by Ray Wyman, Jr.
Appeared in "Query" 10 November, 1995,
and the San Jose, CA and San Antonio, TX "Business Journal"
Fifty years ago, a team of engineers and mathematicians built the first successful digital electronic computer. For all it's girth (30 tons) and fizzle (from 17,000 vacuum tubes), ENIAC couldn't keep up with a Casio hand calculator.
Twenty-years ago, the Altair became the first microcomputer. A $400 build-it-yourself kit that was a big hit with hobbyists, the Altair was difficult to use. It had no keyboard, no monitor and no printer. But, hey, it was a computer.
Fall 1980 saw the IBM PC emerge, draped thick with superlatives of how it would change office life forever. As recently as 1994, the Internet also showed promise to much the same end.
But as significant as these milestones are, life still goes on pretty much as it has since before ENIAC solved its first math equation. An emerging need for electronic currency may change all that.
Data as Good as Cash
Electronic cash, or E-cash, is the inevitable medium of exchange for an increasingly digitized world. While it converts hard currency into a quaint memory, it also will radically change the way we do business and shake the foundations of global financial systems. It may even threaten the sovereignty of countries.
Imagine. In the place of coins and bills will be digitized currency that you can store in a wallet-sized piece of plastic or in whatever personal computer or network technology that happens to be lying around.
While convenience is high on the list of positives for E-cash, it represents the biggest revolution in currency since gold replaced trinkets as a medium of exchange. And driving its formation is its diversity and pluralism. E-cash is perfectly suited to the anarchic culture of the Internet and the emerging World Wide Web.
"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.
The advent of E-cash raises all sorts of questions, most of which remain unanswered. Who will issue E-cash and who will regulate the issuers? How will taxes be paid in a commercial environment that transcends all political 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?
The Money Changers are Charging
While government and financial regulators wrestle with these questions, the big players are forging ahead.
Bill Gates hasn't missed a beat since cutting his first MSDOS deal with IBM in 1980. His recent bid for the finance software maker Intuit was a move to consolidate Microsoft's draw on millions of their consumers into their own online network to pay bills, get financial advice, and shop -- all for a small fee. The attempt set-off alarm bells at the Department of Justice and Gates broke off the deal.
Not one to be slowed by little things like anti-trust regulations, Gates is pushing another Microsoft arrangement with Visa for a system to secure credit card transactions over the Internet.
That's just one piece of a much bigger puzzle Microsoft is trying to solve. Gates has dozens of programmers busy building the Microsoft Network which will include their own network and interactive television systems.
Microsoft won't reveal much about their plans for E-cash, but Gates has them working on the problem as if their future depended on it.
They should be. The stakes are enormous. Seamus McMahon, a vice-president at Booz, Allen & Hamilton, sees as much as 20 percent of all household expenditures going through Internet in just 10 years from now. If any single business (like a software giant) gained control of the new medium for even some of those transactions, they could charge royalties, access fees and earn interest on the E-cash sitting in their accounts. Even a tiny charge (say, a few bucks per transaction applied to millions of transactions) would be highly lucrative.
E-cash will also create a competitive free-for-all. Because the Internet knows no boundaries, a company offering E-cash can gain direct access to millions of consumers and businesses no matter where they are.
Declares Bill A. Frezza, president of Wireless Computing Associates and co-founder of the advocacy group DigitaLiberty, "Over the long haul, this is going to lead to the separation of economy and state."
Government and central banks control the money flow and thereby the movement of economies and ultimately the people. With the growth of E-cash, money could flow in and out of countries at push-button speed and circumvent all controls.
Now, before you start thinking that's anarchy time, remember we're talking about the government here. Anything that might present that much of a threat to government will be fixed, and actually there are some good ol'real world ways of locking down cyberworld.
For one thing, don't forget that telephone lines -- all telephone lines -- are a utility that government can easily regulate, and does so with near impunity. Taxes will likely be raised and there will eventually be regulations imposed on access to the Internet or other networks.
The real threat E-cash presents is to commercial banks. If non-banks successfully introduce their own brand of digital cash, they could bypass banks as primary providers of consumer financial services. These companies, not the banks, will then become the consumers' first contact when they want to obtain digital money.
"Banking is essential to the modern economy, but banks are not," says J. Richard Fredericks, senior managing director at Montgomery Securities.
Microsoft's bid for Intuit last fall was the loudest shot off the bow so far. Banks worry that Microsoft could easily hook its 70 million Windows customers into an electronic-commerce network and replace the checking account and other once exclusive territories. If such a Microsoft utility comes to pass, people may start thinking "who needs a bank?"
Of course, the reserve system gives commercial banks the unique job distributing hard currency. Next to the Federal Bank, commercial banks are pretty high on the food chain. They are also authorized to lend out more than they have on deposit. So, in effect, the banks have a monopoly on the nation's cash flow.
The current money system is largely monolithic, which makes it an easy target. 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. It is that entity alone which is allowed to issue money.
Perhaps because of their monopoly structures, money systems tend to resist change and innovation. However, when traders can move millions of dollars around the globe at the touch of a button, the small check-based transactions of Joe private citizen can take days, even weeks, to clear.
Where most bankers and regulators miss the mark with E-cash is the assumption that each unit must be backed by a corresponding unit of hard cash. The thinking is, E-cash distribution shouldn't create new money.
However, if non-banks started backing some digital cash they distributed with traditional money and the rest with credit -- nonbanks, which are largely unregulated, are suddenly in the business of creating money just as commercial banks do now.
Bankers must move fast to keep up, says Ronald A. Braco, head of electronic banking at Chemical Bank. He estimates that banks have less than five years to come up with viable E-cash 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 big push now is winning consumers' trust and getting them to change their buying habits.
The first step in that direction would be to get consumers used to using credit cards for purchases on the Internet. Once that happens, the thinking goes, bank-controlled E-cash systems can be introduced.
First Virtual Holdings is one of the first to offer a viable Internet-safe credit-card system. Clients send their credit card numbers (via phone or other non-internet method) to First Virtual and are issued a personal ID number that they use to make purchases. To finalize the transaction, the merchant reports the transaction amount with the ID number. First Virtual, in turn, contacts the client via e-mail for final authorization.
It sounds simple enough, but critics frown at the cumbersome three-part process required for each transaction. Other schemes depend on encryption -- the art of scrambling card numbers so they can pass safely on electronic networks.
CyberCash Inc. of Reston, Va. is reportedly ready to try out 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. MasterCard has teamed with Netscape Inc., maker of the popular World Wide Web browser, to pursue a similar goal.
Credit-card-based systems have the advantage of being familiar to consumers, but there are serious drawbacks. Card systems are not anonymous, they don't work person-to-person, and they have credit limits. In those ways, they're not suited for the grassroots economy growing on the Internet today.
That's where E-cash comes in. David Chaum, CEO of the pioneering DigiCash, has done the most to make E-cash a viable method for I-way transactions. Using public-key cryptography, the cash is Net-secure but, most importantly, it can be registered and verified by the issuer without revealing to whom it was originally issued. Unlike an encrypted credit-card transaction, E-cash transactions would be as anonymous as the dollar bill in your wallet (and if dollar bills could talk).
Chaum, a native of Amsterdam, has issued the equivalent of $1 million in E-cash to about 5,000 consumers and 50 merchants to test the E-cash marketplace. No major deals are in the wings, yet, but Chaum's technology is 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 signed up 40,000 consumers and over 1,000 retailers in the Wiltshire town of Swindon to test Mondex money last July. While the final results are still pending, the word around Swindon is that Mondex passed the test with flying colors.
In addition to the credit card system, CyberCash is experimenting with an E-cash method that works much like a checking account. Clients cash into an E-cash account at the "bank" then, using proprietary browser software provided free of charge by CyberCash, they go about their business on the Net. At the end of the day, CyberCash clears all the transactions and converts the E-cash back to hard currency.
No matter who develops the best E-cash method, consumers and businesses alike stand to reap sizable benefits. Consumers will enjoy improved security, privacy and convenience. Businesses will be better able to reach a large population of technologically savvy and affluent consumers.
Moreover, because E-cash 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 office supplies but not a beer at the local tavern. Parents could E-mail their college-bound sons and daughters E-cash 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.
One of the hardest questions merchants ask us is, "When do we owe taxes?" When the merchant is in Guam, the buyer in Canada, and the network computer facilitating the transaction is located in New York, whose sales tax do you pay?
A source at the California State Board of Equalization (sales tax) says that tax liability will likely reside with the merchant, as it currently does for out-of-state transactions. Trade tariffs and federal taxes might be assessed on tangible products as they are shipped into the country.
The potential for crime is another matter. E-cash 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 (of which only the Russians at the height of the Cold War were able to accomplish), hackers and counterfeiters could replicate E-cash coding.
Governments would be hard pressed to monitor or control stateless E-money. The broad ramification of virtual money presents a major threat to every government on the planet that manages currency as a means of controlling their economies.
While it's not clear who the players will be 10 or even 5 years from now, it is inevitable that most or all E-cash sources will be outside the purview of central banks such as the Federal Reserve or the Bank of England.
"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-cash will inevitably convert back to traditional money and get counted, other experts disagree.
Comments Martin Mayer, a guest scholar at the Brookings Institution, the Fed will likely to lose control of a significant portion of the money supply due primarily to the boundless nature of the Internet.
One of the most pitched debates is likely to be over privacy. The problem will be balancing individuals' rights to privacy with government's need to monitor money flow and trace criminal activity.
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 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-cash 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 and the Internet doesn't have an 'off' switch."
And no amount of wishing by regulators will change that.
Ray Wyman is a freelance writer and content creator based in California.