From: rah@shipwright.com (Robert Hettinga)
Date: Wed, 20 Dec 1995 00:30:33 +0800
To: cypherpunks@toad.com
Subject: (fwd) Economics of Digital Money. (part 2)
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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)
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        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 electronic play-money.  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 systems 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 smart cards 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 cash 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 coupons than with cash.  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 economys 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 digital cash, offering high levels of privacy and security.
Its current implementation by the Mark Twain Bank is not exclusive - any
bank licensing Digicashs eCash protocol could become an intermediary in
the eCash scheme.

To undertake transactions13, both buyer and seller would have to have deposits
in the WorldCurrency Access accounts of the Mark Twain Bank.
WorldCurrency Access 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 WorldCurrency Access account into his
eCash Mint.  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 electronic wallet.

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 sellers WorldCurrency
Access account.  The net result is a decrease in the buyers funds and an
increase in the sellers.

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 users hard disk drive should
crash, 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 users account are leakages from the
money creation process, in the same way that cash withdrawals are.  If a users
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 best.  Which system is
adopted depends largely on the needs of the transaction and the agents.
On the consumers 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 whos 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 Virtual Food Stamp 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 consumers 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 Electronic Transfer of Government
Benifits Federal Reserve Bulletin V.77 N.4 April 1991

2       D. Gleason as quoted by S. Levy E-Money (That's what I want)
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 The End of Money? 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 Showing credentials without identification: transferring
signatures between unconditionally unlikely pseudonyms (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
-------------------------------------------------------------------------------

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-----------------
Robert Hettinga (rah@shipwright.com)
e$, 44 Farquhar Street, Boston, MA 02131 USA (617) 958-3971
"Reality is not optional." --Thomas Sowell
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