Consequence_E-cash 1.4e

Possible Economic Consequences of Digital-Cash.

ver 1.3, March 1996

Tatsuo TANAKA

Center for Global Communications

International University of Japan

6-15-21, Roppongi, Minato-ku, Tokyo 160, Japan

Tel +81-3-5411-6677, Fax +81-5412-7111,

E-mail:tatsuo@glocom.ac.jp

Center on Japanese Economy and Business

521 Uris Hall

Columbia University

New York, NY, USA, 10027

Tel:+1-212-854-3976, Fax:+1-212-678-6958

E-mail:tatsuo@glocom.ac.jp

Author discusses possible consequences of digital cash from the view of economics and demonstrates a possible scenario for the future.

There is one important attribute of digital cash, however, that overshadows these benefit and problems. It is the transnationality of digital cash, that is, the ability of digital cash to flow freely accross national borders. Every bank can issue it and everybody all over the world can use it. This transnationality is a cause for both benefits and problems, and could have significant repurcussions internationally. From the economic stand point, the most important characteristic of digital cash is its transnationality. If digital cash circulated only within a traditional national border and was controlled under a central monetary authority, there would be no economic implications that would be worth analyzing. In this case, digital cash would be nothing more than a convenient transaction method such as a credit card.

However, digital cash is more than that. Its transnationality has the potential to cause conflict between cyberspace and nation states. If digital cash spreads successfully in the 21st century, its history may be written as a record of its battle with nation states.

Key Word: Digital Cash, Transnationality, Exchange Rate, Money Supply, Cyberspace, Nation States

[1] Introduction

What are the economic consequences of digital cash? What are its implications from the view of economics? In recent years, several proposals for electronic cash have appeared in cyberspace, and some of them have begun their services already. But the economic consequences of these endevors have not yet been examined.

Some people stress that an important economic consequence of electronic cash is the free-issue of private currency by commercial banks or other non-firms, as Hayek said in his celebrated book "Denationalization of Money". (Hayek 1978, Mantonis 1995, Wall Street Journal, Nov. 23, 1995.). However, if we look at the history of money, we realize that it is not easy task to make privately-issued currency credible in the eyes of the public. As far as there exists a competition among banks, private banks will often end in bankruptcy, and the credibility of the privately-issued currency will suffer as a result.

In this paper, I will discuss another consequence of digital cash. My main conclusions are as follows. The most important characteristic of digital cash is its transnationality; digital cash has no national borders, that is, it is not controlled by any central bank of any nation state. If digital cash circulated only within a traditional national border and was controlled under a central money authority, there would be no economic implications, because, in that case, digital cash would be nothing more than a convenient transaction method such as a credit card or prepaid card. But, in reality, digital cash has no national borders, a fact which will bring both new benefits and new problems to economy as a whole. The main benefit will be an unprecedented efficiency of international payments. The problem will be that digital cash's transnationality will tend to increase the instability of the monetary system. This problem has the potential to cause conflict between digital cash providers/users and the central banks of nation states. If digital cash spreads successfully in the 21st century, its history may be written as a record of its battle with nation states.

Next in chapter 2, I will briefly overview the electronic payment system. Chapter 3 discusses consequences of digital cash from the view of monetary economics. Chapter 4 discusses the transnationality of digital cash and presents a possible future scenario for an illustrative purpose, and Chapter 5 will state my conclusion.

[2] Overview of Electronic Payment System

There are over a dozen proposals for electronic payment systems on the Internet.[1] To briefly overview these proposals, let us begin with the problems we encounter when we pay a bill by sending our credit card number through the Internet. We can point out the following four problems with respect to a credit card payment through the Internet when compared to a cash payment in the real world

(a) Security

Credit card numbers may be tapped by others because the Internet is an open system. In the real world, we can avoid fraud by using cards only at trustworthy or familiar stores. In the cyberspace, however, we cannot avoid the possibility of falling victim to the tapping as far as we send card numbers through the Internet.

(b) Peer-to-peer payments

Credit cards can be used only at authorized stores. Unauthorized small businesses or individuals cannot receive money via the credit card. In other words, credit cards cannot be used for peer-to-peer payment, while cash can be used for it, of course.

Credit card payments usually charge a small fee. Although this cost is low, it can be a heavy overhead cost when the payment itself is very small, say, 20c.[2] As a result, credit cards can not be used for such micropayments, while cash payments can be used for even 1 cent.

(d) Untraceability

Receipts from credit card payments leave records of user's expenditures to credit card companies, so credit card companies know what goods and service users bought where and when. In other words, user's expenditures by credit card can be traced, while cash payments are untraceable.

Proposed electronic payment systems, more or less, try to cope with the above problems.[3] According to the extent to which these systems cope with these problems, I will classify them into three categories.

(I) Credit Card Base Type

To avoid the risk of tapping (problem(a)), First Virtual Holding began a payment system in which users send only their passwords instead of their credit card numbers when purchasing an item (See figure 1-(i)) [4]. In this system, a user registers in advance with First Virtual Holding his password and credit card number. When he purchases goods or services at the shop on the Internet, he sends only his password to the shop. After purchasing, he receives a confirmation e-mail asking if the purchase is valid or not. When he replies yes to this mail, the bill is deducted from his credit card account. Since this system is simple and easy to understand especially for non-computer-expert people, it has been diffused already to some extent. Besides this company, Visa and Mastercard are also planning a similar credit-card based payment system using encryption technology in place of passwords.

But these credit-card based systems solve only the security problem. As figure 1-(i) shows, these systems handle only the communication part between the user and the shop in cyberspace. The transaction of money remains to be done by the conventional credit card transaction system. Thus a fee is also necessary and a peer-to-peer transaction is impossible. Untraceability is not guaranteed.

(II) Check Type

The conventional check system is closer to cash than a credit card payment is, because the a peer-to-peer transaction is possible. Also micropayments are possible to customers, though banks are reluctant to accept maicropayments by checks owing to the high operational cost of check clearance in the real world (Berger and Humphrey, 1986)[5]. As a result, several proposals have emerged to invent checks on the Internet which would be transferable between individuals (CyberCash, NetCheck etc.)[6]. As figure 1-(ii) shows, in that system, a user opens an account in the bank on the Internet, and issues an electrical check for the bill. The receiver of this check sends it to the bank to confirm and cash it. Security is guaranteed by both the encryption technology and the bank's confirmation process with the issuer of the check. (Crocker, et al., 1995)

This system enables peer-to-peer payments to take place and may reduce fees to some extent. But untraceability is still not realized since bank can learn what and where the user buys.

(III) Cash Type

The last, and probably most difficult problem is untraceability. Untraceability is a prominent characteristic of cash. Untraceability keeps the transaction anonymous and prevent a dominance of the Big-Brother (Chaum, 1987).[7] To achieve untraceability on the Internet, encryption technology has to be fully employed because the untraceable money could be easily copied and spent twice (double-spending). David Chaum(1989, 1992) and Okamoto&Ohta(1991) proposed an untraceable electronic payment system using advanced encryption technology.[8]

The mechanism in this system is similar to the electronic check, but it prevents banks from knowing who bought what(figure 1-(iii)). First, a user opens an account at the bank on the Internet. Then the user asks the bank to issue a certain amount of digital cash. The bank issues that amount of digital cash using encryption technology and deducts that amount of money from his account.

The content of digital cash is a combination of two huge integers which have special mathematical relation. No other person but the bank can produce the data with the same relation, because the calculation for it will take an almost infinite amount time if one does not know the secret key, which only the bank knows. Issuing digital cash means that bank calculate these two huge integers and sends them to the user.

When a user pays a bill with digital cash, he sends this data to a receiver. The receiver sends this data to the bank to confirm it. If the bank confirms it, the bank credits the receiver's bank account by that amount, or issues the receiver another digital cash in the same amount. Note that the bank can confirm only that this data (digital cash) is surely issued by the bank and that this data is not double-spent. The bank cannot know who used the digital cash, as long as users do not use it twice.

This payment system deserves the name of "cash on the Internet" because it is almost equal to a cash payment in terms of security, fee, peer-to-peer payment, and untraceability. So I will focus on this cash-type "digital cash" hereafter. That is a reason why I use the term "digital cash" in this paper, not a more broader term such as electronic money. A bank in the US have already started this service since late 1995. (Mark Twain Banks[9])

[3] Consequences

What are the consequences of digital cash? The main benefit of digital cash is to increase the efficiency of transactions, which will enlarge the new business opportunities. Problems are 4-fold; taxing and money laundering, instability of the exchange rate, disturbance of money supply, and possibility of a black Monday in cyberspace.

Benefit: Increased efficiency of transactions

Digital cash will make transactions more efficient, which will in turn enlarge new business opportunities and eventually pass more benefits on to the users.

First, digital cash will make transactions less expensive, because the cost of transferring digital cash through the Internet is cheaper than through the conventional banking system (Grigg, 1996, Chapter 5). To transfer money, the conventional banking system maintains many branches, clerks, automatic teller machines, and electronic transaction systems of its own. These overhead costs increase the fees of money transfers or credit card payments through banks. But since digital cash uses the existing Internet network and user's computers, the cost of digital cash transfer will be much lower, probably nearly zero.[10] Actually, as far as the transaction is done within the Internet, the transfer fee and bank tips are zero in case of Mark Twain Banks.[11] This nearly zero cost enables micropayments like 10c or 50c, which may foster a new distribution system of software such as music, movie and computer software. "Super distribution" is one of its practical applications. (Mori and Kawahara, 1990, and Cox, 1994). This micopayment may solve the dilemma between copyright and public welfare to some extent, because people would not photocopy articles on the books if they could download them through Internet at very low cost.

Second, since the Internet has no national borders, digital cash does not have it either. Thus, the cost of transfer within a state is almost equal to the cost of transfer across states. The cost of international money transfer, which is now much higher than the transfer within national border, will be reduced dramatically. For example, now it takes more than a week to send a small amount of money to a foreign bank. But if the foreign bank accept digital cash, this delay may be slmost diminished.[12]

Third, digital cash payments can be used by everybody. While credit card payments are limited to authorized stores, digital cash payments are possible for person-to-person payments. Thus, even very small businesses or individuals can use these payments.

The consequence of these three effects is an enlargement of new business opportunities and an expansion of economic activities on the Internet. Even small businesses can trade with customers all over the world. Multinational small businesses will become a new trend of business. (Szabo, 1993) There may appear a high school student who sells his software to world computer users through the Internet and gains lots of money. Large firms will also utilize this more efficient transaction tool, especially for international payment. The increased efficiency and enlarged business opportunity will lead to less expensive and more sophisticated services for users.

Problem -1 : Taxing and money laundering

Digital cash may cause some problems. Among them is taxation and criminal usage such as money laundering. Digital cash enables seamless transactions across national borders. However, how should we impose sales tax on the transaction on the Internet? Let us imagine that a Chinese man puts his software on a server in the US and sells it to a Japanese man. Which country's sales tax rate should be applied, and to whom? Which country should benefit that tax? Such conflicts of international taxation, which have appeared occasionally so far, could intensify. To handle this problem, international taxation rules have to be adjusted. To make matters worse, the transfer of digital cash does not leave any record like a bank accounting record that the tax authority can trace, because digital cash is exactly like cash, not a transfer through the conventional banking system.[13] Owing to this untraceability, taxation will not be an easy task even if the international taxation rule is adjusted.

This untraceability will enable criminal usage of digital cash. Money laundering will be an easy task because if you send money as digital cash, you can send it anywhere in the world without any evidence. If investigators dare to obtain evidence, they have to check all packets around the world and crack all cryptography. It is almost impossible. Since underground people are always smart to use new technology, initially digital cash may be used for transactions of illegal goods and services such as pornography or drugs. [14] Note that the untraceabiliy is a source of these problems.[15] As shown in chapter 2, not all electronic money has untraceability; credit card base type and check type are traceable. These traceable electronic payment system will not cause taxation and money laundering problems, because they left transaction records at the bank. Based on this argument, Foomkin (1996b, D) insisted that taxation would not be serious issues for electronic money in medium term. If these traceable money become dominant, his conclusion will be vaild. However, if digital cash of real cash type such as Chaum's Digicash spreads in cyberspace, the taxation and monery laundering will be a issue.[16]

The other three problems associated with digital cash are concerned with the effects of digital cash on macro economic stability. Before analyzing these effects, we should decide whether digital cash is a proxy of real currency or a privately-issued new currency.

I will assume that digital cash will be issued as a proxy of currency in the real world, at least for a while. In other words, digital cash will be issued on the same terms as existing hard currency, e.g. digital cash of dollar, digital cash of yen, etc., and can be exchanged to that hard currency at anytime. Some people assume that digital cash is issued by private firms(Mantonis 1995): "MS-cash" is issued by the Microsoft corporation just like dollar bills are issued by the FED.[17] If so, digital cash does have a monetary freedom as Hayek insisted (Hayek, 1978). But it is not likely because it is difficult to get people to trust a privately-issued currency which is not controlled by the government.

The difficulty is that conditions making government-issued money credible do not hold true for privately-issued currency. In the case of government-issued currency, firstly, almost all people cannot escape from their country and have to use that currency even if its value is depreciated, and secondly, people can control the government through voting. The former condition forces people to keep using that currency even under inflationary conditions, and the latter condition enables people to try to stabilize the value of currency through the political process. These conditions, however, do not hold true for privately-issued currency. If the value of a firm's privately-issued currency begins to depreciate, everybody will quickly start selling off that firm's currency to avoid a loss, which will accelerate the depreciation of that currency, and eventually lead to the bankruptcy of that firm. Since such instability is easily anticipated, people won't use the privately-issued currency.

Thus, I will assume hereafter that digital cash will be issued as a proxy of real currency such as the dollar or yen, at least for a while. Or, that the value of digital cash is exacly equal to real currency, and digital cash is convertible to real currency at anytime.[18] For example, dollar-term digital cash would have the same unit of dollar and customers can convert it to real cash. In other words, digital cash is not "new" currency just like dolar, mark, or yen.[19] Hearafter, digital cash is assumed to be a cash backed (or created) by banks using the real cash as base money and be gurannteed convertibility to real cash. Even under this rather conservative assumption, I can consider the following three monetary problems.

Problem-2: Increased Instability of Exchange Rate

Digital cash will increase the instability of exchange rates. Since digital cash is a proxy of real currency, there has to be an exchange rate applied to it, or there must be a foreign exchange market in cyberspace. (See Figure 2) For example, dollar-term digital cash can be exchanged for yen-term digital cash using the same exchange rate as that of the real world The exchange rates in cyberspace and in the real world should be equal, since, if otherwise, arbitrage transactions immediately equalize the two exchange rates. So two worlds link through the exchange rate.

Figure 2

But there will be two differences between the foreign exchange market in cyberspace and that in the real world. First, the fee for exchanging one currency's digital cash with another currency's digital cash will be very much lower than the fee for exhanging real cash, due to the fact that the exchanging of digital cash is only a rewrite of data on the computer. In the real world, the difference between the selling rate and the buying rate is now about 2% for the general customers, a rate which reflects the costs of the storing of the bills in various currencies, managing branches, and hiring workers. But these costs will be eliminated if digital cash is adopted. Thus, the exchange fee for digital cash will become very small. This fee-reduction will make it possible for not only specialists but also for average person to take part in the foreign exchange market.

Second, holders of digital cash will not stick to one country when they purchase something, because the Internet has no national borders. On the Internet, we can easily move from the homepage of an American boutique to that of an French boutique. So we can easily change the currency to use for payment. On the contrary, in real world, almost all people have to stay and continue to purchase goods in their home country, no matter how the foreign exchange rates change. In cyberspace, however, people can purchase from all over the world. So if the dollar is depreciating, people surely will want to exchange dollar-term digital cash with another-currency's digital cash. In other words, there exists an incentive toward speculations even for general person in cyberspace.

Accordingly, we can expect that a large number of people in cyberspace will participate in the foreign exchange market of digital cash. This massive participation could possibly lead to the destabilization of the foreign exchange rate. For example, if the dollar begins to depreciate, a very large number of people could start selling the dollar's digital cash and buying other currency's digital cash to avoid loss and/or gain profit. This speculative behavior could accelerate the initial depreciation of the dollar and amplify the fluctuation, and a so-called bubble effect could occur.

Logically speaking, of course, an increase in the number of participants may stabilize the market if the participants' expectations are independent of each other. But if participants' expectations are dependent on each other, a bubble is likely to occur (Rapport and White, 1994). Which case will actually happen depends on to what degree people's expectations are independent. Historical experience shows, unfortunately, that bubbles occurr when the general public joins in speculative transactions (Alen, 1931, Galbraith, 1954)[20] This fact suggests that massive participation by the general public may cause a bubble and destabilize the foreign exchange rate. Since the exchange rate of digital cash is linked to the real-world's exchange rate, this de-stabilization could, in turn, affect the real world.

Problem-3: Disturbance of money supply

Digital cash will affect the money supply in the real world. As described before, at least initially, people who want to use digital cash deposit real cash in the bank and ask the bank to issue digital cash. If the bank issuing digital cash does not offer a loan as digital cash (so-called 100% reserve system), the amount of digital cash will be fixed to the amount of the real cash deposited to the bank. In this case, no new money will be created in cyberspace. However, if the economy of the Internet expands, the banks will start lending customers money as a form of digital cash; banks will move to "the fractional reserve system" in the syberspace which is now normal in the real world. Then new money will be created in the cyberspace. In other words, total amount of digital cash will exceed the amount of deposited real cash(see Figure 3). So there should be a money multiplier of digital cash. "Money multiplier" here is defined as the ratio of issued digital cash to deposited real cash (i.e. researve) in cyberspace economy. If cyberspace is an economy similar to a national economy, this is a natural development process of finance.

Figure 3

But this development means that money in cyberspace fluctuates reflecting economic activity there, which eventually affects the real world's money supply. For example, let us assume that cyberspace's economy expands or the money multiplier falls for some reason. This will cause a shortage of digital cash. Then people will try to bring real cash from the real world to the bank in cyberspace requesting the issuance of more digital cash. In other words, to meet the demand for digital cash, cyberspace will absorb real cash. As a result, the money in the real world will shrink. Therefore the money supply in the real world will be affected by cyberspace's economic activity.

This mechanism of interaction is not new to economics. In the real world also, one country's economic expansion increases its interest rate, which causes capital inflow from other countries, eventually resulting in a shortage of other countries' money supplies. But there are new factors in the case of cyberspace. First, since digital cash is a proxy of real cash -- having the same unit and easy exchangeability to real cash --, the interaction will be more direct and rapid. In the real world, there exist national borders and the risk of fluctuating exchange rates which dampen the speed and amount of capital flow to some extent. By contrast, there are no such barriers between dollar digital cash and real dollar bills. Therefore, monetary interaction between cyberspace and a national economy will be more direct and rapid than that between two national economies. Second, since cyberspace has no national borders and no central monetary authority, dollar term digital cash can be issued by non-US banks anywhere in the world. So even if the FED tries to manage the amount of dollar digital cash, it cannot do it. These two factors will make the monetary control of the central banks more difficult than now.

Problem-4: Possibility of Financial Crisis

If banks begin to create new money as a form of digital cash, there appears a possibility of chained-bankruptcy, which may easily cause financial crisis in cyberspace.

If a bank issues digital cash within limits of the real cash which customers have deposited and the bank does not lend it as digital cash again (that is, 100% reserve system), a bank can respond to refunding demand from customers even when all customers want to convert all the digital cash to real cash. In this case, bankruptcy would be unlikely and the chain effect is limited. But as I said before, the natural development of finance and competition among banks will lead to the loan of digital cash beyond the deposited real cash; that is, the fractional reserve system. Then a bankruptcy of a bank can cause chain-effect to other bank's default, which may result in financial crisis.

In the real world, this risk is minimized by the so-called safety-net offered by the central bank or other institutional devises such as the Federal Deposit Insurance Corporation (FDIC). But in cyberspace, there is no central authority to offer the safety-net, at least not now and probably for a while. For example, digital cash in the Mark Twain Banks is not insured by the FDIC.[21] Thus, only one bank's default can easily cause a chain-effect. Many customers may rush to the banks to ask for a rconversion of their digital cash to real cash, which is of course impossible. The possibility of financial crisis is expected to be higher in cyberspace than in the real world owing to the absence of a central bank. [22]

In sum, I listed one benefit: increased efficiency of transaction, and four problems: taxing and money laundering, increased instability of exchange rate, disturbance of money supply, possibility of financial crisis. Note that these effect will not occur unless the amount of digital cash become considerable percent of world GDP.[23] The aim of this paper is not a predicition but an examination of the characteristic of digital cash. Then what is the critical character of digital cash? Is there a common factor in any of these benefit or problems? If these consequences really take place in future, what kind of scenario could happen? I will consider these questions in the next chapter.

[4] Most Important Character of Digital Cash and One Possible Scenario

Most important character of digital cash:Transnationality

What is the most important character of digital cash? I pointed out one benefit and four problems in the previous chapter. In considering these five consequences of digital cash, we notice one common character which played an important role in every case.

It is transnationality; the fact that digital cash is not constrained by national borders. First, people using digital cash are transnational because they can purchase service and goods from every site on the Internet. Second, banks issuing digital cash are transnational because not only the US bank but also all other banks can issue dollar-term digital cash. To put this another way, as far as digital cash is concerned, both the demand side and the supply side has no national borders.

This transnationality is an important characteristic of digital cash which greatly affects benefits and problems discussed above. The benefit of increased efficiency is most striking in the case of international transactions. For example, in Japan, the bank commission of an international money transfer is about 20 or 30 dollars, whereas it is 2 or 3 dollars for a domestic transfer. So the cost reduction effect is more dramatic for international payments.

The problems are also deeply rooted in this transnationality. The taxation and money laundering prblems are caused directly by this transnationality. Instability of the exchange rate is also the result of the transnationality of people living in cyberspace; instability may be caused by mass participation in speculative transactions, and, likewise, mass transactions may be the result of the fact that people can purchase goods and services directly from anywhere in the world by using digital cash i any currency. Disturbance of the money supply may become serious as a consequence of digital cash's transnationality, because one currency's digital cash may be issued by not only that country's bank but also by all other banks outside that country which are beyond the control of that country's central bank. The financial crisis may be intensified by the transnationality of digital cash, because this transnationality makes it difficult for conventional central banks to deal with chained-bankruptcy in cyberspace.

To understand the importance of transnationality, let us assume that digital cash is completely domestic, not transnational. That is, only a home country's banks can issue digital cash in that home country's currency and only a home country's people can use it only at the site located in the home country. Then, the benefit of digital cash will be reduced to the level of just a new payment system something like a credit card or prepaid card. Multinational small businesses will be, of course, impossible. Potential customers in cyberspace, which are now worldwide, may be reduced to those in one nation-state. But, regardless of this loss, the problems caused by digital cash will become far less serious. Domestic taxation rules can be applied to transactions on the Internet. Money laundering is still possible, but will be more easily detected by investigators because digital cash will stay in the home country. The instability of the exchange rate will not be a serious issue; the people of a home country have to keep using that home country's digital cash, so will have less incentive to participate in exchange rate speculation. Disturbance of the money supply will be minimized because the central bank can control not only real cash but also digital cash by the conventional means, such as control of money by bank rate control or open market operation. Chained-bankruptcy may also be controlled by the conventional techniques of the central bank. Therefore, both benefit and problems disappear or are reduced much if digital cash is completely domestic. This thought-experiment indicates that transnationality is critically important for digital cash.

In other words, if digital cash had no transnationality, it would be considered as nothing more than an efficient payment system like a credit card or banks' electronic funds transfer system, and would have no siginificant economic implications. Credit card and electronic funds transfer system increased the efficiency of transaction, probably changed the velocity of money and raised the money multiplier.[24] But that is all it did. It did not bring consequences like those discussed above. It did not cause a taxation or money laundering problem, and did not affect the stability of the foreign exchange rate or money supply. If digital cash had no transnationality, its consequences would be very limited like a credit card or electronic funds transfer system, and there would be no economic consequences to analyze.[25]

This argument leads to a necessity to distinguish between the digital cash discussed here and so-called electronic money, because in general the latter does not have sufficient transnationality. For example, a smart card system like Mondex is sometimes treated in the same way as digital cash. But since the smart cad system usually requires a specialized reading&writing devise, it can not easily spread all over the world.[26] Thus smart card's transnationality is limited compared with Chaum's digicash.[27] As this example shows, not all electronic cash has transnationality. This is the reason why I use the term "digital cash" in this paper instead of the more broader term, "electronic cash". Digital cash, like Chaum's digicash, being different from other electronic cash, has an unprecedented transnationality which may cause significant benefits and problems.

One Possible Scenario - Radical Case -

But will these consequences really occur? It all depends on how much digital cash will be actually used on the Internet. Not only a few people are anxious about the security of digital cash.[28] If concerns and the problems outhweigh the benefits, digital cash will not spread and the consequences discussed above will not be realized. Also, the real world has many regulatory laws for the consumer protection and financial stability, laws which can be obstacles for the introduction of digital cash (Fein 1995). However, it is difficult to predict which way the trend will turn in the future. The only thing we can do now is to consider several possible scenarios, from the most conservative ones to the most radical ones.

Here in this paper, for illustrative purposes, I will consider one of the most radical scenarios, that is, the scenario in which digital cash will become prevalent on the Internet, turning cyberspacinto a large scale economy. This is not a prediction, only a possible scenario. The aim of presenting this radical case is for a better understanding of digital cash. In order to understand the implications of digital cash and to make preparations for the future, it is better to take an extreme case as a thought experiment.

Let us assume that the benefits of digital cash are plentiful enough to overcome the security concerns, and people will increasingly use digital cash. Under this assumption, what will happen? I will consider three stages of development.

Figure 4

(1) Expansion Stage

Digital cash spreads on the Internet. Increased efficiency brings unprecedented benefits to producers and consumers. Multinational small businesses gain momentum and new business organizations appear such as virtual corporations. Consumers enjoy purchasing goods and services from all over the world. Some banks sticking to traditional transaction systems may lose their competitive edge. The size of the cyberspace economy, measured by the total sales on the Internet or something like GNP, grows more rapidly than the economy of the real world.

As long as the size of the cyberspace economy is far smaller than the real world's economy, the effect on exchange rates or money supply is limited. So the main problem in this stage is the taxation problem and crime usage such as money laundering. These two problems demand an international accommodation of rules, such as an international standard taxation rule on transactions through the Internet, or an international agreement on criminal investigations on the Internet.[29] The process of making such rules may warrant a harsh negotiation round among nation states. But in any case, these new rules will be nothing but patchwork regulation which will not change the character of digital cash.[30] So the expansion of digital cash will continue in spite of such weak regulations.

(2) Confusion Stage

The expansion of digital cash will eventually raise the size of the cyberspace economy enough to influence the real world's international economy. For example, imagine the amount of transactions in cyberspace reaching to the 5% of the total of world transactions. Then the destabilizing effect on the exchange rate and the disturbance effect on the money supply will become reality. Many people will begin to be concerned about the possibility of financial crisis. Cyberspace will be under fire as a cancer to the world economy. Experts and scholars may propose various reform plans to solve these problems.

But it might be difficult to enact the reforms before the financial crisis really happens, because the reform means, more or less, the introduction of world-wide regulation into cyberspace, and people living in cyberspace tend to dislike any kind of regulation. People living there love the freedom of cyberspace and tend to be proud of being part of anarchy. On top of this, since this regulation would include all the banks in the cyberspace, it would require word-wide time-consuming negotiation process. If people's resistance is strong enough and negotiation wastes too much time, financial crisis could really occur before any reform are enacted. Once financial crisis occurs, since everybody will try to withdraw their money from cyberspace and move it to the real world, the digital cash may rapidly shrink and economic activity in cyberspace become paralyzed.

(3) Organizing Stage

If the financial crisis actually occur, the necessity of reform become evident to everyone. What kind of reform could happen then? Two typical reform plans can be imagined: territorial segmentation by nation states or establishment of monetary authority in the cyberspace.

(i) Territorial Segmentation by Nation States: One possible reform plan is to let the nation states manage their banks. In other words, every bank on the Internet would have to belong to one nation state and be controlled by the central bank of that state. The central bank would be responsible for the problems discussed here, and would control the issue and circulation of digital cash. For example, home banks are prohibited to issue foreign currency's digital cash for the purpose to stabilize foreign exchange rates.[31] Thus digital cash will lose its transnationality. As shown before, digital cash without transnationality would be only a new means of payment like a credit card and controllable by the central government. To put this another way, the problems would be minimized at the cost of the loss of the benefit of transnationality. This reform would symbolize, in a sense, the "colonization of cyberspace" by nation states. Cyberspace would surrender to the nation states.

(ii) Establishment of Monetary Authority in Cyberspace: The above segmentation reform plan would not be a satisfactory solution for people living in cyberspace, so-called Netizen.[32] They will try to seek another solution. Another possible reform would be to establish a monetary authority in cyberspace just like a central bank in the real world. The organization of this monetary authority may be a union of the banks on the Internet, a committee of experts and bankers, or an organization of representatives elected from regular people in cyberspace. At any rate, this monetary authority would be responsible for the financial problems that could arize such as chained-bankruptcy, or an instability of the money supply and exchange rate. To perform this purpose, all banks issuing digital cash would have to accept regulation by this monetary authority.

However, if digital cash remains a proxy of real cash, the monetary authority in cyberspace will not be able to perform its responsibility, because the authority cannot issue real cash. In the real world, monetary authority can issue real cash (for example, dollar bills or yen bills) to any extent, so it can be a last resort of credit. If digital cash remains a proxy of real cash, the monetary authority in cyberspace would not be able to a last resort of credit.

One of the strongest solutions to this incompetence would be that the authority in cyberspace create a completely new currency for digital cash. If tentatively we call this new currency's unit "e$"[33], e$ would be a new currency similar to the dollar or yen. Only the monetary authority could issue e$-term digital cash, and other banks on the Internet use this cash as a base money and issue their bank's digital cash. Consequently, cyberspace could obtain the sovereignty as far as currency is concerned. Cyberspace could obtain monetary independence with respect to money. [34]

To some readers, this scenario may sound like science fiction. I would like to stress again that this is not a prediction, but a possible and probably most radical scenario, rooted in the basic characteristic of digital cash. The above thought experiment suggests that the scenario will, more or less, be a story of conflict between cyberspace and nation states.[35] Of course we can not be sure yet if digital cash will really spread or not. But if it spreads, the historian in the 21st century may write the history of digital cash as a story of the battle between cyberspace and nation states.

[5] Conclusion

Digital cash will bring us benefits as well as problems. One major benefit of digital cash is its increased efficiency which will open new business opportunities, especially for small businesses. On the other hand, it will bring us four problems: taxation and money laundering, instability of the foreign exchange rate, disturbance of money supply, and the possibility of financial crisis. There is one important attribute of digital cash, however, that overshadows these benefit and problems. It is the transnationality of digital cash, that is, the ability of digital cash to flow freely accross national borders. Every bank can issue it and everybody all over the world can use it. This transnationality is a cause for both benefits and problems, and could have significant repurcussions internationally. From the economic stand point, the most important characteristic of digital cash is its transnationality. If digital cash circulated only within a traditional national border and was controlled under a central monetary authority, there would be no economic implications that would be worth analyzing. In this case, digital cash would be nothing more than a convenient transaction method such as a credit card. However, digital cash is more than that. Its transnationality has the potential to cause conflict between cyberspace and nation states. If digital cash spreads successfully in the 21st century, its history may be written as a record of its battle with nation states.

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