Money Going Electronic

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This article was published by ComputorEdge, issue #2504, 2007-01-26, as the cover article, in both their print edition (on pages 12 and 14) and their website. It was my 100th article for ComputorEdge.

Throughout human history, money has taken many forms. These include small cylindrical beads made from polished shells ("wampum") used by Native American Indians, cowrie shells used in some parts of Africa and Asia, metallic jewelry ("manillas") used in west Africa, and coins made of silver and other precious metals used by Romans.

Perhaps the most unusual form are the large stone wheels ("rai"), used for several hundred years on Yap, a small group of islands in the South Pacific. Rai varied in size, with diameters from a few inches up to 12 feet (each weighing thousands of pounds, and transported on a heavy pole through the center hole).

There may be dramatic differences in size between the dimes created by the US Mint, and the rai quarried by Yapese men, but they share some common qualities. Their acceptance as wealth stems not just from cultural and political convention, but also from the difficult of creating (i.e., counterfeiting) them.

Regardless of form, each type of currency is intended to be used as a common medium of exchange, a unit of account, and a store of value.

But what happens when the monetary medium is no longer precious, no longer difficult to create out of thin air, and no longer backed up by tangible materials that are difficult to produce? For modern consumers, how much value is there in a currency backed up only by say-so?

As an example quite relevant to all Americans, the US dollar is made legal tender by government decree, and is no longer even backed up by a relatively tiny fraction of gold at Fort Knox. Our coins do not contain the precious metals of the past, and our more highly valued Federal Reserve notes are green strips of cotton-based "paper" featuring pictures of dead American presidents.

Money Goes Digital

The issue becomes even more pointed when the money does not even possess the shape of coins and paper currency — when it has no shape whatsoever. This is a result of our wealth being stored as protected numbers on computers, and transferred from one individual and institution to another merely by the communication of numbers over the Internet and over proprietary financial networks.

Most Americans are under the misconception that the bulk of US money are dollar bills and coins of various denominations, and held mostly within our shores. Actually, most American money is stored digitally, as 0s and 1s.

Furthermore, the majority of US notes are held outside the United States. In 1995, more than $380 billion of US currency was in circulation, with two-thirds of it overseas. Nine years later, almost $700 billion was in circulation, with more than half overseas.

We are now so accustomed to using credit cards and bank debit cards to make purchases drawn against account balances stored on computers, that its intangibility does not faze us. If our livelihoods consist of manipulating online information, and our romantic missives take the form of e-mail messages peppered with emoticons, then why not accept digital dollars as perfectly legitimate and secure?

Crooks Get Smarter

One of the major downsides to electronic money is verifying that the person tendering those digital dollars is their rightful owner — a problem not encountered with physical cash and coins, whose ownership is derived from their actual possession. Modern-day criminals are becoming increasingly adept at creating illegitimate credit cards, stealing identities to back them up, and ordering items online using ill-gotten credit information.

Identity verification for credit cards was first pursued through the use of written signatures on the backs of the cards. But signatures are easily forged, especially from a practical standpoint, as retail clerks never compare the signature on the back of a card with any other signature.

Bank debit cards typically employ four-digit personal identification numbers (PINs). But credit cards sadly do not require them, and not all consumers make an effort to keep their PINs secret from "shoulder surfers" who watch as the victims punch in their numbers.

Printing the photos of the owners on the cards, was a huge improvement over signatures. But a remarkably small fraction of financial institutions choose this more secure approach. Instead, they offer photo-free credit cards to everyone in the house, including the dog, and simply pass along the resultant fraud costs in the form of higher interest rates charged to account holders, who rarely if ever complain — except perhaps when hit by identity theft.

The bulk of credit card fraud takes place online instead of in physical transactions (a pattern opposite that of credit card information theft). In response, credit card companies implemented three-digit numbers located on the signature panels on the backs of credit cards, to greatly reduce the fraudulent use of credit card numbers (and expiration dates) in which the thief does not have physical possession of the card.

Money Gets Smarter

Tiny microprocessors can be embedded in credit cards, transforming them into "smart cards" — also known as "chip cards" or "integrated circuit cards" (ICCs). Each chip looks like a gold sticker, usually smaller than a postage stamp, with multiple contact points on the surface of the card, except for the newer "contactless" cards.

These smart cards allow the encryption of the user's financial data, which in turn makes possible more robust security measures. This is far better than the conventional cards, which possess only a readable magnetic strip, as well as the too-readable credit card number and expiration date on the front.

Given their greater capabilities, and their availability in 1983, why are smart cards being put to extensive use throughout Europe and Asia, but relatively little in the United States? Admittedly, some large fast food chains, including McDonalds, are adding smart card scanners to their drive-through ordering windows. This makes it more convenient for patrons to quickly pay for their meals, and, for the "contactless" cards, also eliminates the need of the clerks to handle or even see the patrons' credit cards.

One factor might be security. The computational power of a smart card microprocessor makes it possible for the card to contain the user's account values. European companies took advantage of this when introducing their Mondex service, which allowed for the terminals to be unconnected to the financial institutions' central computers, where the account balances are typically stored and updated.

But there are concerns with this wireless approach, because if a criminal were to hack a card's algorithm and/or a terminal, they could credit the card with counterfeit money.

As always, technology is a double-edged sword. There are disadvantages as well as advantages to converting our wealth into 0s and 1s, instead of the round stones and straight poles favored by the Yap.

Copyright © 2006 Michael J. Ross. All rights reserved.