Finance Without Fingerprints

American Banker aired this encouraging financial privacy video on Friday, February 15, 2013:
 

Physical cash is on its way out and won't be missed, but even in an all-digital future the option of anonymous, untraceable consumer payments must remain, Executive Editor Marc Hochstein argues. Bitcoin and past digital cash schemes show it is technically feasible and that banks can play a role. But regulations and the industry's conservatism augur poorly for payment privacy, and a frank and open debate will be required.

Related Articles:
A Dystopian Vision of Banking from the 'Mad Men' Era
Why Some Payments Should Remain Anonymous 

Will Banks Ever Be Digital Privacy 'Heroes'?

Bitcoin Presentation at DeepSec 2012

Thanks to all my friends at DeepSec in Vienna. It was great to meet you in person during the November 27-30th, 2012 conference.

The Evolution of e-Money (DeepSec) from Jon Matonis

The Evolution of E-Money

I introduced digital bearer certificates and bitcoin at the 7th annual ITWeb Security Summit in Johannesburg, South Africa (May 15-16th, 2012).

The Evolution of E-Money

For further reading:
"E-money raises privacy concerns", Nicola Mawson, ITWeb, May 17, 2012
"Bitcoin: a mobile money alternative", Gareth van Zyl, ITWeb, March 26, 2012

MintChip Misses the Point of Digital Currency

By Jon Matonis
Forbes
Thursday, April 12, 2012

http://www.forbes.com/sites/jonmatonis/2012/04/12/mintchip-misses-the-point-of-digital-currency/

A new digital currency from the Royal Canadian Mint dubbed MintChip boldly claims to represent "the evolution of currency." However, digital currency is not simply about taking official money and making it useful for online and offline environments in a digitized form. The point of digital currency, and especially free-market digital currency, is to broaden the avenues for issuance and adoption of alternative nonpolitical monetary units. Most electronic cash systems already expand and revolve around the State-issued currencies although they don't have to.

I am reminded of the Mondex experiment during the 1990s which is actually when I first met MintChip Challenge judge David Birch of Consult Hyperion. Originally and laudably, Mondex wanted to replicate the characteristics of physical cash via a smart card but due to centralized authorizations, it only embraced partial and contingent privacy for the user. The true test of any anonymous cash-like system is what happens when your device or digital tokens are permanently lost or destroyed similar to burning a paper $100 bill. If they can be recovered and returned to you, then you don't have full privacy.

Then there was DigiCash and the brilliant blind signature protocol from Dutch cryptographer David Chaum. Combining a powerful centralized issuing mint with true transaction irreversibility and anonymity, DigiCash would have flourished if it weren't for the legacy intermediaries that tend to insert themselves into fledgling centralized systems when they smell a loss of revenue. The misadventures of DigiCash paved the way for needing decentralized systems and bitcoin elevated it to marquee feature by resolving the double-spend problem through the distributed block chain.

Yes, the functional goals of MintChip are commendable and we have indeed come a long way when we witness a monetary authority advocating the protection of privacy and emulating the attributes of physical cash, even if they are trying to remove physical cash from circulation at the same time. At its core, MintChip is a smartcard integrated circuit that holds electronic value and can securely transfer value from one chip to another. Since it's based on tamper-resistant proprietary hardware and currently supports microSD cards, USB sticks, and special high-end hardware security modules, it can perform transactions without an intermediary.

According to bitcoin analyst Vitalik Buterin, "It even has a few advantages over Bitcoin; secure transactions are instant, it’s backed by the Canadian dollar and it even manages to solve the double spending problem without connecting to the internet." Cautiously however, Vitalik goes on to say:

"There are other aspects of the system that Bitcoin users are likely to object to. The currency creation model is centralized: value is originally injected into the system by the Royal Canadian Mint and customers can purchase value to spend by going through trusted brokers. The system is designed to be able to force upgrades, giving the Mint the power to introduce onerous tracking features over time if it so desires. Innovative means of value storage like paper and brain wallets are out of the question, since nothing can be done without the physical chip, and it’s impossible to have an online wallet that does not require trusting the provider."

Wow! That's a litany of show-stopping issues to be vigilant about -- not to mention the potential fallibility of the proprietary hardware and the sure-to-come AML (Anti-money laundering) provisions or arbitrary transaction size limitations. I get the feeling that MintChip might be better off if it processed in bitcoin units rather than Canadian dollar units but that would be redundant. Ironically, one of the leading ideas for the use of MintChip in the MintChip Challenge is to purchase bitcoin with it since it's irreversible.

My objection still lies with the fact that it is a non-free-market approach to the payments issue. Bitcoin has so far demonstrated its exchange value without being backed by anything that isn't backed by anything. Remove the standing armies and all money is essentially a mass illusion. Bitcoin just happens to be a voluntary, bottom-up mass illusion with scarcity, like gold.

If the integrated circuit chip is not hacked first, I can imagine a prestigious future gathering in the beautiful resort city of Victoria, British Columbia (similar to Jekyll Island in 1910) where the Royal Canadian Mint officials and the Government of Canada carve up the country into 12 MintChip Reserve Districts and bestow the privileged monopoly of issuance to their well-connected financier amigos. May the odds be forever in your favor.

For further reading:
"Canada Moves Closer to Cashless Society With Digital MintChip Currency", Alex Newman, April 16, 2012
"Bitcoin - The Libertarian Introduction", Erik Voorhees, April 11, 2012
"Bitcoin - Finally, Fair Money?", Scott Lenney, Mute, February 21, 2012
"The (Non-Monetary) Value of Cash", Rivendell, December 1994

Dot Coms Take Golden Opportunity to Trade in New Global Currency

By Leo Lewis
The Independent
Sunday, June 24, 2001

http://www.independent.co.uk/news/business/news/dot-coms-take-golden-opportunity--to-trade-in-new-global-currency-675226.html

Struggling to find its feet after a disastrous 12 months, the dot-com world has turned to the depths of the old economy for inspiration.

In an attempt to prompt more e-commerce activity across the globe, internet companies are hoping to establish gold bullion as an international web currency.

The idea, which was first devised about six months ago, has finally started to blossom. A variety of gold-based "currency" exchanges have now opened and the online bookseller Amazon.com is among a large number of websites that have now signed up to trade using the new system. Bought online, the going price for a Palm Pilot is 1.7oz of gold.

The thinking behind the project is to provide a secure, internationally recognised, unit for buying and selling goods over the web. Several Caribbean-based companies have begun storing gold in vaults in the main metals trading centres of London, Zurich and Dubai.

Instead of relying on credit cards, internet users can then buy pieces of that stored gold to make purchases anywhere in the world. The gold never actually leaves the vaults, making the whole transaction instantaneous.

As the inventor of this trading system, the Bahamas-based GoldMoney, has given the currency its name. A single GoldGram represents a gram of gold held in safekeeping, and at the current market price of $272 an ounce, a gram is worth about £6.

Although GoldGrams are aimed at all internet users, GoldMoney believes that the currency will be of most interest to businesses. Most transactions in cyberspace still involve national currencies, and companies doing business online have found the experience fraught with exchange-rate risks. The commission charge of $1 per trade is also far cheaper than bank fees for wiring currency.

GoldMoney, backed by the New York investment group Hyde Park Holdings, is now just one of several groups that believe gold is the future of the internet. E-gold, based on the island of Nevis in the Caribbean claims to have $14m worth of gold in circulation, and Virgin Islands-based Standard Reserve is equally bullish on its prospects. The idea of creating a global currency for the internet is not new. Cybercash, Digicash and Beenz all tried to set up digital money that could be used anywhere, but all three are now out of business. The founders of the various digital gold ventures argue that humans have used gold throughout the ages, and will turn to it in the new economy.

But the project has attracted the concerns of various crime-fighting organisations, and the US Treasury Department. They worry that the ease of hiding ill-gotten gains in virtual gold creates "tremendous opportunities for money laundering".

The digital currency entrepreneurs claim they seek only legitimate customers, but the speed and volume of transactions have left authorities fearing that the system will be virtually ungovernable.

How DigiCash Blew Everything

By Unknown Author
NEXT! Magazine
January 1999

http://www.jya.com/digicrash.htm

In September 1998 the high-tech company DigiCash finally went bankrupt. The office in Palo Alto, California remained open for a while but it was merely a stay of execution. Two months ago the company filed for Chapter 11.

Nobody realises, but with the "pending failure" of DigiCash, a bit of Dutch Glory died. The company made a brilliant product. Even Silicon Valley was jealous of the avant garde technology invented in the Amsterdam Science Park. Internet "guru" Nicholas Negroponte went so far as to call the electronic payment system, ecash¹, "the most exciting product I have seen in the past 20 years." The rise and fall of DigiCash: a story of paranoia, idealism, amateurism and greed.

David Chaum

The name of one man stands out way above anyone else in the history of DigiCash: David Chaum, US citizen, born into a wealthy family, brilliant mathematician and one who had to always have things his own way². After travelling around the world he ended up in Amsterdam in the late 80's. Here, he became head of the cryptography department of the CWI (Centre of Mathematics and Information Science). Cryptography is the science of encoding and decoding of data, in order to maintain privacy. Chaum had built a big reputation in this field in the previous few years. Insiders estimated he was in the top 5 of the world at the time.

And at the CWI, they also worked on electronic payment systems. In the early 90s, Rijkswaterstaat³ became interested as they were thinking about introducing automatic toll-collection roads. Chaum got together a few researchers, mainly from earlier contacts with the university of Eindhoven. All guys who knew each other through a "young researchers" programme sponsored by Philips. They had all spent their youth programming behind a computer. Enthusiastically they started, and within little over a week the job was done.

DigiCash

Rijkswaterstaat was satisfied and the team got another assignment. That was the moment when Chaum smelt money. Why couldn't he turn the patents he claimed in the 80s into money? On the 21st of April, 1990, the company DigiCash first saw light of day. Unfortunately Rijkswaterstaat decided to put the advanced system on the shelf and to continue with the old standby, number plate recognition. Chaum could have divested himself of the company and continued his work at the CWI, but he had apparently tasted the forbidden fruit of business. He decided to market his research other ways: smart cards, point-of-sale applications, cash registers and tele-banking. Of course, he had to quit his job at the CWI because of the risk of conflict of interest.

Financing of the company was done privately by the American. Former DigiCash employees agree that Chaum and his wealthy family had at least contributed a few million.

It all started out quite nicely. The brand new company sold a smart card for closed systems which was a cash-cow for years. It was at this time that the first irritants appeared. Even if you are a brilliant scientist, that doesn't mean you are a good manager. David Chaum was a control freak, someone who couldn't delegate anything to anyone else, and insisted upon watching over everybody's shoulders. "That resulted in slowing down research," explains an ex-DigiCash employee who wished to remain anonymous. "We had a lot of half-finished product. He continuously changed his mind about where things were headed."

This drove a few people crazy and it didn't take long before the first few turned their back and started their own company. In 1992 Boudewijn de Kerf and Eduard de Jong quit the company and went to Silicon Valley where they invented and sold an operating system to Sun Microsystems for a substantial sum.

Ecash

Annoying as he was, David Chaum had brilliant ideas. In 1993 he invented the digital payment system ecash. According to insiders, it was a technically perfect product which made it possible to safely and anonymously pay over the Internet. This was a field in which a lot of work needed to be done, according to the ever-paranoid cryptographers. They considered that to pay with your credit card was extremely insecure. Someone only had to intercept the number to be able to spend someone else's money. Credit cards are also very cumbersome for small payments. The transaction fees are simply too high. Ecash however was perfectly suited to sending electronic pennies, nickels and dimes over the Internet.

It was especially this idealism that prevented people from leaving the stubborn Chaum. Enthusiasm waxed for the elegance of his perfect inspirations. There were even people flying in from the US to witness the birth of something this beautiful, which was unusual, as this is usually only associated with big pay checks plus leased Mercedes in the parking lot⁴. An ex-employee: "And no nonsense like 'We are going to make this company as big as possible, as soon as possible, and cash out'. No, we really wanted to make this product as big as possible." People who visited and walked around the Matrix building of the Amsterdam Science Park acknowledged that there was a young and dynamic atmosphere. No fast suits, but more like a school-yard gang. Real whiz kids who got coffee from the machine with their own electronic gadgets.

Legendary Suspicion

But even this enthusiasm was unable to withstand the bad feelings generated out of decisions made by CEO David Chaum. Almost every ex-DigiCash employee who you ask is able to tell you a story of his legendary suspicion. "Paranoid" is a word frequently heard. Raymond Stofberg, nowadays owner of the Internet company EURO RSSG Interactive, was responsible for DigiCash financial affairs until August 1996. He explains the story from the beginning. A few years ago Stofberg came to an agreement with Henderson Investment Management. They would invest two tranches for a total of 10 million dollars. When Chaum saw the agreement, he immediately faxed it to all the other venture capitalists which he was negotiating with. Via message drums, word leaked out to Henderson, and the agreement was cancelled.

A little later ING Investment Management was interested. This deal was about twenty million guilders⁵. The plans were all laid out. ING Barings together with Goldman Sachs would also bring DigiCash to the stockmarket within two years. "The day we were all set to sign, David didn't want to", tells Stofberg. "He was so paranoid, that he always thought something was wrong. There were 8 people from ING, including the CEO, and David simply refused to sign!"

Earlier Chaum was contacted by the unavoidable Bill Gates of Microsoft. He would integrate ecash in every copy of Windows 95. Rumor had it, the giant from Seattle offered something like 100 million dollars. David Chaum refused to sell it for less than 1 or 2 dollars per sold copy and that stubborn attitude killed another agreement. "A really sad story," reflects Stofberg. Chaum killed an agreement with another American company, Netscape, in the same way, by insisting straight away that everybody sign non-disclosure agreements, even before negotiations had started. Exit Netscape.

DigiCash was also involved in the first version of I-Pay⁶. The contracts were there, just the signatures were missing. But a week before the deal was made Chaum decided to tell a large Dutch newspaper that the Chipper and Chipknip systems⁷ were absolutely insecure. "The smartcard is broken," he said. The banks had just invested 250 million guilders in the system, so it wasn't surprising that ABN-Amro executive De Ribourdouille personally killed the DigiCash deal.

David Chaum always bailed out at the last moment. Early 1996 there were negotiations with credit card company Visa. The Americans wanted to invest forty million dollars in the company. "But David suddenly demanded 75 million," Raymond Stofberg recalled. "Get lost," was Visa's reply. Retrospectively, a lot of ex-DigiCash employees understand why Chaum was so paranoid. As a cryptographer you have to assume the whole world is trying to rip you off. A certain amount of paranoia is part of the job. Chaum had also worked for intelligence agencies, and that didn't fortify his faith in the good intentions of humankind. His vision of the privacy of the individual was almost an obsession. In 1996 he said, in the relations magazine of Honeywell-Bull: "The difference between a bad electronic cash system and well-developed digital cash will determine whether we will have a dictatorship or a real democracy."

Whilst David might have had little faith in humankind, the employees were getting annoyed with their director. In the beginning they forgave him if another promising deal didn't go through, because David always said there were bigger fish to catch. The world was at their feet. It had to be, because in the whole world there was no product that could even come close to DigiCash. It was this feeling of technological superiority and arrogance that would kill DigiCash. The employees weren't only annoyed with the deals that were cancelled a few days before being closed, but also about the work environment. "David is a real nice guy and you can have a lot of fun with him, but at the same time he abused this employees," tells an ex-employee who wants to stay anonymous. "He always expected an enormous commitment⁸; once every few weeks you had to work for nights on end." "And there was nothing to compensate for that. Once you were lured inside, you never received pay rises, no extras, nothing. That was very frustrating, but they kept the carrot in front of the donkey⁹ with the promise that 'once we make that big deal, we'll all be rich.' " "But we never got any shares. It was a hollow promise."

The Coup

In March 1996, tensions had reached a critical level. The irritation over a series of blunders led to a meeting of eleven important employees. They decided to give David a simple choice: "You're out or we're out." "That was the only way David could no longer fuck up the company," said one of them. The plan was to set up their own company, it had been done before, ex-DigiCash people had set up their own company with success. Accepted tradition¹⁰ has it that two out of the eleven members - Jelte van der Hoek and Wouter Habraken - went to David who panicked and immediately made them interim-managers. He then disappeared into the background, and eventually returned to the US a year later.

The remaining nine co-conspirators were not happy, but they accepted it for the moment. They had achieved their objective of getting rid of Chaum. But this acceptance was soon replaced with anger at the two new managers. "Jelte was a technical guy, who had been programming since he was seven, he couldn't manage at all. And Habraken wasn't suited either. He was too much a deal-maker, not a manager," according to an ex-employee.

Wouter Habraker wasn't impressed with the criticism. From Australia he emailed: "DigiCash was founded by crypto-people, and good crypto-people are a bit paranoid. That's why it's not surprising there are different views on the Jelte's and my reasons. That's a pity, but our objective was to get investment and find a new manager. And that's what we did." Nonetheless frustrations grew. "Three weeks later, I found out they wanted to bypass me and get rid of me," said Raymond Stofberg. "From that time on I knew for sure that Chaum had trusted the wrong people." Other employees shared that belief and hardly 3 months after things had settled down there was a exodus of employees. Since then there is an in-joke that goes: "If you can survive DigiCash, you can handle anything that life throws at you." Amazingly enough DigiCash was still a very sexy company for the rest of the world. A rising star in a world where Internet companies like Netscape and Yahoo showed there were enormous risks, but also enormous benefits. DigiCash was hot and venture capitalists were stampeding to invest in it. Early in 1997 it received an investment of a total of sixteen million guilders from Gilde Investment, a daughter company of the Rabobank, and also Nicholas Negroponte, director of the Media Lab of MIT and writer of visionary books about the Internet. Also included was the well-known venture capitalist, David Marquardt, general partner at August Capital.

A new CEO

The new investors immediately appointed a new Chief Executive Officer: Michael Nash, an American from the credit card company Visa. Most employees didn't really like Nash. "Fast guy, smooth talker, but no content," said one. Nash came from a big bureaucratic company and had no clue on how to run a small company that had to fight in the front line. There were also angered at the fact that Nash immediately opened an office in Palo Alto. You could justify the decision from a marketing point of view, but the result was that the development was split. The costs sky-rocketed to a completely new heights, because the communications between the two departments was slow and cumbersome. The salaries in Silicon Valley were of course much higher than in the Amsterdam Watergraafsmeer¹¹. And the American programmers absolutely didn't do a better job then their Dutch colleagues. According to an ex-employee, Nash had his head in the clouds¹². Everyone had to work on avant garde products like ecash, for which there was only a very slowly growing market. Real products, with which good money could be made, like smart cards and road-toll systems, were left to slowly die. "Mike would rather talk to Swatch, because he wanted ecash in watches. That didn't help us at all, because ecash is made for a PC. You are allowed to shout about futuristic things, but you should not believe in the hype you have yourself created." DigiCash did have a very impressive board with, for example, David Chaum - who had disappeared into the background - and the influential Nicholas Negroponte. But what good did those names do for the company? "A guy like Negroponte is only there for his image," says yet another ex-employee. "For relatively little money he had a share in a high profile company. But that doesn't help with the management of the company itself. Negroponte is just like any ordinary rock star, he gets out of the plane and when he walks down the stairs he still doesn't know which country he is in. That's been very destructive."

The Credit Card Triumphs

Meanwhile the management tried very hard to sell the ecash system to banks and was more or less successful in it. The Mark Twain Bank, in America, was the first to experiment with ecash. Later, another 7 banks followed, banks like Deutsche Bank and Credit Suisse. Banks are very conservative, they did business with DigiCash to prevent them from falling behind, not to storm ahead and be the first. DigiCash never dealt with the "normal" departments but always with a "special product" department. And why would the banks be in any hurry to implement the revolutionary new systems of DigiCash? The electronic payment market was dominated by credit cards, and plenty of money was made off them.

Neither were consumers so unhappy with the current situation. They weren't too convinced about the possibilities of fraud; even if something did go wrong, they weren't the ones to pay, the credit companies were. No worries there. They didn't really care about anonymity either, and certainly with the delivery of physical products this was completely irrelevant.

Everything was in stalemate. The banks were not in a hurry, the consumers didn't see any advantages. Although providers were the ones who would profit mostly from micropayment systems like ecash, they couldn't do anything but wait and be patient. Imagine: CNN receives millions of hits on their website every day. If you could ask one cent every time someone requests a page, that would make millions every year.

Halfway through 1998 everything seemed lost. The high salaries - estimates were that they were shelling out a million a month - quickly ate away reserves and there were no revenues to compensate for that. The company never had a clear marketing strategy. It wasn't till June 1998 that the sales manager at the time, Jan Kees Dunning, chose to change tactics. The dogma of Chaum, that DigiCash should aim for the virtual world, was abandoned. It was no use trying to compete against the credit card companies; they would squash you if you upset them.

Citibank

Jan Kees Dunning explains that from now on, ecash should be offered as a part of a complete range of payment methods. "No longer as the money maker for banks, because it was never that. All banks suffer losses on the traditional payment systems, and with a much cheaper system you could only minimize those losses." "Nowadays, a consumer isn't that loyal anymore. He demands from his bank that it offers all services, if they don't he'll just switch to another bank. Ecash has to be one of those services."

At least that was a clear strategy. But once again things were ruined, this time because of never-ending negotiations with the big American CitiBank. Citibank was a very attractive partner for DigiCash. In the first place, there was a large amount of clients: seventy million. Just as important, the backing of Citibank might convince the other, more skeptical, banks. Citibank is known as very aggressive. In the 70s they introduced a universal payment system which enabled them to have very competitive fares and services. If they had started with ecash, none of the other banks could have afforded to lag behind.

But at the crucial moment Citibank decided to merge with the Traveler Group, which focused attention away from DigiCash. At the same time, the stock market valuation of CitiBank dropped to about half of recent values and at times like that, knee-jerk management rules in the US. So much for DigiCash.

Jan Kees Dunning is convinced that the business could have turned out differently to the fatal chain of events that seems to have happened. He estimates that DigiCash needed only another six months to secure a breakthrough. But the American venture capitalists had had enough at this point. They first pulled the plug on the Amsterdam team, and the Palo Alto team is currently floating between life and death¹³. Only six people remain with the company, and the one thing the new CEO Scott Loftesdale [sic]¹⁴ - Mike Nash was fired in August of 1998 - has left to do is announce the firesale of the DigiCash patents. Which are getting cheaper every minute, because the people who developed the product have all found work elsewhere. The ecash project now conjures up a feeling of history, dead and buried¹⁵. There has not been any product maintenance, and that's fatal in an environment where everything is changing this rapidly. The future of especially ecash is very uncertain. Either it is sold for a maximum of five million guilders to a company like IBM, who has lagged two years behind with a similar product, according to Dunning, or it disappears. A sad fate for a path-breaker in a digital technique which will have completely eliminated regular cash in, say, twenty years. Everybody is convinced of that; the days of cash are numbered. It's too expensive, too cumbersome and too old-fashioned. David Chaum has since been seen around Berkeley, walking with his soul under his arm¹⁶. He was far ahead of his time. Too far.

Translators Notes

1 In the original article, the two words "e cash" were used.

2 "Tot op het bot."

3 Dutch Department of Public Works. Responsible for waterways and roadways.

4 "Lease-bak" is a derogative term in Dutch.

5 About 10 million dollars. The guilder trades at 1.8 to 2 per dollar.

6 A Dutch payment system operated by a cartel of all major Dutch banks.

7 Smartcard systems operating competitively in the Dutch market.

8 "Inzet."

9 "Hielden aan het lijntje."

10 "Volgens de overlevering."

11 Suburb in Amsterdam where the Science Park was located.

12 "Met zijn hoofd in de wolken."

13 "Zweven tussen leven en dood."

14 Scott Loftesness.

15 (German) "Das war einmal."

16 "Lopen met zijn ziel onder de arm."

Editor's note. This was translated by some Dutch natives, and then edited by myself for style. Tricky job really as translation should be done into one's native language. No promises as to accuracy! --Ian Grigg

For further reading:
"Past currency", Steve Bowbrick, Guardian, February 25, 2003
"Digging Those Digicash Blues", Declan McCullagh, Wired, June 14, 2001
"DigiCash: Failure is Interesting", Felix Stalder, December 1999
"Behold the Automated Till", Peter Cassidy, December 1999
"FM Interviews David Chaum", Jens-Ingo Brodesser, First Monday, July 5, 1999
"Digicash files Chapter 11", Tim Clark, CNET News, November 4, 1998
"E-Money (That's What I Want)", Wired, December 1994

IEEE Spectrum Special Issue: Electronic Money

IEEE Spectrum Volume 34, Issue 2
Special Issue: Electronic Money
February 1997

Table of Contents

Electronic money: toward a virtual wallet
Tekla S. Perry
Pages: 18 - 19

The future of electronic money: a regulator's perspective
Edward W. Kelley, Jr.
Pages: 21 - 22

Credits and debits on the Internet
Marvin A. Sirbu
Pages: 23 - 29

“Minting” electronic cash
David Chaum, Stefan Brands
Pages: 30 - 34

Traceable e-cash
Peter S. Gemmell
Pages: 35 - 37

Crime and prevention: a Treasury viewpoint
Stanley E. Morris
Pages: 38 - 39

Locking the e-safe
Robert W. Baldwin, C. Victor Chang
Pages: 40 - 46

In your pocket: smartcards
Carol Hovenga Fancher
Pages: 47 - 53

Banking in cyberspace: an investment in itself
Michael C. McChesney
Pages: 54 - 59

Technology takes to securities trading
Steven M. H. Wallman
Pages: 60 - 65

Nasdaq's technology floor: its president takes stock
Alfred R. Berkeley, III
Pages: 66 - 67

The economics of e-cash
Mike ter Maat
Pages: 68 - 73

Money and the Internet: a strange new relationship
Howard Anderson
Pages: 74 - 76

The End of Cash

By James Gleick
The New York Times Magazine
Sunday, June 16, 1996

http://www.around.com/money.html

Cash is dirty -- the New Jersey Turnpike tried to punish toll collectors recently for wearing latex gloves (thus giving the driving clientele a "bad impression"), but who can blame them? Cash is heavy -- $1 million in $20 bills weighs more than you can lift, and drug dealers have been disconcerted to note that their powdered merchandise is handier for smuggling than the equivalent money. Cash is inequitable -- if you are one of the 50 million Americans poor enough to be "unbanked," you pay extortionate fees to seedy, bulletproofed check-cashing operations (even more extortionate than the fees charged for automatic teller machines, often up to 1 or 2 percent and rising). Cash is quaint, technologically speaking -- unless you're impressed by intaglio-steel-plate-printed paper with embedded polyester strips (meant to inconvenience counterfeiters). Cash is expensive -- tens of billions of dollars drain from the economy each year merely to pay for the printing, trucking, safekeeping, vending, collecting, counting, armored-guarding and general care and feeding of our currency.

Read the rest of the article.

The Future of Money

By Kelley Holland and Amy Cortese
BusinessWeek
Monday, June 12, 1995

http://www.businessweek.com/1995/24/b3428001.htm

E-cash could transform the world's financial life

In his pinstriped suit and wire-rimmed glasses, Timothy L. Jones looks every bit the traditional British banker. Sure enough, he has spent a dozen years at National Westminster Bank PLC. But ask Jones what he is doing now, and he responds with an intensity worthy of a Silicon Valley entrepreneur. Leaning across a table, he waxes eloquent about his new enterprise, Mondex, and the future of the product he's selling: a new kind of electronic money.

Mondex, which was launched by NatWest, is not alone:
A raft of companies are developing their own forms of electronic money, known as E-cash. E-cash is money that moves along multiple channels largely outside the established network of banks, checks, and paper currency overseen by the Federal Reserve. These channels enable consumers and businesses to send money to each other more cheaply, conveniently, and quickly than through the banking system.

Some of the E-cash players are faceless, dubious outfits that exist in cyberspace and can be traced only to a post-office box--in the physical world. But there are plenty of others, ranging from techno-savvy startups with names such as DigiCash and CyberCash, to corporate icons including Microsoft, Xerox, and Visa. Citicorp is even developing what it calls the Electronic Monetary System, an entire infrastructure for using electronic money to be issued by Citi and other banks.

These companies are part of a mass experiment that could transform the way we think about money. In the process, it could change consumers' financial lives and shake the foundations of global financial systems and even governments.

Digital money is the ultimate--and inevitable--medium of exchange for an increasingly wired world. With E-cash, you'll no longer need to carry a wad of bills in your pocket or fumble for exact change. Instead, you might carry a credit-card-size piece of plastic with an embedded microchip that you will ''load'' up with E-money you buy with traditional currency. Or, you might store your digital coins and dollars--downloaded over phone lines from your bank or other issuer of E-money--on your PC or in an electronic ''wallet,'' a palm-size device used to store and transmit E-money.

This digital money will let you shop online, zapping money to a merchant over the Internet, or perhaps paying for a movie on demand over an interactive-TV network. It also has the potential to replace cash and checks for everyday purchases--in stores, restaurants, or taxis that accept E-cash. Businesses could also keep a stash of E-cash on hand for buying office supplies, or use it to transact directly with each other instead of going through banks and electronic funds transfers.

THE START OF A REVOLUTION. In many ways, E-cash, which can be backed by any currency or other asset, represents the biggest revolution in currency since gold replaced cowrie shells. Its diversity and pluralism is perfectly suited to the anarchic culture of the Internet and the evolving web of networks known as the Information Superhighway. ''Electronic commerce will literally change the way business is done worldwide,'' says James G. Cosgrove, vice-president and general manager for business multimedia services at AT&T. ''We're about to see another revolution similar to the Industrial Revolution.'' Adds Richard K. Crone, senior manager in the financial-services group at KPMG Peat Marwick: ''We're in the beginning stages of the cash-replacement cycle.''

But the advent of E-cash raises all sorts of questions, most of which remain unanswered: Who should be allowed to issue E-cash, and who will regulate those issuers? How will taxes be applied in cyberspace, which transcends physical boundaries? Who will set the standards? How do you ensure that payments made over the Net will be secure? How will consumers be protected? How will regulators police money laundering and counterfeiting on private networks?

While regulators wrestle with these questions, technology is remaking the monetary system. That's what Microsoft CEO William H. Gates III had in mind when he bid for personal-finance software maker Intuit Inc. He saw programs such as Intuit's as the gateway that would draw millions of consumers onto his online network where they could pay bills, get financial advice, or shop, perhaps paying him for access. But the Justice Dept. worried about Microsoft's reach, and he abandoned the deal on May 20.

Tough break, but it will hardly slow Gates down. Microsoft is working with Visa on a system for securing credit-card transactions over the Net. But that's just one piece of a much bigger problem Microsoft is trying to solve. Gates has dozens of programmers busy devising a sweeping system, Microsoft Network, to help people do business safely in cyberspace--or more specifically, in Microsoft's own network and interactive-TV systems--using a range of payment options. Microsoft won't reveal much about its E-cash plans, but, says Nathan P. Myhrvold, Microsoft's top advanced-technology expert, ''we're very interested in the area.''

They should be. The stakes are enormous. Seamus McMahon, a vice-president at Booz, Allen & Hamilton, sees as much as 20% of total household expenditures taking place on the I-way just 10 years from now. If any operation, whether Citicorp or a startup such as Mondex, gained control of a new medium for even part of those exchanges, it would have the opportunity to charge royalties or fees for its use and earn interest on the E-money sitting in its accounts. Even a tiny charge, when applied to millions of transactions, would be highly lucrative.

E-cash could also create a competitive free-for-all. Because the Internet knows no boundaries, a company offering E-money can gain direct access to millions of consumers and businesses--no matter what state or country they are in. ''The retail banking market will collapse and give way to global competition,'' says Eric Hughes, president of Open Financial Networks, a Berkeley (Calif.) consulting firm. ''Those [regional] separations don't work on the Internet.''

WINNING CONSUMERS' TRUST. Governments' and central banks' control of money flows has already been loosened, as shown by recent currency and market crises in Mexico and elsewhere. But with the growth of E-cash, money could flow in and out of countries at lightning speed without being traced, weakening governments' ability to monitor and tax. ''Over the long haul, this is going to lead to the separation of economy and state,'' declares Bill A. Frezza, president of Wireless Computing Associates and co-founder of the advocacy group DigitaLiberty.

The growth of E-money could also be bad news for banks. If other companies successfully offer their own brand of digital cash, they could bypass banks as primary providers of consumer financial services. The companies, not the banks, might be consumers' first contact when they wanted to obtain some digital money. ''Banking is essential to the modern economy, but banks are not,'' says J. Richard Fredericks, senior managing director at Montgomery Securities.

Commercial banks are, of course, entrusted with the creation of money through the fractional reserve system. They lend out more than they have on deposit, and they are the only companies authorized to do so. If each unit of E-cash had to be backed by a corresponding unit of traditional currency, that would mean that lending out E-cash wouldn't create new money. But if nonbank money suppliers started backing just a fraction of their digital cash with traditional money--just as commercial banks today keep on hand only a fraction of the deposits on their books--nonbanks, which are largely unregulated, could create money just as commercial banks do now.

Bankers must move fast to keep up. Ronald A. Braco, head of electronic banking at Chemical Bank, estimates that banks have less than five years to come up with viable E-money products before other players carve out the biggest chunks of the market for themselves. ''No question, it's for real,'' says Richard M. Rosenberg, chairman and CEO of BankAmerica Corp. In a couple of years, ''it will take off fairly dramatically.'' The issues now: winning consumers' trust and getting them to change their buying habits.

The first step in that direction could be to get consumers used to using credit cards for purchases on the Internet. Once that happens, the thinking goes, they may be willing to start using E-cash systems.

One of the first purveyors of a Net credit-card system is First Virtual Holdings, run by onetime celebrity manager Lee Stein. Stein has launched a relatively simple system using E-mail that lets consumers use credit cards on the Internet without fear that their account numbers will be misappropriated. The card numbers are stored away on a protected computer system and never pass over the network. Instead, consumers register with First Virtual by phone and receive I.D. numbers in exchange for their card numbers. When they want to buy something electronically, they simply supply their I.D. number to the merchant.

First Virtual, which became the first secure payment system on the Net when it handled its first transaction last October, is growing fast. Stein won't disclose activity levels, but he says volumes are increasing by 16% a week. ''If you make it simple and safe, people will use it,'' he says. First Virtual has enlisted such merchants as Apple Computer, Reuters, and National Public Radio--which sells transcripts of programs.

Most electronic extensions of the credit-card system, though, are built around encryption--scrambling card numbers so they can pass safely on electronic networks. For example, CyberCash Inc., a Reston (Va.) startup, is cutting its teeth on a deal with Wells Fargo & Co. for encrypted credit-card transactions over the Internet.

Visa and MasterCard, not surprisingly, are also working to make credit cards usable on the I-way. Visa is, among other things, developing with Microsoft a system using encryption technology that they hope will become an industry model. ''We want to be sure that the industry as a whole has certain standards,'' says Carl F. Pascarella, president and CEO of Visa USA. Meanwhile, MasterCard has teamed with Netscape Inc., a maker of security and browsing software for the Internet, to pursue a similar goal.

WILTSHIRE EXPERIMENT. Credit-card-based systems have the advantage of seeming familiar to consumers. But the card systems don't do everything cash can: They're not anonymous, they do not work person-to-person, and they have credit limits. They're also not suited for the grassroots economy the Internet makes possible, where any outfit or individual can sell its wares, whether a newsletter or a stock tip.

That's where E-cash comes in. But E-cash needs to be just as secure as credit cards for people to use it. David Chaum, CEO of pioneer DigiCash in Amsterdam, has done the most to solve this problem. He has devised a clever system that uses so-called public-key cryptography that, like encryption, makes it possible to send sensitive information over the Net. But Chaum's big breakthrough was ''blinding'' technology, which lets the issuing bank certify an electronic note without tracing whom it was issued to. The result: Your E-cash, unlike an encrypted credit-card transaction, is as anonymous as paper cash.

Chaum has yet to announce firm deals with companies to issue his E-money. But in a pilot, some 5,000 consumers are part of a DigiCash marketplace, using the equivalent of $1 million in E-money to do business with 50 companies, from Encyclopaedia Britannica Inc. to Ricky's Junk Shop. Chaum's technology is also at the heart of CAFE, a European Commission-sponsored project to develop an electronic wallet for pan-European use.

CAFE's setup is similar to Jones's Mondex system. ''Imagine it's the same as physical money, and you won't be far off,'' says Jones. Mondex money will be created initially by NatWest and a partner, Midland Bank PLC, which will then ''sell'' it to customers. The E-money is loaded onto credit-card-size ''smart'' cards with embedded microchips. The cards can be used in point-of-sale terminals or fit into electronic wallets that can transmit money to merchants or--just as with traditional cash but not with credit cards--to other consumers. Mondex money is still in pilot form, but the company has signed up 40,000 consumers and over 1,000 retailers in the Wiltshire town of Swindon to test Mondex money beginning in July.

CyberCash, too, is experimenting with E-cash in addition to its credit-card-based system. In the E-cash system, consumers will set up E-money accounts at their banks. Then, using proprietary software provided free of charge by CyberCash, they can go about their business on the Net. At the end of the day, CyberCash will clear all the E-money transactions and convert E-cash balances back to dollars.

No matter who develops the best E-cash, consumers and businesses alike stand to reap sizable benefits. No longer will consumers have to wait for change or scurry to automated teller machines for cash--out of sight, they hope, of the nearest mugger. E-cash will let businesses carry out transactions around the world without transferring bank funds--and they will be better able to reach a large population of technologically savvy, often affluent consumers.

Moreover, because E-money is basically software, it can be programmed to do things that paper money could never do. Microsoft's Myhrvold explains that electronic money could be earmarked for special purposes, with conditions on where it can be spent. For example, a business could have an electronic version of petty cash to be used for supplies at an Office Depot--but not a beer at the local tavern. Or parents could wire to a college student E-money that is designated for rent or books. ''There will be new forms of smart money and payment systems that can only be done online,'' says Myhrvold.

Along with the opportunities, though, comes huge uncertainty. Existing monetary regulations don't cover all of the potential uses of E-cash. Nathaniel S. Borenstein, a computer scientist and co-founder of First Virtual, says: ''One of the hardest questions merchants ask us is, 'When do we owe taxes?''' That's not a trivial question: With E-money, the merchant could be in Guam and the buyer in Canada, while First Virtual's computers are located in Ohio. So whose sales tax do you pay? Borenstein's advice to merchants: ''I tell them to consult a lawyer.''

There's also a major potential for crime (page 78). E-money can be easily sent in and out of a country undetected, facilitating money laundering on a grand scale. Tax evasion could become a matter of pushing a button. And without foolproof cryptography, counterfeiters could replicate the series of digits that constitutes E-money. Governments would be hard pressed to monitor or control stateless E-money. ''Digital cash is a threat to every government on the planet that wants to manage its currency,'' says David E. Saxton, executive vice-president of Net1, a startup that has developed a secure way to send electronic checks across the Internet.

BATTLE OF THE LOGOS. Even law-abiding citizens and companies using E-money could be victims of sophisticated hacker attacks. Says Colin Crook, senior technology officer for Citicorp: ''We have to assume electronic money will be the subject of sustained attack from all kinds of people.''

Another open question--and a large one--is the role of banks in the new electronic world. ''E-cash will be offered by both banks and nonbanks,'' says Chaum. Sure enough, DigiCash or CyberCash could join forces with AT&T or Microsoft just as easily as with Citibank. Having one of those companies dispensing E-cash directly to consumers could do serious damage to banks' main link with their customers.

Even if banks are involved, they could find other players taking center stage. Early entrants to the E-money business could set the operating standards for digital cash. And the nonbanks could even devise systems that would make their logos the first thing people see. William M. Randle, senior vice-president at Huntington Bancshares, warns that banks could become ''buttons on a network operated by other entities.''

Improbable? Not really. Take a look at credit-card processing. Twenty years ago, banks owned the card-transaction-processing business. Now, close to 80% of card transactions are processed by nonbanks such as First Data Resources Inc., says KPMG's Crone.

A similar erosion has occurred in wholesale banking, where banks have ceded to such outfits as General Electric Information Services and Electronic Data Systems Corp. nearly the entire market for transferring payment data to corporations, leaving themselves the mundane, low-margin service of transferring money between corporations. Today, says banking consultant Edward E. Furash, although the situation is improving, fewer than 100 banks offer full-service electronic data interchange, as the data part of payments transmission is known. ''We should do more of that,'' says Richard Matteis, head of Chemical Banking Corp.'s Geoserve unit.

Banks have one key advantage: a near lock on consumers' trust when it comes to depositing money. For that reason, many bankers tend to dismiss the threat implicit in E-money. ''The reason financial institutions are going to win in the long run is trust,'' says Kawika Daguio, the American Bankers Assn.'s federal representative on operations and banking. Indeed, many E-cash makers are choosing to partner with banks because of that consumer trust. ''We've positioned ourselves to work with the banking industry and make sure that if there are heroes in this, it is the banks,'' says William N. Melton, CEO of CyberCash.

But Microsoft's bid for Intuit last fall gave bankers a collective scare. And even though the deal did not work out, banks worry that Microsoft could hook its 70 million Windows customers into the electronic-commerce networks that it is developing--with or without banks' help. If Microsoft becomes a utility, ''it will take a lot of business from the banks,'' says Montgomery's Fredericks.

Now several of the biggest banks are pushing hard to develop E-money. Citibank's Electronic Monetary System is one of the most advanced bank offerings, although officials there stress that it is still in development. It would allow retail and business customers of Citi--or any other bank that paid to use Citi's system--to convert money in their accounts to electronic cash. Citi customers would also have access to a credit line they could draw down in E-money, just as they would use a credit card. Banks ''should be experimenting,'' says Sholom Rosen, vice-president for electronic commerce at Citi. ''That's what we're doing.''

Beside NatWest and Midland, Bankers Trust Co. has a group dedicated to electronic commerce. And even some regional banks see opportunities. There is Wells Fargo's work with CyberCash. First Union Corp., based in Charlotte, N.C., has created an electronic mall for Internet transactions. Even Cardinal Bankshares Inc., a $607 million Lexington (Ky.) bank, on May 24 formed a new subsidiary, Security First Network Bank, which aims to grow into a full-service interactive bank on the Internet. ''We'll be a one-branch bank in Kentucky with potential customers all over the U.S.,'' says CEO James S. Mahan III.

While it's not clear who the players will be 10 or even 5 years from now, it is inevitable that much E-money will originate outside the purview of central banks such as the Federal Reserve or the Bank of England, which are largely responsible for traditional monetary regulation. And that has major policy implications.

To begin with, consumers using the stuff could be extremely vulnerable. When consumers lose their credit cards, they are only liable for the first $50 of charges on the card. But for now at least, if a consumer misplaced, say, a Mondex card, it would be like losing cash. Similarly, if your digital coins are stored on the hard drive of your PC, a system crash could wipe out your electronic savings.

Electronic money also creates vast opportunities for tax evasion, money laundering, and other financial crime. ''There is an imaginable potential for a serious challenge to the whole political and social order,'' says First Virtual's Borenstein. ''I am not all that sanguine that the government has the control they think they do.'' For people trying to avoid paying taxes to a national government, the lure of a stateless currency would be powerful indeed. Already, ''virtual currencies'' serving electronic communities of people are springing up on the Internet.

Then there's the issue of the volatility of money. The effects of high-speed electronic trading have been painfully apparent in market crises over the past several years. Market swings could be magnified if consumers and businesses could send their money around the globe with the touch of a button on a PC.

The monitoring of national money supplies will also change. While some regulators dismiss the issue, arguing that E-money will inevitably convert back to traditional money and get counted, other experts disagree. Martin Mayer, a guest scholar at the Brookings Institution, says that he expects the Fed to lose control of a significant portion of the money supply.

One of the most pitched debates is likely to be over privacy. As a society, we have relied on a system that allows us to keep some transactions private by using cash, while others, such as big-ticket purchases, are entrusted to a credit-card company or a bank. Competing forms of E-cash offer wildly differing degrees of privacy: DigiCash's E-money offers virtually complete anonymity, while every dollar you spend using the credit-card-based systems would leave a trail. The problem will be balancing individuals' rights to privacy with government's need to monitor money flow and trace criminal activity.

BREAKING INTO THE E-MINT. More dire is the possibility of major break-ins to E-money systems--the electronic equivalent of penetrating the U.S. Mint. If someone were to crack the sophisticated code of, say, the DigiCash system, he could start minting unlimited amounts of his own DigiCash money.

That's why it is all the more alarming that some regulators and even some central bankers still seem unconcerned with the advent of E-cash. After a breakfast speech to several hundred business leaders in San Francisco last March, Fed Vice-Chairman Alan Blinder was asked whether the Fed is studying the regulatory issues surrounding digital cash. His answer: ''Digital what?'' Then, after pausing a moment, he added: ''It's literally at the thinking stage.''

Slowly, though, some regulators are beginning to explore the concept of E-money so they can set policies. The Federal Reserve's payment-systems committee is meeting with Chaum of DigiCash and other E-money pioneers. State tax collectors are looking at the issue of taxing electronic commerce. The Financial Crimes Enforcement Network is also weighing in. Even the White House technology office is taking a big interest.

It's not a moment too soon. ''There's no going back,'' says DigitaLiberty's Frezza. ''The genie's out of the bottle. The Internet doesn't have an off switch.'' And no amount of wishing by regulators will change that.

The New World Of E-Cash

THE GOOD
E-cash is more convenient and flexible than traditional money. It can be used by consumers and businesses, and for everything from buying wares on the Internet to lending a pal five bucks.

Banks that issue E-cash could find it much cheaper than handling checks and the paper records that accompany traditional money.

Consumers doing business on the Internet will find some forms of electronic money afford much greater privacy than using ordinary credit cards.

THE BAD
Uncontrolled growth of E-cash systems could undermine bank- and government-controlled money systems, giving rise to a confusing and inefficient Babel of competing systems.

E-cash may be less secure than bank money: Money stored on a PC could be lost forever if the system crashes.

E-cash could foster a have and have-not society: Those with PCs would have ready access to the stuff, while those without, many of them low-income consumers, would not.

AND THE UGLY
Money laundering and tax evasion could proliferate in stateless E-money systems as criminals use untraceable cyberdollars to hide assets offshore.

Counterfeiters could create their own personal mints of E-cash that would be indistinguishable from real money.

If computer hackers or other criminals were to break into E-cash systems, they could instantaneously filch the electronic wealth of thousands or even millions of innocent consumers.

DATA: BUSINESS WEEK

EARLY MONEY
Seashells, odd rough-hewn coins--the first money was flexible, highly distinctive, and exchanged in multifarious ways. Objects were gradually replaced by standardized commodities such as gold and silver, and these in turn by paper money. Yet even early currency was at first issued by private banks, local governments, and others--usually backed by gold and silver. Diversity abounded.

E-CASH
E-cash may be technologically light-years ahead of early money. But in many ways, it is closer to seashells than greenbacks. E-cash is digital money that moves through a multiplicity of networks instead of the current bank system. It comes in lots of guises, is created by lots of individual parties, and is backed by anything constituents demand as an accepted medium of exchange: gold, dollars, yen, whatever. It is the ultimate, and inevitable, currency for the wired world. Competition is intense, producing rapid innovations. Using money downloaded to your PC or a palm-size electronic ''wallet,'' you'll be able to zap money to merchants on the Net--or buy a newspaper faster than you can grab a greenback. If you're a business owner, you can bypass banks and move E-cash directly to customers and suppliers. The advantages: convenience, speed, cost savings. The technology is complex, but to the user, E-cash is as easy as pushing a button.

BANK MONEY
The current money system is largely monolithic. Nearly all major countries have a single system of national currencies and bank checks. Most have elaborate infrastructures built around commercial banks and a central governing body such as the Federal Reserve Board. That entity is usually the only facility allowed to issue money. Perhaps because of their monopoly structures, money systems tend to resist change and innovation. Traders can move millions of dollars around the globe at the touch of a button. But the small check-based transactions of consumers can take days to clear. And chartered airplanes physically transport billions of checks around the country every workday.