The Unintended Consequences of E-Cash
A position paper by Michael Froomkin for the
Computers, Freedom & Privacy
Burlingame, California, USA
March 12, 1997, at 2pm.
David Chaum, Michael
This position paper resides at http://www.law.miami.edu/~froomkin/articles/cfp97.htm
Ver 1.2 Mar 12, 1997. © 1997 A. Michael Froomkin. All Rights Reserved. Permission granted
to copy for non-profit uses.
The Unintended Consequences of E-Cash
Electronic cash, broadly defined, includes both smart-card based tokens
of value and digital coins or other digital tokens of value (e.g. "digital
checks"). [If these distinctions are not meaningful to you, please
Cash: A Technical Menu, at URL
For the foreseeable future I predict these new payment media will have
major economic effects only in the part of the economy that uses small
and micro-transactions. Unless legal rules change significantly, consumers
who live in jurisdictions that provide legal protections for debit or credit
cards transactions will tend to use them for larger payments. After all,
why use e- cash when you can use a credit card and cancel the payment if
the seller fails to deliver what was promised? Thus, e-cash will have relatively
modest overall effects on commerce, the money supply, and the economy.
And e-cash will have equally modest effects on taxes and social mores.
The (Mostly) Bad News
I predict that most of the social effects of e-cash will be negative,
in part due to the (over) reaction from regulatory authorities, in part
due to the ways in which corporations will be able to amass more data on
consumers. Government action will (largely unintentionally) exacerbate
the negative effects of e-cash on privacy:
- Profiling. The increasing use of e-cash for small and especially
"micro" transactions such as viewing a web page will vastly increase
businesses' (and, arguably, governments') ability to put together detailed
profiles of consumers/ citizens. If the World Wide Web or its successors
become fee- based systems in which readers are charged for access, consumers
who use traceable digital cash will find that their reading habits as well
as transactions become valuable, tradeable data. This will lessen their
privacy and could have a chilling effect on readers and, possibly, on authors
also. If the Web succeeds in supplanting other media, the social consequences
could be very great. The Internet or related networks may become the foundation
of the opposite of anarchy: life in a transparent data ocean, a life in
which data recording everyone's movements, tastes, purchases, medical history,
reading habits, and contacts with officialdom are commodified and available
to some, and perhaps even to all.
- Limited Regulatory Arbitrage. This is the only major
social effect I foresee which is not wholly negative. E-cash will facilitate
trans-border transactions in which no physical goods are exchanged. Legal
transactions will most often occur in other payment media, notably credit
and debit cards, because consumers will have greater legal protection if
something goes awry with the transaction. Today's trans-border gambling
and trans-border sale of pornography will in time pave the way for trans-border
securities trading and off-shore brokerages, some of which will violate
the laws of the customer's home state. However, unless large amounts of
untraceable anonymous currency are in wide circulation, and these funds
are widely accepted for physical purchases as well as electronic commerce,
the owners of electronic cash will need a means of transferring funds from
electronic cash to ordinary cash. In most cases, the owners of significant
sums of electronic cash will also want to invest their funds. In either
case they will require the services of a financial service provider, such
as a bank. Thus, at least in the medium term, governments may be able to
control anonymous commerce by concentrating on financial service providers.
Financial service providers are already highly regulated, and present a
relatively easy target for governments seeking to prevent fully anonymous
fund transfers. Regulators may also benefit from the reluctance of consumers
to bank abroad, even when offered accounts denominated in their home currency.
If, however, consumers become more willing to bank abroad, the ability
of governments to control anonymous transactions will be reduced further,
unless all or almost all governments are able to agree on common rules.
- Law Enforcement Reaction. Law enforcement agencies' fear that
anonymous e-cash can easily be used for money laundering will lead to vigorous
government action to secure some combination of the following:
- Legal prohibitions on the issuance of anonymous and semi-anonymous
e-cash, thus exacerbating the profiling phenomenon described above;
- Legal prohibitions on the use of anonymous or semi- anonymous e-cash;
- A requirement that some form of "identity escrow," i.e. a
subpoenable record of the user's identity, be built into the e-cash;
- An attempt by governments to influence standards creation to discriminate
against e-cash systems that allow either peer-to-peer transfers or even
- In the somewhat likely event that governments fail to achieve any of
the above objectives, I expect increasingly stringent rules, agreed at
the international level, requiring that all movements of liquid assets,
including ever-smaller sums, be registered with financial authorities.
The existence of violations of these rules will then become a basis for
further erosion of civil liberties, as the "war on money laundering"
becomes an increasingly prominent component of the "war on drugs".
Both financial privacy and privacy generally will decrease.
- Harms to Litigation Concerning the Right to Anonymous Speech.
Because of the technical reality that it is impossible to distinguish an
anonymous electronic payment from an anonymous private or political message,
the legality of the regulation of e-cash will become the legal terrain
over which most legal battles concerning constitutional or statutory rights
to anonymous speech will be fought. While not necessarily fatal to the
cause of anonymous speech in the U.S., the identification of anonymous
speech with money laundering will put anonymous remailers and other facilitators
of anonymous speech into a defensive litigation posture which will tend
to harm their prospects in the U.S. courts.
What Won't Happen
I also predict that the certain social phenomena that one sometimes
sees suggested as likely consequences of the widespread adoption of e-cash
will not come to pass in the near future:
- E-cash itself will not cause major changes in the nature of retailing.
This will happen, but as result of web commerce itself, not due to the
existence of any particular payment mechanism.
- E-cash itself, even anonymous e-cash, will not cause major changes
in the tax system or enable large-scale tax avoidance. Most production
and even more consumption involves transactions that are easily monitored
for tax compliance. Income tax non-compliance requires payor as well as
payee to participate in avoidance. Widespread deduction and reporting of
tax at source makes this unlikely. My income, for example, comes from a
salary paid by an institution that has no incentive to make it easy for
me to engage in tax avoidance. (The U.S. economy is said to be shifting
towards smaller sized businesses. As owner-operated businesses and independent
contractors increase, the potential for tax fraud grows too. This, however,
is as true whether payments are electronic or not.) Some knowledge
workers may be able to demand that payment be routed to accounts held at
untaxed off-shore addresses, thus causing an effect at the margin, but
I think such schemes will remain only marginal for the foreseeable future.
Furthermore, any transaction that encounters the banking system -- for
example, deposits placed on short-term interest -- will be easily traceable
for tax purposes so long as the bank is located in a jurisdiction that
enlists banks as enforcers of its, or its treaty-partners', tax rules.
Few nations offer strong banking secrecy today, and the international effort
to curb money laundering has reduced their number; some nations that continue
to offer strong banking secrecy may lack the political stability necessary
to lure risk-averse investors. Conceivably, the tax system might begin
to feel the effects if a reputable bank in a country with a stable currency
and a trustworthy regulatory system were to offer anonymous electronic
cash accounts on terms attractive to ordinary consumers. In that event,
other countries would still be able to mitigate the effects by switching
to a Value Added Tax (VAT) system, since tax cheating under VAT would require
the participation of more people in the chain of production.
- Most tangible goods regulation known in the U.S. as the "police
power" will remain unaffected by the Internet and its cousins. Food
and drug regulation does not change because research chemists have new
ways of communicating. Traffic laws, pension laws, tort law, indeed vast
tracts of the legal and social landscape will no doubt change in the future
-- but not because of e-cash.
If the internet generally, perhaps aided by the prevalence of e-cash,
were to change migration patterns, things would begin to look very different.
Workplace safety rules do not need to change to lose their effectiveness
if the workplace moves. It may be that certain types of knowledge workers
based in low-wage areas will be able to increase the market for their services.
Mathematicians and programmers have already begun to exploit this opportunity;
perhaps editors and artists will be next. As the Internet becomes the leading
means to rapidly disseminate scientific, technical and even social information,
persons in less developed countries who find themselves isolated in provincial
areas, or are concerned about keeping abreast of developments in their
field may conclude that they no longer have to move to more developed countries
and regions to do cutting-edge work, or to participate in scholarly exchanges.
The increased ability of some persons in traditionally low-wage areas to
sell their services on the world market and participate in global dialogues
may help stem the so-called "brain drain". Indeed, it may increase
the "reverse brain drain" as some expatriates return to their
country of origin, perhaps even joined by a new wave of expatriate knowledge
workers seeking a lower cost of living. Whether or not this happens in
the long term, I am confident it will not happen in any large sense in
the short or medium term.
Background materials and further reading
Two papers of mine that you might find relevant
Flood Control on the Information Ocean: Living With Anonymity, Digital
Cash, and Distributed Databases, is available online http://www.law.miami.edu/~froomkin/articles/ocean.htm
. It describes representative forms of smart card cash and digital
coins, and discusses the interrelationship between e-cash, anonymous speech
The Internet as a Source of Regulatory Arbitrage, is available online
It discusses the limited but powerful ways in which internet commerce,
some of which would use e-cash, can allow users to evade certain government
regulations -- but not others.
Links to Links
An excellent (but slow) link
to many sources of e-cash information hosted by M.E. Peirce in Dublin,
Phillip Hallam-Baker's W3C
extensive collection of links to electronic payment schemes.
Some other useful links
of anonymous e-cash with trustee-based tracing.
work of Stefan Brands.
The W3C electronic payments
links on the nature of money.
Ron Rivest & A. Shamir's article, Payword &
Micromint -- Two Simple Micropayment Schemes (in postsript format).