From: hughes@ah.com (Eric Hughes)
Date: Sat, 27 Aug 94 11:22:07 PDT
To: cypherpunks@toad.com
Subject: In Search of Genuine DigiCash
In-Reply-To: <199408210218.WAA15544@zork.tiac.net>
Message-ID: <9408271800.AA26422@ah.com>
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I just got back from CRYPTO '94 travels yesterday, and it's time to
continue some conversations.

Robert Hettinga and I were discussing some properties of potential
digital cash systems.  At least, _I_ call them potential.

   I meant "is". Like a triangle, or a limit, or an asymptote, "is".  It's
   okay to be non-modal here.

It's OK to be non-modal if you are asserting that your claims hold in
all possible such systems.  I do not agree with the assertion,
however, that all possible digital cash systems will be callable bond
systems.

   Digital cash has to be issued by someone, who
   *really should* back it up with real money, and should thus receive real
   money as collateral for the digicash on the net.  

The basic distinction that is missing in your analysis is that between
legal structure and financial structure.  Here is my very short
clarification of the difference.

-- The financial structure matters when things go right.
-- The legal structure matters when things go wrong.

Your financial analysis is fine, but also mostly irrelevant for
determining legalities.  I've never worried too much at all about the
financial structure for digital cash issuance, because I've always
thought it a straightforward problem to manage the backing portfolio.

   By the way, most people refer to a callable bond as a series of
   options, and that's how modern portfolio analysis is done on
   them.

This equation, callable bond = series of options, is relevant _only_
to the financial analysis.  The legal situation does not flow straight
forth, however, from the financial situation.

   Is "unit of account" a formal term here? Could you define it?

Unit of account is the currency that some deal is denominated in.  The
term implies that the units are fungible (interchangeable), and the
typical example is central bank based currencies.  But some deals are
denominated in terms of commodities, for example.

   >The issuer has a debt mediated by an instrument, yes.  There are,
   >however, more instruments than bonds available for use.

   Yes. But probably short term bonds (money markets, t-bills) are safe places
   to earn higher returns than a demand deposit account.  

I was not speaking above about where the float goes, but what
instrument is the means of transfer to implement digital cash.

   >Is the debt
   >secured or unsecured?

   It's secured by the cash which bought the ecash in the first place, which
   can be put into secure money instruments of some sort. 	

I think you misunderstand me.  Secured and unsecured are legal
concepts, not financial ones.  Merely saying that the money sits
somewhere while it's in transit (which it clearly does) does not make
the instruments secured.

   >What happens during bankruptcy of the issuer?

   This probably won't happen except in cases of fraud.  [...]
   Unwinding a position in the money markets is not really a scary
   proposition at all.

I would strongly suggest that you go look up some references to
systemic failure in payment systems, which is a big concern these
days.  And unwinding a position in the case of bankruptcy can create
real negative value in the system, and cause other banks to collapse.
Unwinding can be _very_ expensive.

Herstadt Bank (German) failed in 1974 and caused a huge crisis in
foreign exchange liquidity.  It had a substantial amount of foreign
exchange trades which had cleared in one jurisdiction but not in
another because of time zone differences.  So one set of trades was
finished and the other half was left holding the bag.  This sudden
shift almost caused several more bank failures.

The differential time lag is being addressed.  Bankruptcy, however,
remains a large issue.  Glossing over it as easy is not a good thing.

   By the way, what does "on-us" mean?

"On-us" means that the transaction took place between two accounts at
the same bank.

Eric