A Payment History of the United States

by Kaz Nejatian

  Then something magical happened in the 1993. That year, buoyed by a late 1980s ruling that ATMs did not count as branches and were thus not subject to strict federal regulations, the number of ATMs and debit terminals in stores skyrocketed. In 1992, there were fewer than 100,000 debit terminals in the United States. By 1994, there were nearly 400,000 such terminals.

  By 1993, the number of debit transactions had increased to nearly 800 million per year. By 2000, Americans used their debit card 8.3 billion times. By 2003 that number had doubled to 15.6 billion transactions. By 2012, the number had tripled to 47 billion transactions. In fact, today more retail transactions are completed using debit cards than any other method of payment.

  In 2016, Americans used their debit cards nearly 70 billion times (compared to fewer than 40 billion credit card transactions). That’s nearly 250 transactions per US person per year; a more than 100-fold increase since 1990.

  5 Digital Currency & Blockchain

  In 1990, as Americans were starting to become more comfortable with the idea of using a debit card and before many of them had even heard of the Internet, an eccentric American inventor named David Chaum incorporated a company called DigiCash to completely re-imagine how money works.

  Nearly a decade earlier, while Chaum was a PhD student at the University of California, Berkley, he had written a paper titled “Blind Signatures for Untraceable Payments”. The paper imagined “a new kind of cryptography” allowing for a “realization of untraceable payments systems” whose main feature would be “increased personal privacy.”

  After leaving the academic world, Chaum funded DigiCash to commercialize his academic work.

  The idea was simple: DigiCash would create an electronic payment system that allowed a user to withdraw money from a bank, encrypt it as a note, and send it to an end recipient. DigiCash payments, the company promised, would be completely private since only the sender and the receiver would have the necessary cryptographic keys.

  To simplify it, these cryptographic keys would allow the sender of money to encrypt a string of plain text containing information about the transaction into something completely indecipherable. Then, using decryption keys, the receiver of the transaction could take that unintelligible text and make sense of it again. Private keys would allow users to both encrypt payment information and also add a unique identifying qualifier that proved users were who they said they were.

  DigiCash worked with a digital currency called “CyberBucks”, and users could buy them using notes and a unique private key. After six years of development, DigiCash signed a deal with Mark Twain Bank headquartered in Ladue, Missouri that would allow people all over the world to open up so called “WorldCurrency” accounts in the bank which could then be used to fund a user’s CyberBucks transactions.

  As Mark Twain Bank stated in its press release in 1996, DigiCash transactions would be “just like withdrawing money from an account at an ATM or teller window and spending the money at stores.”

  Within the first year of its operations, nearly 1,000 customers and merchants had opened up DigiCash accounts allowing them to transact with each other. Since e-mail was not yet broadly used, in order to open up an account each customer would have to ask for an application to be mailed to them, which they would then fill out and mail back to Mark Twain Bank; and since web banking had not yet been invented to pay for items a user would have to call the bank and ask to have some money moved to their DigiCash account before opening up the DigiCash provided software to start any transaction.

  In 1998, less than two years after its launch and with very few successful transactions, DigiCash filed for bankruptcy.

  While DigiCash was not a commercial success, its founding and operations gave rise to a great deal of debate in cryptography message boards and forums of the day. Academics, computer scientists and cryptographers would argue for years about various benefits and flaws of DigiCash.

  One of the people debating the benefits of DigitCash was Nick Szabo, a digital currency researcher who ran a popular blog theorizing on the potential development of cryptography.

  In 1994, Szabo penned a blog proposing the idea of smart contracts, which would leverage digital currency and cryptography to create computer programs that could carry out transactions.

  Szabo argued that because digital currency fulfilled all the necessary requirements for a transaction automatically—verifying identity and funds while remaining secure—in theory, smart contracts could let developers create computer programs that would automatically execute transactions that would only trigger based on a set of rules. One example Szabo used was car leasing.

  “If a loan was taken out to buy that car, and the owner failed to make payments, the smart contract could automatically invoke a lien, which returns control of the car keys to the bank. This smart lien might be much cheaper and more effective than a repo man. Also needed is a protocol to provably [sic] remove the lien when the loan has been paid off, as well as hardship and operational exceptions. For example, it would be rude to revoke operation of the car while it's doing 75 down the freeway.”

  Soon after the idea of digital currencies and smart contracts was proposed by Szabo and others, a small group of researchers became obsessed with the idea. The concept of a digital currency free from the binds of governments and central banks, which could be used by anyone across the world, was profoundly interesting.

  Over the course of the next decade, many researchers published papers arguing whether people would ever actually use such a digital currency. After all, DigiCash had been a commercial failure at least partially because not many people were interested in paying for things with a digital currency.

  Bitcoin

  This debate continued in various forums, until October 2008 when an anonymous researcher or a group of researchers published a paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System”.

  Writing under the assumed name of Satoshi Nakamoto, the author of the paper argued that there were three reasons why a digital currency would succeed.

  First, Nakamoto argued that “commerce on the Internet has come to rely almost exclusively on financial institutions” and thus commerce was harmed because of “[increased] transaction costs” that would go along with a financial institution handling transactions.

  Second, “non-reversible transactions are not really possible” and thus every merchant would have to assume that a certain amount of fraud is unavoidable. This, obviously, increases the costs of goods and services.

  Third, commerce is harmed because of the increased cost of transactions and an entire category of commerce, namely “small casual transactions” where the minimum transaction size is low are not possible.

  Thus, bitcoin was born. As proposed by Nakamoto, bitcoin was a digital currency that emulated gold—it had a limited supply, which would make it a scarce commodity over time; it was a payment that would not be controlled by a government or a central authority; and it would be a currency that would become more valuable in the long run.

  The primary feature of bitcoin, as envisioned by Nakamoto, would be that it could not be controlled by any one financial institution. Unlike DigiCash, which was practically controlled by one bank, bitcoin would be settled on a so-called distributed ledger.

  In order to understand the ingenuity of a distribute ledger, it is important to remember how ACH transactions are settled in the United States.

  As noted earlier in the book, since its earliest day ACH transactions have been cleared through a centralized system. That means that each transaction is sent by the bank to a clearing house, in the early days the Federal Reserve of San Francisco and today the Federal Reserve or the Clearing House. Each clearing house maintains on its book a ledger that shows where the money came from and where it was sent. This is how the system ensures that no money is lost and that money is not sent or received twice. Credit cards, debit cards, and checks work similarly. Each transaction is entered onto a ledger sometimes at a bank,
like in the debit card system, or another central authority, like the clearing houses.

  These one ledger, or centralized ledger, systems therefore by necessity rely on financial institutions. Bitcoin, by design, is meant to avoid financial institutions. In the world of bitcoin, the ledger is shared among everyone in the bitcoin network. This is known as a distributed ledger or a blockchain.

  All confirmed transactions, in the world of bitcoin, are included in the blockchain. The question, then may be reasonably asked, how are transactions themselves done?

  As was the case with of DigiCash, anyone wanting to use bitcoin must have a special bitcoin account. This account is frequently called a wallet. Each wallet has a secret private cryptographic key that is unique to it. This key is used to confirm that a transaction being sent by a wallet holder is genuine and not fraudulent.

  Unlike the single ledger world, however, transactions in the bitcoin network, are not kept between the two parties and the bank. Every transaction in the bitcoin world is broadcast between all the users. This is necessary since every member of the bitcoin world can maintain the ledger of all transactions and transactions on the ledger are updated by broadcasting them through a process called mining.

  Mining is the system to used to confirm that a broadcasted transaction is on the blockchain. With mining, all the computers involved in the bitcoin network can agree that a given transaction has taken place at a given time. However, unlike in the banking system, there is no set fee for a transaction paid by the receiver or sender of the transaction. In the bitcoin world, mining is done by computers all over the world which place transactions in so-called blocks based on cryptographic rules. In order to make this process profitable for those who own these mining computers, the bitcoin network creates a lottery that gives miners a fraction of a bitcoin for every transaction that has been confirmed or placed on the blockchain.

  As is obvious with the above description, bitcoin is not like other forms of currency. It is unique as a payment method, a form of currency, and in how it deals with monetary policy.

  Transactions in bitcoin happen very differently due to the currency’s digital nature. Transaction costs are initially miniscule. Miners would get to pick which transactions they would confirm, and would usually do it on a first-come-first-serve basis. Yet, after the mining reward was reduced, as stipulated by Nakamoto’s white paper, transaction fees have been increasing. This increase, while not designed specifically in the original bitcoin paper, has happened because users who want their transactions confirmed more quickly pay an additional fee to further incentivize miners. As the mining reward grows smaller, many believe that transaction fees will increase.

  Also, unlike regular currency, bitcoins don’t actually change hands during the course of payment. There is a set number of bitcoins at any given time. Instead of electronically moving bitcoins from one wallet to another, the ownership change is simply placed within the blockchain database.

  Because the bitcoin blockchain stores information permanently and is irrefutable, the ownership record that lives in the bitcoin blockchain is even more important. If there’s any dispute on the bitcoin network, the nature of a blockchain database ensures that there’s no doubt as to who owns a bitcoin—there’s a permanent ownership record that you can check. This not only limits theft, but also avoids any concern that a user may attempt to spend the same digital currency twice.

  Bitcoin is also the first digital currency that deals with monetary policy and the first currency of any kind to use computer code to solve monetary policy. Historically, central banks have dealt with problems like inflation, interest rates, and other fiscal issues through human decision making. Yet, when Nakamoto wrote the white paper and created the bitcoin network, he added monetary policy into bitcoin’s code. This means that all future changes to monetary policy are already known and cannot be reversed without a democratic vote of all the major stakeholders.

  This preordained monetary policy means that bitcoin can avoid the problems that beset early American currency. If voters could have enforced the promise of Massachusetts government to limit the printing of money, they would have. If Congress could have been limited in printing continentals, much misery might have been avoided.

  While bitcoin avoids some of the problems of traditional currency, it does have its own issues.

  One of the problems for a decentralized currency is that when decisions need to be made, there’s no central authority to push the consensus one way or another. It is important to remember that unlike DigiCash, bitcoin is not a business or an organization. Bitcoin is an open-source software protocol with no board of directors or a governing authority. Changes in the structure of bitcoin can only be adopted through consensus; and this fact has led to frequent disagreement among the bitcoin community about how the currency should grow and which rules should be adopted.

  This, as is easy to imagine, can lead to debate and controversy. For example, should bitcoin participants do anything to make bitcoin transactions faster? Under its original proposal, a bitcoin transaction would take an average of 10 minutes to be confirmed. There are times, however, when transactions could take up to an hour. By comparison a cash transaction takes no time at all and a credit card transaction can take anywhere from two to 20 seconds to process. If transactions were to be made faster, should the reward given to miners be increased for their work in confirming transactions?

  These are all questions that a legacy payment system could decide with relative authority and ease. Visa could simply change the rules with a stroke of its pen or the Federal Reserve could simply implement a new piece of software. With bitcoin, however, these questions take months and months of debate and are often left unresolved.

  Price & Usage

  According to CoinDesk, a leading bitcoin publication, bitcoin started trading in July 2010 at around $0.06 per bitcoin. Those were the early days of bitcoin and the only people interested in the currency were cryptography enthusiast and computer scientists.

  Over the next three years, as interest in bitcoin grew the price of bitcoin increased. In March 2013, one bitcoin was worth $100.

  It was around this time that two large events brought even more attention to bitcoin.

  Long before Satoshi Nakamoto published the first bitcoin paper, a programmer named Jed McCaleb had built a website focused on allowing users of an online game named Magic: The Online Gathering to buy and sell digital cards. His website, mtgox.com, short for Magic: The Gathering Online eXchange, launched sometime in January 2007. The website didn’t receive much traffic and by the end of 2007, McCaleb had all but abandoned the idea for an online card exchange. The site lay dormant promoting McCaleb’s various gaming interests until July 2010.

  Having read Nakamoto’s bitcoin paper, McCaleb had become interested in bitcoin in early 2010 and decided that his old card exchange site could be used to buy and sell bitcoin instead of digital cards. On July 18, 2010, Mt. Gox was launched as one of the world’s first bitcoin exchanges.

  Given bitcoin’s increasing popularity, Mt. Gox quickly became a popular bitcoin exchange; but by January 2011 its founder had already grown tried of dealing with the website that was receiving tens of thousands of dollars, much of it from unknown sources, every week. So on February 3, 2011 McCalebt sold the business to Mark Karpeles, a French programmer living in Japan.

  Perhaps having perfect foresight or perhaps given the uncertainty around bitcoin and legality of the whole ecosystem, McCaleb insisted that the sale document include a clause specifically saying that “the Seller is uncertain if mtgox.com is compliant or not with any applicable U.S. code or statute, or law of any country” and that “the buyer agrees to indemnify Seller against any legal action that is taken against Buyer or Seller with regards to mtgox.com or anything acquired under this agreement.”

  Having taken over the website, Karpeles began to grow it quickly and within weeks, Mt. Gox was the world’s largest bitcoin exchange. Almost immediately, Karpeles be
came a large name in the bitcoin community and began encouraging the employees he had hired to call him “the king of Bitcoin”. (As an aside, I’m the CEO of a company called Kash but have never been able to have my employees call me the King of Kash.)

  Yet, even from the first days there were signs that perhaps this bitcoin emperor was lacking some clothing.

  Just over two months after he took over Mt. Gox, Karpeles realized that the site was missing nearly 80,000 bitcoins and that it had somehow bean hacked.

  Emails, released through court documents, show that in late April 2011 McCaleb urged Karpeles to among other things consider buying the 80,000 bitcoin on the open market at a cost of nearly $63,000. Yet, it seems, Karpeles did nothing in response to finding the 80,000 bitcoins missing. By June 2011, the price of bitcoin had increased so much that to replace the missing 80,000 bitcoins Mt. Gox would have had to spend over $800,000.

  Later that month, in June 2011, Mt. Gox was hacked again. This time, Karpeles responded by the moving majority of the exchange’s bitcoin holding into a “cold storage” and placing them into safety deposit boxes in various Japanese banks.