The May Scale of Money Hardness and BitCoin

Posted by Pelle March 7th, 2012 12 comments edit

About 10 years ago after a bunch of E-Gold exchangers lost money from fraudulent purchasers performing chargebacks Start e-gold app developer JP May published his May Scale of Money Hardness (only on wayback machine now).

The idea is that the easier it is for a payment to be reversed, the softer it is. I’m trying to update it for 2012 so the next generation of financial startups don’t get burnt more than they already have been and learn the lessons learnt by the e-gold community.

Original May Scale

Hardness Item
1 Street cash, US dollars
(Hard)
2 Street cash, euro currencies, japan
3 e-gold
4 Street cash, other regions
5 Interbank transfers of various sorts (wires/ACH etc), bank checks
6 personal checks
7 Consumer-level electronic account transfers (eg bPay)
8 Business-account-level retail transfer systems
(Soft)
9 Paypal and similar ‘new money’ entities, beenz
10 Credit cards
(Ridiculously soft)

Updated May Scale

Hardness Item
1 Street cash, BitCoin, Gold/Silver Coins
(Hard)
2 Western Union and other money transmitters
3 Account based electronic currencies fire walled away from banking system (e.g. Liberty Reserve)
4 International wires
5 bank checks
6 ACH, personal checks
7 Consumer-level electronic account transfers (eg Dwolla, AlerPay), BitCoin sellers (BitInstant, MtGox etc)
8 Business-account-level retail transfer systems, credit cards (brick and mortar)
(Soft)
9 Credit cards (via internet or phone)
10 PayPal
(Ridiculously soft)

updated 3/8/2012 Based on comments I moved things around a bit. Ordinary bank wires are more less reversible than ACH’s. The scale shouldn’t cover default risk only reversal risk so I’ve moved all street cash to 1. and added gold/silver coins to it. I’ve added electronic currencies like Liberty Reserve that are fire walled away from the banking system to 3. Any account based system that interfaces directly with the banking system will be in 7, so AlertPay belongs with Dwolla as their banking connections can also put undue pressure on them. I still consider Personal checks risky. At least until it clears so I’m leaving that at 6. Also see The BitCoin Wiki’s Payment Method page for alternative rating

Why do I place Dwolla above PayPal? Mainly because they exclusively use the ACH system and not the credit card system, which makes it harder for people to perform chargebacks.

Why is PayPal below Credit Cards then? While it is a blended system of ACH and CC, their risk management procedures makes it even more risky to merchants than using a straight credit card processor. Just by virtue of being successful or having one or two chargebacks they will freeze your accounts.

What can we learn from the May Scale?

Purchasers benefit by having softer money as it reduces risk for them and merchants benefit by having harder money.

If you are selling game credits, subscriptions to a web service without any significant cost to you the benefits and ease of accepting soft money is fine.

It is slightly trickier for merchants sending physical goods to users. The merchant does have a risk, but the shipping infrastructure does provide some insurance and documentation that partly alleviates it.

If you are selling financial instruments, real estate, cars and other high value items you should not accept anything higher than 5 on the May scale. As a matter of fact due to anti money laundering laws since the original May scale was written you probably shouldn’t accept anything less that 5 either.

If you sell BitCoin you are in a little bit of a different situation similar to e-gold exchanges of yore, due to the growing hostility to it from financial institutions and governments. Depending on how high your spread or transaction fee is you could accept the risk of accepting bank transfers, in particular if you limit the size and frequency of transactions with customers until you feel you can trust them. But I would probably stick to 3 or below.

One risk potential risk with Number 3 is that you might accept a Western Union transfer from a party who is on the terrorist watch list, in which case you could get associated with them. This is a particular risk if you are not registered with the FSA (in the US) or similar elsewhere and did not perform some level of Know Your Customer.

Why soft money?

Most of the soft money is based on book entry systems with central authorities. One of the benefits of this is that in case of fraud it is possible to contact this central authority and reverse a transaction.

BitCoin is also a book entry system, but there is no central authority so there is no way of reversing a charge.

So if you as a consumer buy some coffee with BitCoin and the merchant doesn’t send it you there is no real recourse unless you know who the merchant is and are able to take the merchant to small claims court.

Because of this there is a trend within the BitCoin community of having centralized BitCoin denominated book entry systems that temporarily keep the funds in a reversible place. There are also BitCoin escrow agents. These are potentially good solutions, of course you also need to trust the operators of these or they may just run away with your BitCoin. There were probably more fraudulent than trusty escrow services in the e-gold days. I would expect the same with BitCoin.

There is also a risk to the merchant in BitCoin. See the recent Linode Bitcoin fiasco. If they were using softer money they could have called the central authority (PayPal etc), freeze their account and have dodgy transactions reversed.

Anyway none of this is easy. If you are trying to do something with BitCoin or other kinds of alternative financial services you need to think about it for your business.

OpenTransact vs PaySwarm part 2 - yes it's still mostly out of scope

Posted by Pelle January 2nd, 2012 1 comments edit

The debate continues. Please read the first part of my response OpenTransact the Payment Standard where everything is out of scope first.

Manu wrote a new response which I will respond to in a separate blog post. First let me finish responding to the original

Generally this post will again reflect the differences in approaches. OpenTransact is a single layer simple pragmatic standard for performing payments nothing else. PaySwarm is a fully featured idealistic multi layered approach where you must buy into a whole different way running your business.

A Facebook friend suggested that OpenTransact vs PaySwarm is like Libertarianism vs Socialism. I don’t quite buy that in practice as I know that PaySwarm is not about forcing anyone to do anything.

However the basic PaySwarm philosophy of wanting to design a whole world view is very similar to central planning or large standards bodies like ANSI, IEEE etc. OpenTransact follows the market based approach that the internet was based on of small standards that do one thing well.

OpenTransact the payment standard where everything is out of scope

Posted by Pelle December 21st, 2011 1 comments edit

The W3C Web Payments Community Group was launched in August 2011 because Digital Bazaar had created their PaySwarm spec. I have been working with several others since 2009 on bootstrapping an open grassroots created standard OpenTransact with pretty much the same purpose as PaySwarm. I immediately joined the W3C group to see if we could work together towards our obvious common goal.

Different philosophies

So while we both shared this common goal, the fundamental philosophies of PaySwarm and OpenTransact could not be more different.

PaySwarm attempts to solve every single problem up front and thus creates a standard that is very smart in many ways but also very complex. It’s background is I understand in a P2P media market place called Bitmunk where licenses, distribution contacts and other media DRM issues are considered important. Manu Sporny of Digital Bazaar has also been a chair of the RDFa working group so PaySwarm comes with a lot of linked data luggage as well.

OpenTransact comes from the philosophy that we don’t solve a problem until the problem exists and several people have real experiences solving it. I have also been very active in the OAuth community and believe there are many things both good and bad that can be learnt from that process and how developers took to it. OpenTransact also follows the tradition of early web standards of having most parameters as optional.

The Geeks Guide to Currencies: Trust and Promises

Posted by Pelle April 26th, 2011 1 comments edit

Trust is probably the most fundamental property that money should have (but doesn’t always have). You need to be able to trust:

  • that my money does not lose value
  • that I can exchange it again

This article is mainly about the trust of currencies without intrinsic value.

A currency with intrinsic value is something like a gold coin that is worth exactly its weight in gold. There are trust issues here as well as counterfeiters can pull all kinds of tricks, but I won’t go in to that now, but rather point you at the fascinating book Newton and the Counterfeiter: The Unknown Detective Career of the World’s Greatest Scientist

Any currency without intrinsic value consists basically of a promise given by an issuer.

The Issuer and their promise

The issuer is the person or organization who creates money out of thin air. Here are a few examples of currencies and their issuers:

Currency Issuer Promise
US Dollar Federal Reserve Notes (US Paper money Federal Reserve Banks this note is legal tender for all debts, public and private
US Coins US Treasury United States coins and currency are legal tender for all debts, public charges, taxes, and dues.
Euro European Central Bank (too lazy to look up laws)
Wells Fargo Checking Account Wells Fargo Bank NA Access to Cash Consumer Account Agreement
PayPal USD PayPal Inc You may withdraw funds by electronically transferring them to your bank account….
PayPal EUR PayPal (Europe) s.a.r.l You may withdraw funds by electronically transferring them to your bank account…
PicoPoints PicoMoney Company Valid for services within PicoMoney
Pelle Hours Me Every hour is worth one hour of my time.

The three first are national currencies and their promise is made by law that these currencies are legal tender for their particular countries. These are also called Fiat Currencies as they are based on a decree by the government and not on a regular promise from the issuer to the holders of the currency.

You might think that your bank’s checking account is the same as a Federal Reserve Note. It isn’t. In reality it is a promise by the bank that you can exchange their currency at any point for “US Federal Reserve Notes”. The issuer of most regular bank accounts are your bank itself. They may offer MoneyMarket funds, Credit Cards and other currencies that are actually issued by affiliated companies. Banks also have the additional promise of strong regulatory over site by the government regulator and government insurance schemes like the FDIC in the US. In theory this provides more trust, but in practice we can see that it doesn’t always work out that way.

PayPal’s currencies are similar to bank accounts. Each currency is a promise that you can exchange a balance in it for a transfer to your bank account. Most people probably don’t maintain a balance and just use it to transfer between 2 bank accounts, but that is how it works behind the scenes.

PicoPoints Issuer

PicoPoints is an example of a virtual currency for an online service (namely our own PicoMoney service). It is issued by our company and our promise is that you can use it to purchase services within our system. This is also how Facebook Credits, World of Warcraft Gold and even mobile phone credits works. You buy or earn the credits directly from the issuer who is also the main business you can use it with.

The way virtual currencies work is that the amount in circulation is an accounting liability to the account holders. In other words, if you own 1 PicoPoint we owe you 1 PicoPoints worth of service.


Pelle Hours Issuer

Pelle Hours is mainly an experiment, but I’m including it anyway. This is really a virtual currency as well but it is based on my own time. Each unit (hour) is worth one hour of my time. I can sell, exchange or donate my hours. But each one is backed by my personal promise that I will perform one hour of work for it.


Reputation and inflation

The above promises by issuers are all well an good in a perfect world. However a number of factors can affect the trust in the currency. Most of these things are related to how well you as the holder of the currency feel that you can continue to use it or if you think it will loose value. For example if the supply grows of the money while demand lowers. Then you have inflation.

This basically means the value of the currency becomes less and less. Good governance and transparency is important to avoid inflation. In the US we have official inflation numbers and several unofficial measures of it that state something difficult. It is an incredibly complex subject, that is made more complex by lack of transparency amongst many currency issuers such as the Federal Reserve as well as banks. See here how Argentina’s government and central bank are actively trying to fake their inflation numbers. Some people say the US Federal Reserve is doing the same.

What about virtual currencies? While most virtual currencies are run by private or public companies there generally is very little accountability for them. There are no published circulation numbers and little information about the growth of this which could be an indicator of inflation. For example a growth of circulation for a currency might mean that the service is doing well with lots of new customers, but it could also mean that the issuer is overselling credits (maybe for legitimate reasons).

E-Gold innovated a lot in this field. While they weren’t what I would call a virtual currency they created a lot of tools allowing their users to peek inside their currencies. See my previous article about e-gold for more.

Can I use it?

While transparency and good governance is great, the real question is “Can I use it?”. If you can use or exchange it for something it has value to you, regardless of any issuers, promises and transparency. See the story for example of how the Iraqi Swiss Dinar’s continued to have value even after the fall of the government who originally issued them.

Where does BitCoin fit in?

I’m planning a longer article about BitCoin as it doesn’t really fit in anywhere in the above. There is no promise and no issuer. There is plenty of governance through the open source project and transparency through third party services such as BitCoin Charts and Block Explorer. It is very interesting and exciting to see whats going on there so do keep an eye on it.

My initial analysis is that BitCoin has intrinsic value. There is no promise of gold or anything and I still don’t understand all the technical details, but it seems to me that the account containing the coin has intrinsic value, while not in the same way as a digital bearer currency.

Read more

Feel free to read the previous articles see On currencies, virtual or otherwise, 4 flavors of the mighty dollar and Trade, money and Value this one or in order.

While we aren’t officially launched yet, please feel free to check out PicoMoney. We are attempting to create a platform for creating transparent, tradable virtual currencies.

The geeks guide to currencies: Trade, money and value

Posted by Pelle December 10th, 2010 4 comments edit

Continuing on my series about currencies, I thought it would be useful to talk about some of the fundamental properties that currencies have. Feel free to ready the previous articles see On currencies, virtual or otherwise and 4 flavors of the mighty dollar after this one or in order.

My main audience for this article are people who know at least some computer programming, so I will try to explain it with code.

In the beginning there was trade

Commerce used to mean trading 5 bear skins for 8 amphoras of wine. While this is the fundamentally basic form of trade, we now know this as barter and it is looked at in slightly a strange way or as if it was some sort of novel hack.

Trade is the core operation we are interested in solving

Hides for kebabs?

Barter worked for most of our prehistory, but the moment civilizations started appearing it became obvious that this wasn’t particularly scalable. It is very hard to get out from a subsistence economy with barter. The reason being that different things had different value. How many kebabs can I buy with one cow hide? How many bottles of wine?

Lets say I have a cow hide and I want to buy a kebab. It’s not very practical for me to cut off a small piece of it to get my kebab and a cup of wine. I’d first have to find someone who would be willing to trade it for a bunch of smaller items that I can use to trade something for my kebab.

The other problem is, what if the kebab seller already has bought all the cow hides he could possible need this year? Solving this would be finding out what the kebab guy needs selling my cow hide to someone else for that. This could be quite a long complex change of exchange.

On the second day we had money

Money has several properties that solves the above situation. It minimizes the problems of trading.

I simply sell the cow hide for money. With that money I can now buy any number of things, including a kebab. So there is no longer a need to find a chain of trading partners to be able to finally trade my hide for a kebab.

So money is really an abstraction on top of barter.

Fungibility

Fungibility is the most fundamental property of a currency. Essentially one unit of an asset has exactly the same properties as the next one.

Gold is good example. A gram of gold of has the same properties and value as any other of the same purity. Cow hides and Diamonds are not fungible as each one is different.

In Ruby:

As I said in On currencies, virtual or otherwise my definition of a currency is:

A currency is a fungible asset that can be transferred from one person to the other.

So essentially a Currency is a sub class of Money that is fungible between each other.

Intrinsic or Extrinsic Value

A coin made out of gold is literally worth it’s weight in gold. Many national currency names come from that.

The name Dollar comes from the German word Thaler, which itself is short for Joachimsthaler which means “From Joachim Valley”. This valley produced much of Europe’s silver until the Spanish discovered Peru.

Likewise the British Pound has it’s name from originally literally being worth a pound of sterling silver.

Trade flourished with the introduction of money. Much wealth was created and the logistics of transporting large amounts of it around became an issue. Other people who wanted part of your money, pirated your ships and just plain took it away from you.

The solution was to leave it were it was, in your safe where your army could guard it.

One way of transferring it around was to create a piece of paper giving the bearer of said piece of paper the right to exchange it for an equivalent gold coin. Our paper currency today is a distant cousin of this type of currency.

The second way of transferring it was to keep a book of who owned how much of the gold you held in your safe. In the City of London goldsmiths would perform this service. A transfer was done by instructing the goldsmith to transfer ownership of part of it to someone else. Thats pretty much became what a check is today. Nowadays the bulk of all transactions and currencies are book entry, including almost all electronic currencies. Of course rather than having a guy on a tall chair with a funny hat writing entries in the book, servers perform that same job.

With a few exceptions our money nowadays has no intrinsic value, as the metal alloy used in a modern coin or the cost of the paper has little to do with the value. It still does have value which is called extrinsic value.

This abstraction from intrinsic to extrinsic money is pretty much exactly the same as what happened in programming. Early programmers copied values from memory into registers where operations could be performed on them. Programming was revolutionized by the introduction of pointers.

Modern programming languages like Ruby also hide the concept of intrinsic value as everything is abstracted away into an object which by definition is implemented with extrinsic value. But old C programmers would understand it clearly as the difference between primitive and a pointer variables.

The abstraction away from dealing with values in individual CPU registers and memory registers to use pointers, caused a revolution in programming and made it possible for all the data structures we use today such as arrays, hashes etc. Without these we would never have reached the point where you can sit and read this article on your screen.

A bank note is essentially a pointer to some value stored in a vault somewhere.

Any C programmer knows that memory management is one of the hardest issues to deal with. It is very easy to create memory leaks and allow buffer overflow attacks. This is true as well with currencies.

I will cover promises, the breaking of such and other security issues in the next article in the series.

For the previous articles in the series see On currencies, virtual or otherwise and 4 flavors of the mighty dollar. You might also be interested in Benches, Coffee and Bubbles – The origins of Agile Banking which provides more history.