Digital Cash: Or how to make Big Brother ...

How digital cash works—why security is not a problem—why privacy is unexcelled—the obstacles—digital cash as an add-on for the e-currency issuers. ... Masochistium Clickium Hic!

The Prof launches ProCash

What’s the most anonymous form of transaction? That’s easy. It’s a transaction that involves cash. True, a note has a serial number on it, but no one records that serial number as the note passes from person to person—at least not yet, and the story about a future that contains RFIDied notes owned by RFIDied people must wait for another day.

So is there a digital equivalent to paper notes and metal coins? Well, “yes” and “no”. “Yes” in the sense that some people have created digital cash systems, but “no” in the sense that very, very few merchants are prepared to accept any kind of digital cash. The main reason is that no candidate digital cash company has been prepared to burn vast sums of cash—the ordinary kind—to promote the system until it reaches a critical mass.

Various types of digital cash systems have been devised, some anonymous and some not, some online and some offline. We don’t approve of those systems make use of smart cards or similar devices as there is no way to verify that such devices preserve the user’s privacy. And, of course, we certainly don’t approve of those systems deliberately designed to identify their users!

If an anonymous digital cash system became widely used it would be the single must important factor in preventing Big Brother from snooping on people’s financial affairs. It’s actually very easy to create and issue digital cash. Let’s suppose that the Prof decided to set himself up as an issuer of anonymous and untraceable digital cash using the brand name ProCash. Then all he needs is a PGP public key pair. He generates a unique set of serial numbers and allocates various amounts of either fiat or metal currencies to those serial numbers. For example, here are three digital notes:

Digital Notes

ProCash 183873 $100
ProCash 258323 £100
ProCash 397625 100 grams gold

Sitting as character strings on the Prof’s computer they’re worthless, but once the Prof signs them with his private key then they are as good as...as good as the Prof’s word. They become like IOUs.

Suppose I’m a merchant running Morpheus’ Undies Emporium and I sell my silky merchandise in return for ProCash USD. Tiffy espies something nice in my virtual window and wants to purchase something French and frilly for ProCash $100—expensive, non Madame, zit’s cheap at the price! Well, Tiffy pays ProCash $100 in some suitable form plus a small commission, and then ProCash issues Tiffy with a ProCash note “ProCash 183873 $100”.

Now the first thing to note is that Tiffy can be sure that the note is genuine. No one can forge ProCash notes since no one has access to ProCash’s private PGP key—and Tiffy can verify that the note is genuine using ProCash’s public key. Now if Tiffy changes her mind—not very likely with silk in sight—she can return the note to ProCash and get $100 in exchange. The risk here is no more or no less that than encountered in dealing with any financial institution, be it an e-currency issuer or a bank.

So far so good. But the Prof was not born yesterday, or the day before that for that matter. The Prof realised that while no one can forge a ProCash note, anyone can duplicate it. In fact Tiffy might duplicate it millions of times. The result would be that the ProCash note would be subject to inflationary pressures that would make the President of Mupoobay Land jealous, and ProCash would quickly go bust. So in the T&Cs of ProCash there is a little clause that says that where multiple instances of the same note are passed to ProCash for redemption only the first instance will be honoured. It is the responsibility of the recipient of a note to ensure that it has not been duplicated. With this clause in place the Prof gets around the “double spend” problem that dogs all digital cash systems. He simply keeps a list of the valid notes in circulation and removes them from the list as they are redeemed.

Now Tiffy, in the course of purchasing that new acquisition to adorn her nether regions, sends her note to me at Morpheus’ Undies Emporium. Now I have a little problem here. ProCash knows the note is valid; Tiffy knows the note is valid; but I don’t. What if Tiffy had made millions of copies and had been purchasing undies left, right, and centre with the duplicates. What if when I go to redeem the note ProCash says “tough cheese”!

Now of course the Prof had the foresight to help me out in this little dilemma. And to do so he instituted a free note swap. Anyone who possesses a ProCash note can send it to ProCash and if the note is valid ProCash will issue for free another note of exactly the same value. So now when Tiffy sends me the note, but before my web site tells her that the note has been accepted, I send the note to ProCash. ProCash issues me with another for the same value. Now I know that I have a valid ProCash note for $100, so I can wrap those undies in some nice pink tissue paper and dispatch them to Tiffy post-haste.

Since all these operations can be automated a digital cash system is easy to set up and to use.

Security

There are no special issues with digital cash as far as security is concerned. Given the rapid turnover of digital cash one would expect it to be fully backed by assets of equivalent value.

Privacy

This is where it gets a little more interesting. Let’s say that Tiffy purchases her note for some e-currency issued by ECI (yes, it’s fictional). ProCash might record this as: “ProCash 183873 $100 for $101 from account Tiffy at ECI from IP 121.45.98.198”. This record contains quite a lot of information about the transaction. In particular, it lists the source of the funds.

When I do a swap the information recorded might be: “ProCash 183873 $100 swapped for ProCash 832637 $100 from IP 76.276.28.176”.

When I buy a box of silk undies with ProCash I pass the note on to the supplier who in turn passes in on to someone else. Eventually, the note will be redeemed, which ProCash might record as: “ProCash 849898 $100 for $100 to account JG Publications at ECI from IP 97.833.973.834”.

So the transaction log held by ProCash might look like:

ProCash Transaction Log

01-07-06 ProCash 183873 $100 for $101
From account Tiffy at ECI from IP 121.45.98.198

02-07-06 ProCash 183873 $100 swapped for
ProCash 832637 $100 from IP 76.276.28.176

05-07-06 ProCash 832637 $100 swapped for
ProCash 636394 $100 from IP 375.48.376.26

10-07-06 ProCash 636394 $100 swapped for
ProCash 849898 $100 from IP 486.376.927.27

15-07-06 ProCash 849898 $100 for $100
To account JG Publications at ECI from IP 97.833.973.834

Now you can see why the Prof is beginning to spoil Big Brother’s plans for mass surveillance. During the intermediate steps when notes are exchanged the only information that is available about the transaction is the IP address used to swap the note, and this could be hidden behind a proxy chain making the participants in the transaction anonymous.

However, the Prof respects people’s privacy so he only keeps information that is needed for business purposes. There is no need to record the IP addresses associated with the swaps: ProCash receives a note, sends a new note, and the recipient presses a button to acknowledge safe delivery of the new note. Equally, as input and output transactions are non-repudiable there is no need to record the IP addresses once the transactions have been completed. So the transaction log held by ProCash might look like:

ProCash Transaction Log

01-07-06 ProCash 183873 $100 for $101
From account Tiffy at ECI

02-07-06 ProCash 183873 $100 swapped for
ProCash 832637 $100

05-07-06 ProCash 832637 $100 swapped for
ProCash 636394 $100

10-07-06 ProCash 636394 $100 swapped for
ProCash 849898 $100

15-07-06 ProCash 849898 $100 for $100
To account JG Publications at ECI

But Procash has no interest in recording information about what is swapped for what. Just the status of the individual notes is all that is required. So at the beginning of the transaction chain ProCash’s business records might look like:

Business records at beginning

01-07-06 ProCash 183873 $100 for $101
From account Tiffy at ECI

ProCash 183873 $100 Issued
ProCash 832637 $100 Unissued
ProCash 636394 $100 Unissued
ProCash 849898 $100 Unissued

and when the chain is complete:

Business records at end

01-07-06 ProCash 183873 $100 for $101
From account Tiffy at ECI

15-07-06 ProCash 849898 $100 for $100
To account JG Publications at ECI

ProCash 183873 $100 Redeemed
ProCash 832637 $100 Redeemed
ProCash 636394 $100 Redeemed
ProCash 849898 $100 Redeemed

All that has happened is that the issuing and redeeming transactions are recorded and the individual notes move from a status of “Unissued” to “Issued” to “Redeemed”.

If ProCash wishes to boost its credentials by employing an external firm of auditors to report on its business, everything that an auditor is interested in is present in the business records. All flows of funds into and out of the business are recorded so changes in assets can be determined. A complete list of all notes currently issued is available so the current liabilities of the business can be calculated.

But we can do even better as far as privacy is concerned. What if a user is worried that ProCash may be a Big Brother sting operation and is recording IP addresses. Now there is nothing to stop anybody setting up as an independent digital cash swap shop. Let’s say The Swap Shop sets up in business as an independent verifier of ProCash notes. So instead of swapping my note directly with ProCash I can send my note to The Swap Shop. The Swap Shop sends the note to ProCash, which sends a replacement note back to The Swap Shop, and then The Swap Shop sends it to me (for a small commission paid in ProCash). So if ProCash were a Big Brother sting operation the IP addresses that it would record would be those of The Swap Shop, and completely uninformative. In practice The Swap Shop will keep a pool of notes of different values which it knows to be valid, so when it receives a swapped note back from ProCash it will not send that note to its customer, but instead one of equivalent value drawn at random from its pool.

Clearly there can be many swap shops, and, like newsagents that only need to record how many newspapers they’ve sold, all that these swap shops need to do is to record how many notes they have verified. Even if The Swap Shop were collaborating with ProCash in recording IP addresses, others would not. So the anxious whistleblower could swap a note any number of times with different swap shops to make sure it was not traceable by Big Brother. The integrity of swap shops is easily monitored since it’s a simple matter to select at random notes received from a swap shop, and verify them directly with ProCash. If ProCash concluded that the note is not valid because it had been double spent then the business of the associated swap shop would collapse overnight. So in this scenario we could expect to see a number of swap shop verifiers spring up, who regularly verify that swap shops are not cloning notes. New swap shops would be regarded with suspicion at first and would initially have to work at low volumes and with small denomination notes until their trustworthiness was established. Swap shop verifiers would be in a position to offer insurance policies against fraud by individual swap shops so that customers would be able to receive compensation in the case of fraud. Since swap shops with the highest rating would attract the most business it would be in their interest of swap shops to encourage verification by well established verifiers.

Secondary currencies can be derived from ProCash. For example, 1mdc receives Pecunix or e-gold and then issues a 1mdc equivalent in return, an equivalent that can subsequently be used in transactions. This makes 1mdc a secondary or derived e-currency. Whereas Pecunix and e-gold have the overheads of storing and auditing physical gold bars, 1mdc is an entirely electronic operation. In the same way a digital cash reseller can receive a ProCash note and issue its own digital cash in return without incurring the overheads associated with issuing and redeeming that ProCash incurs. And just as we would like to see many secondary e-currency issuers like 1mdc to provide more opportunities for privacy so too we would like, in this hypothetical scenario, to see many secondary currencies derived from ProCash. Secondary currencies are useful in distributing the processing burden of verification. ProCash is likely to focus on issuing higher value notes, leaving it to derived secondary currencies to produce notes of smaller value. In practice, the functions of swap shop and secondary currency issuer are likely to be combined in many cases.

With digital cash we have the best of both worlds. Good business records for the purpose of audit, but no records of cash swaps. So transactions using digital cash can be just like their paper cousins: invisible to Big Brother’s Sauron-like eye!

Obstacles to overcome

So digital cash is easy to set up, is as secure as an e-currency, and provides an exquisite level of privacy. But there are two problems.

The first problem is the same as that of any e-currency that’s a new boy on the block: without a substantial market share merchants won’t offer it as a payment method; and without it being readily available as a payment method it won’t increase its market share. One way around this obstacle is to burn a modest amount of capital in return for a high degree of penetration in specific niche markets. For example, Internet gaming already has some niche payment systems that aren’t used elsewhere. If you can add enough niches then in time your digital cash may become mainstream, but it’s very hard work.

The second problem is that the degree of privacy that digital cash affords causes Big Brother to ..., and to assuage his suffering he is likely to take drastic action, like banning all merchants operating within his domain from offering digital cash as a payment method. The way around this obstacle is a third-party payment chain, which works well and is reasonably cost effective for non-repudiable transactions, but that’s for another day.

Digital Cash as an E-currency Add-On

There is one group of businesses that are ideally suited to offer digital cash, and they are the existing e-currency issuers. The important factor here is the difference between setting up a digital cash operation from scratch and the cost of providing it as an additional service for an existing e-currency issuer. The marginal costing to an e-currency issuer is nominal. The issuer already has the technical infrastructure in place. The programming requirements are negligible. More importantly, if the e-currency issuer insists that the purchase and redemption of digital cash takes place using its own e-currency, then the process simply becomes one of internal bookkeeping. The marginal cost of issuing, swapping, or redeeming is no more than the cost of a few web page accesses and the running of a few scripts against a database. Hence, the commission charged for issuing a note can be very small.

There are a number of advantages for an e-currency issuer in adding digital cash to its portfolio. We had a chat with JG about the marketing potential of digital cash. We came up with the following ideas.

Digital cash becomes a marketing plus for an offshore business that, like Pecunix or 1mdc, is selling itself on its privacy credentials. It provides a “golden opportunity”—sorry for the awful pun—for an e-currency issuer to overtake e-gold. Much as we like e-gold for boldly going where no financial institution had gone before, we feel it has probably made a strategic mistake by being based onshore. It’s highly improbable that it will ever offer digital cash, and indeed it has already made negative comments about digital cash on its web site. And the US government would go “ballistic” if e-gold ever attempted to do so. Given the fractious relationship that already exists between e-gold and the US government, e-gold seems very keen to calm the waters. The danger for e-gold is that it is forced to operate on a know-your-client basis or even to become another Paypal. Even if it retains the distinction of offering non-repudiable transactions it would be operating on the same ground as the big boys in the world’s financial marketplace. These players have vast amounts of cash to burn by way of advertising and promotion and could easily step in and offer alternative e-currencies that would rapidly eclipse e-gold. The most likely scenario would be that after a slide in its fortunes e-gold’s assets and technology would be acquired by a major player that would then market them under its own brand name—anyone for MicrosoftGold! So should e-gold be forced to operate on a know-your-client basis its star is likely to fall very rapidly.

So for those e-currency issuers who operate offshore there is the opportunity for future press coverage to read “while Pecunix, 1mdc, and e-gold all offer e-currencies, in addition Pecunix and 1mdc offer digital cash”. Think of the impact that this sort of statement makes on newbies to the e-currency market. It makes Pecunix and 1mdc seem more substantial than e-gold.

People with an interest in privacy will be attracted to digital cash so it provides a new stream of revenue. As there is no digital cash system of comparable size to the e-currency issuers it is easy for an issuer to leverage its position within the e-currency market place to become number one in digital cash. And we all know the marketing advantage of being number one irrespective of the quality of the product on offer—remember VHS and Betamax? How important digital cash will be in the world’s financial system in the long term is impossible to forecast, but if it does take off in a big way then the small cost of positioning oneself as number one right now could yield an “Intel” or “Microsoft”-like payback.

If customers with an interest in digital cash wished to have notes issued or redeemed then they would need to open an e-currency account with the issuer, which would boost the issuer’s mainstream e-currency business—once someone has gone to the trouble of opening an e-currency account and has put some funds in it they are likely to use it. Therefore the introduction of digital cash would provide a means of taking market share away from competitors.

The same script provided by an issuer to a merchant for a customer to make an e-currency purchase could also be used to make a digital cash purchase. This would be attractive in gaining new business as the merchant gets both an e-currency and a digital cash payment system for the same amount of effort.

While many of these prospective benefits are small we feel that in total they probably outweigh the marginal cost of adding digital cash to an existing e-currency operation.

Tiffium & Morphium – Bigus Brutium-Absentium Zonium

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