ELECTRONIC CASH AND THE END
Stephen J. Kobrin
is the director of the Lauder Institute of Management
and International Studies and the William Wurster
professor of multinational management at the Wharton
School of the University of Pennsylvania. This paper
develops themes raised at a discussion of electronic
money at the 1997 annual meeting of the World
Economic Forum in Davos, Switzerland.
Twenty-six years ago, Raymond
Vernon's Sovereignty at Bay
proclaimed that "concepts such as national
sovereignty and national economic strength appear
curiously drained of meaning."
Other books followed, arguing that sovereignty, the
nation-state, and the national economy were
finished—victims of multinational enterprises
and the internationalization of production. While
sovereign states and national markets have outlasted
the chorus of Cassandras, this time the sky really
may be falling. The emergence of electronic cash and
a digitally networked global economy pose direct
threats to the very basis of the territorial state.
Let us begin with two vignettes. Fact: Smugglers fly
Boeing 747s loaded with illicit drugs into Mexico and
then cram the jumbo jets full of cash—American
bills—for the return trip. Fiction: Uncle Enzo,
Mafia CEO, pays for intelligence in the digital
future of Neal Stephenson's novel Snow Crash:
"He reaches into his pocket and pulls out a
hypercard and hands it toward Hiro. It says
'Twenty-Five Million Hong Kong Dollars.' Hiro reaches
out and takes the card. Somewhere on earth, two
computers swap bursts of electronic noise and the
money gets transferred from the Mafia's account to
Hiro's."
The 747s leaving Mexico are anachronisms, among the
last surviving examples of the physical transfer of
large amounts of currency across national borders.
Most money has been electronic for some time:
Virtually all of the trillions of dollars, marks, and
yen that make their way around the world each day
take the form of bytes—chains of zeros and ones.
Only at the very end of its journey is money
transformed into something tangible: credit cards,
checks, cash, or coins.
Hypercards are here. Mondex, a smart card or
electronic purse, can be "loaded" with
electronic money from an automatic teller machine
(atm) or by telephone or personal computer using a
card-reading device. Money is spent either by swiping
the card through a retailer's terminal or over the
Internet by using the card reader and a personal
computer. An electronic wallet allows anonymous
card-to-card transfers.
It is not just the current technology of electronic
cash (e-cash) or even what might be technologically
feasible in the future that presents policymakers
with new challenges. Rather, policymakers must
confront directly the implications of this
technology—and, more generally, the emergence of
an electronically networked global economy—for
economic and political governance. As the U.S.
comptroller of the currency, Eugene Ludwig, has
noted, "There is clearly a freight train coming
down the tracks….Just because it hasn't arrived
yet doesn't mean we shouldn't start getting
ready."
Electronic Money
Many different forms of "electronic
money" are under development, but it is useful
to look at three general categories: electronic debit
and credit systems; various forms of smart cards; and
true digital money, which has many of the properties
of cash.
Electronic debit and credit systems already
exist.When a consumer uses an ATM card to pay for
merchandise, funds are transferred from his or her
account to the merchant's. Credit cards are used to
make payments over the Internet. Computer software
such as Intuit provides electronic bill payment, and
it is but a short step to true electronic
checks—authenticated by a digital
signature—that can be transmitted to the payee,
endorsed, and deposited over the Internet. Electronic
debit and credit systems represent new, more
convenient means of payment, but not new payment
systems. A traditional bank or credit card
transaction lies at the end of every transaction
chain.
Smart cards and digital money represent new payment
systems with potentially revolutionary implications.
Smart cards are plastic "credit" cards with
an embedded microchip. Many are now used as telephone
or transit payment devices. They can be loaded with
currency from an atm or via a card reader from a
telephone or personal computer, currency which can
then be spent at businesses, vending machines, or
turnstiles that have been equipped with appropriate
devices. At this most basic level, a smart card is
simply a debit card that does not require bank
approval for each transaction; clearance takes place
each day and the value resides in third-party
accounts. There is no reason, however, that smart
cards have to be limited in this way.
Banks or other institutions could provide value on
smart cards through loans, payments for services, or
products. The immediate transfer of funds between
bank accounts is not necessary; units of value can
circulate from card to card—and from user to
user—without debiting or crediting third-party
accounts. Assuming confidence in the creating
institution, "money" could be created on
smart cards and could circulate almost indefinitely
before redemption.
Finally, electronic money can take true digital form,
existing as units of value in the form of bytes
stored in the memory of personal computers that may
or may not be backed up by reserve accounts of real
money. The money could be downloaded from an account,
supplied as a loan or as payment, or bought with a
credit card over the Internet. As long as digital
cash can be authenticated and there is confidence in
its continued acceptance, it could circulate
indefinitely, allowing peer-to-peer payments at will.
These are big "ifs," but they are well
within the realm of the possible.
Imagine a world where true e-cash is an everyday
reality. Whether all of the following assumptions are
correct or even immediately feasible is unimportant;
some form of e-cash is coming, and we need to begin
the process of thinking about its as-yet-unexplored
consequences for economic and political governance.
The year is 2005. You have a number of brands of
e-cash on your computer's hard drive: some withdrawn
from a bank in Antigua, some borrowed from Microsoft,
and some earned as payment for your services. You use
the digital value units (DVUs) to purchase
information from a Web site, pay bills, or send money
to your daughter in graduate school. Peer-to-peer
payments are easy: You can transfer DVUs to any
computer, anyplace in the world, with a few
keystrokes.
Your e-cash is secure and can be authenticated
easily. It is also anonymous; governments have not
been able to mandate a technology that leaves a clear
audit trail. Public-key encryption technology and
digital signatures allow blind transactions; the
receiving computer knows that the DVUs are authentic
without knowing the identity of the payer. Your
e-cash can be exchanged any number of times without
leaving a trace of where it has been. It is virtually
impossible to alter the value of your e-cash at
either end of the transaction (by adding a few more
zeros to it, for example).
DVUs are almost infinitely divisible. Given the
virtually negligible transaction cost, it is
efficient for you to pay a dollar or two to see a
financial report over the Internet or for your
teenager to rent a popular song for the few minutes
during which it is in vogue. Microtransactions have
become the norm. E-cash is issued—actually
created—by a large number of institutions, bank
and nonbank. Electronic currencies (e-currencies)
have begun to exist on their own; many are no longer
backed by hard currency and have developed value
separately from currencies issued by central banks.
DVUs circulate for long periods of time without being
redeemed or deposited. Consumer confidence in the
issuer is crucial; as with electronic commerce
(e-commerce) in general, brand names have become
critical.
The early 21st century is described as a world of
competing e-currencies, a throwback to the
19th-century world of private currencies. The better
known brands of e-cash are highly liquid and
universally accepted. It is a relatively simple
matter for you to set up filters in your electronic
purse to screen out e-currencies that you do not want
to accept.
Governance in the Digital World
E-cash and the increasing importance of digital
markets pose problems for central government control
over the economy and the behavior of economic actors;
they also render borders around national markets and
nation-states increasingly permeable—or,
perhaps, increasingly irrelevant. In a world where
true e-cash is an everyday reality, the basic role of
government in a liberal market economy and the
relevance of borders and geography will be
drastically redefined.
While at first glance this concern appears to reflect
a traditional break between domestic and
international economic issues, in fact the advent of
e-cash raises serious questions about the very idea
of "domestic" and "international"
as meaningful and distinct concepts. The new digital
world presents a number of governance issues,
described below.
Private e-currencies will make it difficult
for central bankers to control—or even
measure or define—monetary aggregates.
Several forms of money, issued by banks and
nonbanks, will circulate. Many of these
monies may be beyond the regulatory reach of
the state. At the extreme, if, as some
libertarians imagine, private currencies
dominate, currencies issued by central banks
may no longer matter.
E-cash will
markedly lower existing barriers to the
transfer of funds across borders.
Transactions that have been restricted to
money-center banks will be available to
anyone with a computer. Peer-to-peer
transfers of DVUs across national borders do
not amount to "official" foreign
exchange transactions. If you have $200 worth
of DVUs on your computer and buy a program
from a German vendor, you will probably have
to agree on a mark-to-dollar price. However,
transferring the DVUs to Germany is not an
"official" foreign exchange
transaction; the DVUs are simply revalued as
marks. In fact, national currencies may lose
meaning with the development of DVUs that
have a universally accepted denomination.
Without severe restrictions on individual
privacy—which are not out of the
question—governments will be
hard-pressed to track, account for, and
control the flows of money across borders.
The U.S. Treasury is not
sure whether existing regulations, which
apply to both banks and institutions that act
like banks (i.e., take deposits), would apply
to all who issue (and create) e-cash. If
nonfinancial institutions do not accept the
extensive regulatory controls that banks take
as the norm, can reserve or reporting
requirements be enforced? What about consumer
protection in the event of the insolvency of
an issuer of e-cash, a system breakdown, or
the loss of a smart card?
It will be almost impossible
to track transactions when e-cash becomes a
widely used means of payment, online deals
across borders become much easier, and many
of the intermediaries that now serve as
checkpoints for recording transactions are
eliminated by direct, peer-to-peer payments.
The widespread use of e-cash will render
national economic data much less meaningful.
Indeed, the advent of both e-cash and
e-commerce raises fundamental questions about
the national market as the basic unit of
account in the international economic system.
Tax
evasion will be a serious problem in an
economy where e-cash transactions are the
norm. It will be easy to transfer large sums
of money across borders, and tax havens will
be much easier to reach. Encrypted anonymous
transactions will make audits increasingly
problematic. Additionally, tax reporting and
compliance relies on institutions and
intermediaries. With e-cash and direct
payments, all sorts of sales taxes,
value-added taxes, and income taxes will be
increasingly difficult to collect. More
fundamentally, the question of
jurisdiction—who gets to tax
what—will become increasingly
problematic. Say you are in Philadelphia and
you decide to download music from a computer
located outside Dublin that is run by a firm
in Frankfurt. You pay with e-cash deposited
in a Cayman Islands account. In which
jurisdiction does the transaction take place?
Participation
in the global electronic economy requires
infrastructure and access to a computer.
This widened gap
between the haves and the
have-nots—those with and without access
to computers—could become increasingly
difficult to bridge. Will the loss of
seigniorage be important as governments fight
to balance budgets? Seigniorage originally
referred to the revenue or profit generated
due to the difference between the cost of
making a coin and its face value; it also
refers to the reduction in government
interest payments when money circulates. The
U.S. Treasury estimates that traditional
seigniorage amounted to $773 million in 1994
and that the reduction in interest payments
due to holdings of currency rather than debt
could be as much as $3.5 billion per year.
The Bank for International Settlements
reports that the loss of seigniorage for its
11 member states will be more than $17
billion if smart cards eliminate all bank
notes under $25.
At the
extreme—and the issue of privacy versus
the needs of law enforcement is
unresolved—transfers of large sums of
cash across borders would be untraceable:
There would be no audit trail. Digital
counterfeiters could work from anywhere in
the world and spend currency in any and all
places. New financial crimes and forms of
fraud could arise that would be hard to
detect, and it would be extremely difficult
to locate the perpetrators. The task of
financing illegal and criminal activity would
be easier by orders of magnitude. E-cash will
lower the barriers to entry and reduce the
risks of criminal activity.
Most of the issues raised in the recent National
Research Council report on cryptography's role in the
information society apply directly to electronic
cash. Secure, easily authenticated, and anonymous
e-cash requires strong encryption technology.
Anonymous transactions, however, cannot be restricted
to law-abiding citizens. Encryption makes it as
difficult for enforcement authorities to track
criminal activity as it does for criminals to
penetrate legitimate transmissions. Should privacy be
complete? Or should law enforcement authorities and
national security agencies be provided access to
e-cash transactions through escrowed encryption, for
example? What about U.S. restrictions on the export
of strong encryption technology? E-cash is global
cash; how can governments limit its geographic
spread? Can they even suggest that strong encryption
algorithms be restricted territorially?
Geographic Space vs. Cyberspace
A recent U.S. Treasury paper dealing with the tax
implications of electronic commerce argues that new
communications technologies have "effectively
eliminated national borders on the information
highway." It is clear from the paper's
subsequent discussion, however, that the more
fundamental problem is that electronic commerce may
"dissolve the link between an income-producing
activity and a specific location."
The source of taxable income, which plays a major
role in determining liability, is defined
geographically in terms of where the economic
activity that produces the income is located. Therein
lies the rub: "Electronic commerce doesn't seem
to occur in any physical location but instead takes
place in the nebulous world of 'cyberspace.'" In
a digital economy it will be difficult, or even
impossible, to link income streams with specific
geographic locations.
Digitalization is cutting money and finance loose
from its geographic moorings. The framework of
regulation that governs financial institutions
assumes that customers and institutions are linked by
geography—that spatial proximity matters. E-cash
and e-commerce snap that link. What remains are
systems of economic and political governance that are
rooted in geography and are trying nonetheless to
deal with e-cash and markets that exist in
cyberspace. The obvious disconnect here will only
worsen over time.
The geographical rooting of political and economic
authority is relatively recent. Territorial
sovereignty, borders, and a clear distinction between
domestic and international spheres are modern
concepts associated with the rise of the
nation-state. Territorial sovereignty implies a world
divided into clearly demarcated and mutually
exclusive geographic jurisdictions. It implies a
world where economic and political control arise from
control over territory.
The international financial system—which
consists of hundreds of thousands of computer screens
around the globe—is the first international
electronic marketplace. It will not be the last.
E-cash is one manifestation of a global economy that
is constructed in cyberspace rather than geographic
space. The fundamental problems that e-cash poses for
governance result from this disconnect between
electronic markets and political geography.
The very idea of controlling the money supply, for
example, assumes that geography provides a relevant
means of defining the scope of the market. It assumes
that economic borders are effective, that the flow of
money across them can be monitored and controlled,
and that the volume of money within a fixed
geographic area is important. All of those
assumptions are increasingly questionable in a
digital world economy.
Many of our basic tax principles assume that
transactions and income streams can be located
precisely within a given national market. That
assumption is problematic when e-cash is spent on a
computer network. It is problematic when many
important economic transactions cannot be located, or
may not even take place, in geographic space.
The increasing irrelevance of geographic jurisdiction
in a digital world economy markedly increases the
risks of fraud, money-laundering, and other financial
crimes. Asking where the fraud or money-laundering
took place means asking Whose jurisdiction applies?
and Whose law applies? We need to learn to deal with
crimes that cannot be located in geographic space,
where existing concepts of national jurisdiction are
increasingly irrelevant.
The term "disintermediation" was first used
to describe the replacement of banks as financial
intermediaries by direct lending in money markets
when interest rates rose. It is often used in the
world of e-commerce to describe the elimination of
intermediaries by direct seller-to- buyer
transactions over the Internet. Many observers argue
that e-cash is likely to disintermediate banks. Of
more fundamental importance is the possibility that
e-cash and e-commerce will disintermediate the
territorial state.
To be clear, I argue that we face not the end of the
state, but rather the diminished efficacy of
political and economic governance that is rooted in
geographic sovereignty and in mutually exclusive
territorial jurisdiction. Questions such as, Where
did the transaction take place? Where did the income
stream arise? Where is the financial institution
located? and Whose law applies? will lose meaning.
E-cash and e-commerce are symptoms, albeit important
ones, of an increasing asymmetry between economics
and politics, between an electronically integrated
world economy and territorial nation-states, and
between cyberspace and geographic space. How this
asymmetry will be resolved and how economic and
political relations will be reconstructed are two of
the critical questions of our time.
What Is to Be Done?
The question asked here is not What is feasible?
but What are the limits of the possible? Whether the
picture presented here is correct in all—or even
some—of its details is unimportant. A digital
world economy is emerging. Imagining possible
scenarios is necessary if we are to come to grips
with the consequences of this revolution.
The purpose here is to raise problems rather than to
solve them and to imagine possible futures and think
about their implications for economic and political
governance. A digital world economy will demand
increasing international cooperation, harmonizing
national regulations and legislation, and
strengthening the authority of international
institutions.
The harmonization of national regulations will help
to prevent institutions, such as those issuing
e-cash, from slipping between national jurisdictions
or shopping for the nation with the least onerous
regulations. However, it will not address the basic
problem of the disconnect between geographic
jurisdiction and an electronically integrated global
economy.
If it is impossible to locate transactions
geographically—if the flows of e-cash are
outside of the jurisdictional reach of every
country—then the harmonization of national
regulations will accomplish little. The basic problem
is not one of overlapping or conflicting
jurisdictions; it stems from the lack of meaning of
the very concept of "jurisdiction" in a
digitalized global economy.
The erosion of the viability of territorial
jurisdiction calls for strengthened international
institutions. It calls for giving international
institutions real authority to measure, to control,
and, perhaps, to tax. The Basle Committee on Banking
Supervision—an international body of bank
regulators who set global standards—could
perhaps be given the authority to collect information
from financial institutions wherever they are located
and formulate and enforce regulations globally.
Interpol, or its equivalent, may have to be given
jurisdiction over financial crimes, regardless of
where they are committed. That does not mean a world
government; it does mean a markedly increased level
of international cooperation.
The questions we must face are whether territorial
sovereignty will continue to be viable as the primary
basis for economic and political governance as we
enter the 21st century and what the implications will
be for the American economy—and Americans in
general—if we refuse to cooperate
internationally in the face of an increasingly
integrated global economy.
Electronic
Cash: A Glossary
Digital data: Information
coded into a series of zeros and ones that can be
transmitted and processed electronically.
Digital signature: A code that allows
absolute authentication of the origin and integrity
of a document, check, or electronic cash that has
been sent over a computer network. A blind signature
allows authentication without revealing the identity
of the sender.
Disintermediation: The substitution of
direct transactions for those that are mediated. The
term originated when rising interest rates caused
savings to be withdrawn from banks—whose
interest rates were capped—and invested in money
market instruments that were the direct debts of
borrowers. Banks were disintermediated. In electronic
commerce, the term refers to the rise of direct
buyer-to-seller relationships over the Internet,
disintermediating wholesalers and retail outlets.
Electronic
money: Units or tokens of monetary value that
take digital form and are transmitted over electronic
networks. Digital Value Units are the basic units of
denomination of electronic money; they may or may not
correspond to units of national currency.
Encryption: The coding of information for
security purposes, such as credit card numbers or
electronic cash used over the Internet. Public-key
encryption uses a mathematical algorithm comprising a
pair of strings of numbers to encrypt and decrypt the
data. For example, the sender would encrypt the data
with the receiver's public key and the receiver would
decrypt with his or her private key.
Internet: A global network of linked
networks that allows communication and the sharing of
information among many different types of computers.
The World Wide Web is a graphical system on the
Internet that allows rapid movement between documents
and computers through the use of embedded (hypertext)
links.
Smart card: A plastic card, similar to a
credit card, containing a microchip that can be used
to retrieve, store, process, and transmit digital
data like electronic cash or medical information.
Want
to Know More?
A readable and knowledgeable introduction to the
digital economy and the impact of
"internetworking" on business and
government can be found in Don Tapscott's The
Digital Economy (New York: McGraw-Hill, 1996).
Michael Dertouzos provides an evaluation of how the
advent of the Information Age will transform how we
live and learn, our business, and our national
governments: What Will Be (San Francisco: HarperEdge,
1997).
The June 12, 1995, issue of BusinessWeek
featured an overview of smart cash, electronic money,
and the issues they raise for business and government
("The Future of Money").
For a
solid discussion of some of the technical aspects of
e-cash and the public policy issues raised by its
advent, see Steven Levy's "E-Money (That's
What I Want)" in Wired 2, no. 12. The
article also focuses on David Chaum, the founder of
DigiCash, and his views on privacy vis-à-vis
traceability.
See Robert Teitelman & Stephen
Davis's "How the Cash Flows," in
Institutional Investor (August 1996), for a
discussion of the digitalization of banking and
finance at both the wholesale and the retail levels.
The primary focus of the discussion is the impact of
global electronic networks on traditional financial
intermediaries and the regulatory process.
If what you seek is a solid introduction to electronic money
and the digitalization of finance in general and a
thorough review of the regulatory issues raised, see
"An Introduction to Electronic Money Issues,"
a paper prepared for the United States Department of
the Treasury conference, "Toward Electronic
Money and Banking: The Role of Government" (Washington,
D.C.: September 19–20, 1996).
Finally, read
Raymond Vernon's seminal work, Sovereignty at Bay
(New York: Basic Books, 1971). This time around, it
might well be.
__________
Copyright (c) 1997 Carnegie Endowment for International Peace. Reprinted with permission from FOREIGN POLICY magazine, Summer 1997.
Permission has been obtained covering republication/translation/abridgment by USIS and the local press outside the United States.
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