Electronic Payment Systems
There are dozens of electronic payment systems proposed or already in practice. But they can be grouped into three based on what information is being transferred online.
The first type uses a trusted third party who maintains all sensitive information (such as bank account and credit card numbers) for its clients, which include both buyers and sellers. When there is a transaction, order information is transmitted along with information about payment confirmation and clearing, all of which do not include sensitive information. In effect, no real financial transaction is done online. The primary example of this type is First Virtual. In this type of system, the information need not be encrypted since financial transactions are done completely off-line.
The second type is an extension of the conventional notational fund transfer. In credit card or check transactions, sensitive information is being exchanged. For example, you give your credit card to a merchant, who sends the card number through phone line and receives confirmation. Banks meanwhile receive the same information and adjust buyer's and merchant's accounts accordingly. The information being transmitted online in this case is encrypted for security. The primary example is the use of digital credit cards (e.g. CyberCash and VISA/Mastercard's SET-based transactions). This type is becoming the mainstay of online payment methods because consumers are familiar with this system and current players have vested interest in extending that system to the Internet. The problem with transactional security has been overly played on the traditional media, but with proper caution and encryption, the Internet may be more secure than phone lines for this same old payment methods. (Can you encrypt your voice when you give your credit card number over the phone? Can you be sure who the other person is?)
The third type include variations of digital cash, electronic money and coins. What distinguish these systems from the other two is not simply the anonymity they afford, but the fact that what is being transferred is "value" or "money" itself. With the second type described above, some one can commit fraud by lifting your message (credit card number) by running up the charge on your account. With digital currency, intercepting a message is an outright "theft" of your property, not just information.
Digital money, currency or coins are but an encrypted serial number representing money, but money in all sense since they are convertible to real money (e.g. US dollar) if desired. (Just as US dollar bill is only a paper with funny graphics.) It took hundreds of years before people accepted paper money (and checks) as payment. Digital currency will become dominant when paper-based economy finally turns into the digital economy.
In the short run, digital money is just a convenient form of existing money since digital money is created against existing money. However, in the long run, digital money may be created on its own if users accept it on its face value, which will be determined by how dependable its issuers are. All monies are only as good as their issuers.
Why do we need digital currency? Not because it is the ultimate in anonymous money. Rather, digital money is necessary if we are to operate fully in the digital marketplace. Non-currency electronic payment systems will be sufficient for some transactions; for others, digital currency will be more efficient, e.g. microtransactions as well as anonymous trades. Furthermore, digital currency is very flexible since it can be made to behave like electronic checks or anonymous cash as situation warrants. Electronic checks or digital credit cards become useless if their sensitive payment information is erased, or become costly if that information is hidden and calls for an elaborate process of verification.
The smart card will emerge as the ultimate interface device for the mobile digital economy. It will hold your cash, ID information, house and office keys, subway tokens, all types of preference files (for house temperature setting, driver seat setting, etc.) and other information. You will exchange these information and digital products with other people, transact business, present to police officers, check into a hotel or a sports arena, and all other things yet to be imagined.
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A micropayment system is needed for pricing microproducts and microbundles. Fees for bundled products often are large enough to be paid by credit cards and checks, and some economists argue that microproducts and micropayments discussed in connection with electronic currency will become largely unimportant. If transaction costs can be made low enough to handle even sub-dollar payments, why should digital product sellers be limited to accepting credit card payments and other large-scale payment methods? To justify a large bill, consumers are often require to purchase multiple products or a bundle with unwanted products. Micropayments are as essential to electronic commerce as product customization.
Micropayments and unbundling will be a natural response to a growing abundance of customized microproducts. We see the potential sources and applications of microproducts in all different areas. Take, for example, the traditional media world. Newspapers, magazines and TV programs are intermediary services that collect, edit, and distribute materials from various sources, often packaged in a bundled program or newspaper. However, there is no reason why information should be distributed only via a centralized distribution system. In other words, the New York Times or CNN may not be the sole gatekeepers of news, ideas, information and knowledge. The Internet is a natural dispersed information channel for small, occasional sales. Its unique interactive capability also makes everyone a potential guest columnist on the net. These microproducts will be paid for not by subscription but by micropayments.
Another motivation for the development of microproducts and micropayments stems from the need to assure product quality. A long term subscription of bundled digital products may be sufficient to guarantee quality based on the reputation of the seller. However, reputation has to be developed after repeated purchases. If sellers know, on the other hand, that the market will end soon-or they are short-run players-it is profitable to cheat by selling low-quality products at high-quality price. Knowing this, would consumers be willing to buy a product from unknown sellers? This problem is magnified if buyers are required to commit for a long-term subscription or to pay for a large bundle of unknown quality. Instead, recent research in contract theory offers some positive evidence that short-term sales may indeed produce higher quality than subscription and bundling. Short-term sales (some involving only one page of information) will be based on micropayments.
