DATA, or the Digital Asset Transfer Authority’s founding members include the CEO’s of leading Bitcoin businesses such as BitInstant, BitPay, & BitStamp as well as the CEO’s of other digital currency businesses including Ripple’s OpenCoin and Ven.

However, the groups stated goals seem sure to heat up the regulation debate.

From DATA’s official announcement …

To reach this potential, to inspire confidence in the services we offer, and to ensure fair and responsible treatment of consumers and merchants, we believe our industry must evolve in compliance with law and regulation. We must work proactively with regulators and policymakers to adapt their requirements to our technologies and business models. We must develop and implement common risk management and compliance standards that address the public policy concerns associated with our businesses. And our firms must build risk management and compliance programs that meet those standards.

This would seem to suggest a willingness to alter software protocols to appease authorities. Many in the Bitcoin community, such as the Bitcoin 2 authors, have been fearing such proposals and the possibility that they will lead to Bitcoin being watered down and absorbed by the current financial establishment.

For example, an elimination of Bitcoin irreversibility which could transform it into simply a PayPay 2.0, or as the Bitcoin Foundation’s Jon Matonis put it “Govcoin”.  In a new post for American Banker, Don’t Let Bitcoin Morph into Govcoin, Jon expresses his concern with an over eagerness of industry organizations to appease regulators.

 Although SROs can be extremely beneficial in advancing an industry, clear political lines must be drawn to mitigate the risk that an SRO would be co-opted by government and this is where it gets tricky. To avoid more direct and onerous regulations, the government may ask the SRO for certain guidelines or rules to be incorporated among its membership. If such modifications are objectionable to the majority of industry participants, the SRO faces the dilemma of challenging the authorities and risking its relevance or being complicit in harmful and over-reaching backdoor legislation.

The path of complicity ultimately leads to an SRO that has strayed from its core constituency and could be absorbed by the government as a direct regulatory body. The SRO should periodically conduct a reality check by remembering Voltaire’s words: “To learn who rules over you, simply find out who you are not allowed to criticize.”

Unfortunately these bridges which make up the exchange market are concentrated and often broken.  This leads to concerns over reliability and security, which can cause market panic and extreme volatility. As Bitcoin enters the mainstream a wave of new businesses, services and software developers have recently dedicated their efforts to solving this problem. Their task will not be easy, and the while the exchange rate has seen some recent stability, there is a long way to go before obtaining bitcoins can be called user friendly and reliable.

This is an especially big problem for the expansion of Bitcoin. Attempting to purchase bitcoins is a frustratingly slow, nervous and difficult process for a consumer who is used to the convenience of internet shopping.  The usual reversible and/or disputable payment methods of credit cards, PayPal, etc. are rarely available in the purchase of non-reversible bitcoins. Generally consumers are required to use slow and expensive bank wires. This situation is an example of the difficult task facing exchanges as they attempt to integrate two very different systems.

Bitcoin was not designed for compatibility with traditional banking.  There is no Bitcoin protocol for ID verification. There are no accounts to freeze or confiscate.  As such exchanges have the unenviable task of attempting to shove Bitcoin transactions into the current banking regulatory mould.  While Bitcoin’s recent gains in popularity have brought about new entrants to the exchange market, it has also brought the scrutiny of regulators. Compliance with financial regulation, particularly in the states, is costly, time consuming and no small barrier to entry.

The Bitcoin exchange market is in the midst of a rapid evolution which will be critical for Bitcoin’s continued adoption. Here we will attempt to provide an overview of the current market and developments on the horizon. This is a tricky task as it is an attempt to take a snap shot of a rapidly moving target.

What are the current options in the Bitcoin exchange market?

While there are a number of different ways to obtain bitcoin, however, the large online exchanges are currently the dominant players in the exchange world.

Online Exchange Markets

By far the most popular option is a large online exchange such as the market leader Mt.Gox. Exchanges such as these operate entirely online. Customers must first open an account which now usually requires sending in copies of ID and waiting for verification in accordance with anti-money laundering polices. Once an account is set up a money wire or another form of irreversible payment is sent in to fund the account. After those steps, which are likely to take days if not weeks, bitcoins can be purchased. While this method requires some patience, the advantage is that it can be done entirely online.

At some exchanges there are faster funding options such as Dwolla or cash deposits, however, these options are often suspended or shut down due to banking and regulatory issues.

Over the Counter Alternatives

For those looking to avoid common delays from online exchanges, or perhaps looking for greater privacy, a common option is a local Bitcoin exchanger.  Services such as LocalBitcoins.com match local Bitcoin traders with those looking to buy or sell. Exchanges can be arranged entirely online using options such as bank wires and the site offers an escrow service. However, many transactions that originate via the site happen in person and with cash. Another OTC option is services such as Bitcoin-OTC.com which helps to match buyers and sellers via an IRC channel.

New Software Options

On the horizon are projects that aim to provide peer-to-peer exchange solutions. MetaLair is an open-source project designed to create a decentralized exchange network. The network created would allow for both crypto-currency to crypto-currency via an automated escrow service with plans for fiat to crypto capabilities. While still very much in development, a solution such as this technology would provide a quick, peer-to-peer exchange solution.

The Expanding Market

Earlier this year Bitcoin’s USD exchange rate hit all-time highs at near $260. This happened as Europe was experiencing a new round of financial trouble in Cyprus and Bitcoin hit the mainstream press.

What was once considered to be only the play thing of computer nerds or conspiracy theorists was now seen by the mainstream press as a possible opportunity. Perhaps still a very risky and out-there opportunity, but Bitcoin got quite of lot of attention.  And it sparked a rush to invest in the new currency and related businesses.

Many Bitcoin start-ups went from being small operations run by one programmer in his/her spare time, to potential big businesses being courted by major venture capitalists. This is especially true for the exchange market as many realize that Mt.Gox’s huge market share can be chipped away at, and the race to do so is on. As Bitcoin exchange support service Bex.io’s co-founder Yurii Rashkovskii put it, the current situation “is a land grab.”

The many new exchanges entering the market is exciting news for the Bitcoin economy which has suffered from extreme market concentration.  The oldest and by far the largest Bitcoin exchange is the Japan based Mt.Gox. While its market share is starting to slip, for years the exchange enjoyed an over 80% market share for USD/BTC exchange.

This extreme concentration has been an ironic problem for the brilliantly decentralized Bitcoin as it leaves one very large point of failure in the exchange market. The trouble this can cause was shown earlier this year during Bitcoin’s run up in price. Mt.Gox is such a dominant force in the market that it’s posted BTC/USD exchange rate is the defacto ‘Bitcoin price’.

In April, as Bitcoin’s price was soaring over $200, Mt.Gox was hit by a series of DDoS attacks that delayed and briefly blocked access to the site. Market speculators panicked and the price plummeted to near $60.

This exchange volatility makes accepting Bitcoin payments a risky business for merchants, often undermines the currencies legitimacy and holds back those considering investing in the Bitcoin world.

However, as the Bitcoin economy continues to expand, new entrants in the exchange market not only stand a chance of making quite a lot of money, but also will wind up solving some of the currencies biggest problems in the process; exchange market concentration and price volatility.

The Race is on

The new businesses entering the market are numerous and varied and any list or figure given here would likely be out-dated by the time it reached the reader. However, some idea of the activity in the area can be gained by looking at new investments in Bitcoin exchanges and exchange related businesses.

Many investors go about their business quietly and solid numbers are unavailable, however, there have been a number of well publicized investments in the Bitcoin exchange space in the past few months.

In April Coinsetter, a Bitcoin trading platform offering margin trading, raised $500k from a number of investors including the Bitcoin Opportunity Fund run by SecondMarket founder Barry Silbert.

Coinbase, a Bitcoin wallet service that can be used to purchase BTC, announced in May this year that they had raised $6 million from a number of big investors including Fred Wilson, Ribbit Capital, SV Angel, and Fundersclub.

Also in May BitInstant, a Bitcoin exchange funding service, raised $1.5 million in a seed funding round led by Winklevoss Capital.

There has also been a number of venture capital funds created for investing in startup Bitcoin businesses. These include Liberty City Venture’s Digital Currency Fund and BitAngels.

The race for market share is such that new businesses providing support to exchanges are springing up; specifically BTCGlobal and Bex.io.  These new businesses provide technical support for new exchanges. “We do the tech. You do the rest” reads the Bex.io website. Or as co-founder Yurii puts it they are “Mt.Gox in a box”.

“Looking at the eco system as a whole there is definitely a need for more access points into and out of the Bitcoin economy and it makes no sense for everyone to be reinventing the same wheel” explains Bex co-founder Jessie Heaslip. ”We are inventing one wheel that we are going to license out.”

The start-up has the goal of making opening an exchange a less capital intensive and technically challenging endeavour.  Bex will focus on developing “the most repeatable parts of this business” and then link together the exchanges using their platform in a “global liquidity pool.” This liquidity pool would allow small exchanges in various locations to operate reliably without a large amount of start-up capital. Instead they would be able to access liquidity from other Bex based exchanges.

Support businesses such as Bex could dramatically lower technical and capital barriers to entry for new exchanges. But Bex is not aiming to capture any of the very large US market share, that would be too resource intensive and risky.

Also looking to create an exchange network is the new Ripple system. Operated by OpenCoin Inc., which received a round of venture capital funding in April, Ripple is looking to create a network of small and large exchanges which are ‘Gateways’ to the Ripple network. With Gateways in many locations Ripple users will be able to exchange a wide variety of currencies. Leading Bitcoin exchange BitStamp is already setup as a Ripple Gateway.

What is the online exchange market doing?

For years Mt. Gox has been the undisputed market leader with a USD exchange market share of 80%+. Mt. Gox came to be in this position largely by getting in first and managing to be the last man standing as the Bitcoin economy grew and became the subject of many theft attempts.  Mt. Gox simply survived the growing pains that killed many others.

Since April, Mt. Gox has slowly been losing its market dominance.  And now sits at just below 50% of the USD exchange market.

*Via BitcoinCharts.com

 *Compiled from data obtained via BitcoinCharts.com. Shows total BTC volume including trades in USD and other currencies, using 7day averages.

Mt. Gox’s decline in market share, as can be seen from the above chart, is due largely to a loss in its own volume rather than being over taken by a competitor.

With all of the issues Mt. Gox has expirenced this year, law suites, bank account closures and issues with USD withdrawals,  it’s not terribly surprising that it has lost volume. But where has the volume gone? Perhaps there has been a reduction in speculator trading. Perhaps Bitcoin users are moving to exchange alternatives.

Unfortunately there are not easily available numbers on the use of exchange alternatives, but as all Bitcoin transactions are public, we can have a look at the Bitcoin transaction numbers in general.

*Chart taken from BlockChain.info 180 day USD major exchange volume using 7 day averages.

The above chart shows USD volume on the major exchanges. It is clear that USD exchange volume in general has been on the decline, particularly in the last month.

However, USD transaction volume on the Bitcoin network has seen a rise in the last few months. This shows that while exchanges have been losing some volume, the Bitcoin network has not.

*Chart taken from BlockChain.info 180 day USD transaction volume using 7 day averages.

It would be very interesting to look at a comparison of trade volume of various exchanges vs. total transactions on the Bitcoin, however, due to a number of technical factors this is quite difficult. However, BlockChain.info provides an estimate of Bitcoin transaction volume and produces a Trade vs. Transaction ratio chart.

The chart was created to examine speculation in the Bitcoin economy. It compares Bitcoin ‘Trade’ volume, volume of exchange between BTC and fiat, to Bitcoin ‘Transaction’ volume, number of transactions which likely represent transactions between users or for purchases of goods and services.  The charts tracks the ratio of transactions to trades; transactions/trades. A higher ratio means less speculation. 

*Via BitcoinCharts.com

The US Dollar remains the dominant national currency in the Bitcoin economy.

Regulation

While Bitcoin’s recent explosion in value and mainstream attention has brought many new entrants to the exchange business, it also brought about the attention of regulators and the scrutiny of banking partners.  Just as the Bitcoin economy is moving into the mainstream regulators and bankers are applying the brakes.

Serious regulation entered the Bitcoin economy earlier this year with US financial regulator, FinCEN, releasing a guidance paper on ‘virtual currencies’.  The guidance made it clear that any entity which buys and sells virtual currencies, such as an exchange, is considered to be a money transmitter.  This is a heavy burden to bear. Not only does it require strict adherence to anti-money laundering policies but also lengthy and costly licensing hurdles. To legally operate as a money transmitter in the States, a business needs to obtain money transmitter licenses from 48 different states. Estimates vary on the time and cost of this compliance but it is certainly a significant hurdle for a start-up business to clear.

One US based exchange start-up, Vaurum, has experienced interest from investors and has raised a seed round, but also faces an uphill battle with compliance. Avish Bhama, Vaurum founder, sees compliance as being a barrier to entry and one which has been very costly for his business. “Complying will cost us ~100k+ / year.  It is expensive and time consuming and is a big barrier to entry. … It’s hard to put a number on it, but lately more than half of my time has been spent on regulatory stuff.”

CampBX, an established US based exchange, also puts a significant amount of resources into staying compliant. “Bitcoin regulation is evolving at a fast clip, and we actively revise our compliance program every quarter to remain fully compliant.”

One could assume that friction with US regulators would simply move Bitcoin businesses off shore. However, this did not save Japanese based Mt. Gox from a run-in with US authorities. Shortly after the release of their guidance regulators seized the Dwolla account of Mt.Gox’s  US subsidiary, Mutum Sigillum LLC. The subsidiary also had its Wells Fargo bank account closed as regulators accused the business of operating in the US as an unlicensed money transmitter. Nearly two years prior while opening the Well Fargo account the businesses CEO, Mark Karpeles, signed a form declaring that the business was not a money transmitter.

While they have now registered with FinCEN, Mt.Gox had failed to register immediately after FinCEN’s guidance which categorized exchanges as money transmitters.

US regulators willingness to enforce their rules on any digital currency based service with US customers was demonstrated in their dealing with Mt. Gox and in the recent shut down of Costa Rican based digital currency provider Liberty Reserve. Statements after the May shutdown of the business make it clear that US regulators intend to enforce their anti-money laundering standards on foreign companies. Under Secretary for Terrorism and Financial Intelligence, David S. Cohen, clarified that the US would pursue illicit financial actors wherever they may be, in the US or overseas.

“We are prepared to target and disrupt illicit financial activity wherever it occurs – domestically, at the far reaches of the globe or across the internet.” 

Any exchange which hopes to share in the very large US market will have to keep US financial regulators in mind. However, the ever resilient Bitcoin economy is developing services designed to ease compliance issues for exchanges.  BTCGlobal, a Uruguayan based support service for Bitcoin businesses, has launched a “Massive Parallel Licensing” program which aims to create a network which will allow members to leverage each other’s regulatory infrastructure and resources.

Via the BTCGlobal Site: “The highest hurdle for entrepreneurs interested in launching a Bitcoin exchange business is the significant international and local regulatory requirements. It is estimated that an investment of over $10 million would be required to reach total legal compliance in all the U.S. 50 states alone. The BTC Global Massive Parallel Licensing program addresses this hurdle with a package that includes comprehensive regulatory support and a full suite of Bitcoin products and services.”

However, increasingly Bitcoin businesses are simply choosing to block US customers as they see entering the US market as too risky and/or costly and focus on other jurisdictions which have been comparably much friendlier.

Regulation outside the US

Many countries have not directly addressed digital currency regulatory issues, however, some countries have stated that they are not requiring any regulatory compliance at this time. Both British and Canadian regulators have issued letters to exchanges stating that they are not required to register with financial authorities.

In Canada a letter from regulator FINTRAC was sent to a number of exchanges confirming that the exchanges were not money service businesses and were therefore exempt from laws governing those businesses.

The UK’s financial regulator HM Revenue & Customs (HMRC) sent a letter to at least one exchange start up making it clear that the business was not required to register with HMRC under money laundering regulations.

In Europe ‘e-money’ is regulated, however, for the moment the European central bank does not view Bitcoin as money or e-money and does not require compliance for Bitcoin businesses.

While regulators may change their policies, it’s clear that some locations are far more lenient than others. However, lenient regulation does not necessarily translate to co-operative banking partners.

Nervous Banks

Recent moves by regulators, particularly in the States, have scared many banks out of the Bitcoin arena and their caution is understandable. Commercial banks cannot exist in their current form without accounting rules and national currencies that are created and supported by national legal structures. They cannot afford to be on the wrong side of these legalities.  Bitcoin should be a concern for them; it was not built to fit the regulatory mould and it seems that banks are frightened of inadvertently enabling violations of financial regulations via the Bitcoin network.

There have been numerous examples of banks, often abruptly, ending their relationships with Bitcoin exchange businesses. Earlier this year US based exchange BitFloor ceased trading after CapitalOne closed their bank account, and this is just one of many examples from the US.

In Germany Bitcoin exchange Bitcoin-24 had its bank account closed by authorities in April who were concerned that the site was being used for fraudulent transactions. More recently, LibertyBit, a Canadian based exchange, halted operations as a result of bank account closures and alleged fraudulent account activity.

While start-up Vaurum has managed to build banking relationships, it took some convincing. “The hard part is that banks won’t even talk to Bitcoin exchanges because their compliance teams are scared of the regulatory issues that come along with banking a Bitcoin exchange. …  The mechanics of the partnership are pretty straight forward – it’s just that banks don’t want to get in trouble with regulators and are quite conservative by nature. … It took some time to educate banks on our business.”

The Other Options

While some are putting their effort into making the Bitcoin/banking partnership work, others are busy finding ways around it. For the moment it would seem that there is only a small percentage of Bitcoin trade happening outside the large exchanges and most exchanges do not view these options as competitors. However, the alternative exchange market is experiencing rapid growth of its own.

As Fiat currencies in their digital form exist only on the servers of banking institutions, Bitcoin to fiat exchange cannot take place without the co-operation of a banking institution.  Many who are looking to bypass the regulatory and banking relationship hurdles are attempting to fly under bank’s radar with small transactions.  This means peer-to-peer transactions rather than a large intermediary such as an exchange.

There are a number of options that aim to connect individual Bitcoin users for trades. Two examples are LocalBitcoins.com and MetaLair.

MetaLair is an open source software project that aims to create a decentralised exchange mechanism which would facilitate peer-to-peer exchanges between crypto-currencies and in the future fiat to crypto exchanges.

The project will begin by building a network to enable peer-to-peer, crypto-currency to crypto-currency exchanges. In this scenario the MetaLair software acts as an automated escrow agent which makes for a very low trust system; but of course fiat to crypto exchanges would be more complicated.

Due to the nature of the banking system, the project’s crypto to fiat exchange plans would necessarily involve fiat funds being held by a third party escrow service. MetaLair plans to provide an open protocol to allow anyone to set up as an escrow service and to build a reputation via a rating system. As lead architect Johnathan Turrall explains, “what we are creating is an open system. The details of how the fiat to fiat transactions occur between the entities are effectively between them, we are just providing an interface by which they can do that.”

While MetaLair aims to create online exchange, LocalBitcoins.com has been in operation for years offering primarily in person exchanges.  The service matches local Bitcoin traders with those looking to buy or sell. The site is known for finding exchange agents for in-person trades, however, exchanges can be arranged entirely online. These trades use options such as bank wires and the site offers an escrow service for added user security. Via a local trader it is possible to purchase bitcoins quickly, privately, in person, and with cash in over 2,200 cities worldwide.

Earlier this month the sites founder Jeremias Kangas said his site has been gaining roughly 300 new users each day and has over 50k users overall. The site currently employs 4 people and is looking to hire more as they continue to improve their service.

New local Bitcoin markets calling themselves Buttonwood have sprung up in a number of US cities. The name is a reference to the 1792 Buttonwood agreement that created the New York Stock Exchange and which took place at 68 Wall Street under a buttonwood tree.

Conclusion

While the exchange market is changing, things are still largely the same. Mt. Gox is currently the largest exchange and USD/BTC exchange is the largest market.

Venture capital backed start-ups are determined to capture the US market and they seem likely to succeed. Only those start-ups who can attract large investment funds will be able to calm nervous banks and clear the regulatory hurdles.  As such the exchange options in the States will become much more serious and will require verification from all clients, likely above the current law. Privacy will not survive in the US online exchange market.

As compliance in the States is a large and expensive hurdle to clear, many innovators who’s projects do not fit the regulatory mould will avoid the US and likely actively block US users. Bitcoin innovation may be driven out of the States.

The large online exchanges are the dominant exchange options and it is difficult to guess the percentage of the market for exchange alternatives such as local markets or OTC trades. These options would seem to be much more appealing to Bitcoin veterans, however there is no doubt that alternative exchange options are experiencing a boom of their own.

As the world of traditional banking collides with the new world of crypto-currencies there will continue to be friction. New exchanges will appear, bank accounts will be closed, regulators will take action, businesses will be shut, some will get rich, some will face prosecution and how the exchange rate reacts is anyone’s guess. But this weak point in the evolving Bitcoin economy is where the action will be. Watch this space!

Via CoinDesk…

The letter from HMRC reads as follows:

“With reference to your enquiry at this time there is no requirement to register with HMRC under the Money Laundering regulations, however HMRC recognise that the issuing of Bitcoins represent an emerging development.

We are currently in discussions with HM Treasury concerning this market and whether HMRC will be a Supervisor for this market. HMRC will be watching any developments relating to the Bitcoin market and may change our view, therefore I would suggest that you regularly check our news and update section on our website at www.hmrc.gov.uk/mlr and sign up for our e-mail alert system at www.uktradeinfo.com/AboutUs/Pages/EmailAlertServices.aspx.

If at any time HMRC recognise Bitcoins as a currency you would then have to register straight away without any prior correspondence from HMRC as this would be your responsibility to register should the ruling change regarding Bitcoins under the Money Laundering regulations.”

In the late 90’s and early 2000’s, e-gold was the industry leader.  As one of the world’s first successful online payment systems e-gold was a pioneer using many now standard practices such as SSL connections and API’s.  Brought down by a run in with regulators in 2008 the e-gold story is required reading for anyone involved in the digital currency world.

Sent in by Wikipedia editor Cadwallader, below is a thoroug review of the e-gold story.

e-gold (deliberately spelled with a lower-case ‘e’) was a digital gold currency operated by Gold & Silver Reserve Inc. under e-gold Ltd. that allowed users to open an account on their web site denominated in grams of gold (or other precious metals) and the ability to make instant transfers of value to other e-gold accounts. The company was founded in 1996 and had grown to five million users by 2009, when transfers were suspended due to legal issues. At its peak in 2008 e-gold was processing more than USD 2 billion worth of precious metals transactions per year ^[1], on a monetary base of only USD 20 million worth of gold (~2.54 metric tonnes) ^[2], indicating an extremely high monetary turnover (velocity) of about 100 times per year (similar to M-PESA). e-gold Ltd. was incorporated in Nevis, Saint Kitts and Nevis with operations conducted out of Florida, USA.

Beginnings

e-gold was founded by oncologist Douglass Jackson and attorney Barry Downey in 1996. The pair originally backed the services accounts with gold coins stored in a bank safety deposit box in Melbourne, Florida.

The company, which was launched two years before PayPal and had obtained over one million user accounts by 2002, and was the first successful digital currency system to gain a widespread user base and merchant adoption. It was also the first website or payment service to offer an Application Program Interface (API) enabling other services and e-commerce transactions to be built on top of it. ^[3] e-gold was used by both individuals and merchants for services ranging from metals trading, online auctions, to online casinos, and a donation platform. By 2001 several dozen companies and individuals began offering third party exchange services between national currencies and e-gold, allowing e-gold to become a company with an international user base.

e-gold, which allowed transactions as small as one ten-thousandth of a gram of gold, was also the world’s only successful micro-payment system. The company’s payment statistics were published live and showed hundreds of thousands of micro-transactions were being made daily by computer programs using the API.

Governance

e-gold was unique at the time in that they created the “e-gold Special Purpose Trust” which held title to the physical bullion on behalf of the users. ^[4] They also created a real-time statistical reports page ^[5] that showed the total holdings of each metal in the trust account, list of gold bars with serial numbers, the total number of accounts, as well as the total number and value of transactions in the previous 24 hours. This transparency enhanced e-gold’s reputation and popularity with their users, and also enabled many observations to be made about how e-gold was being used.

Imitators

e-gold’s market success by 2001 spawned a wave of imitators. These included Goldmoney.com, e-Bullion.com, CrowneGold.com, Pecunix.com, INTgold.com, and several others including a multi-million dollar Ponzi Scheme with no gold at all called OSgold.com. ^[6]

Crime Wave

e-gold’s early success also proved to be the cause of its demise. e-gold’s store of value and large user base made it an early target of financial malware and phishing scams by increasingly organized criminal syndicates in Eastern Europe. The first known phishing attack against a financial institution was made against members of the e-gold mailing list in June 2001. ^[7] The technique was refined with attacks against the digital gold systems like e-gold and later used to attack other financial institutions starting in 2003.

The Rise of the Romanian Hackers

With no effective means of verifying the identity of account holders, e-gold began to suffer from an increasing rate of criminal activity mainly perpetrated by Eastern European hackers against its users. In addition to phishing, the attackers made widespread use of flaws in the Microsoft operating systems and Internet Explorer web browser to collect account details from millions of computers to compromise e-gold accounts. ^[8]

Jackson’s theory was that e-gold is a book-entry system with account histories, making it simple to conduct an investigation to track down misappropriated funds after the fact. ^[9] However, the public perception, similar to that of Bitcoin today, was that e-gold accounts were anonymous. (That perception was erroneous, as is the similar belief that Bitcoin is anonymous.) e-gold accounts were “pseudonymous”, ^[10] allowing the creator of the account to use any name or label he wished to use. However, the account history was permanent, and e-gold could in most cases correlate a person’s real identity to an e-gold account when they funded or liquidated an account with G&SR, e-gold primary exchanger to US Dollars.

Unfortunately, e-gold users did not enjoy the same ability to determine the real identity of the owner of an e-gold account, and this is what facilitated the explosion in auction fraud and other types of identity fraud using e-gold accounts.

Fourteen Flavors of Fraud

Various fraud artists from Western countries were also able to take advantage of the e-gold system as a means of funding their schemes, enabling for the first time in history, international ponzi schemes, calling themselves “High Yield Investment Programs” or HYIPs. ^[11] DGC Magazine Editor Mark Herpel identified the probable source of e-gold’s mysterious micropayments as automated interest payments made by ponzi schemes to their tens of thousands of members. ^[12]

Perpetrators of auction fraud on e-bay who were based in Eastern Europe and would sell fake or non-existent items on the site. These criminal syndicates preferred their victims to pay in e-gold because it was the fastest and easiest way for them to move the funds overseas. ^[13]

The wave of online crime that engulfed e-gold led to a steady stream of complaints to government authorities by defrauded account holders, who often did not understand the difference between e-gold and the fraudulent person or company that encouraged them to open an e-gold account and wire money to fund it. ^[14]

The Systemic Problem

As an online transactions system with exchange agents worldwide, e-gold enabled criminals and hackers in Eastern Europe the ability to quickly and easily move money from victims in America back to the country from which the attacks were originating. Several of the cyber crime gangs that plagued and used e-gold were based in Râmnicu Vâlcea, Romania. ^[15]

e-gold was unknowingly part of a larger systemic problem with the banking system. The banking and credit system in the United states were not designed for a digital environment, and are therefore fundamentally insecure and highly vulnerable to identity theft and check fraud, as well as trust based attacks such as phishing. The willingness of credit card companies to allow people to apply for a card without being identified in person enabled the massive growth of identity theft. ^[16] (Ironically, not verifying the identities of account holders would be one of the main criticisms raised against e-gold.)

The Internet made it possible for organized crime networks outside the United States to used strategically placed members in financial institutions in the United States to perpetrate billions of dollars worth of financial crimes, primarily through identity theft. ^[17] The money from these crimes then needed to be laundered and transferred back to the headquarters of the perpetrators in Eastern Europe. This is normally done through bank wires from big american banks, such as Bank of America, ^[18] and traditional money transmitters like Western Union. ^[19] However, e-gold and other digital gold systems, with their low cost instant clearing payments and international network of exchange agents, provided a much faster and cheaper conduit for getting the already laundered money back home. Therefore, certain crime gangs started using the digital golds as the return conduit for part of their operations.

The Public Relations Problem

In 2001 Goldmoney.com was founded by James Turk and became a competitor to e-gold. Turk, who had filed patents on a digital gold payment system in 1993 but launched his system five years behind e-gold, took a two-pronged strategy to outmaneuver e-gold. First, he sued e-gold for patent infringement. ^[20] Though this action failed in court, Turk had successfully positioned himself in the market as the “inventor of digital gold” even though Jackson was the one who had taught himself how to program and written the first version of e-gold himself. (Turk sat on his patents for several years, and eventually hired a software company to build his “invention” because he is not a computer programmer.)

Second, Turk recognized the e-gold crime problem and began positioning Goldmoney as the “white glove” gold system that required identity verification to open accounts, versus e-gold as the irresponsible “wild west” operator riddled with crime. ^[21] This marketing strategy worked very effectively for Goldmoney as it drove e-gold founder Jackson to entrench himself in defense of his libertarian principle that the user is responsible for his behavior and the courts are the way for disputes involving allegations of fraud to be resolved. Ten years later, e-gold would be out of business, shut down by the US government, but Goldmoney would be sitting on USD 1 billion worth of gold and millions of users. ^{[22] [23]}

While Goldmoney succeeded in becoming the world’s largest gold storage system, and held four patents for a gold payment system, ^[24] they were never able to replicate e-gold’s success as a payment system, because they were so fearful of replicating e-gold’s success as a magnet for criminal activity. Goldmoney prohibited the development of independent exchange agents, which greatly limited their global reach. In January 2012 Goldmoney turned off the ability to make payments from one account to another citing “insignificant” demand for P2P metal transactions as not justifying the high cost of regulatory compliance. ^[25] It was e-gold’s usefulness and ease for payments combined with their international network of exchange agents that made it a magnet for crime.

There were early reports where e-gold had actively helped to catch and collar cyber criminals, such as the one who stole Cisco Systems’ firewall code and offered it for sale to be paid in e-gold. ^[26] And Jackson claimed to have “aided 300 investigations and reported 3,000 suspected kiddie porn buyers to the National Center for Missing and Exploited Children.” ^[27] However, Turk’s PR strategy was highly successful, as first Goldmoney, and then federal law enforcement agencies began to characterize e-gold as the payment system of choice for criminals, terrorists and child pornographers. ^[28] (In reality, the US Dollar is by far the most popular transaction medium for criminals of all types. ^[29] US Banks are the most popular institutions for money laundering, on the order of USD 500 Billion per year, dwarfing e-gold’s transaction volume by two orders of magnitude. ^[30] )

Criminal Prosecution

The Changing Definition of a Money Transmitter

The USA Patriot Act, passed in the wake of the 9/11 terrorist hijackings more than five years after e-gold had been launched, made it a federal crime to operate a money transmitter business without a state money transmitter license in any state that required such a license. At the time a “money transmitter” was in most states defined as a business that cashed checks or accepted cash remittances to send from one person to another person across international borders, such as Western Union or MoneyGram. For example, prior to 2010, California regulated money transmitters under the “Transmission of Money Abroad Law”. ^[31] One of e-gold’s competitors, the e-Bullion company, applied for a money transmitter license from the State of California in 2002, but was informed by the State of California that their business which dealt in gold accounts did not fall under the state’s definition of a money transmitter.

In 2004 G&SR (the parent company of e-gold) requested that the US Treasury Department conduct a compliance examination in order to clarify what regulations, if any, e-gold fell under. ^[32] The Treasury issued a report on January 11, 2006 confirming that e-gold accounts were excluded from the definition of “currency” under the USC and CFR definitions. The Treasury did not want e-gold to be acknowledged as money, which made it impossible to obtain a money transmitter license.

However, in its actions from 2006-2008 the U.S. Treasury Department in conjunction with the DOJ stretched the definition of money transmitter in the USA Patriot Act to include any system that allows transfer of any kind of value from one person to another, not merely national currency or cash. Using this new interpretation they then proceeded to prosecute the USA-based gold systems, e-gold (and later e-Bullion) under the USA Patriot Act for not having money transmitter licenses, even though these companies had previously been cooperating with regulatory authorities and told they did not fall under the definition of money transmitter. (Although the charge of not having a money transmitter license was eventually dropped against e-bullion.) Several years later FINCEN further expanded this definition to apply to foreign companies allowing US persons to open accounts, which forced Jersey based Goldmoney.com to suspend the ability to transfer value from one holder to another in December 2011. ^[33]

e-gold The Black Sheep

e-gold was in many ways the philosophical predecessor of Bitcoin. Unlike PayPal, which ran on top the USA banking system and therefore posed no competitive threat to the banking system, e-gold was a maverick outsider with no allies in the banking establishment, whose founders self-consciously viewed themselves as offering an alternative to the banking system. While banks suffer from the same problems with criminal activity, phishing, ponzi schemes and money laundering on a much larger scale ^[34], and some of the biggest banks have even knowingly participated in money laundering with apparent impunity ^[35], e-gold’s iconic status as a controversial alternative currency system loved by cypherpunks and libertarians made it an attractive target for US law enforcement agencies, with a big pile of assets to seize and few political allies.

While e-gold had begun implementing much stronger controls against abuse by users of the system by 2005, and was actively combating the use of its system for child pornography as a founding member of The Financial Coalition Against Child Pornography ^[36], the Justice Department had apparently made a high level policy decision to blame e-gold themselves for the malignant activities of a small minority of their users. ^[37] In 2007 the proprietors of the e-gold service were indicted by the United States Department of Justice on four counts of violating money laundering regulations and knowingly allowing a transaction to purchase child pornography. ^[38]

The government also claimed that e-gold was a ponzi scheme that did not have the gold to back the accounts. However, that claim was later shown to be false when judge rejected any charges of fraud regarding the e-gold user agreement and confirmed the veracity of the company’s gold reserve audit – showing that e-gold was fully reserved.

Resolution

The case against e-gold was brought under Title 18 USC section 1960 in UNITED STATES OF AMERICA v. E-GOLD, LTD, District of Columbia court. e-gold filed a motion to dismiss the case on the grounds that they did not fit the definition of a money transmitter. The court ruled against e-gold, stating that “a business can clearly engage in money transmitting without limiting its transactions to cash or currency and would commit a crime if it did so without being licensed.”^[39] This ruling enshrined in case law the Treasury Department’s expansion of the definition of a money transmitter to include any system by which stored value of any kind may be transferred from one person to another, even if the stored value is not cash, or national currency.

After vigorously contesting the charges for a year, in July 2008 the company and its three directors accepted a bargain with the prosecutors and plead guilty to one count of “conspiracy to engage in money laundering” and one count of the “operation of an unlicensed money transmitting business”, in exchange for the other charges against them (allowing a transaction to pay for child pornography) being dropped. ^[40] The company was ordered to pay fines of $3.7 million.

In November Gold & Silver Reserve CEO Douglas Jackson was sentenced to 300 hours of community service, a $200 fine, and three years of supervision, including six months of electronically monitored home detention.^[41] He had faced a maximum sentence of 20 years in prison and a $500,000 fine. Judge Rosemary Collyer said the men deserved lenient sentences because they did not intend to engage in illegal activity. Jackson’s lawyer claimed Jackson was spared the heavier fine because he is deeply in debt – the Judge said “Dr. Jackson has suffered, will continue to suffer, and may never be successful with E-Gold”. Reid Jackson, Douglas Jackson’s brother, and E-Gold director Barry Downey were each sentenced to three years of probation, 300 hours of community service, and ordered to pay a $2,500 fine and a $100 assessment.

Gold Seizure

Initially the US Attorney’s Office of the District of Columbia entered a motion to seize and liquidate the entire gold reserve of e-gold under asset forfeiture law. This would have allowed the law enforcement agency to add the proceeds of the sale to their operating budget. At the time e-gold held more gold in its vaults than the bottom third of the countries on the IMF list of central bank gold reserves, which would have made it one of the largest asset seizures in history, comparable to invading a small country and seizing its gold reserves. However, the federal judge in the case denied the motion and ordered the reserves to be held and liquidated for the e-gold account holders who could prove the origin of their funds.

e-gold was placed into receivership and the gold reserve was liquidated for USD 90 million. The court ordered “Rust Consulting”, a private company in Maryland, to organize refunds to account holders who could prove legitimate sources for the funds. The balance of unclaimed funds will be claimed by the US Attorney’s Office for the District of Columbia under the asset forfeiture law. A three month window has been set from June 3rd, 2013 to October 1, 2013 for e-gold account holders to submit a claim on their funds. ^[42]

Aftermath

After the e-gold and e-Bullion cases, California (2010) ^[43] and several other states amended their regulations to follow the federal precedent to define all digital value transfer systems as money transmitters. However, California’s new law is so broadly worded as to define a very wide range of Internet startup companies, such as the room booking service AirBnB, as “money transmitters”. ^[44] If the law were consistently applied many more Internet start-ups might be subjected to the same kind of prosecution that e-gold experienced.

After the resolution of the criminal case, the directors of e-gold Ltd vowed to continue operations following the new Federal KYC guidelines. They applied for a money transmitter license for the company, but it was denied because the directors are now convicted felons. Jackson and Downey have continued trying to find a way to sell the company to persons eligible for a money transmitter license in order to recoup some value from their once wildly successful internet payment system.

Conclusions

e-gold was one of the first, if not the very first pioneer of Internet payments. While e-gold received a lot of bad press due to the criminal case against them, it is important to recognize e-gold’s place in Internet history as the world’s first successful online payment system which pioneered many of the systems and techniques that e-commerce users now take for granted, including making payments over an SSL encrypted connection, and offering an API to enable other websites to build services using e-gold’s transaction system.

e-gold presaged Bitcoin as an alternative internet transaction system that operated completely outside of and independent of the legacy banking system. This proved that alternate financial systems were possible and that a significant number of people would enthusiastically use such a system.

Though e-gold was ultimately shut down by the US government, the federal judge on the case ruled that the founders of e-gold “had no intent to commit illegal activity.”

Founder Douglas Jackson failed to foresee the ways in which criminals and hackers could exploit an internet payment system by manipulating the appearance of identity (identity theft and fraud). Their payment model failed to include a web of trust that would enable users to have some degree of confidence of whom they were dealing with, and to eliminate bad actors. In retrospect e-gold’s tardiness in addressing the identity issues allowed the criminal syndicate to grow so large that the resulting crime wave ruined the company.

e-gold’s failure was ultimately due to the inability of their business model to provide a system of reliable user identification and the failure to provide a workable dispute resolution system to identify and cut off illegal and abusive activity in their user community. Other transaction systems such as Webmoney.ru ^[45] and Goldmoney.com ^[46] learned from e-gold’s mistakes and were able to successfully field similar systems with low rates of abuse by addressing these deficiencies. While PayPal has done a better job of addressing abuse than e-gold did, they now suffer from ^[47] and battle against the same crime wave that took down e-gold. ^[48] Financial cryptographer, Ian Grigg, has observed that Bitcoin has repeated the same fundamental errors that e-gold made and that despite its decentralized nature the cyber crime-wave may bring Bitcoin to a similar ending.^{[49] [50]}

]]> http://www.dgcmagazine.com/the-e-gold-story/feed/ 0 http://www.dgcmagazine.com/the-liberty-reserve-indictment/ http://www.dgcmagazine.com/the-liberty-reserve-indictment/#comments Thu, 30 May 2013 09:14:17 +0000 Julia Dixon http://www.dgcmagazine.com/?p=1478 Continue reading →]]> The Defendants

Liberty Reserve S.A., Arthur Bodovsky (owner), Vladimir Kats (left the business in 2009), Ahmed Yassine Abdelghani (left the business in 2009), Allen Esteban Hidalgo Jimenez, Asseddine El Aminr, Mark Marmilev, Maxim Chukharev.

The Charges

1. Conspiracy to Commit Money Laundering

2. Conspiracy to Operate Unlicensed Money Transmitting Business

3. Operation of an Unlicensed Money Transmitting Business

Read the indictment here.

Liberty Reserve owner, Arthur Budovsky, a former U.S. citizen and naturalized Costa Rican of Ukrainian origin, was arrested in Spain last Friday. U.S. officials will likely to seek his extradition.

Also on Friday, in San José Costa Rican prosecutors raided Budovsky’s home and offices. They seized documents, computers, three Rolls Royce, Jaguar automobiles, and a motorcycle.

Seizure

US officials have seized the following domain names, Libertyreserve.com, Exchangezone.com, Swiftexchanger.com, Moneycentralmarket.com, Asianagold.com and are seeking the forfeiture of the following domain names for related exchanger sites: Wm-center.com, e-naira.com, ecardone.com, ebuygold.com, getemoney.com, epaymonster.com, instantgoldng.com, jtgold.com, goldnairaexchange.com, superchange.ru, webmoney.co.nz, m-gold.com, goldmediator.com, absolutexchange.eu, mewahgold.com, centregold.ca, electrumz.com, tukarduid.com, entelnova.com, tacoauthorized.com, intexchange.com, ukrnetmoney.com, wmirk.com, nigeriagoldexchanger.com, edealspot.com, duyduychanger.com, magnetic-exchange.com, moneyexchange.vn, abc-ex.net, mi-billetera.com, nicciexchange.com, exhere.com, alertexchanger.com, velaexchange.com, goldexpay.com.

Read it here.

28 bank accounts have been seized and the indictment is seeking the forfeiture of “all funds” in 45 different bank accounts in 9 different countries.

Patriot Act

The shutdown of Liberty Reserve was initiated and orchestrated by the Treasury. While Liberty Reserve was based in Panama and the owner had given up his US citizenship, US officials conducted the investigation using a provision of the Patriot Act that allows “the prevention, detection and prosecution of international money laundering and the financing of terrorism.”  Via the Patriot Act Liberty Reserve was declared to be “a Financial Institution of Primary Money Laundering Concern”.

Liberty Reserve did have US customers (20k according to estimates by US officials), however, the Treasury made it very clear that they intend to go after businesses regardless of location stating “We are prepared to target and disrupt illicit financial activity wherever it occurs – domestically, at the far reaches of the globe or across the internet.”

Legitimate Use

Almost certainly the service was used by thieves, but US officials failed to see any legitimate use for the service calling it “structured so as to facilitate money laundering” and stating that its structure made “any legitimate use economically unreasonable”.

I personally know a number of businesses that used the service legitimately and a number of news stories have noted legitimate business who have had their funds caught up in the shutdown.  A few examples are forex brokers based in countries where it is difficult to transfer funds and e-pay cards, a service that allowed consumers outside the US to fund cards that could be used similarly to US-issued Visa or Mastercard credit cards.

AML and Anonymity

Liberty Reserve did not comply with standard KYC and AML policies allowing customers to use the service without providing proof of identity. However, the Treasury seems to equate privacy with criminal behaviour.

“This lack of customer due diligence means that the accounts can be entirely anonymous and thus that account holders can transfer fund to or from anywhere with anyone with anonymity. Indeed, Liberty Reserve advertises this fact as a virtue of the service.“

Avoiding the US

It is interesting to note that Liberty Reserve’s owners took many steps to remove themselves from US jurisdiction and avoid direct violations of US anti-money laundering laws. Many would see this as a prudent move for owners of alternative financial services; however, US officials see this as a sign of guilt.

“In October 2007, Liberty Reserve’s official blog explained that registering in Costa Rica allowed the company to avoid U.S. authorities because Costa Rica does not have a mutual legal assistance treaty with the United States. Taken together, these facts suggest that Liberty Reserve has specifically sought out jurisdiction with weak anti-money laundering controls and apparent immunity from U.S. prosecution.“

Liberty Reserve used third party exchanges to move funds into the service; it did not directly accept money wires, etc.

“Liberty Reserve has structured its business to separate itself from knowledge that would allow it to detect money laundering.”

“As of 2009, Liberty Reserve had outsourced its own verification process for new exchangers to a non-affiliated company …. Relying on exchangers to conduct what little due diligence Liberty Reserve purports to require enhances the gravity of Liberty Reserve’s money laundering risk.”

FinCEN’s Special Measure

In an effort to cut Liberty Reserve off from the US financial system, it FinCEN has proposed a special measure. This new rule would require US financial institutions to perform special due diligence to ensure that correspondent accounts held by foreign banks are not used for transactions involving Liberty Reserve.

History

This isn’t the first time Liberty Reserve’s founders have had a run-in with US officials. Arthur Bodovsky and Vladimir Kats previously ran GoldAge which was an E-gold exchanger. Both were convicted in New York State of operating an unlicensed money transmitting business. Bodovsky was placed on probation, renounced his US citizenship and immigrated to Costa Rica where he became a citizen.

Search Warrants

The investigation involved more than a dozen countries and many search warrants were issued for covering phone, email, bank records, and “’cloud’-based search warrants, directed to a service provider used to process Liberty Reserve’s Internet traffic.” Authorities also “captured” online chats between two of the defendants.

Costa Rican Troubles

In 2009 Costa Rican regulators, Superintendencia General de Entidades Financieras (SUGEF), notified Liberty Reserve that it needed to apply for a license to operate as a money transmitting business. Liberty Reserve did not obtain a license and allegedly reported to Costa Rican officials that they had sold the business, emptied their Costa Rican bank accounts and setup shell companies in other countries.

Anonymity not Allowed

Secret Service Special Agent-in-Charge Steven G. Hughes said:

“These arrests are an example of the Secret Service’s commitment to investigate and apprehend criminals engaged in the misuse of virtual currencies to conduct global monetary fraud. Cyber criminals should be reminded today that they are unable to hide behind the anonymity of the Internet to avoid regulated financial systems.”

It seems clear that US regulators do not want to allow anonymous money transmitting businesses and/or money businesses outside the financial system to exist, anywhere.

I’ll just end with this tweet from the always entertaining Max Keiser…

Links:

Treasury Press Release

FinCEN Notice of Finding That Liberty Reserve S.A. Is a Financial Institution of Primary Money Laundering Concern.

FinCEN Imposition of Special Measure against Liberty Reserve S.A. as a Financial Institution of Primary Money Laundering Concern.

DOJ Press Release

DOJ U.S. v. Liberty Reserve, et al. Redacted AUSA Appln with Exhibits

DOJ U.S. v. Liberty Reserve, et al. Redacted Domain SW

DOJ U.S. v. Liberty Reserve, et al. Redacted Injunction Order

DOJ U.S. v. Liberty Reserve, et al. Redacted PIRO

DOJ Liberty Reserve, et al. Related Exchanger Website Domain Names Redacted Filed Complaint 13CV3565

DOJ U.S. v. Liberty Reserve, et al. Indictment – Redacted

The Tico Times, an English newspaper in Costa Rica, is reporting that Budovsky has been under investigation since 2011 after a request from a prosecutor’s office in New York.  Liberty Reserve is a Costa Rican business and Budovsky is a Costa Rican citizen of Ukrainian origin.

Liberty Reserve had many US customers and was an important player in the Bitcoin economy.  The business offered irrevocable and instant payments making it a popular funding option for Bitcoin exchanges.  Liberty Reserve was accepted by Mt. Gox and BitStamp and many others.

While Liberty Reserved claimed to be AML compliant and users are asked for identifying information, name, address, DOB, etc., when opening an account, no ID or other proof of identification was required.

It would appear that this shutdown was co-ordinated by US officials. KrebsonSecurity.com is reporting that the Liberty Reserve domain name is now pointing to a service previously used by the Justice Department.

“On Friday, the domain name servers for Libertyreserve.com were changed and pointed to ns1.sinkhole.shadowserver.org and ns2.sinkhole.shadowserver.org. Shadowserver is an all-volunteer nonprofit organization that works to help Internet service providers and hosting firms eradicate malware infections and botnets located on their servers.

In computer security lexicon, a sinkhole is basically a way of redirecting malicious Internet traffic so that it can be captured and analyzed by experts and/or law enforcement officials. In its 2011 takedown of the Coreflood botnet, for example, the U.S. Justice Department relied on sinkholes maintained by the nonprofit Internet Systems Consortium (ISC).“

Krebs also notes 5 online exchange services that have also gone offline last week.

“Libertyreserve.com is not the only virtual currency exchange that has been redirected to Shadowserver’s DNS servers. According to passive DNS data collected by the ISC, at least five digital currency exchanges –milenia-finance.com, asianagold.com, exchangezone.com, moneycentralmarket.com and swiftexchanger.com – also went offline this week, their DNS records changed to the same sinkhole entries at shadowserver.org.”

It would seem that other businesses are worried about US officials as Panama based Perfect Money changed its policy to ban US businesses, residents and citizens shortly after the Liberty Reserve shutdown.

Via the PerfectMoney website.

“Dear Perfect Money Customers,

We bring to your attention that due to changes in our policy we forbid new registrations from individuals or companies based in the United States of America. This includes US citizens residing overseas. If you fall under the above mentioned category or a US resident, please do not register an account with us.

We apologize for inconvenience caused.”

FinCEN covers their bases here discussing “users, administrators, and exchangers… persons creating, obtaining, distributing, exchanging, accepting or transmitting” virtual currencies, both centralized and de-centralized, e-currencies and e-precious metals.

• FinCEN sees those dealing in virtual currencies as their regulatory responsibility
• Users, and Bitcoin miners seem to be exempt from regulation for the moment
• Buying or selling virtual currencies for “any reason” can make you a money transmitter and subject to FinCEN regulation
• Virtual currency dealers are NOT necessarily foreign exchange dealers
• FinCEN rules can also apply to those dealing in e-precious metals
• However, Prepaid Access rules do NOT apply to virtual currencies

Summary below.

FinCEN contrasts virtual currency to “real” currency and describes it as…

“a medium of exchange that operates like a currency in some environments, but does not have all the attributes of real currency. In particular, virtual currency does not have legal tender status in any jurisdiction.”

Bitcoiners will have to chuckle at this line…

“This guidance addresses “convertible” virtual currency. This type of virtual currency either has an equivalent value in real currency, or acts as a substitute for real currency. “

Of-course that would more accurately be equivalent or greater value.

It seems that those hoping to escape financial regulation by claiming that ‘virtual currencies’ are not money, or ‘real’ currencies won’t have much luck. While FinCEN tends to agree with you, it still sees your play money as its problem.

“Virtual currency does not meet the criteria to be considered ‘currency’ under the BSA, because it is not legal tender.“

However, appearing a several times in the paper is this line…

“The definition of a money transmitter does not differentiate between real currencies and convertible virtual currencies.”

“Accepting and transmitting anything of value that substitutes for currency makes a person a money transmitter under the regulations implementing the BSA.“

“Users” are not subject to FinCEN regulations.

“A user who obtains convertible virtual currency and uses it to purchase real or virtual goods or services is not an MSB under FinCEN’s regulations.”

Bitcoin miners appear to be exempt from FinCEN regulation for the moment.

“A person that creates units of this convertible virtual currency and uses it to purchase real or virtual goods and services is a user of the convertible virtual currency and not subject to regulation as a money transmitter.”

However, anyone who then sells the virtual currency to another for “real” currency “or its equivalent” is then subject to money transmitter rules. And this is perhaps the most concerning line from the document…

“An administrator or exchanger that (1)accepts and transmits a convertible virtual currency or (2) buys or sells convertible virtual currency for any reason is a money transmitter under FinCEN’s regulations.”

The paper does mention that there are some exemptions, however this bring up some important questions. Does FinCEN now see small time over-the-counter Bitcoin exchangers as subject to their regulations?

FinCEN rules also apply to those dealing in e-precious metals if they…

“transfers funds between a customer and a third party that is not part of the currency or commodity transaction”

“Since the definition of a money transmitter does not differentiate between real currencies and convertible virtual currencies , the same rules apply to brokers and dealers of e-currency and e-precious metals.“

Prepaid Access rules do NOT apply to virtual currencies…

“A person’s acceptance and/or transmission of convertible virtual currency cannot be characterized as providing or selling prepaid access because prepaid access is limited to real currencies.”

Virtual currency dealers are NOT engaged in foreign exchange unless they also exchange ”the currency of two or more countries.”

The guidance paper is only 6 pages long and can be found here.

Also worth a read is the Bitcoin Foundation’s reaction to FinCEN’s guidance. “Today, we are all money transmitters… (no, really!)“

Part II  examines the Voucher-Safe economy, trust, security and software.

This final part looks at Voucher-Safe’s interaction with Bitcoin, Issuers and OnionPay.

Bitcoin

The idea behind voucher-safe is that money can be anything that people value and want to exchange.  Money can be national fiat currencies, silver or gold and increasingly, Bitcoin. Bitcoins can be exchanged via the Voucher-Safe system with the creation of Bitcoin backed Vouchers.

One of the benefits that Bitcoin backed Vouchers have is increased anonymity.  Voucher-Safe’s principal developer Kevin doesn’t see Bitcoin as anonymous.  “You actually see people offering to sell bitcoins that are free of taint now. Because taint means there are certain payment hashes that have been used for criminal activity or looted bitcoins … And because everything is recorded on this massive block chain, it’s like a chain of titles… And so if you end up with a house or car that has been owned by a criminal it casts a taint on your property. And that’s a horrible problem for the Bitcoin block chain.”

Kevin sees a solution to the block chains problems in Vouchers. “If you bailed bitcoins into a Voucher-Safe Issuer that issued Vouchers against bitcoins, they could circulate in the wild without having any foot print in the block chain whatsoever, except in what was created when the bitcoins actually moved in or out of the Issuer. I really think that would be a huge improvement and would solve one of Bitcoin’s biggest problems.“

Kevin sees further benefits adding, “Circulating bitcoins in voucher form would also eliminate problems with clearing times and transaction dependencies, which arise from the fact that bitcoins actually exist in blocks of 20 whole coins. This means that when some of the coins in a block are involved in uncleared transactions, it prevents any other coins in the same block from clearing until the earlier transactions are closed. Bitcoins carry the full transaction history of every coin. Vouchers are always destroyed and replaced any time they are used in a transaction, so they can carry no history.”

A Voucher Issuer for Bitcoin is being discussed.

Issuers

At the heart of Voucher-Safe are the Issuers who put the currency into the system.

One of the first Voucher-Safe Issuers will be PXGold. The business is run by the creators of Pecunix and they hope that Pecunix’s good reputation is also applied to the new business. However, PXGold is a separate entity and will have no direct connection to Pecunix.

As an Issuer PXGold will issue gold backed Vouchers and maintain 100% backing for all their Vouchers.  However, they will not make the location of their gold vaults public. The reasons behind this move is explained in part II.

When demand becomes sufficient to justify it, PXGold plans to do a run of PXGold Medallions, which customers will be able to take delivery of in exchange for their PXGold Vouchers. The business will work with Vouchi.com, the current Voucher-Safe publisher.

There is currently one active Voucher-Safe Issuer, voucher-issuer.com. The site issues Vouchers backed by USD and EUD. The decision to have the first Issuer back their Vouchers with national fiat currencies is explained by Sidd. “People need to come to terms with the fact that these Vouchers can be used as a payment system to pay each other and used as real money. Not just as vouchers to claim back whatever is backing that system. “

“When I’ve spoken to people, often the reaction is that we’ve created this voucher system where the vouchers are for gold. And they say ‘that’s great, so if I want to give my aunty some gold I can give her a voucher.’ And I say yes but you can also buy her a pair of shoes with that Voucher by paying for it with a Voucher. And you could be paid in Vouchers. And that seems to be a difficult problem for some people. And that’s why we are considering an issue with USD and Euro’s, so that they can see that well one Voucher is equivalent to one Euro, that makes sense to me. “

Plans are also in the works for two more Issuers, one for silver and another for Bitcoin.

Issuers and KYC

Any Voucher-Safe Issuer who intends to interface with the fiat banking system will need to be KYC compliant and require ID from their customers. Not doing so would be a violation of AML laws and would risk a shutdown of the business.  However, there are options for obtaining Vouchers anonymously. An obvious choice would be to receive one in trade with an existing Voucher Issuer customer. There is also the possibility of an Issuer which does not interface with the banking system and is not subject to KYC rules.

It is possible to have an Issuer which only trades its assets in exchange for other types of Vouchers or anonymous digital cash.  For example, suppose an Issuer existed for a metal-backed Voucher currency which only bought or sold the metal using Bitcoin. That Issuer could likely get away with not requiring ID from its customers.

OnionPay

OnionPay (The name is a “humorous tip of the hat” to Tor) is add on software for the Voucher-Safe system.  It is essentially a Voucher-Safe based PayPal alternative for e-commerce websites. OnionPay is intended to provide a more traditional merchant checkout experience for websites that accept Voucher-Safe.

The Voucher-Safe payment process involves a few steps; the sender has to send and then the receiver has to pick up. “Well how is that going to work if the receiver, the payee, is actually a website?” OnionPay solves this problem.

As Kevin explains, “the way it works is that it borrows a concept from public key cryptography where you have a public key that you give to everybody and you have a private key. Only here you have a public Voucher-Safe and a private Voucher-Safe.”

To use OnionPay, an e-commerce website would set up what amounts to a merchant account with OnionPay. The service creates a public safe to which both OnionPay and the merchant have joint access. This provides the merchant with a payment gateway that allows customers to check out. The customer can make a Voucher payment that goes to the public safe. OnionPay then logs into the public Voucher-Safe, picks up the payment, confirms that it is the correct amount and then takes the customer to the success page back on the merchant’s website.

After sending a message notifying the merchant of the payment, OnionPay sweeps the money from the public safe to the merchant’s private safe. “This keeps the merchant from actually having to trust OnionPay with any of their money unlike PayPal where it sits there in your account until you withdraw to a debit card or take an ACH payment.”

Auto Exchanger

A planned additional feature of the Voucher-Safe system is an auto exchanger or escrow system.  As Kevin explains, “We used to have this kind of functionality with something called Open to Exchange. And this was back in the day when people wanted to exchange between e-gold and Pecunix, etc. It was mostly exchangers who used it when they had too much of one and not enough of another. But in theory, this is something that can be done by anyone. I think there is room for a lot of synergy there in terms of people using different kinds of Vouchers and being able to exchange with each other.”

“So one of the easy things that we would be able to do is to create an auto exchanger that would act as the escrow system, it would probably be an Onion Pay merchant, that would let people exchange all these different things as anonymous digital cash without ever having to go through an exchange. So for example, you have a Bitcoin Voucher and you want a Dollar Voucher, you just post that on this site for someone who wants the reverse of that trade. Then each of them pays their Voucher to the middle man and he reverses it.”

While the Voucher-Safe system is designed to allow anything to be money, the system offers one of the best options for those who want to transact in gold, silver, etc. Voucher-Safe is about as de-centralized as you can get while still being able to transact with real assets. The system is a versatile, more decentralized, Anti-Money Laundering compliant way to anonymously exchange value. It is a smarter, more resilient generation of digital currency.

Ripple was created by Ryan Fugger in 2006 as a trust network where people can grant each other credit, and anyone can ‘be their own bank’. The project has since been acquired by a team of developers including Mt. Gox creator Jed McCaleb. Ryan’s trust network is still there, but it is now one feature of a much expanded system.

The new features of the soon to be open source software include the possibility for a decentralized currency exchange, a p2p transaction network, “Gateways” for bringing other currencies into the system, and Ripples (XRP), a new digital currency.

Passing around IOU’s

To understand the system, let’s start with Ryan’s original vision, the trust network. Ripple allows users to extend credit to their friends, or to anyone whom they trust. The new version of Ripple expands upon this idea with a very sophisticated system of passing around and tracking IOU’s. Ripple is a series of trust limits strung together to form a trusted pathway.

Here is an example of how the system can work…

You grant your friend, Bob, $100 of credit. You do this by telling Ripple that you would accept an IOU up to $100 from Bob. Now imagine that Bob is from the other side of the world where his sister, Marie, still lives. Bob trusts his sister and as such has grated her $50 of credit in the Ripple system.

Marie comes to visit and you all go out for lunch. Marie forgets her wallet and you cover her portion of the bill, $20. Instead of Marie finding an ATM and withdrawing $20, she logs into Ripple and sends you an IOU for $20. This is possible because there is a trust pathway between you and Marie via Bob. You are willing to let Bob owe you up to $100 and Bob is willing to let his sister owe him up to $50. Via this trust pathway a $20 IOU can get from her to you, by passing through her brother.

This trust pathway works because everyone along the path has ‘vouched’ for the person directly before him or her on the pathway. Bob accepts an IOU from Marie and then he issues an IOU of his own for the same amount to the next person in the path who accepts his IOU’s, and in this example, that’s you.

This system works to encourage a large trust network. The more people you trust and the more people who trust you, the more pathways there will be. This enables more transactions. On top of this the software also includes a number of other features such as a ranking mechanisms that allow you rate others debt.

When taking a close look at the potential networks, and imagining the flow of funds between people and through the network, things can get very complicated and difficult to follow. Some of the common stumbling blocks will be reviewed at the end of the post.

Settling

Tracking credit in your network of friends is great, but how is all this debt actually settled?

One option would be to simply say ‘Hey Bob can I have that $20 back?’, and then Bob hands you a $20 bill. To report this in the Ripple system you would simply issue Bob with an IOU of $20 which cancels out his IOU to you. Or, you can settle with a Ripple Gateway.

Gateways

What happens if you’re not interested in exchanging IOU’s with your friend’s, yet you want to send money via Ripple? For situations like this, or when no “trust pathways” exist between two users, a Ripple Gateway provides the solution.

Gateways are designed to be Ripple servers running as businesses. Ripple’s creators envision Gateways as competing businesses who will likely be compliant with AML/KYC rules and financial regulatory agencies. Gateways may make their money in a variety of ways including, account or deposit fees, converting currency denominations with a spread, placing funds in an interest bearing account, etc.

As the name implies Gateways are the bridge between national currencies, other digital currencies and the Ripple network. A Gateway would likely have a traditional bank account, a Bitcoin wallet, etc. and accept funds from Ripple users in exchange for credit or IOU’s in the Ripple system. Inside the Ripple system money, USD, EUR, BTC, etc., are represented as the network currency, Ripples (XRP) or as IOU’s denominated in that currency.

You can, for example, deposit USD with a Ripple Gateway in exchange for a USD denominated IOU from that Gateway. You can then send this IOU to a friend, who can then ‘cash out’ at a Gateway themselves.

XRP and Fees

Ripple includes its own ‘Network currency’, Ripples, also called Ripple credits or XRP. The network was created with 100 billion Ripples, with no more to be created. ‘Ripples’ can be sent between accounts or converted to other currencies and some consider them a possible rival to Bitcoin.

There are fee’s for transactions in the Ripple system, however, these are charged not ‘for profit’ but for the protection of the system. The idea is to prevent ‘spam’ transactions swamping the system. The transaction fee is meant to be very minimal, only a fraction of a Ripple. The transaction fee is not collected but redistributed evenly throughout the network in proportion to account holder’s balance.

De-centralized Bitcoin exchange?

One of the much discussed features of Ripple is the ability to exchange Bitcoins for other currencies. The way this works is essentially that every Ripple Gateway can act as an exchange agent. This is how the process would work trading USD for BTC

• Find a Gateway you trust and send them the USD you want to sell
• You will receive an IOU from that Gateway in the amount of your deposit
• Enter an exchange offer in the Ripple system
• Assuming someone holding an IOU for BTC accepts your offer, your exchange will be recorded on the Ripple public ledger and you will now have an IOU for BTC
• Take this BTC denominated IOU to your Gateway
• Your Gateway sends your BTC to your Bitcoin address

De-centralized exchange is often discussed in the context of Bitcoin surviving hostile regulation. Should Bitcoin, or Bitcoin exchanges become illegal this would also outlaw Ripple Gateways acceptance of the currency.

P2P Transactions

To understand the Ripple network, think Bitcoin. Like Bitcoin, Ripple is open source software that creates a distributed network. “At its heart, ripple is a distributed database, a network of shared information. Instead of a central server, all the servers around the globe running the free ripple software power the ripple network.”

Ripple’s architecture includes a lot of the same concepts as Bitcoin, but with some very important differences.

Like Bitcoin:

• Ripple is an open source, distributed peer-to-peer payment network.
• Ripple transactions are irreversible, sent over the Internet, and counterfeit proof.
• Ripple uses the same underlying cryptography as Bitcoin.
• Ripple has multi-signature support.
• Ripple has low to no transaction fees.
• Ripple servers can be run by anyone.

Unlike Bitcoin:

• Ripple can send any currency.
• Ripple can automatically exchange currencies.
• Ripple transactions are fully confirmed in seconds.
• Ripple has no block chain download, clients are ready in seconds.
• Ripple has no mining or direct monetary reward for running a Ripple server.
• Ripple has no currency risk as people can hold whatever fiat they want.
• Ripple solves the double spending problem with consensus instead of proof-of-work.

Consensus

Transactions in Ripple are recorded via a public ledger using “consensus”. The idea is this: when a transaction occurs your Ripple client software announces to the network the details of the transactions…”I’ve sent Bob 100XRP”. Later if Bob, or anyone else, asks the network “Did Julia send me 100XRP?” the majority answer will be ‘Yes’. Of course this is a very simplified example; the reality is a bit more complicated.

Nodes on the network listening for transactions are ‘Validators’ and every client will have a preferred Unique Node List (UNL). You can also manually select your UNL.

Anyone can run a validation node; however, there is no monetary compensation for doing so. Ripples creators believe that Gateways, merchants, day traders, libertarian groups, universities, etc. will run these servers to support the Ripple network.

Rather than a block chain, Ripple records transactions in a ‘public ledger’. The Ledger contains a list of all the accounts and their balances. Every Ripple node has a synchronized copy of the current Ledger.

Scratching your head

Ripple has added so much additional capability that the original Ripple ‘trust network’ is now simply an option in the system. However, wrapping your head around the complicated IOU network that Ripple is capable of can be a bit difficult. Ripple’s IOU’s are designed to be exchanged in a manner that could allow them to be a medium of exchange themselves. This brings up a few questions: are all IOU’s ‘backed’ by other currencies? How does someone holding IOU’s access ‘backing’ funds? What happens if there is a default in a chain of credit?

Here are some examples that will hopefully clear these issues up.

IOU’s can be ‘backed’. For example, you can back an IOU that you receive after depositing funds with a Gateway. IOU’s can also be un-backed, for example if you send an IOU to a friend. If your friend is willing to accept this IOU they must trust your willingness to repay them and that trust you have or will have backing funds. However, these funds do not have to be currently in the Ripple system. And the Ripple system does not differentiate between backed and non-backed IOU’s. Should this cause concern about defaults and systemic risk, there is another important feature of the Ripple system to consider here.

Granting someone trust, or agreeing to accept their IOU’s gives them access to your ‘trust network’ and also gives you access to theirs. Or put another way, you now have access to each other’s IOU’s from other parties. For example, if I owe you $20 and I have deposited $20 with a Gateway and I am holding the Gateways $20 IOU, you can ‘take’ the Gateway’s IOU from me. In doing this you would owe me $20, and given that I owe you $20 these IOU’s cancel out, debt settled.

Another common concern is with the way the Ripple system will allow IOU’s to ‘Ripple’ through the system via chains of credit. What happens when someone defaults? Who is left holding the bag? The quick answer is that when there is a default, it only affects those people who have specifically agreed to trust that person; those upstream or downstream are unaffected. To sort this out, here is an example.

Jane wants to pay Charlie $50 and Charlie has agreed to hold Bob’s IOUs and Bob has agree to hold Jane’s IOUs, then a chain Jane->Bob->Charlie exists to make the payment. Now, Jane owes Bob $50, Bob owes Charlie $50, and Charlie considers Jane to have paid him $50 because she made Bob owe him $50 and he has agreed to accept Bob’s IOU’s. Bob owes Charlie $50, but Jane owes him $50. Since he agreed to accept Jane’s IOUs, he’s no worse off. If Bob defaults, Jane doesn’t care; she didn’t agree to trust him.

You can also think about this situation differently by picturing the people in this arrangement as banks. After all, allowing people to act as their own bank is one of Ripple’s goals.

When your friend sends you a check and you deposit it in a bank account, your friend has made your bank owe you more money, so you consider your friend to have paid you. You trust your bank to hold your money, you are happy to hold their IOU’s. In this situation your friend’s bank owes her less money (or she owes her bank money). If your bank fails, your friend doesn’t have to pay you again; you agreed to trust your bank, she didn’t.

It’s complicated, and very interesting. The new Ripple is full of promising features and DGC will be keeping a close eye on it.

In this part we examine the Voucher-Safe economy, trust, security and software.

The Voucher-Safe Economy

“One of the things that occurred to us as being necessary in order to have a robust economy, is that the people who are operating the servers need to get paid for doing that.”

All of the players in the Voucher-Safe economy, the Publisher, DHT (Distributed Hash Table) server, OFS gateway, SDS (permanent database) server, etc. are in the business of earning tokens. As Kevin explains it, “you can think of tokens kind of like micro Vouchers, which are backed by Vouchers which are in a special Voucher safe.”

Tokens are created by the Publisher, from backing Vouchers, and are sold to Voucher-Safe users. “What is silently going on here in the middle of all these payments, pickups, storing receipts and so on, is that all these charge some number of tokens. For example, it costs a token to store a receipt, and it also costs tokens to make payments or to pick them up.”

Once the players in this system, for example the OFS gateway, accumulate a certain amount of tokens they can redeem them for Vouchers. The OFS gateway operators would initiate an exchange with the Voucher Publisher and say ‘ok, I’d like to cash in my tokens.’ Those tokens are then taken out of circulation and the Publishers Voucher safe, where the users who have been buying the tokens have been placing Vouchers, is debited to create a new Voucher. This new Voucher is then paid to a special safe which is owned by the operator of the OFS server.

This method encourages the OFS gateway, and other server operators, to be very careful about which Issuers and Publishers they do business with. Kevin explains that this is an intentional incentive. “Basically what this boils down to is that the publisher and all of the other servers are getting paid in the same issuer’s currency. You wouldn’t want to accept any Issuer that you didn’t have confidence in because this is how you are making your money as well.”

It is also important to note that “the number of tokens is fixed by the publisher but the value of a token is fixed by the Issuer.” For example, an Issuer may set the of value of a token at .005 grams of gold, about 2 ½ cents.

“And that means that although it gets divvied up in different ways, the total cost of a payment is about 47 & ½ cents. About 2/3 of that is paid by the payer and the other by the receiver. 50 cents or less to make a payment and that’s regardless of the amount of the payment. As the same amount of work has to be done and the same operations have to take place whether your payment is for 5 clams or 5 million clams.”

How does a user obtain, exchange and ‘redeem’ Vouchers?

There are many ways to obtain Vouchers, an obvious method is to purchase some from a Voucher Issuer.

Voucher-Safe was designed to be an AML compliant, and yet anonymous, digital cash system. The Issuers are charged with maintaining AML compliance.  To purchase a Voucher from an Issuer a user would (dependent upon the policies of the Issuer) likely have to provide ID in accordance with Know-Your-Customer rules. Similarly, if a user wanted to redeem their Vouchers, they would likely have to have an account with the Issuer and provide ID and bank account information.
While most Issuers will likely require ID as they will have to interface with the fiat banking system, Voucher-Safe’s creators do envision Issuers that may not require ID. “It is conceivable that one could have an Issuer which only traded its asset base in exchange for other types of vouchers or anonymous digital cash.  For example, suppose an Issuer existed for a metal-backed voucher currency which only bought or sold the metal using Bitcoin. That Issuer could likely get away with not requiring ID from its customers.”

“But the idea here is that many users wouldn’t need to be ID’d, just as many people can have physical cash in their wallets and purses without needing a bank account. One could imagine ‘Voucher-cashing’ services just like there are check-cashing services.  Also decentralized exchanging operations, along these lines:”

Purchasing a Voucher from an exchange would be like purchasing Bitcoins on an exchange, and it would come with many of the same issues. Kevin notes that “the exchanger issue is a problem for any digital currency. There’s just no way to fix it that I can see other than going to this decentralized model … about dealing in cash and dealing with other people who use the currency. … And it gets around single points of failure such as large exchangers that are doing millions of dollars a day in through put. And I think that kind of thing is ultimately where we are going not just with Bitcoin but with Voucher-Safe and pretty much everything else.”

Plans for the voucher-Safe system include an ‘auto exchanger’ or escrow service.  This service would allow people to exchange between different Voucher-Safe currencies or Vouchers from different Issuers “as anonymous digital cash without ever having to go through an exchanger.”

Another interesting feature of Vouchers that is important to note, is that they expire.

“We didn’t want this to be a money storage facility. We want this to be a transactional system. … The idea is that it is very, very important to make sure that you don’t end up with value that is permanently in limbo. If Vouchers are somehow lost, you can’t just leave that value out there forever. You have to have some way to take it out of circulation.”

What happens to the backing of an expired Voucher will be determined by the Issuers policy. But there are safe guards in place to prevent Vouchers expiring. “Whenever you’re doing a voucher transaction, your client will automatically use the oldest vouchers possible first.”

It is also possible to simply log into your Voucher-Safe every few months and revalidate any expiring Vouchers. This will however cost you a few tokens.

Trust

When dealing with the digital exchange of physical assets, trust is an unavoidable factor. Users of Voucher-Safe, or any currency with a physical backing, have to trust the Issuer.

Voucher-Safe is designed to be as decentralized and require as little trust as possible. But there is no escaping it, you must trust the Issuer.

Issuers will be discussed in detail in Part III, but one of the first Voucher-Safe Issuers will be PXGold.

Reputation is a huge factor in Issuer trust. Sidd, the creator of PXGold and monetary architect of the Voucher-Safe system, is also a co-founder of Pecunix, a well-respected gold custodian. “Pecunix has a good reputation. But at the same time the bottom line is when you bring me the Voucher, can I give you the gold? So far, we’ve been going for 12 years and there’s never been a problem.“

An important difference between Pecunix and PXGold is that PXGold will not make the location of it’s gold vaults public. While this may cause some trust concerns, it is done to protect customers gold from confiscation. “PXGold is based on an entirely different premise.”

Sidd explains the reasoning behind this decision. “With Pecunix, we held audits, we said ‘this is how much gold we’ve got, this is where we keep it, these are the checks and balances, this is how much gold is in the account, etc.’ But we have now got evidence of the danger of that because of what happened with e-gold. Because all of e-gold’s information was out in the open, the government came along and confiscated the gold. They literally took that gold even though it didn’t belong to e-gold, it belonged to the customers.”

“So, when it comes to PXGold, that information won’t be made public. There will be people who know and people who can verify, but it won’t be public.”

Trust in the Issuer is necessary, but very little trust in the Publisher, and other Voucher-Safe players, is needed.

Kevin explains that it “would be very hard for the Publisher to run off with much of anything. The Publisher has zero ability to do anything with Vouchers outside of those presented by a user for a specific transaction.  It cannot determine anyone’s ‘balance.’  It cannot tamper with the values of vouchers, despite being the party who signs them, because Vouchers with incorrect amounts would be rejected at the Issuer.”

“The same can be said about the DHT and SDS operators.  Yes they maintain ‘databases’ but all the records are encrypted using keys to which the server operators have no access.  The worst thing they could do would be malicious deletion, which profits them in no way.  And there are mirrors and backups in place to allow for this possibility.”

Security

PXGold’s security systems are impressive and are an improvement upon Pecunix’s well-known security. “Everything in Pecunix is encrypted, a lot of it is double encrypted. The entire database is encrypted. If our server got stolen by the authorities they wouldn’t be able to make a dent in it.”

Sidd is very seriouse about the security of PXGold “What we’ve done with PXGold, is that every single account is encrypted to its own key and the key for that account is actually that persons login details.” If authorities were looking for information on an individual from PXGold’s database, “they would actually have to come to us with the persons account details before we would even be able to find them in the database otherwise they’re not even searchable.“

“Nobody builds systems like that; I think I’m the only one. I’m a bit pedantic about that.”

Software

The software that makes up the Voucher-Safe system will be published. “Voucher-Safe has published source clients (3 of them). This is not quite the same thing as ‘open source’ because open source technically means that anyone can check in changes.  For obvious security reasons, we wouldn’t want that.  However by publishing the client source, we invite others to create competing client versions white labelled for particular Issuers or even ground up rewrites.  It would be great if someone made one for Android phones, for example.”

“The network source code (for the server side) is not published at this time.  However, every line of code which runs on a user’s computer has source code available, either from us or from the authors of the particular library component.”

The decision to delay the publishing of this code was done for several reasons. Sidd believes it is important to ‘vet’ Issuers and Publishers for the first few years to prevent any shady server operators from destroying trust in the system.  “As it stands now, we will run the only Publisher (vouchi.com) and we will vet every Issuer to make sure that that Issuer is trust worthy. And that way we can, to a certain extent, protect our investment in the software.”

Kevin adds that “ultimately the software for the VP/OFS/SDS/DHT/PKS should be published also, or at least licensed and franchised out to others who will make wise and profitable use of it.”

“In the end it’s about enabling free market money, which is not the purview of a single Publisher, Issuer, or network, any more than it should be the purview of a central bank.”

The final part of the Voucher-Safe special will discuss Voucher-Safe’s interaction with Bitcoin, Issuers and Onion Pay, a Voucher-Safe merchant checkout.