Since the advent of banking in the Middle Ages, bank customers have used paper-based instruments to move money between accounts. In the past 25 years, electronic messages moving through private networks have replaced paper for most of the value exchanged among banks each day. With the arrival of the Internet as a mass market data network, new technologies and business models are being developed to facilitate electronic credit and debit transfers by ordinary consumers.
These new systems include CyberCash (which is a gateway between the Internet and the authorization networks of the major credit cards) and the Secure Electronic Transactions protocol (a standard for presenting credit card transactions on the Internet), as well as First Virtual (a way of using e-mail to secure approval for credit card purchases of information), GC Tech (a payment system that can use credit or debit via an intermediation server), and NetBill (a publicprivate-key encryption system for purchasing information).
In today's banking world, money consists of ledger entries on the books of banks or other financial institutions. A checking account, also known as a demand deposit account (DDA), records deposits by the consumer and can be used, via the consumer's instructions in the form of a check, to make payments to third parties. Typically, a check is written by a consumer, authenticated by signature, and presented to a merchant, who may endorse it with a signature before presenting it to a bank for payment. If the merchant's bank and the consumer's bank are the same, it can simply transfer the funds on its ledgers from the consumer's account to the merchant's. If the payer and the payee keep accounts at different banks, the payee bank presents the check for settlement to the payer's bank and receives the funds in return through a settlement system. Several private check clearinghouse systems, as well as the Federal Reserve system, provide settlement services in the United States [Fig. 1].
When checks are sent to banks for deposit, merchants do not yet know if consumers have adequate funds and therefore need to find out whether the checks cleared. Similarly, consumers receive statements from their banks showing which checks have been paid. Any discrepancy between bank records and those of the payers may indicate that forged checks were presented against consumers' accounts.
This model works equally well when there is a negative balance in consumers' accounts, at least if the consumers' banks are willing to extend credit--that is, to lend the consumers funds needed to pay off the checks. Many banks in the United States and Europe provide such credit facilities, sometimes referred to as "overdraft protection." A credit card is another example of an account that lends money to the consumer.
The simple model below illustrates the major issues that must be addressed in designing an electronic credit or debit system.
- Naming: there must be an unambiguous way of identifying the payers' bank accounts and the payees' bank accounts.
- Signatures: it must be possible for the payers' banks to verify that payment instructions were generated by people authorized to use accounts.
- Integrity: electronic checks should be difficult to alter.
- Confirmation: payees must have confirmation that transfers took place; payers must have notification of transfers out of their accounts.
- Confidentiality: third parties should not be able to monitor such payments.
- Settlement: separate banking institutions must have a way of settling their accounts.
Such a system does exist for paper checks. In the United States and Canada, a bank identification code and account numbers are encoded in magnetic ink on the check. But the naming of accounts is not standardized internationally. Payees provide their account numbers when endorsing checks. The payers' banks match the signatures on checks with customers' signatures on file at banks. Integrity is ensured by the use of special paper and the practice of writing checks in ink with no alterations. The U.S. Federal Reserve system provides a vehicle for settlement, and confirmation takes the form of periodic statements or special notices for bounced checks. If checks are presented in person or mailed in sealed envelopes, they are generally protected from observation by third parties.