E-Cash: Can't Live With It, Can't Live Without It ------------------------------------------------- _American_Lawyer_, February 1995 David G. Post With some twenty or thirty million individual users, and twenty thousand businesses, already linked electronically to one another, and thousands more arriving on the scene each day, the Internet's potential as a marketplace--a place where buyers and sellers can come together to exchange goods or services for value-- is vast. It is thus no surprise that businesses are rushing headlong onto the Internet (even if most of them have not quite figured out what they will do when they are there). But the thousands of willing sellers (of everything from books, magazines, computer programs, and other information-based products to more tangible items) hawking their wares online face a problem: how will buyers pay for these goods and services? What is the currency that will serve as the medium of exchange in this new marketplace? At present, there is no secure way to effect payment of the public Internet, and so users are forced to go off the 'Net to make the purchase--mailing the seller a check or phoning in a credit card number. Eight hundred years ago, give or take a few, the merchants of medieval Europe faced a similar problem when trying to unlock the commercial potential of the continent-wide marketplace. After the fall of Rome, with Europe divided up into dozens of competing sovereignties, long-distance commerce came to a virtual standstill for hundreds of years. Merchants and traders seeking to exploit this new territory faced any number of seemingly insurmountable obstacles--e.g., the difficulty of obtaining protection against armed and organized marauders, conflicting local laws and customs regarding commercial practices, and incompatible and inconvertible currencies. To circumvent some of these problems, these medieval merchants invented, in effect, a form of private money: negotiable instruments (promissory notes, bills of exchange, and the like). The merchant-developed commercial law surrounding use of these instruments, incorporated into the lex mercatoria in the early middle ages, stands as one of the truly remarkable achievements of the western legal tradition and one of the critical turning-points in the history of the expansion of trade and commerce. We may be on the verge of a similar sort of development today, but one that, in keeping with the general acceleration of all things technological, is likely to take far less time to conclude than the centuries it took for the commercial payment system to evolve. Although I am generally loathe to make predictions about future developments on the Internet (other than a forecast of continued rapid growth and activity), one prediction may stand as an exception to this general rule: I am virtually certain that we will soon find true electronic cash ("e-cash") -- digital tokens accepted as the equivalent of legal tender (see sidebar) -- circulating over the Internet's wires. ************************************************** SIDEBAR: WHAT IS E-CASH? Although there are any number of schemes currently under development, the basic e-cash system is likely to work roughly as follows 1. Alice establishes an account at her bank, First Digital, in the ordinary manner. 2. When she wants cash, she sends an electronic mail message to First Digital requesting, say, $100. Using one of the available "public key encryption" programs I described in last month's column, she encrypts her message -- scrambles it using First Digital's public encryption code, which means that only First Digital can make any sense of it whatever. She also electronically "signs" the message -- encrypts it again, but this time using her own private encryption code -- which allows First Digital to verify that the message indeed came from Alice. 3. First Digital debits her account by $100 and sends off her cyber-currency, which consists simply of a digital file, a string of 1s and 0s, that the bank's computers will recognize as the equivalent of a $100 bill. This file, too, is encrypted by First Digital (so that only Alice can make use of it) and signed by First Digital (uniquely identifying First Digital as the issuer). 4. When Alice finds Bob offering something on the Internet that she want to buy, she transfers this file to him -- encrypting it again (for Bob's eyes only) and signing it. Bob decrypts the file and, verifying that First Digital is the issuer, transmits it back to First Digital, which confirms that it issued the file and credits Bob's account accordingly. All of these manipulations, needless to say, are handled automatically in the parties' computers. What Alice really does, sitting at her PC, is choose "get $100" and "send $100" from the menu of her Internet navigation program. ************************************************** Don't take my word for it. Microsoft's Bill Gates, a man with a fairly good track record at predicting future technological developments (if only, perhaps, because he has the resources to will them into existence) calls the "electronic wallet" -- a microchip storing e-cash, credit card information, and various other tidbits of information one might like to carry around in one's pocket -- his "favorite idea," and everyone from Microsoft to financial services giants such as Citibank and Visa International -- and dozens of smaller and (currently) less well-known operations -- is hard at work developing its version of the currency of the future. It is not hard to see why. Existing paper money, to be sure, is inconvenient (physically cumbersome, difficult to transport and process, easy to steal) and it has been steadily losing "market share" to other payment systems (checks, credit cards, electronic funds transfer) that seem better suited to the needs of the modern world of electronic commerce. But shorn of these disadvantages, cash is pretty wonderful stuff: portable, instantly recognizable, instantly accepted by everyone without any of the overhead associated with the other payment systems, and entirely anonymous. And any form of cash that can retain these features and be utilized in the world of electronic commerce is going to prove extremely attractive. It also will likely earn its developers significant amounts of money, digital or otherwise. So what, you ask? So Microsoft (or others) finds some way to issue e-bills, earns billions of dollars in transactions fees, and helps transform the Internet into a kind of Home Shopping Network in overdrive -- why should the law or lawyers pay this any mind? Because e-cash poses, appropriately enough, a binary choice for regulators and other law-enforcement types that will do much to determine the ultimate fate of lawful activity on the global network. As a result of the very features that make it so attractive, cash has always occupied a somewhat unstable and uncomfortable place within the existing legal regime. Anonymous and virtually untraceable, cash transactions today occupy a place in a kind of legal netherworld, an underground domain where the law is an uncertain presence. Because paper money in large quantities is indeed so cumbersome to use and manipulate, this underground economy is generally confined to relatively small-scale transactions. (Some large-scale drug operations and other organized crime are the obvious exceptions). So long as the transactions are mostly small, they can, perhaps, be tolerated by the state as an unfortunate, but largely insignificant, by-product of the modern commercial state. As transactions get larger, the state becomes more suspicious, and enlists the aid of the banks, through the currency reporting and anti-structuring laws, in reporting large disbursements of cash so that additional oversight can be ordered. Anything that makes cash substantially easier to use in a substantially broader range of transactions holds the potential to expand this extra-legal netherworld to proportions posing ever more serious threats to the existing legal order. Under the most ambitious visions of e-cash, we would see a new form of a currency--units of money in the form of digital files instead of engraved notes that could be freely passed off from one computer to another with no record, yet incapable of being forged. A consumer could draw such e-cash electronically from his or her bank. The bank would have a record of that transaction, just as a withdrawal or check is recorded now. But after that, the encrypted e-cash file could be handed off without the knowledge of anyone but the parties to the transaction (see sidebar). Consider the impact of this on taxation. Transaction-based taxes (e.g., sales and use taxes) account for a significant fraction of state and local government revenue, and Congress itself is considering implementing a transaction-based national sales or valued added tax. But if electronic money really is made to function like paper money does, payments we would never think of making in cash--to buy a new car, say, or the down payment on a house--could be made in this new form of currency because there would be no problem of bulk and no risk of robbery. From the government's standpoint, if much larger and more significant transactions could be effected safely and securely by an electronic means that leaves no more of a paper trail than cash does today, that could eliminate records of many taxable transactions. The threat to the government's revenue flow should such schemes be implemented is a very real one (and officials at the US Treasury Department, at least, are starting to take cognizance of this development and to prepare their responses). Perhaps the banks and the public will never have enough confidence that the most powerful, untraceable, forms of e-cash can be safe from forgery. But e-cash's proponents think the technology will prove trustworthy. If it does, the government may move to prevent any truly anonymous and untraceable e-cash system from developing. But that raises its own problems because, as we escape the Scylla of the Underground Economy, the Charybdis of Big Brother rears its ugly head. Just as powerful encryption schemes permit the design of radically untraceable e- cash systems, so, too, do powerful electronic record-keeping tools permit the design of equally traceable systems -- systems where all of your financial transactions are duly recorded in the Great Database, allowing those with access to know more about you than anyone could know today. However the politics and business of e-cash play out, the technology is far enough along that the legal issues can't be avoided. The question e-cash poses is not, "Should the law take cognizance of this development?" but rather, "How can it not?" By pointing an arrow at the heart of the state's revenue-raising capabilities, e-cash cannot escape scrutiny and regulation; but it is going to take some serious thinking to design a regulatory scheme that does not fulfill our worst fears about the personal privacy implications of the new digital world.