UC Berkeley [School of Information Management and Systems]

[Introduction] [Consumer Issues] [Business Issues] [Financial Issues] [Governmental Issues] [Digital Cash Products:] [Digital Cash] [Digital Wallets] [Micropayment Systems] [Niche Products] [Questions Raised] [References]
[Info Sys 204]

December, 1997

Exploring Digital Cash

Governmental Issues

        The U.S. Government has a central role in the nation’s economy through monetary policies (including control of the money supply) and bank regulations.  Policies and regulations that were originally geared towards a cash-based society have developed over time to handle banking innovations such as credit cards, ATMs, traveler’s checks, and wire transfers.  Many of these rules were developed in response to problems arising from the implementation of new technologies rather than in anticipation of potential problems.  Digital cash is another major technological development in the financial services industry in which the U.S. government is taking a "wait and see" attitude.  Advocates of the "wait and see" approach believe that government intervention at this time is likely to inhibit and distort the emerging market — the unstated assumption being that digital cash is good for the U.S. economy.

       Given the "wait and see" attitude of the government and the desire by many Internet content providers to charge for their services, it is likely that a thriving digital cash market will eventually emerge.  As a result, it is likely that additional government intervention will be necessary to address problems digital cash creates.  The kinds of regulations needed would depend upon the type of electronic money that becomes most prevalent.  For example, digital cash that was designed for micro-payments (e.g., low cost transactions including those less than one cent) for material provided over the Internet would be a very different product from digital cash that could handle large dollar transactions.  While some government concerns regarding the impact of the two forms of digital cash might overlap, (such as the ability to detect illegal use of the money); there would also be numerous concerns specific to each product.

       Given the nascent stage of the digital money market, it is impossible to predict what type(s) of digital cash systems will become the standard(s).  As a result, it is difficult to isolate government concerns with respect to a specific form of digital cash and this paper does not attempt to do so.

       The G-10 governments (Belgium, Canada, France, Germany, Italy, Japan, Netherlands, Sweden, Switzerland, the United Kingdom and the United States), developed the following list of five broad areas of interest with respect to digital cash in it's April 1997 Report on Electronic Money:

  • Limiting systemic and other risks that could threaten the stability of financial markets or undermine confidence in the payment system;
  • Providing consumers with adequate protection from fraud and unfair practices, financial loss, or unnecessary intrusions on personal privacy;
  • Encouraging the development of effective, low-risk, low-cost, and convenient payment and financial services for consumers and businesses;
  • Ensuring the central bank’s ability to conduct monetary policy (in the U.S. this is the Federal Reserve, an independent body with members appointed by the President); and
  • Not hindering the ability of law enforcement authorities to prevent and detect movements of funds associated with criminal activity.


         The following provides a brief discussion of each of these categories.

Stability of Financial Markets 
Current regulations surrounding the financial services industry are intended to ensure the stability of financial markets and confidence in the payment system.  Some experts believe that a digital cash system that allowed for large transfers of funds through non-regulated institutions and organizations could cause distortions in the stock market, weaken the control of the money supply by the Federal Reserve, and generally undermine confidence in the payment system.  It is unlikely that the federal government would allow such an unregulated system to develop.  Nevertheless, a digital payment system that allowed large transfers of anonymous funds may not be too far fetched and would require the government to institute appropriate regulations.  Possible regulations could include required reserve ratios that would help the Federal Reserve control the flow of funds.  In addition, regulations similar to those that exist to prevent money laundering may help.

Consumer protections

Fraud and unfair practices – There are many laws to protect citizens generally from fraud and unfair practices, many of which would provide protection from fraud with respect to digital cash.  For example, consumer protection laws would apply if a retailer did not deliver a good purchased.  On the other hand, if the transaction was not traceable, the consumer may not be able to prove that she purchased the good and as a result could not recoup her losses.

Financial loss – The government has traditionally protected consumers from certain kinds of losses and has developed systems to instill confidence in financial institutions.  For example, FDIC insurance was created to insure a consumer from loss due to a bank failure and to restore confidence in the banking system.  There are also regulations (specifically, Regulation Z) that limit losses due to unauthorized credit card transactions.  However, the federal government does not protect citizens from loss or theft of hard cash.  The government’s approach to this issue with regard to digital cash will depend in part upon the use of the digital cash.  If digital cash is spent in very small quantities, similar to the use of coins, the government may not need to provide consumer protection.  Since only those credit card losses above $50 are protected, the government may not need to provide protection in a system in which consumers had no reason to keep more than $50 on their computers or smart cards at any one time.

On the other hand, if digital cash were used for high dollar transactions, the government may want to protect consumers from failure of the institutions that "mint" the cash and may want to provide protections for loss and theft similar to those given for credit cards.

Privacy — The electronic world has eroded personal privacy through the collection, storage and even sale of information about individual purchasing patterns, financial information and health status.  Digital cash has the potential to increase the amount of data collected about individuals.  If the digital payment system were not anonymous, each purchase could be collected and stored, providing retailers and others very detailed spending profiles of individual customers.  In addition, consumption profiles of an individual could become much more detailed if digital cash were used for micro-purchases in which consumers could presumably be involved in hundreds of transactions a day.  Through the use of cookies and other tracking systems, some data on Internet users is already being collected.  However, digital cash transactions that were not anonymous would provide incentive to additional retailers to collect ever increasingly detailed information.

While the government has a duty to protect personal privacy, it often conflicts with proposed solutions to stem criminal activity.  For example, very strong encryption is one way to make digital cash transactions private, however, the government regulates encryption methods to attempt to ensure that it has the ability to crack encryption codes used by criminals for illegal activity.

Development of effective, low-risk, low-cost, and convenient payment and financial services for consumers and businesses

        The current regulatory system already provides for an effective and convenient payment and financial services with acceptable risks and costs for consumers and businesses for nearly all transactions.  An exception is those transactions occurring over the Internet where a host of issues are unresolved including privacy, security and convenience.

        The government’s interest in developing an acceptable payment system is its general interest in a strong economy, increase in GDP and tax revenues.  Assuming the government believes that increased Internet commerce will be beneficial, the government may assist in developing an effective and convenient payment system by encouraging the development of technical standards.   The government may assist in developing a low-risk system and by attending to the criminal issues discussed below it could encourage a low-cost system through anti-trust regulation and judicious application of other regulations.


Money Supply

        Digital cash systems include those in which the digital cash has intrinsic value (e.g., cash) and those that are representations of money (e.g., checks).  A system in which the digital cash had intrinsic value would increase the amount of money in circulation.   This would require the Federal Reserve to take into account the total value of digital cash in circulation when adjusting the money supply according to its monetary policy.  In addition, the government may want to impose required reserve ratios to limit the amount of digital cash in circulation.

        In his remarks at the U.S. Treasury Conference on Electronic Money and Banking, Alan Greenspan, Chairman of the Federal Reserve said that the Federal Reserve could continue to have adequate control over the money supply if a digital money market emerged.  He is a proponent of the "wait and see" attitude arguing that "Our optimum financial system is one of free and broad competition . . ."  However, others argue that unless digital cash is legal tender so that only the Government can mint it, the Federal Reserve’s ability to control the money supply will become dangerously limited.

Criminal Activity

        Criminal activity can be divided into two categories: 1) illegal uses of digital cash including money laundering, tax evasion and illegal gambling; and 2) tampering with digital cash itself, including counterfeiting, fraud and disruption of the system.

        Illegal uses of digital cash would probably proliferate if digital cash were used for large value and anonymous transactions.  Although cash is the preferred form of payment for illegal activities, completely anonymous, large volume transactions with U.S. financial institutions are not possible for cash transactions.  For example, there are serial numbers on bills and regulated financial institutions must report deposits over $10,000 and wire transfers over $750.   As a result, the federal government would likely want to ensure that no digital cash system was completely anonymous. As noted above, this goal needs to be balanced with the goal of consumer privacy protection.  Another option would be to place low limits digital cash account balances.

        The amount or ease of counterfeiting, fraud and disruption of the digital cash system would also depend in large part on the solution to the anonymity/encryption dilemma.

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