The Unintended Consequences of E-Cash

A position paper by Michael Froomkin for the

Panel on 'Governmental and Social Implications of Digital Money'

Computers, Freedom & Privacy Conference (CFP'97)
Burlingame, California, USA
Wed. March 12, 1997, at 2pm.
Panelists: Roger Clarke, David Chaum, Michael Froomkin, and Tim May.

This position paper resides at

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 see Digital 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:

  1. 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.
  2. 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.
  3. 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:
    1. Legal prohibitions on the issuance of anonymous and semi-anonymous e-cash, thus exacerbating the profiling phenomenon described above;
    2. Legal prohibitions on the use of anonymous or semi- anonymous e-cash;
    3. A requirement that some form of "identity escrow," i.e. a subpoenable record of the user's identity, be built into the e-cash;
    4. An attempt by governments to influence standards creation to discriminate against e-cash systems that allow either peer-to-peer transfers or even payor anonymity;
    5. 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.
  4. 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:

  1. 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.
  2. 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.
  3. 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.

The Long-Term

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 . It describes representative forms of smart card cash and digital coins, and discusses the interrelationship between e-cash, anonymous speech and profiling.

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, Ireland.

Phillip Hallam-Baker's W3C extensive collection of links to electronic payment schemes.

Some other useful links

Tim May's cyphernomicon.

The Digicash Homepage.

A Discussion of anonymous e-cash with trustee-based tracing.

The work of Stefan Brands.

The W3C electronic payments area.

Some off-beat links on the nature of money.

Ron Rivest & A. Shamir's article, Payword & Micromint -- Two Simple Micropayment Schemes (in postsript format).