Digital Cash and Monetary Freedom
Jon W. Matonis
April, 1995

Presented at INET '95
Internet Society Annual Conference
Honolulu, Hawaii
June 26-30, 1995


Abstract

Much has been published recently about the awesome promises of electronic
commerce and trade on the Internet if only a reliable, secure mechanism for
value exchange could be developed.  This paper describes the differences between
mere encrypted credit card schemes and true digital cash, which presents a
revolutionary opportunity to transform payments.  The nine key elements of an
electronic, digital cash are outlined and a tenth element is proposed which
would embody digital cash with a non-political unit of value.

It is this final element of true digital cash which represents monetary freedom
- the freedom to establish and trade negotiable instruments.  For the first time
ever, each individual has the power to create a new value standard with an
immediate worldwide audience.

If all that digital cash permits is the ability to trade and store dollars,
francs, and other governmental units of account, then we have not come very far.
Even the major card associations, such as Visa and MasterCard, are limited to
clearing and settling governmental units of account.  For in an age of inflation
and government ineptness, the value of what is being transacted and saved can be
seriously devalued.  Who wants a hard drive full of worthless "cash"?  True,
this can happen in a privately-managed digital cash system, but at least then it
is determined by the market and individuals have choices between multiple
providers.

The section on key elements of a private digital cash system compares and
contrasts true digital cash to paper cash as we know it today.  Each of the
following key elements will be defined and explored within the bounds of
electronic commerce:

	*	Secure (unable to alter or reproduce)
	*	Anonymous (untraceable)
	*	Portable (physical independence)
	*	Infinite duration (until destroyed)
	*	Two-way (unrestricted)
	*	Off-line capable (availability)
	*	Divisible (fungible)
	*	Wide acceptability (trust)
	*	User-friendly (simple)
	*	Unit-of-value freedom (non-political)

The transition to a privately-operated digital cash system will require a period
of brand-name recognition and long-term trust.  Some firms may at first have an
advantage over lesser-known name-brands, but that will soon be overcome if the
early leaders fall victim to monetary instability.  It may be that the smaller
firms can devise a unit of value that will enjoy wide acceptance and stability
(or appreciation).

True digital cash as an enabling mechanism for electronic commerce depends upon
the marriage of economics and cryptography.  Independent academic advancement in
either discipline alone will not facilitate what is needed for electronic
commerce to flourish.  There must be a synergy between the field of economics
which emphasizes that the market will dictate the best monetary unit of value
and cryptography which enhances individual privacy and security to the point of
choosing between several monetary providers.  It is money, the lifeblood of an
economy, that ultimately symbolizes what commercial structure we operate within.






























"Money does not have to be created legal tender by government: like law,
language and morals it can emerge spontaneously.  Such private money has often
been preferred to government money, but government has usually soon suppressed
it."
			-  F. A. Hayek, Nobel Laureate [1]

1.	Prologue

The year is 2005.  I buy lunch at a deli and I pay in wireless digital cash from
my electronic wallet.  Currently, all promised visions of the future - with one
notable exception.  The cashier gives me a choice of monetary units which are
both displayed on the flat-panel screen for me to view.  My turkey and cheese
sandwich will cost me US $50 or 5 pvu.  The monetary symbol "pvu" is an
abbreviation for "private value units", which now compete in most commercial
settings with the US Dollar and have stayed remarkably stable since their
initial issuance in mid-1996.

The future belongs to superior private currencies and the linchpin for
successful digital cash ventures will undoubtedly be freedom in the unit of
value.  We are witnessing nothing less than the birth of a new industry - the
development, issuance, and management of private currencies.  Once seeded,
digital cash as the representation of binary value, will pave the way to a
further off-network revolution in money [2].

Much has been published recently about the awesome promises of electronic
commerce and trade on the Internet and World Wide Web if only a reliable, secure
mechanism for value exchange could be developed.  This paper highlights the
differences between mere encrypted credit card schemes, as Visa, Mastercard, and
others are currently developing, and "true" digital cash, which presents a
revolutionary opportunity to transform payments.  The nine key elements of an
electronic, digital cash are outlined and a tenth element is proposed which
would embody digital cash with a non-political unit of value.

It is this final element of true digital cash which represents monetary freedom
- the freedom to establish, circulate, and trade negotiable monetary
instruments.  The opportunity to launch an alternative monetary system on a
grand scale simply has not been available until recently.  Granted, small local
experiments, such as LETS and constants, with limited real-world penetration
have always seemed to exist in one form or another.  But, only lately with a
global, inter-networked society can we truly say that the established monetary
order is susceptible to challenge.

Specifically, the Internet provides (1) ease of mass issuance and circulation,
(2) accessible encryption technology, (3) affordable currency transfer
infrastructure, and (4) real-time conversion between competing units.
Essentially, for the first time ever, each individual has the power to create a
new value standard with an immediate worldwide audience.  This should serve as a
friendly warning to the clearing associations, banks, and financial service
providers of the current paradigm.


2.	Why Monetary Freedom is Important

Monetary freedom is essential to the preservation of a free-market economy.  As
the current trend on the Internet demonstrates, robust economic commerce depends
on a flexible, responsive monetary system which can best be provided by
unbridled market competition [3].  This implies not only market competition
among issuers but strong competition among the units or representative units
that are being issued.  Ultimately, the competition for the standard of value
should be no different than the competitive market of multiple providers that we
see for toothpaste or shoes [4].

When a single currency issuer, such as the "Fed", controls the supply of money
and the specific units being transacted, the potential exists for monetary
manipulation and an overbearing control of the economy.  With the unprecedented
growth of the Internet, the standards for electronic commerce are still
evolving.  Neither the US Dollar, nor any other governmental unit, has gained a
foothold into this new economy.  The monetary landscape is ripe and wide open
and private currencies should infiltrate now.

If all that digital cash permits is the ability to trade and store dollars,
francs, marks, yen, and other governmental units of account, then we have not
come very far.  Even the major card associations, such as Visa and MasterCard,
are limited to clearing and settling governmental units of account.  For in an
age of inflation and government ineptness, the value of what is being transacted
and saved can be seriously devalued.  Who wants a hard drive full of worthless
digital "cash"?  True, this can happen in a privately-managed digital cash
system, but at least then it is determined by the market and individuals have
choices between multiple providers.


3.	Key Elements of a Private Digital Cash System

As would-be currency providers should note, there are ten key elements to a
successful, private digital cash system.  This section compares and contrasts
true digital cash to paper cash as we know it today.  Each of the following key
elements of a digital cash "token" will be defined and explored within the
bounds of electronic commerce.  I have yet to discover a working digital cash
system which meets all ten criteria although several are reportedly close.  In
1991, Tatsuaki Okamoto and Kazuo Ohta proposed six properties of an ideal
digital cash [5], which are incorporated into elements one through six below:  

3.1	Secure.  The transaction protocol must ensure that a high-level security
is maintained through sophisticated encryption techniques [6].  For instance,
Alice should be able to pass digital cash to Bob without either of them, or
others, able to alter or reproduce the electronic token.	

3.2	Anonymous.  Anonymity assures the privacy of a transaction on multiple
levels.  Beyond encryption, this optional untraceability feature of digital cash
promises to be one of the major points of competition as well as controversy
between the various providers [7].  Transactional privacy will also be at the
heart of the government's attack on digital cash because it is that feature
which will most likely render current legal tender irrelevant [8].  Both Alice
and Bob should have the option to remain anonymous in relation to the payment.
Furthermore, at the second level, they should have the option to remain
completely invisible to the mere existence of a payment on their behalf.

3.3	Portable.  The security and use of the digital cash is not dependent on
any physical location.  The cash can be transferred through computer networks
and off the computer network into other storage devices.  Alice and Bob should
be able to walk away with their digital cash and transport it for use within
alternative delivery systems, including non-computer-network delivery channels.
Digital wealth should not be restricted to a unique, proprietary computer
network.

3.4	Two-way.  The digital cash can be transferred to other users.
Essentially, peer-to-peer payments are possible without either party required to
attain registered merchant status as with today's card-based systems.  Alice,
Bob, Carol, and David share an elaborate dinner together at a trendy restaurant
and Alice pays the bill in full.  Bob, Carol, and David each should then be able
to transfer one-fourth of the total amount in digital cash to Alice.
	
3.5	Off-line capable.  The protocol between the two exchanging parties is
executed off-line, meaning that neither is required to be host-connected in
order to process.  Availability must be unrestricted.  Alice can freely pass
value to Bob at any time of day without requiring third-party authentication.
	
3.6	Divisible.  A digital cash token in a given amount can be subdivided into
smaller pieces of cash in smaller amounts.  The cash must be fungible so that
reasonable portions of change can be made.  Alice and Bob should be able to
approach a provider or exchange house and request digital cash breakdowns into
the smallest possible units.  The smaller the better to enable high quantities
of small-value transactions [9].
	
3.7	Infinite duration.  The digital cash does not expire.  It maintains value
until lost or destroyed provided that the issuer has not debased the unit to
nothing or gone out of business.  Alice should be able to store a token
somewhere safe for ten or twenty years and then retrieve it for use.

3.8	Wide acceptability.  The digital cash is well-known and accepted in a
large commercial zone.  Primarily a brand issue, this feature implies
recognition of and trust in the issuer.  With several digital cash providers
displaying wide acceptability, Alice should be able to use her preferred unit in
more than just a restricted local setting.
	
3.9	User-friendly.  The digital cash should be simple to use from both the
spending perspective and the receiving perspective.  Simplicity leads to mass
use and mass use leads to wide acceptability.  Alice and Bob should not require
an advanced degree in cryptography as the protocol machinations should be
transparent to the immediate user.
	
3.10	Unit-of-value freedom.  The theme of this paper: the digital cash is
denominated in market-determined, non-political monetary units.  Alice and Bob
should be able to issue non-political digital cash denominated in any defined
unit which competes with governmental-unit digital cash.


4.	Implementing a Non-political Unit of Value

The transition to a privately-operated digital cash system will require a period
of brand-name recognition and long-term trust.  Some firms may at first have an
advantage over lesser-known name-brands, but that will soon be overcome if the
early leaders fall victim to monetary instability.  It may be that the smaller
firms can devise a unit of value that will enjoy wide acceptance and stability
(or even appreciation).

4.1  Potential Unit Providers

Who will be the new monetary unit providers ?  Opportunities abound for almost
anyone but in reality the greatest advantage currently goes to the on-line
shopping malls and the large merchant sites on the Internet, such as Open
Market, Internet Shopping Network, and Net Market.  For it is this group that
will directly influence the payment channel between consumer and merchant
through their extensive contact with both.  And, this influence can be utilized
to their advantage to build preference for their "site" through money issuance
in much the same way that various forms or scrip and coupons build customer
loyalty and guarantee repeat visits [10].  As will be explained later, the true
business gain is realized when the units are negotiable in their own right and
not merely accepted at the mall only.

Other potential unit providers include internet service providers (ISPs),
bulletin board system operators (BBSs), content publishers, card-based payment
networks, and well-known manufacturer or service companies.  They all share in
common the existence of an extensive base of on-line customers.  As the new
digital cash providers, international brand names, such as Coca-Cola, Microsoft,
and IBM, find themselves in an enviable position to capitalize immediately on
their global name recognition.


4.2  Distribution and Circulation

What will the providers be issuing and how will they circulate it ?

Probably the least exploited system in the world of money is the metric system.
To cite an example, I propose a decimal unit-of-value measurement system that is
based on the 1864 metric system.  It possesses built-in ease of calculation and
is universally recognized.  Hypothetically, it would have the following monetary
unit prefix designations:

	kilo- (1,000)
	hecto- (100)
	deka- (10)   
	base unit name (1)
	deci- (0.1)
	centi (0.01)
	milli (0.001)

The base unit name becomes the unit which is being distributed, such as a pvu in
the 2005 example.  Initial distribution techniques for the new private money
include elimination of discount fees for merchants [11], free coupons or
promotions to consumers, and royalty schemes for content providers that accept
payment in the new digital cash.  This area affords unique opportunities for
innovative advertisers and marketers to involve themselves in electronic
commerce.  Once digital cash has hit the market, circulation will then be a
factor of merchant acceptance and the rewards of ultimate redemption.




4.3  Redemption and Convertibility

What will back the new monetary units and how will they be redeemed ?

Suggestions for monetary backing include equity mutual funds, commodity funds,
precious metals, real estate, universal merchandise and/or services, and even
other units of digital cash.  Anything and everything can be monetized.  This
will undoubtedly develop into a main basis for competition among digital cash
providers as each one promotes their underlying currency backing as the
strongest and most reliable.  Unlike today's national monetary systems, the
benefits of a strong currency will be immediately noticeable within a country's
borders.  With multiple monetary unit providers, domestic prices will adjust
rapidly to reflect relative values of monetary units and the holders of stronger
currencies will benefit.  This is a vastly different world then we have now and
consumers will analyze currencies as the investments that they really are.

Focusing on the option of equity mutual funds, this does not imply that a
prospective digital cash provider learn to become adept at managing an entire
portfolio.  Mutual funds of mutual funds exist today and contracts can be
executed with the specialist managers of those funds.  Outsourcing the portfolio
function takes advantage of the experts in the field today who compete already
on reliability and overall performance - prime benchmarks for a private monetary
unit.  The issuer's skills should concentrate on distribution, monitoring
geographic circulation of the unit, and managing the rate of redemption. 


5.	Managing a Non-political Unit of Value

After initial issuance and circulation, the digital cash providers must turn
their attention to the management of the monetary unit if it is to survive in an
ultra-competitive environment.  This can prove the most difficult area due to
the perennial temptation of over-issuance.

5.1  Digital Cashflow Administration

Since electronic monetary units on a client/server network can return to the
issuer almost instantaneously, extreme diligence is required in accounting for
digital cash and tracking redemption patterns.  This need not be solely the
function of the issuer and probably will not be as newsheets and databases
evolve to manage the discounting and exchange function.  As multiple currencies
infiltrate the market, their relative values will dictate that they trade at a
discount or premium to some other benchmark.

These free-market clearinghouses act as a central bank forcing each issuer to
maintain an adequate balance between digital cash outstanding and the chosen
reserve backing.  Systems of clearing and redemption are a necessity for the
smooth operation of free banking as they provide a check on over-issuance and
the general deterioration in sound credit [12].  

Therefore, the manager of a private monetary unit can rely on these
clearinghouse parties to communicate to the public the unit's standing in the
economy.  Moreover, if the discount of a particular unit begins to deteriorate,
it can alert management to the fact that some market forces are affecting the
demand for that unit.


5.2  Issuer Benefits

Taking the proposal one step further, let us assume that after witnessing the
on-line successes with monetary freedom a point-of-sale brand such as American
Express wanted to capitalize on their global infrastructure and issue
proprietary monetary units, in both digital cash and non-digital cash form.
Just as with our on-line provider, the benefits to American Express are
substantial if an American Express monetary unit can gain worldwide acceptance.
Primarily, American Express will benefit from:

(a)	Increased acceptance of American Express card products at merchant
locations.  This will be possible because of the lower fees and discount rates
derived from managing a private unit of account.

(b)	Increased demand for American Express card products in countries without
established currencies and in countries with severe monetary instability of the
established currency.  This applies to several new democracies in Eastern Europe
and the volatile third world nations of Africa and South America.  Devaluations
and revaluations of a currency have always plagued American Express from a
financial management perspective.  However, a new American Express monetary unit
will provide these countries with a stable alternative to their own currency
without the political ramifications of adopting the "imperialist" US Dollar.

(c)	Natural marketing benefits associated with a private currency or unit of
account.  It is easiest to displace cash and cheques by becoming cash and
cheques.  American Express will gain clout from the name association and brand
identification that accompanies a pricing system.  Since American Express's
private monetary unit will be the first non-governmental unit of account, it is
difficult to compare to other products, but it is fair to say that from a trade
perspective American Express will benefit in much the same way that the United
States benefits when products globally are priced in US Dollars.

(d)	Transaction volume that remains within the American Express system by
providing a unit of account with ultimate redemption only at an American Express
location.  A sharp, sustained increase in transaction volume can be expected
because the majority of cardholder transactions made in the American Express
monetary unit will be duplicated by the acceptor of the American Express
monetary unit.  This will occur because of the incentive to avoid costly
conversion out of the American Express monetary unit.  The user incentive is
maintained by providing a stable unit of value with strong merchant acceptance.
The great irony occurs when Visa and Mastercard begin accepting and processing
transactions denominated in the American Express monetary unit through their
authorization and clearing systems.

(e)	Open market operations conducted by American Express that expand or
contract the available supply of American Express currency.  The gains in this
case are derived from the fact that American Express can determine its own
monetary unit's short-term interest rate, and hence lending revenue, by
manipulating its own unit's supply.  The capital for these operations is
generated from the difference between the digital cash face value and the cost
to produce and ultimately back the electronic token.  Issuers may lend capital
or spend capital that is generated in this fashion. 

Since the treasury division of American Express would resemble, in some
respects, the dealing room of the Federal Reserve Bank, American Express could
artificially expand the supply of its own monetary unit to generate direct
corporate revenue with the obvious constraint being the long-term preservation
of the unit's market value.  This may prove to be a tricky endeavor and it is
the tightrope that a monetary issuer walks.

(f)	Increased corporate borrowing capacity resulting from an almost immediate
increase in overall capitalization of the company.  Over time, the balance sheet
of the issuing entity will largely be a function of the American Express
monetary units in circulation.  A stronger balance sheet can only enhance the
strategic position of the corporation in financial markets.

(g)	Potential unrealized profits from a managed portfolio comprised of a
reserve-backed currency at a time when government fiat currencies are suffering
from international market instability.  The profits of currency held are a
direct result of the appreciation of the new monetary unit relative to other
monetary units.



6.	Epilogue

True digital cash as an enabling mechanism for electronic commerce depends upon
the marriage of economics and cryptography.  Independent academic advancement in
either discipline alone will not facilitate what is needed for electronic
commerce to flourish.  There must be a synergy between the field of economics
which emphasizes that the market will dictate the best monetary unit of value
and cryptography which enhances individual privacy and security to the point of
choosing between several monetary providers.  I refer to this new sub-discipline
as cryptonomics.  The Internet is a new world and a new world demands a new
currency - a new standard of value.

As an enabling mechanism for social change, digital cash has vast implications
for macro-economics in the area of a government's money monopoly and taxing
authority, just to name a few [13].  In light of the growing attacks on
individual privacy both in the United States and abroad, there has never been a
more important time to emphasize the concepts behind the vigilant protection of
total financial and monetary privacy.  It is money, the lifeblood of any
economy, that ultimately symbolizes what commercial structure, and hence what
political structure, humans operate within. 



References

[1]  F. A. Hayek, Denationalisation of Money - The Argument Refined, Institute
of Economic Affairs, 1978.

[2]  J. Matonis, The Political Appropriation of the Monetary Unit, Institute for
Monetary Freedom, November 1984.

[3]  K. Dowd, Private Money: The Path to Monetary Stability, Institute of
Economic Affairs, 1988.

[4]  E.C. Riegel, Private Enterprise Money: A Non-Political Money System,
Harbinger House, 1944.

[5]  T. Okamoto and K. Ohta, "Electronic Digital Cash," Advances in Cryptology
CRYPTO '91, J. Feigenbaum (Ed.), Springer-Verlag, pp. 324-350, 1991.

[6]  S. Garfinkel, PGP: Pretty Good Privacy, O'Reilly & Associates, Inc., 1995.

[7]  B. Schneier,  Applied Cryptography: Protocols, Algorithms, and Source Code
in C, John Wiley & Sons, Inc., pp. 117-125, 1994.

[8]  D. Chaum, "Security Without Identification: Transaction Systems to Make Big
Brother Obsolete," Communications of the ACM, Vol. 28 no. 10, October 1985. 

[9]  K. Kelly, Out of Control: The Rise of Neo-Biological Civilization,
Addison-Wesley Publishing Co., pp. 203-229, 1994.

[10]  M. Eichenbaum and N. Wallace, "A Shred of Evidence on Public Acceptance of
Privately Issued Currency," Federal Reserve Bank of Minneapolis, Quarterly
Review, Winter 1985. 

[11]  W. Baxter, "Bank Interchange of Transactional Paper: Legal and Economic
Perspectives," Journal of Law and Economics, vol. 26, October 1983.

[12]  G. Trivoli, The Suffolk Bank: A Study of a Free-Enterprise Clearing
System, The Adam Smith Institute, 1979.

[13]  M. Rothbard, What Has Government Done to Our Money ?, Libertarian
Publishers, 1964.



Biographical Sketch of Author

Jon Matonis is the founding director of Private Payment Systems, a research
organization for private currencies on the Internet based in Moss Beach,
California.  He has held positions of Foreign Exchange Manager for Deak
International's World Bank office, Director of Futures Trading for Sumitomo Bank
Ltd., and Foreign Exchange Manager for a major credit card association.

In 1982, Mr. Matonis founded the not-for-profit Institute for Monetary Freedom
which has published several academic articles on monetary economics and free
banking.  In 1988, he developed the proprietary Freedom I Trading System which
has been utilized by institutional money management funds and hedge funds in the
United States.  He is a former member of the National Futures Association and
holds a B.A. in Economics from George Washington University.