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The Spreading Use of Digital Cash and Its Problems 89


payments are handled through credit cards. Throughout the rest of the world payment
methods vary and include electronic payments, direct debits, and credit cards. While this
is cost-effective for most transactions, it is not efficient for smaller “micro” transactions.


Disadvantages of Digital Cash

Despite the bright prospects that digital cash can offer, the flip side of the digital coin
reveals some serious dilemmas. Here is a list of some important problems.
1) Who pays the cost of a digital cash system?
The cost of creating digital cash is high (Rosenblum, 1996). Because it is expensive
to invest in the advanced technology of the IC cards and equipment and to set up
the required minimum infrastructure, the commitment to this mode of transaction
must be authentic, official, and for the long term.
2) How are the users protected?
This is a legal question as well as an “economic and technological” one. A standard
has been emerging around the world that in online-type transactions, a debt
incurred from the fraudulent use by another person of one™s registered identity or
account is the sole responsibility of the registered owner3. Still, the U.S. Commerce
and Trade Code (Title 15, Chapter 41, Subchapter 6, Section 1693g) states that a
consumer™s liability for an unauthorized transfer shall not exceed a) $50, or b) the
monetary amount or value obtained in the unauthorized electronic funds transfer,
whichever is less. Japan™s commerce code has no equivalent safeguard at present.
3) Problems facing the issuing entity
What happens when the issuing entity experiences an emergency, along the lines
of bankruptcy for instance? In the case of the European Central Bank (ECB), it
assumes that the issuance of digital cash is the same as the acceptance of the
deposit for those who issue it. Thus the issuing organization should be limited
specifically to the financial institution in order to a) defend the settlement system,
b) protect the consumer, c) properly execute monetary policy, and d) promote
competition. It should be noted that there is some debate within Japan™s Ministry
of Finance about whether the issue of digital cash should be allowed via other
entities as well as traditional financial institutions.
4) Customer selection criteria
Aspects of customer eligibility could become more technology based. For in-
stance, being unable to use a personal computer could mean being denied certain
services. Users need to perform difficult and different procedures in order to
participate in it in some cases.
5) How and where would taxes be levied and what would be an appropriate global
standard?
It is feasible that taxation of digital cash could be circumvented. And neither the
World Trade Organization nor the U.S. has much will to tax network trading.
Elsewhere in the world, the stance on the issue varies.



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90 Kurihara


6) What could be done to combat high crime?
High crime such as counterfeiting will be significantly more difficult to pursue in
the digital financial realm than it has been traditionally (Winer, 2002). At the
consumer level as well there are a number of serious security concerns associated
with IC-type financial transactions, including the ease with which an IC card can
be lost or stolen, not to mention the possibility of its use in cash laundering, which
has been noted before. Despite the privacy advantage of using digital cash, IC-type
transactions are not all that widespread (Berger et al., 1996). But there is a serious
crime risk among network-type transactions because of the sheer volume of them4.
7) The issue of user privacy
Privacy is a difficult issue as it is inseparable from security. Hackers have also aimed
at collecting information and using it fraudulently. The principal drawback of e-
transactions is the lack of privacy features associated with traditional cash
transactions. The anonymity that can be achieved by dealing in cash is missing.
But blinding causes another problem. How does the bank identify double-spenders
if the coin-holder can™t be identified? Essentially, the balance between individual
financial privacy rights and legitimate law enforcement interests is a problem.
The battle that emerges is between the privacy afforded to a consumer by means
of anonymous digital cash verses the desire of law enforcement to ferret out crime.
The fact of complete anonymity guarantees that some money laundering will be
easier to pull off.




Digital Cash and Financial Institution
Management
Many banks in developed countries have adopted several kinds of Internet banking
services, and some financial institutions that specialize solely in Internet banking have
been established. The possibility of cost reductions in customer services, severe
competition, and a rapid increase in consumer use of the Internet have all contributed
to the boom in Internet banking5.
The spread of digital cash is understood to have brought about an evolution in financial
settlement. For one thing, no longer do we need to be physically present at a shop or a
bank or even an ATM. We are free from having key activities of our daily lives dictated
by the hours, the location, and the protocols of the business establishment. In this
respect, the advantage of digital cash is substantial, as described in the previous section.
Moreover, even with the extra costs of incorporating the system into our financial
institutions, economies of scale are such that a broad customer base is assured
(Davidson, 1997; Redman, 1997).
Several major companies have announced an interface standard to be used for bank
services that is expected to further reduce the construction cost of the digital system.
Moreover, a movement to recognize such a global standard is growing in the United



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The Spreading Use of Digital Cash and Its Problems 91


States. I can imagine, then, the possibility that some new types of financial settlements
not dealt with by the banks will emerge with the spread of digital cash. In Japan such new
transactions are being realized today. With regard to this, non-banking institutions pose
a threat to banks and other traditional financial institutions. It is certain at least that the
trend will push down cash handling costs (Timewell, 1996), and the following may also
develop as symptomatic of financial industry digitization:
1) Overall decrease in the number of bank branches and staff.
2) Banks with fewer of their own branches (commercial mega-banks and some trust
banks, etc.) have an advantage (Orr, 1997; Cline, 1998).
3) A reduction in service fees in the case of net settlements or immediate settlements
(The Banker, 1997), as well as through use of one™s personal computer for banking
transactions.
4) By the acquisition of business information concerning commercial distribution, a
bank has the means to create a monopoly.
5) When institutions other than banks join the settlement network, it increases the
possibilities of systemic risk.
6) Likely to occur are tie-ups with credit-card companies and similar institutions
having their own set infrastructures (Business Week, 1995).
7) Shifts in these types of risks are forecast. Rather than the traditional concerns such
as interest rates, liquidity, and market fluctuations being at the center of attention
(Basle Commitment on Banking Supervision, 1998), operation risks may become the
focus. Having to lower the cost of information acquisition while globalization
continues to influence worldwide business trends makes it difficult for banks to
establish a central standard of technology and risk-management operations6.
8) If competition turns severe, confidence and reputation become more important
than before.


Each is trying to provide a better way of streamlining digital payments or replacing cash.
Of course, some new trend in the financial realm will have a ripple effect. There is the view
that any move to ensure that banks are not deprived of their vested right to profit from
certain transactions, for instance, would disturb the development of electronic banking.
Paper-based transactions are still the mainstay, according to Humphrey and Pulley
(1998), BIS (2000), and Weiner (2000), not only in the United States but in the other
countries as well.
Banks have a vested interest in keeping payment systems as slow as possible ” the
longer money takes to get from one bank account to another, the more use can be made
of it. This is why banks are not pioneers when it comes to more efficient ways of making
payment. Yet if they do not establish a relationship with the new payment schemes, they
risk losing their franchise (Shirreff, 2001).
New banks entered the market for merchant acquisition and a price war broke out,
reducing profit margins. All sorts of banks now complete fiercely to act as acquirers for
individual traders (Revell, 2001).




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92 Kurihara


Recently, digital cash helps to buoy the current bank merger wave (Solomon, 1999).
Mergers may pool risks and make it easier to launch successful credit card or electronic
cash operations just by capturing the infancy of less risk.




Digital Cash and Policy Authorities
Digital cash or the Internet payment has excited economists to speculate whether any
of the possible forms of money will make the present methods of operating monetary
policy impossible or much difficult. It is easy to predict that digital cash will influence
policy authorities. However, digital cash is seen as a bank-issued debt, or in other words,
a deposit. It circulates under the assumption, the trust, or the guarantee that 100% of it
can be converted to cash (a central bank note). The digital cash itself does not possess
the finality of the settlement. I doubt that the policy authorities will be greatly influenced
by it anytime soon. The mechanism of digital cash essentially is no different than a bank
note7.
How the policy authorities might be influenced by the appearance of digital cash is laid
out in the following:
a) Problem concerning management of the cash supply
I will discuss this problem in some detail. The debate continues about difficulties
managing the cash supply because settlements with deposit currency will decrease
as settlements by digital cash increase (BIS, 1996). So there are fears that the
function of deposit creation will decrease. However, there would be no change in
the cash supply if the issued digital cash were to be converted immediately to
traditional currency. Or if non-depository digital cash issuers hold their digital cash
in their own checking account, the cash supply will not be altered (Congressional
Budget Office, 1996; Hancock and Humphrey, 2000). The problem might instead
reside in what the monetary amount is and the length of time it is kept as digital cash.
For instance, there would be no change in the multiplier if the digital cash is issued
against a bank deposit, but the multiplier increases if digital cash is issued against
a treasury bond, for example. Moreover, it™s feasible for the multiplier to become
unstable at the diffusion interval of digital cash. However, in the case where digital
cash is increasingly substituted for paper cash, authorities would better be able to
manage high-powered cash. And regarding the national debt as well, it would
not be particularly difficult for monetary authorities to gain better control of
finances.
Then what would happen relating to deposit payment preparation? The effect of
the multiplier exists as long as demand continues for the cash that the central bank
issues or prepares for deposit payment. However, as digital cash prevails, the
comparative ratio of deposit payment preparations shrinks. Though the spread of
digital cash naturally decreases the preparation requirements for payment, the




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The Spreading Use of Digital Cash and Its Problems 93


multiplier rises and so does the possibility of the trend having an effect on monetary
policy.
There is a possibility that a rise in the inter-bank market interest rate would rise
because of a lack of deposit payment preparations. It can also be assumed that the
confidence multiplier could expand to infinity, because a legal preparation frame-
work does not currently exist. However, since a) the issuing body handles payment
preparation, b) part of it is converted into cash and a deposit, and c) the lending
demand is limited, the independent acceleration of such a movement may not occur.
The interest rate elasticity of cash-card substitution is a function of the level of
digital cash adoption in the economy and this elasticity is high at low interest rates.
This may result in perverse effects from attempts to contract (expand) bank credit
and liquidity by raising (lowering) interest rates.
Finally, when the digital currency of one country is converted into the digital
currency of another, cash-supply management becomes difficult.
b) Problem of cash demand
The function of cash is as a) a value standard, b) a payment instrument, and c) a
stored value. Digital cash is viewed as chiefly functioning as a payment instrument.
Tobin™s “stock theory” is useful when thinking about this. The cost of going to
a bank, changing a deposit into cash, and the cash demand are positively
correlated. If I apply this theory, then it follows that digital cash decreases the cash
demand. However, it is true that liquidity will rise, so digital cash has the possibility
of making the overall cash demand unstable.
The influence of digital cash was considered from the cash-supply side and from
the demand side in a) and b) of this section. Then, the shift of the multiplier and
the cash demand that may result cannot be predicted accurately. At this time, what
should policy authorities do? According to standard economic theory, if the shock
of the economic fluctuation is real, stabilizing the amount of the cash supply rather
than the interest rate reduces the breadth of the shift in real GDP. Conversely if the
shock to the cash demand is large, stabilizing the interest rate rather than the cash
supply reduces the change in real GDP (Poole, 1970). Therefore, when an unantici-
pated cash shock occurs in the market in the guise of digital cash, financial
authorities should stabilize the interest rate.
There has been much discussion about whether monetary authorities should give
precedence to controlling the cash supply (or the exchange rate) as an intermediate
goal over attaining price stability or economic growth. A typical example in which
the cash supply has been targeted as the intermediate goal is Germany (Gerlach,
1999). However, if authorities adopted such an approach, their control over the
cash supply would disrupt the stable relationship between the cash supply and
inflation, and thus economic growth as well. So it appears preferable for monetary
authorities to control interest rates instead of the cash supply in the digital cash
environment. Woodford (2000) says macro-economic stabilization depends only
upon the ability of central banks to control a short-term nominal interest rate.




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94 Kurihara


c) Problem of the expansion of foreign currency use
If part of domestic economic activity is based on foreign currency, its influence,
which is conveyed by the domestic currency™s short-term interest rate, can pull
down the “real economy.” Moreover, the influence of monetary policy can become
insignificant, being limited to bank lending in domestic currency. Price changes for
goods and services provided by foreign countries may influence the domestic
economy as well.
The impact on domestic short-term interest rates would not be weak, but would be
relatively strong as long as the policy authorities control the “high-powered”
money. However, it™s possible that the effect of fluctuations in the domestic short-
term interest rate on the long-term rate is weakened through arbitrage trading. The
mechanism of arbitrage trading buffers itself against much influence from the
movements in short-term interest rates. However, this is not limited to the digital
cash environment alone.
d) Problem of taxation
Tax evasion and trends toward tax cutting would lead to a decrease in revenue.
e) Restrictions and supervisory problems
Via the Internet, money is easily transferred to and deposited in financial institu-
tions overseas, especially into those countries having few or no regulatory
controls. This risks creating the domino effect of currency contagion and transfer-
ring some of the corruptive influences of the recipient country to the originating
country. Restriction and supervision of such transactions is virtually impossible
without the countries™ mutual cooperation. Moreover, the individual scope of the
financial institutions poses their own problems, since financial systems differ
among countries. The problem of the scope of deposit insurance is present as well.
f) Problem of cash laundering, etc.
Government intervention regarding code keys and other transaction aspects may
arise. Wanting to adopt such measures is natural for the authorities, but in conflict
with the issue of personal privacy (Mester, 2000).
Finally, the authorities lose profit, because cash (not digital cash) is a debt with no
interest and the authorities acquire interest from assets. Or the substitution of
privately issued digital cash for government-issued currency reduces seignorage8.
But the pursuit of profit is not their objective, nor is it the goal of the central bank,
as the ECB says.




Conclusions
Here I have laid out the advantages and disadvantages of digital cash. It™s easy to believe
that there are many advantages to promoting digital cash. It also seems that the progress
of IT is unstoppable, but fortunately this will make our world a more convenient and
efficient place to live.



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The Spreading Use of Digital Cash and Its Problems 95


Nevertheless, there are a number of concurrent problems. None of these challenges are
apt to be resolved swiftly and painlessly. I have analyzed these issues not only from the
customer standpoint but also regarding financial institutions and authorities.
For financial institutions, this trend cannot be stopped, and so it would be prudent for
them to view it as a business opportunity. If they do not find ways to adapt, they will
become obsolete and fade away completely from the market. By promoting e-finance, a
company can give market share and negotiating power over suppliers, as well as earn a
profit. The authorities should pay careful heed as well, guiding the “sound” market to
maturity and taking care not to confuse it with excessive intervention. At the same time,
they must maintain a sound financial system.
As online marketplaces are created, the choices that are made in their construction will
shape the experiences of consumers. To make online shopping more familiar it may be
useful to simulate the physical world, to bring into the virtual world analogs of physical
objects and spaces. It is also incumbent on those who stand to benefit from e-commerce
to make positive efforts to educate both the media and the public regarding e-commerce
and its security (Jarupunphol and Mitchell, 2002). Now, many potential participants are
reluctant to participate in e-commerce because of payment confidentiality, payment
integrity, and payment authorization concerns. Software agents have the potential to
take on characteristics of people in the new marketplace.
We cannot turn back now. What we need to do is analyze this trend not just from a
practical perspective but also from a theoretical one. Much research ahead is also
anticipated within the academic fields.




Endnotes
1
In detail, see Kurihara (2000).
2
See, for example, U.S. Department of Commerce (1998).
3
The settlement service for which insurance is included.
4
Counterfeiting has broadened to include digital cash as well as paper cash. And
the liquidity, speed and anonymity of digital cash tends to be higher than that of
paper cash.
5
See, for example, Lubove (1996), U.S. Department of Commerce (1998), and Mack-
intosh (1999). In Japan it is becoming preferable to avoid low interest rates.
6
Salomon (1996) also suggests the possibility that some computer software compa-
nies may be competing against financial institutions.
7
However, a current system is subject to radical change if it is first established
outside of an existing system; for example, a second central bank.
8
Lacker (1996) has applied this result in a general equilibrium model.




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96 Kurihara


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