12 January 2011

Creating money is easy

Physical cash drives 60% of all transactions. Everyone knows it has a few issues though: production/distribution costs, counterfeiting/terrorism use, loss/theft, coinage doesn't pay interest, you need a purse/wallet and a digital divide (cannot use a physical $1 note to pay for a digital newspaper) amongst others.

Why can't we directly replace physical cash with digital cash?

By digital cash here, I mean specifically anonymous digital cash: a $10 note simply being a string of digits - a number. This number would most usefully be stored on a mobile for payment purposes (or anything else digital). What stops people inventing their own numbers – making their own money? - Cryptography. Cryptography acts like the intricate banknote design/watermark – preventing counterfeits.

How does it work? At a high level, validators and consumers have public-key encryption keys. Public-key encryption keys come in pairs. A private key known only to the owner and a public key, made available to everyone. Whatever the private key encrypts, the public key can decrypt and vice verse.

Digital cash itself accumulates the complete path the digital cash made through the economy and therefore "grows" each time it is spent. The history of each transaction (minus the identities involved) is appended and travel with it as it moves from person to person, merchant to vender. When deposited (or validated), the validator checks its database to see if the piece of digital cash was double spent. If it was copied or spent more than once, it will appear twice in the "spent" database. The validator uses the transactional history to identify dates and potentially locations associated with the double-spend and reacts appropriately e.g. contacts authorities/blacklists etc. It has more tracking potential than physical cash (despite still being anonymous).

The validator can always reconstruct the path the digital cash took through the economy (except who owned it). The validator will know what was bought, where it was bought, when it was bought and how much was paid. A side benefit of anonymity i.e. not including identities in transaction history means that the war being fought over global Internet identity is conveniently side-stepped (Facebook, Google, Twitter, OpenID [even Angry Birds] etc.).

If your mobile (or any other device containing your digital cash) is stolen or lost, you could remotely deactivate the cash (and additionally claim it back). This process would not (by necessity) be fully anonymous but it could be just tied to your mobile number, making it semi-anonymous in much the same way that Standard Bank in SA have done with mimoney.

In respect of transactional proof, the basic rule is: everyone can prove that they took part in a transaction but no-one can prove that someone else took part in a transaction.

Why is digital cash a good idea for both consumers and merchants? Simply, cost, convenience and privacy in that order.

  1. Cost
    1. Credit/debit card based solutions are expensive. Merchants prefer cash since it is the cheapest to process. A British Retail Consortium (BRC) survey claims that credit cards account for 11% of transactions (but 49% of merchants' costs in accepting them). The biggest single cost of card payment collection is the bank merchant service charges. These cost the UK merchant 2p per transaction for cash, compared with nearly 8p for debit cards, 35p for credit cards and 53p for cheques. These costs are inevitably passed onto the consumer in the form of higher prices. Credit/debit cards companies simply cannot reduce this charge and are obliged to focus on target based rewards programs in order to compete. Credit/debit card solutions may not be available to all. Finally many consumers have bad credit ratings and find it difficult to obtain credit/debit cards. This also affects PayPal since it takes these cards into its wallet. In the US, this figure is reportedly 25%. Finally, merchants are never quite sure how much a credit card transaction will cost. MasterCard and Visa charge hundreds of different rates (interchange fees) for every type of card that runs through their network. MasterCard for example has 243 different fees.
    2. PayPal based solutions are commonly portrayed as the liberator of cashless payment however they also incur substantial fees: +2.9% + 0.30$ per transaction, +1% for transactions from abroad and +3% for transactions in a different currency. This could reach +6.9% + $0.30. This is 2-4 times as much as banks charge. Again, these costs are inevitably passed onto the consumer in the form of higher prices.
    3. Carrier billing based solutions are new and very considerably in terms of cost. However they also make money/transaction. It depends on volume e.g. takes around 5-10%. On top of this, there are carrier charges. They take anywhere from 25-45% of the transaction amount. Carrier billing solutions typically pay merchants once a month which affects their liquidity. Carriers are currently reticent of supporting transactions of physical goods due to issues of returns/payment disputes and so typically have $100 transaction limits for virtual goods only. Finally, carrier billing solutions are not widespread. They are unsuitable as a complete replacement for physical money, particularly in the developing world due to mobile coverage.
  2. Convenience
    1. Card/PayPal/Carrier solutions are all centralized, you lose a bet and want to give your friend $10; one of you has to pay the cashless overhead? Who? You and three friends share a dinner at a restaurant and you pay the bill in full. Your three friends each then need to be able to transfer a quarter of the total amount to you – creating four transactions in total (and four times more transactional revenue for payment processors). You all also need to be online.
    2. Card/PayPal/Carrier solutions just don't work offline. With digital cash, if you and a friend are both offline, as your friend is in your social graph, you can accept it money he gives you at face value (and then perhaps validate it later when you are online). A bit like a cheque. The concept of trustspace could also be used to grade and evaluate trust outside a user's social graph.
      1. With trustspace, consumers would be rated by how many times their balance has reached zero (since here you have contributed exactly as much to society as society has contributed to you). To avoid rating manipulation (a sort of new credit rating), trustspace could be parameterized by personal turnover, a damping factor and a connectivity index derived from the number of other people you have dealt with. Your rating would diminish over time and so you would need to continue earning/purchasing with digital cash to stay active.
  3. Privacy
    1. Card/PayPal/Carrier solutions log all transactions made by the consumer. If you lose a bet and give your friend $10, that transaction is recorded. If you go into a bar and rack-up a large tab, that transaction is recorded. If you pay for prescription medicine, a DVD in a bar, "herbal" remedies, a massage or Playboy magazine; all –all those transactions are recorded and used, at the very least, to target marketing to you. There is a growing demand for data privacy and consumers want the option to remain invisible to a payment made on their behalf. Privacy is not so much a blanket consumer need to be unseen in terms of online/digital activity but a desire for easy control. The recent WikiLeaks scandal compelled some services to stop handling Wikileaks' business including payment services (inc. PayPal). Anonymous digital cash helps fund enterprises that, for whatever reason, others object to.
Additionally, there are wider economic benefits to digital cash:

  1. Being a zero transaction cost solution enables consumers to sell online content and would be an alternative to advertising revenue meaning a reduction in distracting/invasive banner ads (micropayment). The fact that it is free means that it will stimulate a free market economy on the web where the best people, organisations and content will rise to the top because they can be directly paid. This, in turn, would make it easier to find things of most importance (currently we are spending 53% of our time searching for the right information).
    Consumers should also see an improved web experience through a freer market economy.
  2. A 10% shift in consumer spending, from chains/Internet to locally owned retail (currently being driven out of business due to Internet purchases), would create nearly 1,300 new jobs and over $190M in increased economic output for San Francisco alone. More jobs and more economic output in a specific geography where you own a house also means houses increase in value.
Twenty years ago, a digital cash solution was developed called ecash. It was sold by a company called DigiCash. A now defunct US bank and a handful of small European banks went live with it in the mid nineties but DigiCash went bankrupt later that decade and assets were acquired by InfoSpace in 2002. There was a similar story with CyberCash (over a similar timeframe). They went bankrupt in 2001 and assets were acquired by PayPal in 2005. No commercial organisations are now known to be operating these or similar systems.

Both organisations are considered to have failed due to security, implementation and administrative problems. They also made the validators – banks (when they really just needed to be web-services) which added unnecessary overheads/slowed down time-to-market. Countries historically used to back bank notes with gold but this is barely done any more. Canada for example has no gold backing for its currency.

Media interest in digital cash coincided with the dot-com bubble of 1995-2000. The vast majority of books on the subject date from that time. Online finance in general has stalled since then e.g. W3C abandoned attempts to incorporate micropayment into HTML. InfoSpace itself was a notorious dot-com casualty (in March 2000 stock reached $1,305/share but by April 2001 had crashed to $22/share).

Other than the fact that over two-thirds of the world still have no Internet access, there are several convergent trends right now that could build a landscape for a digital cash solution:

  1. Smart-phones replacing traditional dial and text mobile phones.
  2. Cheap/pervasive contactless NFC technology with an open API. Estimated 40-50M phones on market in 2011. Widespread NFC adoption of payments (149+ projects worldwide). High-profile assertions that mobile is the safest way to pay.
  3. A thriving start-up culture (possibly due to the recession?).
  4. Widespread and growing mobile/app culture. Mobile app market to be worth $25BN by 2015App downloads to increase 605% by 2014. There is also more evidence that consumers are more likely to buy using a mobile app than regular web applications. Location services are on the rise.
  5. General distrust of existing financial services (esp. banks) with consumers being open to alternatives. With both cash and clients in limited supply, barter networks e.g.
    Dibspace , ITEX, BarterCard and IMS are becoming popular. P2P lending in particular e.g. Zopa, FriendsClear, LendingClub is becoming accepted.
  6. Rising social graphing acceptance (bolstering trust issues).
  7. Widespread acceptance of storing personal details in the cloud via trusted sites.
  8. Digital signature/public key based cryptography acceptance.
  9. 25% of consumers have poor credit scores.
  10. Distinct lack of retail banking innovation.
What about other forms of cashless payment?

Visa's payWave system was introduced last year as a digital wallet for the iPhone although this requires a separate case for the mobile (basically containing the same chip as new Visa cards). AT&T, Verizon and T-Mobile also announced as Isis, a joint venture to equip mobiles with NFC chips; linking them to credit/debit cards. Barclaycard has signed on to issue credit accounts through this system. Google have said that they will work with industrial partners for their digital wallet solution and with them pulling players together (highlighting better loss rates); previous collaboration issues should be resolved. Google clearly say though they want to replace your credit card not your cash.

Square allows anyone to accept physical credit card payments through a mobile or computer by plugging in a free sugar-cube-sized device so no expensive card reader is required. Of course this solution suffers from credit/debit card dependency.

Obopay lets consumers and businesses purchase, pay and transfer money through a mobile phone using a mobile application, text message, mobile Web or Obopay.com. It works on any mobile phone and any US carrier; again though it is tied to a card, in this case MasterCard debit.

Start-up Bling Nation went live in the US last year. They partner with both PayPal and banks, who then offer consumers a Bling Nation and "Bank" branded chip that can be stuck onto any mobile device. The chip allows any user to make a payment directly out of their checking account similar to a debit payment.

Rovio is taking a carrier billing approach with their payment system Bad Piggy Bank, intended for in-app payment of virtual or online goods. Zong have a similar approach. They also run a points system if you link your credit/debit card to your mobile and have reportedly processed transactions from 15M unique consumers.

All of these solutions are various themes on Card/PayPal/Carrier solutions and so also carry their failings. It could be argued that consumers and merchants are having installed on their behalf technological solutions that continue established order in preference to directly addressing their needs. In much the same way that PayPal principally extended the credit card model into the online world, current social/cashless payment solutions are seemingly doing so now.

Digital cash, in theory at least, straddles online and physical worlds better than any other solution. It empowers consumers and merchants through clear cost, convenience and privacy benefits over existing/planned solutions (physical cash or cashless payment solutions) and affords wider economic benefits to both.

The market has moved away in the last couple years from online/online solutions (payer/payee respectively) e.g. PayPal toward online/offline e.g. Groupon, Uber. On the topic of Groupon, receiving/generating a coupon then integrating this with digital cash (applying usage constraints/"increasing" your digital cash as appropriate) automatically within your digital wallet would be very powerful. It is quite possible the market will shift again to an offline/offline model in the near future. Is the best way to realise this - digital cash?

Obviously, big issues of system and national security, cryptography restrictions, economic stability and consumer acceptance would need to be overcome. As Minsky said "creating money is easy; the hard part is getting it accepted". However, alternative payment systems are already being adopted; being 20% of all online transactions. We are also seeing a surge in self-organized /managed citizen activism especially around finance and digital cash perhaps hooks into this trend too.

UPDATE: There are several ways to obtain digital cash.
UPDATE: Possible ways to monetize digital cash.


  1. Makes a lot of sense. I'm not sure how easy this would be though. How would you get - digital cash?

  2. I'll do a quick post as the links will be handy.