Digital money: electronic cash may make sense.

Tomorrow's shoppers - on the Web or in stores - may pay for purchases with digital tokens representing cash.

The future of shopping, many Internet merchants insist, is electronic commerce - using your computer as a shopping cart and the World Wide Web as a giant mall. There is already plenty

Today, if you want or need to pay online, you'll probably key in your credit-card number and expiration date, then cross your fingers because you've heard all the horror stories about cyberthieves. Despite the secure transmission protocols now used by many Internet merchants, many consumers are still fearful of entering credit-card numbers online.

One thief stole over 100,000 credit-card numbers - issued by 1,214 different banks - by using "packet sniffers," viruslike programs that surreptitiously hunt through networks for specific chunks of electronic information like credit-card numbers.

The risk from a compromised credit card is that having your name, account number, and expiration date unlocks your entire line of credit to the thief. The average monetary loss from credit-card fraud associated with mail and telephone orders is said to be over $600. Although your liability is limited to $50 - provided you immediately report the loss or theft - it may take you untold time and work to get fraudulent charges corrected and your credit record restored.

Credit-card companies are working hard to develop better Internet security measures, such as a new Secure Electronic Transaction protocol (SET) for encryption and authentication of transactions. Unfortunately, such protocols also slow down processing so much that transactions may take several minutes. That is surely a minor delay compared with a trip to the store, but one that irritates those who've become spoiled by nearly instantaneous electronic exchanges.

Merchants find that credit cards aren't practical for small purchases under about $10, because the merchant has to give 6% or more of the purchase price to the credit-card company. If this cost could be eliminated, numerous micro-transactions would be possible. For instance, the Internet makes it possible to buy and sell information in small quantities, such as a statistical table, a map, or a special recipe. You could buy such information immediately, to finish a report or to prepare dinner. The way might also be open to micro-consultations with lawyers, physicians, psychologists, and other professionals who might answer a question for a few dollars, once transaction costs were reduced.

So shopping on the Internet has prompted the development of a new kind of money - currency that can be sent over electronic networks in the form of digital information. Many kinds of digital money have been invented or proposed: icons or electronic tokens stored on a computer's hard drive and transmitted over the Internet using a modem and special software; monetary value loaded onto "smart cards" with embedded microprocessors for recording transactions and calculating changes in value; and hybrid versions that allow digital money to be uploaded from smart cards to a personal computer or downloaded from the computer to a smart card for greater portability.

Home electronic banking software could easily be adapted to convert money from your bank account into computer tokens and to allow the exchange of value between your computer and a smart card.

Smart cards also have applications other than the Internet. They have been widely used since the late 1980s in Europe and Asia, where credit-card use was slower to develop than in the United States, partly because less-reliable telecommunications systems made instant authentication checks more difficult. Some Americans were introduced to smart cards through the 1996 Olympic card that was field-tested in Atlanta.

Smart cards carry microprocessors that provide memory and enough computational ability to subtract expenditures from the value stored on the card and preserve a record for the user. Depending on its design, the smart card may be able to download funds from bank accounts through a personal computer or a modified bank machine, then pay the funds out to a point-of-sale terminal, vending machine, toll booth, or another smart card or computer. Smart cards can also be designed to hold identification and personal records, such as immigration papers, access to secure areas, credit history, or medical records. A single smart card could potentially replace all of the cards and cash now stuffed into your billfold.

Current Prototypes

Some versions of digital money are especially designed for small purchases of information over the Internet. Millicents, offered by the Digital Equipment Corporation, is electronic "scrip" in the form of a signed message carrying a serial number and an expiration date. An authorized broker will buy Millicent scrip from one or more vendors at a volume discount and then sell it to customers, who will receive and then spend it using their modems.

CyberCoins are another form of digital token used to buy electronic information costing 25[cents] to $10. Customers can purchase the tokens, developed by CyberCash, Inc., of Reston, Virginia, from a participating bank. The customer downloads an encrypted information product, and the Internet merchant supplies the customer with the encryption key after receiving payment in CyberCoins.

Most other forms of digital money developed so far are really like electronic credit cards. CyberCash, for purchases larger than those appropriate for CyberCoins, requires software that creates a gateway between the Internet and a credit-card company's authorization network. You send CyberCash your credit-card number, and CyberCash gives you an "electronic wallet" that records your transactions over the Internet, encrypts your payment, and sends it to the merchant. No encryption is needed for messages between customer and merchant.

First Virtual Bank (FVB) began offering digital money in 1994 and now claims more than 150,000 accounts. You supply FVB with your credit-card number and receive an FVB account number. When you give an Internet merchant this number, the merchant logs on to the FVB server to check the validity of the account, then electronically sends you the software or other product ordered. FVB asks you to confirm the transaction, then charges your credit card. The merchant receives payment three months later.

Another digital money system, not yet in full operation, is more like an electronic check. With the Financial Services Technology Corporation (FSTC) system, you would use a secure card in your desktop computer, which will generate a digitally signed payment instruction to your bank, just like a check, and send it to an Internet merchant. The merchant will digitally endorse it and send it to his bank, and it will ultimately be cleared through an automated clearinghouse - the mechanism that handles direct deposit of salary checks and government benefits. As with a paper check, the merchant does not get instant confirmation of the check's validity, so he is delivering his goods to the customer on trust.

These and other versions of digital money now available or almost ready are designed for very specific and limited uses - to buy goods and services that can be immediately delivered, such as software or some other form of information. For larger purchases that must be delivered in tangible form - such as computer hardware - you might phone or fax your order using an ordinary credit card. One reason is that you'd want to limit the amount of funds you have tied up on your hard drive or a smart card, where your money earns no interest and is vulnerable to crashes or theft.

The biggest problem is that it will be hard to find Internet merchants that can accept your digital money. Even the few versions already in operation have not signed up many merchants, perhaps because merchants are waiting to see which of the competing systems will win out in the marketplace.

What Do Consumers Want?

No one is yet sure what kind of electronic currency, if any, will most appeal to consumers. For example, would you want it to be unattributed or anonymous, as is a $10 bill, so that once you have received the goods and paid the merchant with electronic tokens no record exists of who made the purchase? That kind of privacy is valuable to people who are concerned about the financial trail created by the use of ATMs, credit cards, and debit cards. On the other hand, in exchange for anonymity you would have to live without consumer protections such as limited liability if the smart card is lost or stolen.

Many enthusiasts want digital money to become just like paper money - they look forward to the day when it can be freely exchanged between any two people holding it, rather than only between pre-certified, licensed customers and merchants. Then it could be used to settle debts, make charitable donations, or give kids their allowances. Or, of course, to gamble or buy pornographic material directly through your desktop, without the need for a brown paper wrapper and without creating a paper trail.

If digital money is to be like paper money, it will have to be not only anonymous but also:

* Portable - which would mean at a minimum transferable between computer, laptop, and a smart card, so that you can access it wherever you are.

* Widely accepted, so that you can use just one kind of digital money and spend it in many places, for many things.

* Interchangeable - the value of money may change over time, but at any given place at a given time, one $10 bill is worth exactly the same as another $10 bill.

* Indefinite - you don't want it to expire unspent, although this poses the problem of how long any encryption can be expected to resist those determined to break it.

* Divisible - you want to be able to "make change," or break large units down into smaller ones that are simple to use.

Other enthusiasts argue that digital money should not be like paper money - it could have many desirable features that paper money lacks. It could be customized and conditional-for example, parents might want to give children digital allowances that cannot be spent for cigarettes, beer, or even junk food. It could be designed to be traceable if stolen, or recoverable if lost.

In one way, digital money will certainly be unlike paper money. Real money is defined as a circulating medium of exchange authorized and backed by a government, but digital money will not necessarily be backed up by government's "full faith and credit." Instead, it will be issued and backed by commercial entities. These issuers must therefore struggle with the problem of building trust in their digital money systems - both customers and merchants must be confident that the value of a digital token, or an amount loaded onto a smart card, will remain stable from the time it is issued until it is spent and then redeemed by the issuer.

For all of these reasons, therefore, the costs and risks of developing digital money systems are high, although less so for banks and credit-card companies than for start-up companies. The more types of digital money competing for the market, the less chance there is that any one type will succeed. They will be competing to sign up merchants, and customers are likely to hold off until one form of digital money is very widely accepted. In all network technologies, the value of the technology to a user is proportional to the number of users on the network. We are reminded of the old question of who was fool enough to buy the first telephone when he had no one to talk to.

For merchants, digital money could have big appeal over credit cards if they are paid immediately and if transaction costs are a lot lower. Immediate payment depends on the design of the digital money being used; lower costs already look promising, but not yet certain. One new "e-cash" system now being field tested in Australia will charge consumers 30[cents] a transaction on top of the charge for loading funds into an electronic wallet on their hard drive. If consumers react to such costs with a resounding "no, thanks," it is likely that issuers will find a way to shift those charges to merchants, leaving them little better off than with credit cards.

So far, the only inducements to consumers to shift to digital money are the new ability to buy small quantities of information over the World Wide Web and, in the case of smart cards, the marginal convenience of carrying one card instead of a pocket full of cards and currency.

Uncertainties remain: What if the issuer of your digital money goes bankrupt after you buy its monetary tokens but before you spend them? Can you be sure to find a merchant who accepts the tokens and that there's something you want to buy? Do you care if digital money allows issuers and merchants to build a dossier on your spending habits, the better to target you with customized advertising? If privacy concerns you, perhaps you will opt for a kind of digital money that promises anonymity, at least at the transaction stage. But then you must give up indemnity for lost or stolen tokens.

Security Issues

At least one group is likely to give digital money a warm welcome: money launderers. Money laundering is concealing the origin of money acquired through crime by introducing it back into legitimate commerce so that it can be freely spent and enjoyed. Drug lords must have the support of complex money-laundering operations to get the benefits of the millions of dollars harvested from American street corners. Detecting and prosecuting money launderers has become a mainstay of the war on drugs and accounts for most of its few bright successes.

It will be much easier to send criminal proceeds as digital tokens through a desktop modem to a foreign location, or to store them on a smart card that can be slipped into a wallet or the sole of a traveler's shoe. At present, the money must still be deposited into a bank account for the purchase of digital money, but in the future some kinds of digital money may not require a bank account.

Law enforcement agencies, therefore, are not eager to see the wide dissemination of digital cash. Bank regulators worry about possible security threats. The Internal Revenue Service wonders whether digital money will complicate the tracking of income for tax purposes. The Federal Reserve System is pondering the possible effects on its already limited tools for curbing inflation and adjusting the amount of money in circulation. International organizations are reexamining currency agreements and global trade negotiations.

So far, the U.S. government has adopted a hands-off, wait-and-see position on digital money. Federal Reserve Chairman Alan Greenspan says that premature regulation could either stifle innovation or create monetary instruments that neither consumers nor merchants want.

What then is the outlook for digital money? The likeliest scenario is that a simple form of electronic token will evolve, possibly issued by banks but available also from brokers, that is easily exchangeable among smart cards, store-based readers, bank ATMs, and computer hard drives.

In the meantime, Internet security for credit-card transactions will be greatly improved, the move away from credit cards to debit cards for conventional (nonelectronic) transactions may be greatly advanced, and under that pressure credit-card companies will find ways to reduce the costs of credit-card transactions for both merchants and consumers.

Digital money may prove most popular and useful to consumers for very small purchases of information and related services and amenities over the Internet. Some consumers may also use digital money along with credit and debit cards for store purchases as well.

In short, digital money is likely to start small, more of an electronic change purse than a stuffed wallet.

RELATED ARTICLE: Experiments in Digital Money

In New York City last fall, a joint venture among MasterCard, Visa, Chase Manhattan Bank, and Citibank put stored-value cards into the hands of about 50,000 residents of Manhattan's Upper West Side.

The Chase Manhattan cards use the international digital money system of Mondex International, a unit of MasterCard, while Citibank cards use VisaCash, the digital money product of Visa. Customers can fill a card with cash value at a Chase or Citibank ATM, then use the cards at more than 600 participating merchants equipped with card readers.

MasterCard claimed the first international card use in February when MasterCard CEO Robert Selander paid for breakfast in New York with a Mondex card issued in Hong Kong.

Meanwhile, Harvard University students are using "Crimson Cash," Harvard's own version of digital money. Crimson Cash is primarily used in dining halls and library photocopiers, and will soon be good for laundry and vending machines, according to a report in Harvard Magazine.

Unlike smart cards, the Crimson Cash cards do not actually hold any digital money. They simply allow the user to access their Crimson Cash account, which is maintained by Harvard University Dining Services. Cardholders add cash value directly at special ATMs, or call the central office with their credit-card numbers; the requested value is charged to the cardholder's credit card and added to the user's account.

Sources: Mondex International, Ltd., Web site www.mondex.com.

Harvard Magazine (March-April 1997).

About the Authors

Vary Coates is the president and Steven Bonorris the former counsel of The Institute for Technology Assessment (ITA), a nonprofit research group established by analysts formerly with the Congressional Office of Technology Assessment, which was closed by the Congress in late 1995. ITA recently released a report, Digital Money: Industry and Public Policy Perspectives, from which this article is drawn. The address is 5431 Connecticut Avenue, N.W., Suite 201, Washington, D.C. 20015. Telephone 1-202-686-0693; e-mail ita@concentric.net.