The Monster from the Crypt:
Impacts and Effects of Digital Money
Principal, Xamax Consultancy Pty Ltd, Canberra
Visiting Fellow, Department of Computer Science, Australian National University
Version of 27 June 1997
? Xamax Consultancy Pty Ltd, 1997
This paper was presented at a plenary session of QuestNet'97, Brisbane, 4 July 1997
An earlier version was presented at the Computers, Freedom & Privacy Conference (CFP'97), San Francisco, 12-14
March 1997, on a panel comprising Michael Froomkin (a Uni. of Miami Law Professor), Chief Cypherpunk Tim
May ('national borders are just speedbumps on the information superhighway) and David Chaum (Mr Digicash)
This paper is at http://www.anu.edu.au/people/Roger.Clarke/EC/Monster.html
The term 'digital money' encompasses stored-value cards based on chips, plus net-based payment mechanisms. It is set to have substantial impacts on financial services industry, plus flow-on effects on society as a whole. Depending on a whole host of factors, these may be evolutionary, or utterly revolutionary.
The paper first presents an analysis of direct impacts. Whether existing financial institutions sustain control of the payments marketplace, or lose share to new players, depends on whether open schemes eventuate; whether the risk of failures and scams is managed; and whether transaction risk is limited to very short durations. Second-order effects will be mediated by existing industry and social structures. The intrinsic supra-jurisdictionality of digital payment schemes appears likely to reduce the importance of national regulators, and the capabilities of national tax collection agencies. This will stimulate a last-gasp attempt by nation-states to impose their waning power on the populace, in particular through dataveillance technologies.
Public services, funded through taxation imposed on captive audiences by nation-states, will prove unsustainable. But the coming breakdown in established authority does not mean the end of civilisation as we know it. Law and order will be sustained within geographically localised communities; and federations of similarly-minded communities will form strategic relationships to keep portions of the world relatively safe for their members.
In this paper, I use the term 'digital money' to encompass both chip-based stored-value cards, and net-based payment schemes.
Chip-based payment schemes are described in a hard-copy publication by this author, excerpts from which are at http://www.anu.edu.au/people/Roger.Clarke/EC/CBPSBk.html.
Net-Based Payment Mechanisms are described in a web-page maintained by the author, at
This page provides the following classification of net-based payment mechanisms:
; evolutionary approaches:
; credit-card details;
; debit-card details;
; revolutionary approaches:
; electronic value-token creation and passing (cash-like), including micropayment schemes;
; electronic payment instructions (cheque-like);
; integrated approach:
; stored-value card payment.
Transactions using digital money may be fully identified as to payer and payee, or fully anonymous. They may, alternatively, be 'pseudonymous'. I use this term to imply the use of an identifier for a party to a transaction, which is not, in the normal course of events, sufficient to associate the transaction with a particular human being. The data may, however, be indirectly associated with the person, if particular procedures are followed. (Note that some other authors use it rather differently, importantly Ian Goldberg, David Wagner and Eric Brewer at Berkeley).
The paper assesses digital money's likely direct impacts and less direct, second-order effects. In order to do so, it first considers the possible patterns of development and application of digital money technologies. A key assumption underlies the analysis. Digital money is entirely dependent on the impenetrability of 'strong' cryptography. This paper assumes that there will be no quantum leap in crypto-cracking techniques that catches up the lead that cryptography has over them, nor even strongly credible rumours to that effect. If that assumption proves to be incorrect, the security of electronic payment mechanisms would be undermined.
The Crystal Ball
Privacy and Smart-Card Based Schemes
The time has passed when we could afford to simply pontificate on the impacts and effects of powerful technologies. It is essential that we apply the tools at our disposal, in order to get a grip on our future. This section considers the state of play in the area of digital money, in order to highlight some key features of the emergent marketplace, and infer whether digital payments mechanisms are likely to be highly concentrated among a few players, or highly fragmented among many.
Starting Point for the Analysis
There are many existing forms of payment mechanism, each with characteristics that fit some need of corporations or individuals. Tele-commerce (e.g. telephone ordering of goods and services) has already spawned refinements to existing mechanisms.
Electronic commerce, the conduct of trade using telecommunications infrastructure and tools, takes place in substantially different contexts from conventional trading, and hence demands substantial refinements to existing mechanisms, or (more likely) new mechanisms.
The marketspace offers significant advantages over conventional physical marketplaces. It supports the negotiation for and settlement of contracts for physical goods (but not their delivery, maintenance and replenishment). For digital goods, on the other hand, it supports the entire process of electronic commerce, from discovery of suppliers, through selection of supplier, delivery and settlement, through to after-sale service.
The Invention Phase
Digital money services initiatives abound, as was evidenced by the long list of products and product-types referenced in the introduction. These will enable payment via the open Internet, and using other elements of the emergent information infrastructure (including such proprietary networks as may survive, closed segments of the Internet, and developments on the cable TV model).
The Adoption / Innovation Phase
The payments marketplace is large and diverse. Like other large marketplaces (e.g. cars, car-engines, pharmaceuticals), there is a great deal of difference between inventing something, and refining the invention, integrating it with existing infrastructure, and implementing it. This process is commonly referred to as the 'innovation' or 'adoption' phase.
New payment mechanisms may be a adopted by existing organisations, as extensions or adjuncts to their existing services. Alternatively the innovation process may be driven by new players entering the market. The following two alternative scenarios therefore need to be considered:
1. Prudentially supervised banks dominate the existing payment systems of each major country. Those banks,
through the payments processors and brand-owners Visa and MasterCard, also dominate consumer
payments that have an international dimension. One possible path is that digital money technology
developers will place their products almost exclusively with established financial institutions. Initial
services would therefore be available through conventional channels, and alternative providers would be
small niche-players, unless and until they established recognisable competitive advantages. This scenario
then bifurcates into two sub-paths:
1. the financial institutions continue to (by and large) respect the wishes of national regulatory bodies;
2. the financial institutions, whose payment schemes would no longer be primarily within any one
nation-state, progressively shrug off the controls imposed by national regulatory bodies;
2. Large banks move slowly. This creates a window of opportunity, such that small, new entrants use the
new technologies to establish themselves as non-supervised electronic bankers. This scenario sees
widespread early use of these new players. It then bifurcates into two alternative paths:
1. a few well-publicised failures and scams result in a large-scale movement by consumers back
towards supervised financial institutions; or
2. to manage the risks of failure, fraud and large-scale theft, the majority of new players form their
own self-regulatory body (by definition international in nature), and establish standards, audit
requirements and insurance mechanisms. These mitigate the inevitable collapses. The new players
retain a substantial market-share, and the result is a new world order among financial institutions. Which Path?
The following factors appear to be critical in assessing which of these scenarios is most likely to eventuate:
1. the speed with which the large financial institutions move, and hence the size of the opportunity window
for new entrants. During the last year, there have been many signs of urgency among the large players;
2. the degree to which digital money technologies are openly available. Many inventors, including both
Digicash and Mondex, appear to have adopted the strategy of dealing with large, existing players, at least at
this stage of development;
3. the capital requirements to establish schemes and to reach potential customers. At this stage these still
appear to be large; but on the other hand the economics of market reach is greatly changed by the net;
4. the scale of early adoption, in terms of numbers of people, numbers of transactions and value of
transactions. The dramatically steep take-up rate of the web generally needs to be contrasted against the
much more reticent behaviour patterns evident when it comes to making purchases and payments on the
5. the timing and appropriateness of actions by regulators. There is a serious disincentive involved in
being subject to prudential supervision, because it imposes significant capital requirements, cost, and
bureaucratic inconvenience and delays. On the other hand, prudential supervision acts as a 'barrier to entry',
and limits the rate with which newcomers change the pattern of the financial services marketplace. The potential for digital money to function with limited regulatory interference is being aided and abetted by at least some central banks. The Chair of Australia's Reserve Bank (with similar responsibilities to those that Allan Greenspan has in relation to the U.S. Federal Reserve) stated in early February 1997 that he viewed stored-value cards not like currency, cheques or loans, but rather like travellers' cheques: they are not a proper financial instrument, and hence do not require the Reserve Bank's direct supervision. The implication is that at least some forms of net-based payment schemes are perceived by the Reserve to have similar non-money characteristics. Hence financial services organisations that offer only those kinds of payment facilitation would not be subject to prudential supervision.
As the competition warms up, it could be that regulators will deny existing banks a 'prudential-supervision' barrier to entry to the market by new players, and even force the existing institutions to fight holding one hand behind their backs.
Moreover, it is unclear at this stage to what extent prudential supervision will actually provide greater security of services, and whether consumers will actually (a) understand, and (b) value, the 'comfort-zone' that supervision is meant to provide.
I speculate that one particular feature of net-based payment technologies may be particularly critical. This is their ability to conduct all settlement and clearance procedures within a very short time, measured in seconds
(using the transaction-boundary and two-phase-commit concepts conventional in distributed database systems). If this feature is offered, then most consumers will have only one a limited amount and proportion of their funds at risk at any one time, and the incentive to an electronic bank to 'stage a heist' will be much lower than it would be if it held substantial 'float'. As a result, the need for prudential supervision is far less, the image-advantage that prudential supervision provides to established financial institutions is very limited, and the established players have to use other ways to compete with the new entrants.
The first implementations of new stored-value card and net-based payments schemes involve substantial capital investment. Existing large financial services providers appear likely to be heavily involved, but additional large corporations may become involved, such as telcos, GM and Ford. The relationship between the payment services multi-nationals, Visa and MasterCard, and the financial institutions that own them, may also go through some changes, including re-consideration of their present constitutional arrangements.
As standardisation occurs, the capital investment needed to launch a new service seems likely to decrease. This will enable smaller players to offer services, perhaps only in niches, but perhaps across whole market-segments. This advantage for small players will be all the greater if the schemes are relatively open. Elements are emerging of an open system that would facilitate large numbers of small players, including:
; software agents that enable payers and payees to negotiate which payment mechanism to use (in particular
W3C JEPI); and
; clearing mechanisms that enable payees to convert into usable value electronic payments made in
whatever forms are convenient to payers.
Because there are so many factors involved, it will be some time before it is clear whether digital payments will lead to more concentrated or more fragmented marketplaces in payment services.
This section considers ways in which digital money will directly affect consumers and corporations. Benefits and Disbenefits for Consumer Segments
Superficially, digital money would appear to offer substantial advantages to net-dwellers, through enhanced
convenience, time-savings and the ability to buy and sell in many marketplaces, and in the emergent marketspace.
For non-net-dwellers, there may be equity disadvantages if digital money were to significantly displace existing
payment mechanisms. This is a variant of the arguments concerning the unavailability of credit-cards to members of lower socio-economic groups, and the information-rich/information-poor dichotomoy.
There is, of course, a considerable risk of greater intrusions into individuals' behaviour by financial services
organisations, and by the government surveillance apparatus that stands close behind them. Information privacy protections are seriously inadequate in some countries, and all-but non-existent in others. An Appendix to this paper
provides access to an analysis of the privacy implications of stored-value cards.
Benefits and Disbenefits for Corporate Users
It appears likely that the needs of small enterprises, and perhaps also medium-sized enterprises, may be well-served by much the same capabilities as are delivered to consumers.
It is to be expected, however, that large corporations and government agencies will continue to take advantage of more sophisticated services offered by established financial services institutions. They may, however, make considerable use of digital money for small-scale and spontaneous purchasing, as they have done during the last decade with credit-cards.
This section groups together a range of second-order effects. The discussion is necessarily even more diffuse and uncertain than was the case in the preceding section. It largely overlooks the many other changes that are occurring, driven by factors other than digital money. These not only have their own penumbra of second-order effects, but will also interact with the ripples arising from digital money.
Digital money is part of the general tendency towards substitution of labour-intensive work by 'high-tech / low-labour' processes. The workplace impacts are inevitable:
; fewer people will be employed in the delivery of payment services;
; the posts that remain will demand greater educational background and higher-order skills; and
; the existing trend in large financial institutions away from large numb numbers of manned branches will be
These developments may, however, be complemented by a strengthening of the role of community-based organisations such as credit unions and Raiffeisenkassen.
A challenge for corporations will be to enable digital payment by employees on the organisation's behalf, without undermining the authorisa