The retail banking industry stands on the edge of a crisis today after the US Treasury announced it would start issuing digital cash.
The new eDollars will run on virtually any platform, including personal computers, mobile phones and traditional banking networks. China and the EU are expected to match the US move almost immediately, giving digital money the official endorsement and security it has been lacking.
The eDollar will feature “the most secure encryption known to mankind,” according to Treasury sources. The move has been welcomed with delight by traders and retailers, since the recent failure of Vodafone’s V-Cash to live up to expectations.
Alan Greenspan remarked: “This is the economic equivalent of the moon landing, an important milestone in consumer behavior that will make the US economy much more accessible to world markets.”
Some services offered by traditional banks may become irrelevant to anyone who is connected digitally. Shares in eBay fell sharply in the face of this new threat to its PayPal business. “Certainly the major credit card issuers like Visa and MasterCard must be worried. This undermines their core business,” said one analyst.
The announcement will also open major questions around taxation, with the possibility of eDollars moving invisibly across national borders.
ANALYSIS >> SYNTHESIS: How this scenario came to be
The Demise of Hard Cash
Money was originally a physical substance of value like gold and silver. It could even be alive – cattle were one of the oldest forms of money. Although much of the money used today by individuals in everyday transactions is still in the form of cash, its quantity is small in comparison with the intangible electronic forms of money that exist only as entries in bank records and whistle along wires in digital form. In the future, perhaps coins and banknotes will become as obsolete as cowrie shells.
Today, when a financial transaction takes place between a merchant or service provider, and a consumer, it typically takes one of three forms – cash, cheque, or credit card.
When a consumer wants to make small purchases, say less than four or five dollars, a merchant will not usually agree to the transaction if a credit card is presented, or a cheque from an unfamiliar customer is offered. However, there are many times when consumers don’t have coins, and would much prefer to pay electronically.
Electronic cash offers a solution to this problem – regardless of how big or small the transaction, electronic cash can be a viable alternative to traditional payment mechanisms.
It is understandable that that traditional banks and credit card vendors would zoom in on cards as the preferred platform. Visa International launched Visa Cash and MasterCard acquired Mondex.
But, the cost of processing a credit card transaction (between one to two US$) makes that platform a strategic no-no. Consider that the same transaction on a mobile phone network would cost less than 5% of that.
Several start-ups emerged that attempted to capitalize on the electronic cash and ‘micro payments’ on the Internet. Of these, CyberCash and DigiCash were likely the most visible. Started by cryptography guru David Chaum in 1993, DigiCash is a form of electronic cash, that could be traded between parties over the Internet. They actually succeeded in creating digital dollar bills that would stymie counterfeiters.
CyberCash started as a mechanism for payment of goods and services on the Internet, and users could choose one of three payment mechanisms – cheques, electronic cash, or credit card transactions. Although they developed a large customer base, none of these really captured consumer imagination.
PayPal and Peppercoin emerged more recently, but still are a bridge between credit cards, banks, merchants and consumers.
The success of the PayPal platform did not go unnoticed and in 2004 eBay acquired PayPal. Today, PayPal still remains essentially a front-end for eBay auction payments and for the credit card companies and banks. Amazon and other eBusinesses can keep customers coming back with plastic cards, so why should they push for anything else?
In the heady days of the dotcom boom, it was widely expected that a mega-corp like Microsoft could produce a private currency linked to smart cards and optimized for use on the Internet and electronic payment networks. This never materialized.
True electronic cash and micro payments remain elusive, and without an apparent customer demand. The runaway success of digital mobile phones should now capture the imagination of national Treasury operations. A major change in the nature of money could have significant consequences – the advantages for consumers might well be overshadowed by new opportunities for criminals and tax evaders. Could we maximize the benefits to society while still reducing the risks?
Will a new virtual form of cash emerge to replace the traditional forms of money? Will this be in the guise of a private currency, business barter or a government-backed digital unit? Or will the economic turmoil of the new millennium and declining faith in government stability precipitate a backward step to re-monetize currencies with precious metals and commodities?
1998: Smart cards and DigiCash hit the skids
A smart-card based electronic cash trial in the Upper West Side of Manhattan fails. Citibank, Chase Manhattan Bank, MasterCard and Visa participated in the trial. About 96,000 people acquired the cards, 600 merchants signed up, but consumers used the cards to spend only about one or two million dollars from October 1997 through October 1998. Average spending per card was about $10 or $20 per card, and Citibank gave consumers $5 to sign up for its card.
To put it mildly, the first week of November 1998 brings grim news for anyone who thinks that smart cards are likely to be important in the near future. Two headlines on 4 November are: “Banks, Credit Card Companies Withdraw Support for Money Cards” and “Firms to End Smart-Card Test As America Shuns Plastic Cash.”
A day later, DigiCash announces that it is filing for bankruptcy, which does not suggest that electronic cash on the Internet is just around the corner. It becomes clear that electronic cash on smart cards will not completely replace currency and coin issued by the United States federal government.
There has to be another way.
2003-5: Consolidation and Emergence
Surprisingly (for anyone outside of the US), 2003 is the first year that credit card payments and other electronic systems carry more payments than bank checks in the US.
PayPal is acquired by eBay in 2004 and CyberCash’s Internet payments business is acquired by VeriSign in 2005.
Peppercoin, the brainchild of two MIT computer scientists, attempts a new attack on micro payments.
2005: Mobile phones show the way
In countries such as Sweden, Ireland and the United Kingdom drivers can avoid putting coins in a parking meter by simply sending a text message on their mobile phone. About two million customers of Japan’s NTT DoCoMo Inc can already use mobile phones with built-in debit cards to pay about 20,000 merchants such as restaurants and supermarkets.
In Uganda and other African countries, mobile phones have helped bridge the digital divide and far outnumber land lines. Payments over the mobile network are relatively cheap and gain traction among lower-income customers. The security of the network and its mobile connectivity allow even hawkers to buy stock and accept payments from anonymous customers.
In South Africa MTN Bank claims it’s not a bank. Actually it is a banking account with SMS based transactions operating on the MTN cellular network, and backed by a major bank branch and ATM network where cash deposits and withdrawals are required. It boasts the lowest cost service and transaction fees.
In fact the mobile networks have for years been accepting payments for services on behalf of service providers through the mechanism of ‘Premium SMS’, where an SMS is sent to pay for content or a low value product, and charged to the subscriber at a premium, which is shared between the network operator and the merchant.
Meanwhile, in July one of the biggest security exposures is identified – 40 million credit card details are compromised when the CardSystems network is breached.
2006: Credit Card fraud on the increase
It seems that identity theft and the associated credit card fraud has beaten terrorism to the world’s front pages this year. Consumer associations are calling for consolidation of the obvious benefits of cryptography and security technologies to allow consumers to transact without the risk (and cost) of credit cards.
Politicians begin to get behind the call for government action. A significant conflict emerges between left and right-wing views of the future. The right-wing conservatives believe that any move to ‘electronic cash’ will enable terrorism to flourish, making money completely untraceable.
They quote a paragraph from a popular thriller by Linda Davies, A Nest of Vipers:
“The money screamed across the wires, its provenance fading in a maze of electronic transfers, which shifted it, hid it, broke it up into manageable wads which would be withdrawn and redeposited elsewhere, obliterating the trail.”
Elsewhere, doom-sayers point to the increasing US deficit and predict the collapse of the almighty dollar as an inevitable consequence of increasing amounts of ‘imaginary money’.
2007: Vodafone launches V-Cash
Vodafone decides to launch the first trans-national private currency. Dubbed V-Cash and only available in digital form, it is designed to replace cash payments for mobile phone users. With over 150 million subscribers, Vodafone has a larger revenue base and reserves than the governments of most countries.
At first V-Cash is wildly successful, and is quickly adopted in twenty countries. However, a security breach allows hackers to generate their own V-Cash balances, and confidence in the currency falls. Vodafone, as the currency’s backer, takes a big hit as the run on V-Cash spills over to the Vodafone share price.
2008: US Government decides to intervene
Recognizing that, unless digital cash is legal tender, the Federal Reserve’s ability to control the money supply will become dangerously limited, the US concludes that only the Government can mint electronic cash. China now has foreign reserves of almost US$ one trillion and views experiments with private currencies with great suspicion. They are concerned that Japan’s NTT DoCoMo might succeed where Vodafone failed. On the other hand, the US fears that increased cyber crime could permanently damage confidence in the US Dollar.
In a landmark decision, the US government comes out on the side of active support for the electronic economy. With the biggest growth in consumer spending now in SE Asia, and those consumers typically not likely to deal in US dollars, it is decided that regulation of electronic payments is not the answer. Rather the government should take pre-emptive steps to create a globally-available dollar-based platform for payments on the Internet and mobile networks.
By consolidating current best practice with leading-edge R&D it is hoped that this new solution will be available within a year.
2009: US Treasury issues eDollar
Just as the critical mass of consumer emotions seems to indicate a real need for electronic micro payments, the US Treasury gets into the act, obviating one of the nagging problems with all privately-issued e-cash currencies. Now, eDollars are denominated in the official US unit of account, the dollar.
This is the first viable electronic micro payment solution that is not backed by a credit card. It can be used by consumers with merchants and between consumers. It works as well with a one cent payment or thousands of dollars. Not insignificantly, it will be available in time for the Christmas shopping season. The banks are being dis-intermediated from consumer payments.
The US Treasury has promised unbreakable encryption and traceability. While the encryption is believed to be based on a CIA standard and existing MIT research, they are not revealing just how the ‘traceability’ works and exactly who will have access to the information. They are simply saying that no law-abiding citizen or business should have anything to fear. Some things however never change – all eDollars will be encrypted with the traditional message “I promise to pay the bearer on demand….etc.”
Observers believe the entire banking system will be forced into radical change, particularly as other major economies, including China and the EU, are expected to match the US move almost immediately, giving digital money the official endorsement and security it has been lacking. Are those hard-line monetary conservatives that have been predicting a return to the gold standard for 20 years even further out of touch with reality, or is this the last straw that sends the global monetary system into a deadly tail-spin?
It seems that initial reaction is good. Merchants and consumers the world over prefer eDollars to paper dollars – eDollars are impossible to counterfeit, cannot be stolen, are easily and cheaply transferred and you have automatic proof of payment. Trust in digital cash soars.