In the 1600s the British Barings Bank and the Rothchilds merchant trading and banking family made it possible for merchants and governments to conduct financial transactions without physically moving gold or silver. Centuries later the establishment of national central banks laid the foundation for modern electronic (or computer mediated) banking. Most people now have their pay checks deposited electronicly and spend most of their money either via personal checks or credit cards. Companies and governments transfer most of their funds electronicly. Banks sit on the shores of this huge financial stream and keep a small amount of the vast flow of money that passes through their hands. Since the Rothchild and Barings Bank, this has been one of the great businesses to be in. And it makes Internet startup companies drool with dreams of riches. "Just think", they say to themselves, "I could be the Visa of the Internet".
The Internet has created one of the cheapest ways to publish information that the human race has yet devised. As sites like the Advanced Book Exchange show, the Internet has also provided a powerful and cheap medium for bringing together buyers and sellers. Obviously the Internet did not invent publishing or markets, but in some cases it reduced their overhead. So far the Internet has had no effect on the cost of financial transactions. These transactions are still largely controlled by the existing banking infrastructure, at the existing cost levels (e.g., Visa and Mastercharge). Banks and their associated transaction clearing companies (Visa and Mastercard) have no incentive to reduce their charges. While the Internet has shaken the foundations of stock brokerages, greatly reducing brokerage fees, banking, and banking fees, have so far remained largely untouched.
A number of different kinds of financial transactions have been conceived of for the Internet. Early in the World Wide Web's history people observed that professional writers need to be paid for their work or they will not publish on the Web. On the other hand, the subscription model has not worked well for the Web as Slate discovered. Ideally readers would visit a Web site and pay a small amount, perhaps less than a penny (US $0.01), to read an article. The more readers an article attracted, the more money the author would make. Larger micro-payments, of a few dollars, which are uneconomic for Visa or Mastercharge, could be made for music (e.g., MP3 recordings). The only company that I know of that is providing micropayment transaction support is CyberCash's CyberCoin. This is now being marketed under the name "InstaBuy". The changing business model suggests that the original CyberCoin scheme may not have been successful.
Internet bandwidth and computer resources cost money. Many Internet business models seem to regard the infrastructure as free, until they see these costs in their bottom line. In addition to Internet bandwidth, communications equipment (routers), computers, office space and technical support staff must be paid for. When this overhead is factored in, plus a profit margin, the cost of a micro-payment transaction must be less that the transaction amount. This is a real technical challenge. The MilliCent project at HP (previously Digital Equipment Corp., and then Compaq) has been working on technology to support micro-payment transactions that can be less than a penny. As yet there is no commercial product. Although this technology is not viable yet, the MilliCent group is one of the first to seriously consider the cost structure of small transactions. This engineering work seems to be lacking in some Internet transaction schemes, where the overriding idea seems to be that if only the company can grow large enough everyone will make millions.
Since the early days of the Internet there has been a strong Libertarian culture that wants as little government oversight and as much privacy as possible. Science fiction writers like William Gibson, Bruce Sterling and Neal Stephenson wrote of offshore "data havens" that would clear untraceable data and financial transactions. Computers provide the means for a modern state to attack privacy, but they also provide the means to protect it. The cypherpunk cryptographic groups are a strong expression of this. An offshoot of the cypherpunk idea of privacy through cryptography is the idea of true electronic cash. Just as paper currency can be used for untraceable transactions, electronic cash, which would be cryptographically protected against forgery, could be used for untraceable on-line purchases. DigiCash Inc., a company that entered Chapter 11 bankruptcy proceedings on November 4, 1998 was an early pioneer in technology to support confidential on-line transactions. The press release announcing the entry into Chapter 11 reorganization states:
DigiCash's eCash[tm] payment solution offers a secure, low cost and private payment option to consumers for payments of any amount. The intellectual property owned by DigiCash consists of a series of patents, protocols, and software systems that were specifically designed to be privacy protecting for consumers and which also enable other applications like online electronic voting. The ability to pay privately, without revealing personal information and avoiding the capture of personal transaction information for marketing or other subsequent uses is a growing concern among consumers globally.
The huge sums of money culled from the global financial stream by banks has spawned a variety of companies producing products to support financial transactions on the Internet. These include pure technology companies like InterTrust which sells software to handle licensing and usage transactions. There is an even larger range of companies like CyberCash (CyberCash is now owned by Verisign) and CryptoLogic that support electronic "cash" transactions on the Internet. Although dreams of riches have drawn people to the business of supporting financial transactions on the Internet, virtually all the companies offering transaction services are losing millions of dollars a year
MilliCent and DigiCash were founded by engineers and have done real engineering work. But the dream of Internet riches has drawn a variety of people from outside the engineering community. For example, First Virtual, a new defunct Internet transaction company, was founded by Lee H. Stein, "a former lawyer and financial manager for such celebrities as Peter Gabriel, Rod Stewart and Gene Hackman" (The Industry Standard, January 12, 1998).
One company, E-gold, was apprently founded by Douglas L. Jackson, an MD and Barry Downey, a lawyer. E-gold is an Internet financial transaction company that supports transactions not in US dollars but in gold. I have been unable to understand why there is an advantage to using gold (or some other commodity) as the currency for electronic transactons. About fifteen years ago gold was selling for around $800/troy ounce. At the time this Web page was written it was selling for about $254/troy ounce. So clearly the price of gold, relative to the US dollar, fluctuates. Since most of what I want to buy is denominated in dollars, I can't see an advantage to having a gold account. As far as I'm concerned, gold is just another form of matter. It is rare and it costs a lot to mine. But the same thing can be said for a variety of metals and other substances. Gold exerts a strange pull on people and perhaps one reason for E-gold's use of gold accounts is the idea that gold is better than any other currency.
In addition to gold denominated accounts, E-gold also offers low transaction fees, compared to credit cards. The question in any scheme for low cost financial transactions is whether the cost of the infrastructure can be covered profitably by the transaction cost. This is not discussed on the E-gold web page (if this analysis has been done, they presumably regard it as confidential). But in a landscape littered with failures like First Virtual and DigiCash, another Internet company that bleeds red ink may give any conservative depositor pause.
Apprently one attraction of e-gold currency is laundering money, for example, funds stolen via credit card fraud, avoiding taxes or hiding funds.
The Secret Service raided a company called Gold-Age in Syracuse NY which apparently exchanged funds for gold in an offshore e-gold account (where in this case I mean e-gold the company discussed above). See this article in Wired News. The Gold-Age company seems to be independent of e-gold, the company. Their "value added" seems to be to allow credit card transactions. This presumably removes credit card theft risk from the e-gold company itself.
Since I wrote the original article, E-gold has apprently moved offshore, although the company is operated from Florida. This may be why the US government is going after some of e-gold's customers. The e-gold terms of service states e-gold Ltd., a Nevis Corporation. The US Department of Treasury has an advisory that suggests that Nevis is a good choice for money launderers and people who may have criminal connections:
Nonetheless, the legal, supervisory, and regulatory systems of St. Kitts and Nevis at present create significant opportunities and tools for the laundering and protection of the proceeds of crime, and allow criminals who make use of those systems to increase significantly their chances to evade effective investigation or punishment. St. Kitts and Nevis. commitment to bank secrecy and the absence of sufficient supervisory and enforcement mechanisms aimed at preventing and detecting money laundering increase the possibility that transactions involving St. Kitts and Nevis offshore entities and accounts will be used for illegal purposes.
The Case Against Micropayments by Clay Shirky, 12/19/2000, published on the O'Reilly Network
This well thought out essay argues against micropayments ever being a viable model. Shirky points out that the micropayment schems disaggregate content. You pay for a single article in the micropayment scheme, rather that a collection of articles in a like subscription scheme. It is much more difficult to decide whether you want to pay for one article in a newspaper than for the entire newspaper, consisting of many articles. The same is true of a magazine subscription (or a subscription to Salon.com.
This excellent article by Damien Cave discusses some customer problems with PayPal and how PayPal operates without the kind of regulation imposed on banks. Some interesting quotes from the article:
As one FTC lawyer put it, "if they filed for bankruptcy tomorrow, no one knows what would happen to their accounts."
"This is banking circa 1928," says Tom McGrath, managing partner of Bank Earnings International (BEI), a banking consulting company. "It's backwards. They could take all these customers' dollars and misapply them, so the money isn't available when the person wants it. They could be insolvent and no one would ever know.
The article also mentions a growing area of Internet funds transfer: laundering stolen money. On-line payment services are attractive ways to move cash out of stolen credit cards. PayPal has cracked down on transactions that they suspect of being improper, sometimes catching valid transactions in the process.
Secret Service Raids Gold-Age by Declan McCullagh, Wired News, March 30, 2001
Digging Those Digicash Blues, by Declan McCullagh, Wired News, June 14, 2001
An excellent article on the continuing failures of commercial digital cash ventures and how the dream still lives on with some engineers. The articles mentions PayPal:
PayPal, probably the most popular system of the sort, is trying to lure Internet shoppers away from credit cards with surprising luck so far: The company has raised $225 million in financing and claims to have 8 million customers.
As this article points out, the on-line transactions handled by payment services like PayPal are a tiny fraction of the volume handled by Visa, so Visa considers them too small to bother with. Since these are all bank mediated transactions, the banks and credit card companies have a huge advantage (some would say, monopoly). It is difficult to understand the venture capital business model that sees the usual venture capital multiplier return in the $225 million invested in PayPal.
I'll Gladly Pay You Tuesday by Robert X. Cringely, August 31, 2001
As somewhat puffy piece on the "Masters of the Universe" at X.com (PayPal).
Fame vs Fortune: Micropayments and Free Content, by Clay Shirky, September 5, 2003
This article continues Clay Shirky's arguments against micropayments. The article points out that there is a psychological overhead in micropayments, which I had never considered. This overhead is the mental effort to figure out if the material you want to read is worth a certain sum of money. This overhead does not decrease with the size of the micropayment.
This article was apparently written in response to some recent articles on micropayments. There is an almost utopian ideal that seems to inspire the continuing interest in micropayments. After all, thinks the author of The Bearcave, wouldn't it be wonderful to collect those micropayments for all of this wonderful material while living in the bucolic Carmel Valley?
Feds accuse E-Gold of helping cybercrooks by Bob Sullivan, May 2, 2007, MSNBC
From the article:
A federal grand jury has indicted online payment company E-Gold, accusing the company of money laundering, conspiracy, and operating an unlicensed money transmitting business.
The founder of E-Gold, Douglas Jackson, denies the US government charges.
Revised: May 2007
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