cypherpunks@toad.com
Subject: e$: Interbank Digital Cash Clearing, Better Living through
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Date: Mon, 3 Jun 1996 21:03:16 -0400
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Subject: e$: Interbank Digital Cash Clearing, Better Living through
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 Date: Mon, 3 Jun 1996 17:34:31 -0400
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 From: Robert Hettinga <rah@shipwright.com>
 Subject: e$: Interbank Digital Cash Clearing, Better Living through
  Walletware, Microintermediation, Net.Currencies and ECM
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 e$: Interbank Digital Cash Clearing, Better Living through Walletware,
 Microintermediation, Net.Currencies and ECM

 June 3, 1996
 Boston,Massachusetts


 People have asked me what I think about interbank digital cash clearing, and
 I say I'm all for it. Flippant comments aside, I'm not sure I can add
 anything to the discussion, but I'll take a shot at it.

 It's easy to argue that there's no real need right now for *on-net*
 interbank clearing, especially with online cash. If you handle the
 transactions right, the merchant just verifies and deposits cash as it comes
 in. This works especially well with the underwriter-as-internet-ATM-machine
 model I like to use in discussion. (I include that here only by reference,
 as I've beat it to death. The e$ home-page is http://thumper.vmeng.com/rah/
 ) If the trustee behind the underwriter is, well, trusted, to do deposits as
 well as withdrawls, then the "problem" of interbank clearing on the net
 itself goes away. Actually, we just translate it into "normal" world of
 book-entry banking transactions, and the trustee does the interbank clearing
 there. Same as it ever was.

 In this scenario, if the customer presents a certificate requiring change,
 the change can be issued in the same transaction as the deposit of the rest
 of the transaction's proceeds. Frankly, in a world of ubiquitous networks,
 this is clearly the way to go for merchants of any means whatsoever, because
 it's completely safe for them, and it doesn't matter who the underwriter of
 the cash is. With the proper level of software abstraction, it may not even
 matter what the cash protocol is.

 However, networks are a long way from ubiquitous, and that means offline
 transactions for a lot of cases. Fortunately, if we want to think about
 offline transactions, we can pilfer some more ideas from, as usual, the
 market for traveller's checks. When a merchant deposits a traveller's check,
 her bank clears it like any other check. That's possible because not only is
 the check secured, but it is hard to replicate. Most importantly, American
 Express offers a virtual guarantee of payment even if the checks are proven
 to be lost or forged, which speaks volumes about the susceptability of the
 system to any large-scale fraud.  However, in the unlikely event that AmEx
 goes out of business, the merchant, not the bank, would be left holding the
 bag, just like she would be with a bounced check. Obviously, the same thing
 happens with money orders, a market in which there are many more issuers.
 All banks issue money orders, but traveller's checks require large consumer
 marketing campaigns, so there are fewer underwriters of them.

 So, if it is possible to build linkages between digital cash and the
 checking system through the merchant's bank, we might have another solution.
 Fortunately, this is no problem. A merchant takes in various forms of
 off-line cash all day and deposits it electronically at the time she
 deposits her other money.  The bank validates, clears, and deposits the cash
 right there at the teller/ATM, through it's connections to the net. This is
 (barely!) analogous to what happens to a traveller's check or money order,
 which is deposited and sometimes physically flown to the issuer's bank to
 clear, and paid back to the depositor by fed wire to settle the transaction.
 Making change for the transactions themselves in this scenario is
 problematic, but the merchant can just hand back physical cash, just like
 she does with traveller's checks.

 An all-electronic variant on this "mixed-money" change method is for the
 merchant to hand back whatever digital-note change she has, regardless of
 who issued, and this implies a lot of preconditions, but it's not as scary
 as it looks, which we'll see in a little bit.


 Right now, when we talk about the need for interbank clearing, a lot of
 people seem to be talking about offline cash. As we saw, online clearing is
 pretty much a geodesic process, because you're connected straight to the
 underwriter of the cash you're using for the transaction under way. It's
 hard for me to see any need for on-net intermediaries for online cash, at
 least for the time being, because the trustee, the actual financial
 intermediary in the transaction, is hooked into the "physical" financial
 system of banks, ATM networks, and central-bank fund-wires. I'll talk about
 on-the-net financial intermediaries a bit later, though, and there might be
 one wild card, but I'm not sure.

 In the same way that I claim that certificate-based clearing and settlement
 is always going to be cheaper than book-entry methods, I think that offline
 cash is always going to be cheaper at the margin than online cash. The risk
 of offine transactions is always going to be double-spending, and that has
 to be traded against convenience, lower cost of not needing net access and
 the absolute anonymity you can get by not having to ever reveal yourself to
 even the underwriter of the digital cash in question. My claim of
 "marginally cheaper" for offline cash is strictly because of the lack of a
 net connection, but this cost-component will continue to fall into the
 forseeable future, so it will be less of an issue. Today, however, with only
 tens of millions of people on the net out of a world population in the
 billions, off-line digital cash has a significant cost advantage, and as
 long there's a bank with in a few transactions' proximity to the offline
 transaction in question, I think it can still be pretty safe to do offline
 digital cash transactions.  Precicely because we're only a transaction-hop
 or two from an on-line transaction, double spending is reduced to a physical
 phenomena at the smartcard-to-smartcard level, which is much easier to deal
 with. The hoary old bugbear people like trot out at times like this, that of
 a bajillion salami-slice transactions done simultaneously all over the net
 all at once, goes back under the bed -- or back into the monster closet --
 where it belongs. (Speaking of bugbears, remember, the problem of someone
 stealing a bank's key, and literally printing free money, is more a problem
 of issuing digital cash batches with expiry dates than anything else.  More
 to the point, the problem belongs to a single underwriter, and not to a
 robust market with many competing underwriters.)

 Anyway, the upshot of the double-spending problem is that it assumes a world
 of strictly offline transactions, which is almost as ludicrous as a world of
 strictly online transactions. ;-). Any robust and marketable system of
 digital cash will need to be able to do both.

 Like I said above, the transaction handling mechanisms are everything in a
 multi-underwriter, multi-trustee, and even multi-certificate-protocol
 regime. We need to have a set of standards for digital cash clearing and
 settlement which makes the actual issuer as transparent as possible to the
 transaction's participants. After all, that's what we have with checks. The
 bank the check's drawn on doesn't really matter. To a lesser extent, neither
 does the issuer of a traveller's check or money order. Who printed the check
 *certainly* doesn't matter.

 That's about where we want to be with digital cash. If I want to buy
 something from you with ecash, the last thing we should care about is the
 mechanics of the transaction, and *that* includes who the issuer of the cash
 is, who the trustee is who's going to do the interbank settlement out in the
 book-entry world, who the protocol designer is who invented the type of cash
 we're using, who the software developers were who developed my wallet and
 your register. None of that. We just want to settle the trade.  Better
 living through walletware.

 That means that we need think about multi-underwriter clearing from the
 outset, preferrably at the merchant level, and I'm sure that's what Digicash
 is moving towards.  Digicash's walletware and registerware, or anyone else's
 for that matter, should be able to transact business with ecash of any form,
 without discrimination. If I spend some ecash with you, your cash register
 should take any and all combinations of my Deutche-ecash, or my Twain-ecash,
 or my Finn-ecash, validate them online with their underwriters (whose
 responsibility for transaction clearing turnaround should make speed a major
 selling point to their customers), and hand me back change however I want
 it, choice of underwriter (or not) and all. In fact, if everything works
 out, and markets for digital cash underwriting become efficient and
 competitive, then *who* underwrites my ecash becomes less of an issue to me
 over time. One form of ecash is as good as another, because it all
 interoperates. So, if we assume that walletware takes different protocols,
 it seems that the dominant digital cash protocol would be that which
 operates best from the *underwriter's* standpoint, which is where it should
 be, since they're the ones whose reputations are being risked, "rented", as
 it were.


 Okay. Let's look quite a few years ahead, to a time when most money that
 comes onto the net stays here and just gets moved around, to digital bearer
 bonds, or to digital mutual fund certificates, or whatever. Let's say that
 Tatsuo Tanaka's scenario has come to pass. That is, because the money's not
 leaving the net as soon as the transaction takes place, like we've been
 talking about, the digital cash underwriters and trustees, most likely with
 the knowing collusion of users who want to pay lower purchase discounts,
 start "creating" money by issuing cash against fractional, instead of 100%
 reserves. More to the point, to follow Tanaka some more, a panic or two
 brought about by these shenanigans has caused the underwriters to police
 themselves by creating some kind of independent currency control for various
 associations of fractional-reserve underwriters, much in the same way that
 fractional reserve bank panics were handled prior to the advent of central
 banking. We may even have several full-blown internet currencies, controlled
 by currency boards of some kind. I'm not talking about nation-states, here,
 either. All of this could be done on a private basis. Real live private
 currencies, offered by an association of digital cash underwriters.

 This is a *long* way off, but do you see what I'm getting at here? What we
 end up with is an on-the-net interbank clearing system, doing just what the
 book entry system does now, only without governments or central banks in the
 middle. We have intermediaries in the form of a board which manages the
 quantity of a given private currency based on "foriegn" reserves, that is,
 the holdings in its member banks in the *other* currencies, which prevents
 monitary inflation, and that's one place where the "interbank" clearing
 takes place. In this environment, we also have currency hedgers and
 speculators, who make (or save) money by trying to figure out where
 currencies of various kinds are going to go relative to one another.  These
 days we have institutions moving large amounts of currencies around, doing
 insecure trades on secure networks. However, the technology of digital
 bearer certificates and ubiquitous public networks could enable a legion of
 very small autonomous entities to do the same kinds of activity that the big
 boys do now. So we don't get "disintermediation", which lots of people see
 right now with the merger of your local savings bank into a big
 conglomerate, or your local stockbroker getting bought or put out of
 business by a discount broker or mutual fund. We end up with
 "microintermediation".

 Actually, I've written about the same idea elsewhere, of underwriting "bots"
 providing ubiquitous auction markets for things like personal digital bearer
 bonds, etc., but in this case we have a bunch of trading 'bots making
 secondary markets in currency, hedging and speculating on price fluctuations
 for money, all like a bunch of microscopic George Soroses. Like George Soros
 and his famous takedown of the EU's exchange mechanism, these bots would be
 who actually "determine" the price of a given net.currency versus another,
 and not the net.currency boards at all.


 Okay. I've wandered way out here on a limb, and I'm going to climb off of it
 soon, before I either fall or someone cuts it off. :-). However, before I
 go, let's look at something which actually happened, and which may be a
 pointer to what could happen again soon, without too much trouble. I'm
 talking about ecm, or the electronic cash market trading list.

 Last summer, when I got back from my New Orleans trip, I was up in Montana
 hanging out while my wife was at an educator's conference, and Lucky Green
 sends me e-mail about having just sold, for cash, some of the demo
 "cyberbuck" certificates that Digicash was issuing at the time. I commented
 about this to cypherpunks, one thing led to another, and the next thing I
 knew, Rich Lethin had started up a mailing list and set up a protocol for
 trading these beta-certificates for cash over that list. He named the list
 ecm. (Send "info ecm" in the body of a message to majordomo@ai.mit.edu, if
 you want to see what the fuss was all about.) It was used sporadically up to
 the time when, you guessed it, Mark Twain came on line with *actual* digital
 cash, and people stopped trading beta-certificates altogether. I can't even
 remember what the last settlement price was, but it was pennies on the
 dollar. Actually, now that I remember  it, there was a period where the
 beta-certificates were traded for real Mark Twain ecash on someone's
 web-page and then announced on ecm, but things have pretty much gone
 moribund on ecm lately. I haven't seen a trade go across in many months.

 ECM is the "wild-card" exception to using the current banking system for
 interbank digital cash clearing. The one that I was talking about above,
 after I said we didn't really need an interbank clearing mechanism on the
 net itself.  If someone wanted "clear" these different versions of ecash on
 the net some day, they could just take positions in both the Finnish, Mark
 Twain, and eventually Deutchebank certificates, and run a little currency
 exchange operation for fun, and maybe profit, between the three by
 announcing their bid/ask prices on ecm in both certificates. Hint: buy low,
 sell high. :-). They could even do currency-speculation-by-proxy by taking
 different positions in these certificates if they wanted to. It may even be
 that someone could do this and make a living at it, someday, if enough
 digital cash was used on the net, particularly if they could do it cheaper
 than it would cost someone to "deposit" their cash, through an underwriter,
 into their own bank account.

 Would income or capital gains taxes be considered part of that deposit
 "cost"?  As Francis Urquart (RIP) used to say, "*You* might say that, but
 *I* couldn't possibly comment."


 Cheers,
 Bob Hettinga








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 -----------------
 Robert Hettinga (rah@shipwright.com)
 e$, 44 Farquhar Street, Boston, MA 02131 USA
 "If they could 'just pass a few more laws',
   we would all be criminals."    --Vinnie Moscaritolo
 The e$ Home Page: http://www.vmeng.com/rah/



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-----------------
Robert Hettinga (rah@shipwright.com)
e$, 44 Farquhar Street, Boston, MA 02131 USA
"If they could 'just pass a few more laws',
  we would all be criminals."    --Vinnie Moscaritolo
The e$ Home Page: http://www.vmeng.com/rah/