"Forensic accounting" sleuths are taking advantage of sophisticated programs to catch the crooks in action.
In the 1920s, Frank Benford, a physicist at General Electric (GE), discovered an astonishing mathematical law: In just about any given set of numerical data, numbers occur as the first or second digit at a predictable rate. For example, "1" will appear as the first digit 31% of the time, but "9" will appear first only 5%. While that sounds unlikely, Benford tested lists of numbers from many different sources -- accounting ledgers, geographic data, even magazine articles -- and found that the same probability persisted.
Applied to accounting, Benford's Law makes for a great way to check to see if numbers are fabricated (since when liars make up figures, they usually don't follow the same statistical pattern Benford identified). The law is now enjoying booming popularity as the basis for a fairly easy, routine test that's used to uncover accounting fraud. Easy, that is, if you have a sophisticated software package and enough high-powered computers to crunch numbers from reams of documents.
In 2002, Darrell Dorrell, a principal at accounting firm Financial Forensics in Lake Oswego, Ore., used a computer program to apply Benford's Law to more than 21,000 payroll records of a health-care company accused of defrauding investors. He found that the number "0" turned up as the second digit in the payroll records twice as often as it should have, and "5" showed up 60% more often than would be expected. With that information, plus lots more evidence from other tests, he reported to the company's receiver that the records "appear to be contrived."
FUELED BY FEAR. Benford's Law provides just one small example of the way in which technology used to uncover accounting fraud has been growing in both sophistication and popularity. The growth hasn't really been stimulated by technological innovation, which has mostly amounted to fine-tuning sleuthing programs so that they issue fewer false alarms, customizing such programs for use with new industries, and upping raw computing power so the programs can crunch more data. Instead, the boom is being fueled by accounting scandals, terrorism threats, and new regulations such as the Sarbanes-Oxley financial-disclosure law and the Patriot Act, which both require companies to be more vigilant about avoiding financial fraud and about keeping employees honest.
All of those threats "have made businesses more aware of the potential catastrophic damage to organizations that fraud presents," says Toby Bishop, president of the Association of Certified Fraud Examiners. "In the past, companies were unwilling to spend money on solutions until they had a bad experience," he adds. But over the past couple of years, "financial-statement fraud has risen to the top of the agenda."
Partly, that's because of the weak economy, says Carolyn Newman, president and co-founder of Houston-based Audimation Services, which sells software that's used by forensic accountants. "When individuals have a financial need, or a need to protect their jobs, they're more likely to commit or participate in fraud," she says.
EYE-GRABBING RESULTS. However, despite the high-profile instances of malfeasance that have plagued Corporate America lately, the companies leading the charge to find fraud are trying to root out dishonest customers more than crooked executives. In the last 10 years, credit-card companies have cut their losses due to card theft in half using programs like Fair Isaac's (FIC) Falcon Fraud Manager, which flags potentially bogus transactions at checkout based on analysis of past spending patterns by cardholders. And software that's used to spot insurance fraud typically delivers a return on investment of more than 300%, says Bishop. "Those are figures that will grab the eye of any chief financial officer," he adds.
Returns are so high because fraud-finding software, including programs used by auditors to check a company's financial records, is better than ever. While auditors typically sample small portions of data to check that accounting policies are being followed, now they can easily check every transaction, a capability identified by the oxymoron "100% sampling."
"We're in a complex business environment where the number of transactions companies have to monitor has increased in conjunction with more regulation," says Harald Will, chief executive of Vancouver (B.C)-based ACL Services, a leading provider of software for internal audits. ACL will debut its "Continuous Monitor" suite of software tools in mid-October. "Companies need to manage the risks, ensure that controls are working properly, monitor the integrity of transactions -- and they need to do it continuously," Will says. "The only way they can do that is with technology."
CONFLICT CHECKERS. Increasingly, companies are also using outside databases to look for relationships between potential new hires and business units, with an eye to uncovering conflicts of interest or illegal activity. The latest systems will scroll through payment information looking for suppliers that aren't listed in any online commercial database -- a possible sign that they aren't legit -- or that operate from addresses that have been associated with fraud in the past.
From its Springfield (Va.) home base, a company called I2 sells the "Analyst's Notebook," a program developed for law-enforcement agencies but becoming more widely used in corporate settings. One of its corporate tasks is to check for conflicts of interest on a company's board of directors. The software will troll through open databases, like D&B (DNB ) or LexisNexis, to look for connections between individuals and companies. Then it will illustrate the connections graphically, with lines connecting people and organizations.
"We can take three feet of written documents and turn them into a picture that shows relationships," claims Jack Reis, I2's president. He has noted increasing demand from forensic accountants -- those who look for fraud. "I expect we're going to see more," he says.
ELIMINATE OPPORTUNITIES. Large accounting firms tend to develop their own, proprietary software for forensic accounting that performs many of the same checks as off-the-shelf programs. And internal auditors at companies that want to do detective work on the cheap often use basic desktop applications such as Microsoft Excel and Access (a database management program) to hunt for fraud. For example, they might use those programs to identify duplicate payments to the same vendor.
Eventually, says the ACFE's Bishop, basic accounting software will incorporate many of the tools that now come in anti-fraud programs. Even as that happens, companies that specialize in accounting technology will develop many more ways to either prevent fraud or find and close loopholes before they can be exploited. "Frauds that are possible will happen," says Bishop. "The key is to minimize the opportunity." And for the good guys, that's a never-ending task.
By Amey Stone in New York
Some time today, Tuesday 27th January, the U.S. Senate Finance Committee meets in Washington D.C to hear testimony on the mutual funds scandal. Included is this written testimony.
Abstract: Mutual funds are vulnerable to abuses involving market timing and late trading. Primarily, this is due to a failure of governance, and the delayed nature of settlement of both payments and transfers. This vulnerability is only exploited over time, through a progression of small steps that, individually, raise no alarm, but in sum, cross the line of acceptable behaviour. Solutions to the abuses will be found not in more regulation, but in open governance and a move towards real time gross settlement.
There's also PDF and PS on the same page at http://iang.org/papers/.
How do you specify the contract, and then link it into the systems such that all this boring paper disappears? One answer is the domain specific encoding approach, another is the natural language approach. An example of the latter is Ricardian Contracts, and here is an example of the former, domain specific encoding, method by a company called LexiFi .
Lexifi have created a language that allows specification of an entire set of contract possibilities within one narrow market. For example, if one considers the trades that occur between traders in an institutional options market, each trade can only have a score or so paramaters.
The language developed by this company, MLFi, claims to reduce such contracts down to 20 elements, and from there it is possible to compose the full set of contracts.
This seems to work well in a market where one contract is easily relatable to another - perhaps where these contracts are fungible by some measure or other. But, I wonder if it works outside a specific domain? When I see an example of a contract itself I might be able to answer that question.
( another cousin is Risla which finds this entry in
citeseer which says this:
"The Risla project has met its targets: the time it costs to introduce a new product is down from an estimated three months to two or three weeks. Moreover, financial engineers themselves can use the questionnaire [tool] to compose new products. Furthermore, it has become much easier to validate the correctness of the software realization of the interest rate products. In addition to that, the component library appears to be useful for other product families, such as insurances or options."
)
Simon's blog picks up a Wired article on sales of Ring Tones - $3.5bn this year. The comparisons were more useful: that's 10% of the world music market of $32bn, which again is beaten by the world SMS market: $40bn.
For those who don't know what SMS is, it's IM for phones. Yes, they charge for those messages, and "That figure is expected to explode as phone users get into the habit of sending multimedia and picture messages!"
Ring Tones Bringing in Big Bucks
12:57 AM Jan. 13, 2004 PT
http://www.wired.com/news/business/0,1367,61903,00.html?tw=newsletter_topstories_html
LONDON -- Sales of mobile-phone ring tones, those tiny song recordings programmed into millions of cell phones around the world, jumped 40 percent in the past year to $3.5 billion, according to a study released Tuesday.
The worldwide sale of ring tones, which started as a marketing gimmick for music labels and mobile phone companies, is roughly equivalent to 10 percent of the $32.2 billion global music market.
Replacing the standard phone ring with a few bars from Elvis or a favorite TV show was first popularized by tech-savvy teenagers in the late 1990s.
The subsequent success of ring tones is a rare bit of good news for the music industry, which has been stung by Internet piracy and fickle fans who would rather spend their money on video games than compact discs.
The popularity is also an important revenue generator for indebted mobile-phone operators who have invested vast sums on the roll-out of 3G phone networks.
Revenues for ring tones are divided between the music labels, their artists and mobile-phone operators. The average price of a ring tone is 60 cents, according to the study by London-based telecommunications consultancy, The Arc Group.
"It's become a very profitable area and there's strong growth ahead," said Richard Jesty, an analyst for The Arc Group.
Ring tone prices vary widely by region, with SK Telecom Co, South Korea's largest mobile carrier, charging the equivalent of 20 cents while Britain's Vodafone charges roughly $2.75, Jesty said.
He forecast that sales will remain brisk through 2008 when downloads will top $5.2 billion. But as higher-power phones come on the market, consumers will turn to downloading larger files such as video games, sport highlights and short video clips.
As is the case with other forms of music, piracy is a problem with a host of small websites selling cheap music downloads without authorization from music companies.
Ring tones and games still lag well behind basic text messaging, which generated $40 billion last year for mobile phone companies. That figure is expected to explode as phone users get into the habit of sending multimedia and picture messages, Jesty said.
The program for CodeCon 2004 has been announced.
CodeCon is the premier showcase of active hacker projects. It is a workshop for developers of real-world applications with working code and active development projects. All presentations will given by one of the active developers, and accompanied by a functional demo.
Highlights of CodeCon 2004 include:
PGP Universal - Automatic, transparent email encryption with zero clicks
Osiris - A free Host Integrity Monitor designed for large scaleserver deployments that require auditable security
Tor - Second-generation Onion Routing: a TCP-based anonymizing overlay network
Vesta - An advanced software configuration management system that handles both versioning source files and building
PETmail - Permission-based anti-spam replacement for SMTP
FunFS - Fast User Network File System - An advanced network file system designed as a successor for NFS
Codeville - Distributed version control system
Audacity - A cross-platform multi-track audio editor
The third annual CodeCon takes place February 20 - 22, noon - 6pm, at Club NV (525 Howard Street) in San Francisco. CodeCon registration is $95; a $20 discount is available for attendees who register online prior to February 1, 2004.
http://www.codecon.org/2004/registration.html
Another sign of the increasing maturity of the DGC ("Digital Gold Currency") sector is in this article over on the Gold Economy blog/news site. The hallmark of a mature sector - independent analysis of the things the Issuers would rather keep mum about!
With a sample of 2000 independent exchange provider fraud reports, it was possible to graph where most of the fraud was. e-gold leads with 82% which is probably due to its massive lead in number of transactions. eBullion comes second, with 7%, indicating many transactions as well, possibly.
What is less easily explainable is goldmoney's position - they are down in the noise level, with Pecunix at 1% total. As goldmoney is now the star mover in this field (recently confirmed as on track growth of 4xpa), this is a surprisingly low figure. See the relative bar chart in red.
I don't think it's to do with goldmoney's technical systems. I more think it is to do with their consistent and aggressive positioning from their very first days - they couched themselves as having a zero tolerance for frauds, even to the extent of suggesting that they would break the accepted norms of the highly libertarian DGC society if they had to - privacy, sanctity of contracts etc.
Now it is paying off with lower fraud activity, and thus lower costs.
PS: originally this entry referred to a diffferent article on a dispute between two issuers. It only referred glancingly to the fraud figures. New article, linked above is more focused.
As I was walking past my local supermarket, a pleasant looking young man handed me a leaflet explaining how I could acquire "Adult Website Prepaid Cards" that would let me browse instantly without the need of a credit card - no personal information required.
I'll spare you the details (quite mild and uninteresting, especially for anyone who suffers under 100 spams a day).
The point here is that if I can be handed this near my local supermarket, this means that alternate payment systems are now well-entrenched in the "fringe" world of Adult content.
This development has been expected for years, ever since Visa and various US and other regulators launched their cleanup campaign. In some senses it is a surprise that it has taken so long; in other senses, one can understand that building an alternate payments system that works is really a tough job, above and beyond the call of your average entrepreneur. (Hats off to those who succeed.)
In a sense, those in Visa got what they desired - the cleanout of all "undesirable" businesses within their system, and the spawning of dozens of hundreds of alternate payment systems.
Hardware tokens from PicoDisk start at about 30 Euros for a 32Mb store that could fit on your keyring. These Italian stallions even have one that boasts AES encryption, and another with a biometric fingerprint sensor, for what it's worth...
Big enough to carry your secret keys, your transactions and your entire copy of WebFunds! You have to pay a bit more to get Java installed on them, but they do go up to a whopping 2Gb.
Of course, serious FCers know that the platform that runs your financial application also has to be secure, but nothing's perfect. These cheap tokens could go a long way to covering many of the sins found in "common windowing environments'" predeliction to being raided by viruses.
(I've since found out that these tokens are only accessible from Windows, and drivers are "closed". Whoops. My interest just hit the floor - it's hard enough to integrate these sorts of things into real apps without the supplier trying to stop you using them. Apologies for wasting your time!)
Finally, an online Law dictionary . I can now look up what the definition of a contract is, at least according to "The Real Life Dictionary of the Law" which is the paper version of this dictionary.
Caveat Lector - the authors, Gerald and Kathleen Hill , are dyed in the wool UC Berkeley Democrats. I hear the 9th circuit is the most dynamic and progressive rewriter of the law on the planet. If you like that sort of thing, you'll be in clover!
Read on if you want to share the definition of a contract.
contract
1) n. an agreement with specific terms between two or more persons or entities in which there is a promise to do something in return for a valuable benefit known as consideration. Since the law of contracts is at the heart of most business dealings, it is one of the three or four most significant areas of legal concern and can involve variations on circumstances and complexities. The existence of a contract requires finding the following factual elements: a) an offer; b) an acceptance of that offer which results in a meeting of the minds; c) a promise to perform; d) a valuable consideration (which can be a promise or payment in some form); e) a time or event when performance must be made (meet commitments); f) terms and conditions for performance, including fulfilling promises; g) performance, if the contract is "unilateral". A unilateral contract is one in which there is a promise to pay or give other consideration in return for actual performance. (I will pay you $500 to fix my car by Thursday; the performance is fixing the car by that date.) A bilateral contract is one in which a promise is exchanged for a promise. (I promise to fix your car by Thursday and you promise to pay $500 on Thursday.) Contracts can be either written or oral, but oral contracts are more difficult to prove and in most jurisdictions the time to sue on the contract is shorter (such as two years for oral compared to four years for written). In some cases a contract can consist of several documents, such as a series of letters, orders, offers and counteroffers. There are a variety of types of contracts: "conditional" on an event occurring; "joint and several," in which several parties make a joint promise to perform, but each is responsible; "implied," in which the courts will determine there is a contract based on the circumstances. Parties can contract to supply all of another's requirements, buy all the products made, or enter into an option to renew a contract. The variations are almost limitless. Contracts for illegal purposes are not enforceable at law. 2) v. to enter into an agreement.
See also: adhesion contract bilateral contract consideration oral contract unilateral contract
Place this dictionary on your site
What fantastic news for the open source community ... This week's cryptogram reports that Adobe has added anti-money-counterfeiting technology to products.
What is not openly revealed is which products and how it works. My first knee-jerk obvious reactions are confirmed, almost paragraph by paragraph - this is going to backfire on Adobe. Read on for the full fascinating story...
Posted on Fri, Jan. 09, 2004
Adobe Helped Gov't Fight Counterfeiting
TED BRIDIS
Associated Press
WASHINGTON - Adobe Systems Inc. acknowledged on Friday it quietly added technology to the world's best-known graphics software at the request of government regulators and international bankers to prevent consumers from making copies of the world's major currencies.
The unusual concession has angered scores of customers.
Adobe, the world's leading vendor for graphics software, said the secretive technology "would have minimal impact on honest customers." It generates a warning message when someone tries to make digital copies of some currencies.
The U.S. Federal Reserve and other organizations that worked on the technology said they could not disclose how it works and wouldn't name which other software companies have it in their products. They cited concerns that counterfeiters would try to defeat it.
"We sort of knew this would come out eventually," Adobe spokesman Russell Brady said. "We can't really talk about the technology itself."
A Microsoft Corp. spokesman, Jim Desler, said the technology was not built into versions of its dominant Windows operating system.
A rival graphics program by Ulead Systems Inc. also blocks customers from copying currency.
Adobe revealed it added the technology after a customer complained in an online support forum about mysterious behavior by the new $649 "Photoshop CS" software when opening an image of a U.S. $20 bill.
Kevin Connor, Adobe's product management director, said the company did not disclose the technology in Photoshop's instructions at the request of international bankers. He said Adobe is looking at adding the detection mechanism to its other products.
"The average consumer is never going to encounter this in their daily use," Connor said. "It just didn't seem like something meaningful to communicate."
Angry customers have flooded Adobe's Internet message boards with complaints about censorship and concerns over future restrictions on other types of images, such as copyrighted or adult material.
"I don't believe this. This shocks me," said Stephen M. Burns, president of the Photoshop users group in San Diego. "Artists don't like to be limited in what they can do with their tools. Let the U.S. government or whoever is involved deal with this, but don't take the powers of the government and place them into a commercial software package."
Connor said the company's decision to use the technology was "not a step down the road towards Adobe becoming Big Brother."
Adobe said the technology slows its software's performance "just a fraction of a second" and urged customers to report unexpected glitches. It said the technology was new and there may be room for improvement.
The technology was designed recently by the Central Bank Counterfeit Deterrence Group, a consortium of 27 central banks in the United States, England, Japan, Canada and across the European Union, where there already is a formal proposal to require all software companies to include similar anti-counterfeit technology.
"The industry has been very open to understanding the nature of the problem," said Richard Wall, the Bank of Canada's representative to the counterfeit deterrence group. "We're very happy with the response."
He said nearly all counterfeit currency in Canada is now created with personal computers and ink-jet printers.
"We've seen a shift of what would normally be highly skilled counterfeiters using elaborate equipment to basically counterfeiters who need to know how to use a PC," Wall said.
Some policy experts were divided on the technology.
Bruce Schneier, an expert on security and privacy, called the anti-counterfeit technology a great system. "It doesn't affect privacy," he said. "It stops the casual counterfeiter. I can't think of any ill effects."
Another security expert, Gene Spafford of Purdue University, said Adobe should have notified its customers prominently. He wondered how closely Adobe was permitted to study the technology's inner-workings to ensure it was stable and performed as advertised.
"If I were the paranoid-conspiracy type, I would speculate that since it's not Adobe's software, what else is it doing?" Spafford said.
ON THE NET
Adobe Systems: www.adobe.com
Facts about banknote images: www.rulesforuse.org
Bureau of Engraving & Printing: www.moneyfactory.com
--
Additionally, stories on inevitable circumvention .
http://www.technologyreview.com/articles/huang1203.asp?p=0
A new generation of e-payment companies makes it easy to "pay as you go" for inexpensive Web content, portending big profits for online businesses.
By Gregory T. Huang
December 2003/January 2004
Ask Ron Rivest if he's ever been whisked away by the CIA in the middle of the night, and he laughs-but he doesn't say no. At Peppercoin, a two-year-old MIT spinoff in Waltham, MA, the renowned cryptographer oversees an operation far less secretive than an intelligence agency but almost as intense: a clearinghouse for electronic "micropayments," pocket-change transactions that may finally allow magazines, musicians, and a multitude of others to profit from selling their wares online. It's September, and with only weeks to go until commercial launch, Peppercoin's software engineers troubleshoot at all hours. Marketing executives shout across the room and over the phone, making deals.
But in the eye of the storm, Rivest is calm and collected. Eyes sparkling, real change jingling in his pocket, he even wears sandals with authority. What Peppercoin is trying to do, he says, is make it easy to "pay as you go" for inexpensive Web content-so you won't need to pay subscription fees, limit yourself to free content, or share files illegally. With a click of the mouse-and Peppercoin's software churning away behind the scenes-you can now download a single MP3 from an independent-music site, watch a news video clip, or buy the latest installment of a Web comic from your favorite artist. All for just pennies.
It sounds simple, but it wasn't possible a few months ago. Most Web merchants still can't support micropayments-transactions of about a dollar or less-because the processing fees from banks and credit card companies erase any profit. But Peppercoin, the brainchild of Rivest and fellow MIT computer scientist Silvio Micali, is in the vanguard of a new crop of companies-including BitPass of Palo Alto, CA, and Paystone Technologies of Vancouver, British Columbia-that make cash-for-bits transactions superefficient. These companies' founders are well aware of the string of defunct e-payment companies whose virtual currencies have gone the way of the Confederate dollar. But they've got something new up their sleeves: easier-to-use technology that allows Web sites to accept tiny payments by effectively processing them in batches, thereby cutting down on bank fees.
So throw out your current conceptions of Web surfing. Rather than sifting through pop-up ads and subscription offers, imagine dropping a quarter on an independent film, video game, specialized database, or more powerful search engine. If programmers and Web artists could profitably charge a few cents at a time, their businesses could flourish. And with an easy way for users to buy a richer variety of content, experts say, the current deadlock over digital piracy could effectively dissolve, giving way to a multibillion-dollar business stream that rejuvenates the wider entertainment industry the same way video rentals did Hollywood in the 1980s. Down the road, cell phones, personal digital assistants, and smart cards equipped with micropayment technology could even supplement cash in the real world.
"The key is timing and technology," says Rivest, who thinks Peppercoin has both right. The company's technical credibility, at least, is not an issue. Rivest coinvented the RSA public-key encryption system, used by Web browsers to make credit card purchases secure. Micali holds more than 20 patents on data security technologies and won the 1993 Gödel Prize, the highest award in theoretical computer science. Their system uses statistics and encryption to overcome profit-erasing transaction fees; the approach is unique and more efficient than its predecessors.
The timing looks good, too-not just for Peppercoin, but for other micropayment companies as well. "One year ago, it was, 'Will people pay?' Now it's, 'How will they pay?'" says Ian Price, CEO of British Telecommunications' Click and Buy division, which uses micropayments to sell articles, games, and other Web content to customers in more than 100 countries. And in September, Apple Computer announced that its online music store sold more than 10 million 99-cent songs in its first four months. Apple's success was the "starting gun for a track meet of companies" planning to roll out pay-per-download services by 2004, says Rob Carney, Peppercoin's founding vice president of sales and marketing.
Indeed, 40 percent of today's online companies would sell content they're currently giving away if they had a viable micropayment system, says Avivah Litan, an analyst at Gartner Research who specializes in Internet commerce. According to Forrester Research, the market for music downloads is expected to grow from $16 million in 2003 to $3 billion in 2008. And a Strategy Analytics report states that mobile-gaming revenues could top $7 billion by 2008. "The market is ready" for micropayments, says Rivest.
Even so, getting the technology to take off won't be easy. Micropayment companies need to make their systems fully reliable, secure, and easy to use. Just as important, they need to increase demand by working with Web businesses to deliver a broader range of digital products. So on the eve of Peppercoin's commercial launch, the question is not whether the timing and technology are good. It's whether they're good enough.
In Statistics We Trust
Understanding Peppercoin requires a little history. According to old English common law, the smallest unit of payment that could appear in a contract was a peppercorn. Silvio Micali's wife, a professor of law, suggested that as the name for his startup back in 2001, and it stuck (becoming "Peppercoin" for the sake of clarity). Now, in his office at MIT's Computer Science and Artificial Intelligence Laboratory, Micali is explaining what makes Peppercoin tick. On hand are technical books and papers in neat piles, should we need them. It's simple mathematics, says Micali-but don't believe him.
Micali knows two things: cryptography and coffee. His micropayment analogies involve cappuccinos. There are two standard ways of buying digital content, he says. One is like prepaying for a certain number of cappuccinos, the other like getting a bill at the end of the month for all the cappuccinos you've had. That is, the customer either pays up front for a bundle of content-say, 10 archived New York Times articles-or runs a tab that's settled every so often. The problem with both models is that the seller has to keep track of each customer's tab, and the buyer is locked into a particular store or site. But in the spring of 2001 came a "very lucky coffee break" when Micali and Rivest, whose office is just down the hall, put their heads together. "We started discussing this problem, and within minutes we had the basic solution," says Micali. "And we got very excited! First, from the discovery. Second, from the coffee."
What they discovered was a way to cut the overhead cost of electronic payments by processing only a statistical sample of transactions, like taking a poll. On average, Peppercoin might settle, say, one out of every 100 transactions-but it pays the seller 100 times the amount of that transaction. Given enough transactions, it all evens out, says Micali
It looks simple to the buyer, who only has to click on an icon to charge an item to her Peppercoin account, but the action behind the scenes is pretty complicated. In beta tests, special encryption software runs on both the buyer's and seller's computers, protecting their interactions from hackers and eavesdroppers. And encrypted in each transaction is a serial number that says how many purchases the customer has made over time, for how much, and from whom.
Ninety-nine transactions out of a hundred are not fully processed-but they're still logged by the seller's computer. One transaction out of a hundred, selected at random, is sent to Peppercoin. After Peppercoin pays the seller 100 times the value of that transaction, it bills the customer for all of her outstanding purchases from all sites that use Peppercoin. Since about one out of a hundred purchases is processed, her last bill will have come, on average, a hundred purchases ago. That's the trick: by paying the seller and charging the customer in lump sums every 100 purchases or so, Peppercoin avoids paying the fees charged by credit cards-roughly 25 cents per transaction-on the other 99 purchases. "This is fantastic," says Greg Papadopoulos, chief technology officer at Sun Microsystems and a member of Peppercoin's technical advisory board. "Ron and Silvio have done what needed to be done-get the cost of transactions down without ripping up the existing infrastructure of credit cards and banks."
But what's to keep all this fancy statistical footwork from cheating sellers out of their due? And what's to keep buyers and sellers both from cheating the system? "That's the secret sauce," says Micali.
He's talking about cryptography, the sweet science of codes and ciphers. Its inner workings are, well, cryptic-paper titles at conferences include things like unimodular matrix groups and polynomial-time algorithms-but it's used every day to keep communications, documents, and payments secure. Roughly speaking, says Rivest, statistical sampling of transactions makes the system efficient, while cryptography keeps the random selection process fair and secure. So Peppercoin charges users exactly what they owe, and if Peppercoin's payment to the seller happens to be more or less than the value of the purchases customers actually made, the discrepancy is absorbed by the seller. Over time, this jiggle will become negligible, especially compared to the amount of money Web sites will make that they couldn't make before.
Think about it for too long, and most people get a headache. But Micali and Rivest have been thinking about this sort of thing for 20 years, so they make a formidable and complementary team: Micali is as animated as Rivest is understated, like fire and ice. "They've done brilliant work over the years," says Martin Hellman, a professor emeritus of electrical engineering at Stanford University and a pioneer in cryptography going back to the 1970s. "Peppercoin has a clever approach."
But clever mathematics aside, the proof is in the pudding. In the end, Peppercoin's executives say, their system must be as easy to use as cash. Perry Solomon, Peppercoin's founding CEO, explains it this way, pulling some change out of his pocket. "I can give you this quarter, and you can look at it quickly and say, 'Okay, that's a quarter.' You don't need to call the bank to verify it." Online merchants, however, must check a credit card holder's identity and available credit before approving a purchase. Going to that trouble makes sense for a $50 sweater or a $4,495 Segway transporter, but not for a 50-cent song. So Peppercoin's software stamps each transaction with the digital equivalent of e pluribus unum-a guarantee to the seller that it's Peppercoin handling the transaction, and that payment is forthcoming. The seller can quickly verify this stamp and deliver the goods.
Bootstrapping with Bits
The theory may be impeccable, and the founders' credentials outstanding, but how does a startup transform a micropayment system into a practical, sellable product? That's the stuff of late-night whiteboard discussions enhanced by takeout Chinese food and bad TV movies, says Joe Bergeron, Peppercoin's vice president of technology. Bergeron, a baby-faced programming whiz, has the task of translating Rivest and Micali's algorithms into software. Like any good engineer at a startup, he has spent many a night under his desk trying to squeeze in a few hours of sleep. "I'm dreaming in Peppercoins now," he says.
Minting micropayments starts with hardware. A secure data center a few kilometers from company headquarters houses hundreds of thousands of dollars' worth of computing horsepower and memory. All of Peppercoin's money transfers flow electronically through these machines. A rack of 20 processors and backups and four levels of hardware security are set up in a special cage walled off by Plexiglas guaranteed to withstand a 90-minute riot; the rental contract even specifies that the cage will repel "small-arms fire and manual tools."
First Out of the Gate
Andreas Gebauer remembers the pesky young guy well. Five times in 2000, Firstgate Internet founder Norbert Stangl showed up at the Berlin offices of Stiftung Warentest (Product Testing Foundation), Germany's leading consumer reports magazine, to peddle his e-payment technology. Five times Gebauer, the magazine's online editor, said he wasn't interested. Finally, on the sixth trip, Gebauer agreed to give it a try if Stangl would just leave him alone.
Persistence pays off. "We've been very successful," says a converted Gebauer. In the three years since Stiftung Warentest adopted Firstgate's system, its monthly online revenues have skyrocketed from $5,000 to more than $100,000. And today, while the U.S. micropayment market is still in its early stages, Firstgate has some 2,500 merchant users and almost two million paying customers in Europe-and pulls in more than $1 million a month in revenues, making it one of the world's leading e-payment and distribution companies. Its users in media and publishing, the fastest-growing market segment, include the Independent, Der Spiegel, Reader's Digest, Encyclopedia Britannica, and Gruner and Jahr.
Firstgate's software, unlike Peppercoin's, must keep track of every transaction, and most are dollars rather than cents. But it works. Web customers can go to any Firstgate-enabled site, click on an article, and read it. They are billed via their credit card, debit card, or phone bill once they accrue a few dollars in charges. The system works by fetching digital content from Web merchants and delivering it only to paying customers. Firstgate charges a setup fee for merchants and pockets 10 to 30 percent of each transaction. (That may sound steep, but for micropayments, Firstgate can be cheaper than a credit card company.) Meticulously hand-tailored, the system has won a slew of European industry and consumer awards. "It's finely tuned, like a BMW," says Ian Price, CEO of British Telecommunications' Click and Buy division, which has partnered with Firstgate to sell online games, articles, and even a voting mechanism for interactive TV shows.
Most important, Firstgate has proven that a global market exists for Internet content priced in the $1 to $10 range, says Stangl, who is now the company's chairman. In late 2002, the company set up offices in New York. How will its success in signing up newspapers, magazines, and other media groups translate to the U.S. market? "We have experience working with so many online companies," says George Cain, Firstgate's CEO in North America. "What people are thinking about here, we've already got built into our system."
But Peppercoin's system must also be bulletproof to electronic problems. Take transaction speed, for instance. Peppercoin is working with one Web site that delivers 1,000 digital maps per second. For Peppercoin to handle that many purchases, and for buyers to get their content without waiting, the behind-the-scenes computations must happen in milliseconds. As Bergeron explains, sketching a flow chart on a whiteboard, the software module that identifies what the buyer is paying for, verifies that the payment is good, and sends the digital content to the buyer has been taking a few milliseconds too long in beta tests. The solution: do these steps in parallel, and manage customer queries in a flexible way by devoting more computing resources to the steps that take longer. Trimming bits of fat like this saves precious processing time per click-and ultimately keeps the system running efficiently.
Perhaps even more crucial to Peppercoin's success, though, is its sales strategy. "The challenge isn't getting people to buy the math. It's enabling a new business model for the Web," says Rob Carney. In two respects, micropayment startups are fundamentally different from online person-to-person payment companies like Mountain View, CA-based PayPal, one of the most successful of e-payment companies. First, they are enabling Web merchants to sell low-priced digital content, not physical items. Second, they don't have anything approaching the captive market that PayPal has in the customers who use eBay, the San Jose, CA, online auction house that purchased PayPal in 2002.
So Peppercoin's plan-similar to those of other micropayment startups (see table "The Micropayment Movement,")-is to go after Web merchants, work with them to decide what kinds of content to sell, and build up a brand name with which to approach larger distributors. It's a painstaking process; Solomon and Carney have attended more than 400 sales meetings in two years, trying to persuade merchants that Peppercoin's own fees-which work out to be much lower than the flat transaction fees charged by credit cards-are a small price to pay for the extra business micropayments will generate.
But all this work is starting to pay off. "Peppercoin has been a huge benefit for us," says Rex Fisher, chief operations officer at Music Rebellion, a Terre Haute, IN, company that last June started selling 99-cent MP3s by the download, using a beta version of Peppercoin's system. The bottom line: micropayments allow the music site to triple its profit margin, as compared with traditional payment methods. As for the user interface-buyers sign up for a Peppercoin account and then click on music icons to charge songs-Fisher says he's working with Peppercoin to make it "easy and hassle free." He acknowledges that it's still early, however, and that results in the next year will say more about the overall success of micropayments.
Other users go further in their praise for e-payments as enablers of new kinds of Web content. "The promised land is filled with micropayments," gushes David Vogler, a digital-entertainment executive formerly in charge of online content at Disney and Nickelodeon. One of Vogler's current ventures is a humor site called CelebrityRants.com. There, using Peppercoin's software, you can buy animated recordings of embarrassing diatribes or confessions from celebrities caught on tape-everyone from Britney Spears to new California governor Arnold Schwarzenegger. "We explored many solutions, but Peppercoin seemed like the right horse to bet on," says Vogler. Moreover, he adds, it was "insanely easy" to get the system up and running. That and a painless consumer experience seem to be the keys to early adoption.
So this is how it starts: not with a conglomerate of media giants adopting micropayments, but with pockets of small entertainment and Web-services sites. Plenty of sites will still be free, supported by advertising, says Carney. But micropayments, alongside ad sales and subscriptions, will become another leg of the stool that supports Web businesses. And micropayment companies are hoping that their systems will give entrepreneurs and consumers the freedom to try out new kinds of commerce on the Web, and to buy and sell an ever wider variety of digital goods. "The Web was dying," says Kurt Huang, CEO of BitPass, a micropayment startup he cofounded while he was a graduate student at Stanford University. "We needed to do something to change its economics."
Take Web comics. Today there are more than 3,000 online cartoonists worldwide, and that number is growing fast, says Scott McCloud, an author and Web comic artist based in Newbury Park, CA. "Micropayments are the missing piece of the puzzle," he says. Using a beta version of BitPass's technology-users prepay a few dollars into an account-McCloud sold 1,500 copies of his comics for 25 cents each in eight weeks. Not huge numbers, to be sure, but the potential for steady growth is there. And it's not supplementary income-this is how Web artists will make their money. "We're not just slapping a price tag on what could be free," says McCloud. "This is allowing us to do work that we couldn't do before."
The Micropayment Movement
Company Technology Market/Status
BitPass (Palo Alto, CA) Costs of Web content and services are deducted from an account
prepaid via credit card or PayPal Independent artists, publishers, musicians; beta trials under way; commercial release in late 2003
Firstgate Internet (Cologne, Germany) Servers fetch Web content and deliver it to customers; charges
appear on credit card or phone bill News and analyst reports; in operation since 2000; nearly two million customers in Europe
PayLoadz
(New York, NY) Delivers digital items via e-mail after users have paid using PayPal Electronic books, music, software; commercial release in May 2002;
9,600 sellers signed up
Paystone Technologies
(Vancouver, British Columbia) Customer accesses Web content after paying via bank account Music, publishing; commercial release in May 2003; 700 sellers signed up
Peppercoin
(Waltham, MA) Uses statistics and encryption to process a sample of transactions; users pay via credit card once per 100 or so transactions Music, games, publishing; commercial release in late 2003
The Coin-Op Web?
In the 1990s, e-payment startups like DigiCash, Flooz, and Beenz crashed because dot-com companies didn't think they needed the technology to make money, and because consumers expected Web content to be free. Times have changed, but there are still plenty of skeptics who doubt micropayments will catch on broadly, considering that MP3 listeners and Web-comics fans are the technology's main U.S. consumers so far. Even those who have made their fortunes in the online-payments world acknowledge that it's an uphill battle. "It's quite possible they could fail miserably in this economic climate," says Max Levchin, cofounder and former chief technology officer of PayPal (see sidebar "The PayPal Precedent").
But both the supply of digital content and consumers' willingness to pay for it are increasing, and the micropayment companies' strategy of signing up Web merchants, one at a time, has promise. "There will be small companies who figure out how to play this chicken-and-egg game," says Andrew Whinston, director of the Center for Research in Electronic Commerce at the University of Texas at Austin. "The key is to become successful before big companies like Microsoft get into it."
The PayPal Precedent
Max Levchin believes that micropayment companies' two keys to success are a simple user interface and an aggressive distribution strategy. TR's 2002 Innovator of the Year, Levchin is the cofounder and former chief technology officer of PayPal, the online-payments pioneer that was sold to eBay for $1.5 billion in October 2002.
Technology Review: Are micropayments ready to take off?
Max Levchin: The Apple music store is a good example that 99-cent payments are a reality. What is uniquely different about the market now is that personal publishing has become a lot more pervasive than it was three to five years ago. There are literally thousands of Web sites that specialize in comics, music, and art that's only available on the Internet. [Artists] look to the Internet to actually make money. So demand is definitely increasing. The question is, are these solutions actually what the market needs?
TR: What do Peppercoin and other micropayment startups need to do to become successful?
Levchin: Most of the technical challenge is about the user interface, not the billing process. Overall, Peppercoin's [beta version] user interface is very raw. I have to download software. I have to wait for a confirmation e-mail. What if my computer crashes? You should never force people to download software. The security is a good thing, but it adds complexity.
TR: What's the greatest challenge, going forward?
Levchin: The biggest difficulty, by far, is distribution. How do you get all these people to start using the system? At PayPal, as soon as we "infected" a couple popular eBay merchants, very quickly we saw this massive growth, where buyers started pushing other merchants to sign up. But there isn't a giant market online right now where you can go to look at all digital content available. Digital merchants are very disparate. And consumers aren't going to sign up, download software, or prepay for a card, because there are not that many places to spend it yet. So marketing to digital merchants directly is one way to go. But it will take an incredible amount of human effort to get enough people to sign up.
For a glimpse into the future of micropayments, look overseas. In Japan, most mobile content and services, such as cell-phone users downloading games and ring tones, are paid. And micropayments are becoming prevalent in Europe's publishing and news-media markets. Firstgate Internet, a digital content distributor in Cologne, Germany, has nearly two million customers and 2,500 clients, including British Telecommunications' Click and Buy, and it is bringing in more than $1 million a month in revenues, says founder and chairman Norbert Stangl (see sidebar "First Out of the Gate"). Its most successful kinds of low-price content: news, research articles, and financial reports.
But Firstgate tallies each purchase separately and pays credit card fees, so its own fees are higher for merchants than most micropayment startups'. Peppercoin and BitPass hope to succeed in the U.S. market by being more efficient for small payments. So will micropayments take off here? "The truth is, nobody knows," says Guy Kawasaki, CEO of Garage Technology Ventures, a venture capital firm that is funding BitPass. "But I look around and I see 50,000 unsigned bands in the world. I see thousands of bloggers, analysts, and artists who want to publish their stuff. And how many databases would you want to search for 50 cents?" Asked when he expects to see a return on his investment, the former Apple guru laughs and says, "Before I die!"
Other observers see a clear path to adoption. "The future of micropayments is very simple," says Sun's Papadopoulos. "You'll get to a critical mass on the network. It will become the equivalent of pocket change, and you'll see fierce price competition on digital content." Falling prices, companies hope, will only increase demand. And as digital content gets cheaper, the temptation to pirate should diminish.
We're already seeing competition: last summer, the music-download store BuyMusic.com put up billboards parodying Apple's music ads and undercutting Apple's 99-cent pricing by selling songs for as little as 79 cents. With America Online, MusicMatch, and Roxio (Napster 2.0) launching stores as well, the music industry will be a proving ground-or perhaps a killing field-for e-payment technologies.
As the contest begins, most micropayment startups have enough capital to see them through the rollout phase. In September, Peppercoin announced that it had raised $4.25 million in its second round of venture funding. But in the long run, how will micropayment companies stay in business? Signing up Web merchants is fine now-deals are quick and the need is there-but an eventual goal is to hook up with a distributor that will become the eBay of bits.
So as Peppercoin makes final preparations for its commercial launch, Carney and Solomon make sales calls. Engineers sit on the edges of their seats, watching the ebb and flow of processing loads and user levels on their monitors. Rivest and Micali, ever patient, stay out of the limelight. If victory arrives, it won't come thundering out of the sky. For companies like Peppercoin, success will build up gradually, like coins clinking into a piggy bank, one by one.
A couple of articles on Insider Trading by Sheldon Richman : first part is an analysis of the Martha Stewart case . Second part is a broader look at the concept of Insider Trading .
Is Insider Trading good? Or bad? Here's some personal comments...
It's a tricky question. On the face of it, Insider Trading is a straight out-and-out fraud. An insider has internal information that will - in the insider's opinion - cause the stock price to move. So, she buys or sells ahead of the move, and takes the profits.
This is a straight fraud because it takes money from the shareholder base. The shareholders are poorer because they did not enjoy the benefits of the change in price. Of course, this assumes that an insider cannot also be a shareholder, and therein lies the conflict of interest: an insider has a fiduciary duty to shareholders, which may be breached if acting on the basis of own shareholdings.
However, the real issue that is at the heart of this fraud is that, economically, it's pretty nigh on impossible to detect and prosecute. In practical terms, the information is a) in the heads of the insiders, b) subject to misinformation constraints as much as any market noise, and c) hard to determine as being "inside" or "outside" some magic circle.
Thus in purely transaction cost terms, making Insider Trading illegal is a very difficult sell. It's a bit like the Music intellectual property debate: songs became property when records were invented, because it was now possible to control their sales by following the shellac and the pianola rolls and sheet music. Of course it took a few decades for this to shake out.
Songs lost their property characteristics with the invention of the personal MP3 player, and we are into the first decade of shaking out right now....
Contopronto had been awarded a licence under the EC's electronic money directive. Follow to the
Dutch Retail Payments blog.
Follows is an additional story that indicates this is the first ever for mobile phones:
For those that didn't follow the decade long debate (!) the existence of the EC electronic money directive has its roots in the Bundesbank's paranoia at non-banks competing against the banks. They succeeded in destroying the electronic money lead that the Europeans had, by constraining it to large players who were uninterested in cutting consumer's costs (read: banks); only now are new independent operators able to use the advantage of the open mobile platform to be able to regain the lost ground.
Meanwhile, as I predicted in my old paper , the Americans continue to lead in eMoney, partly due to their deliberate slowness in regulating something they did not and still do not understand.
Here's the additional story:
Contopronto wins e-money licence
06 January 2004 - The first-ever European e-money licence allowing for payments and money transfers to any bank, credit card, business or individual through mobile phones has been granted to Norwegian-based virtual bank Contopronto.
Issued by the Norwegian Royal Ministry of Finance, the licence allows for the international expansion of Contopronto's mobile-based payment system, which was first rolled out to Norwegian businesses and personal users last year.
In Norway, merchants such as McDonald's, Peppe's Pizza, and the country's number one loyalty programme Trumf have participated in the one-year pilot. Contopronto users dining at McDonald's or Peppe's, for example, text the billing code for their meal into their mobile to transfer payments to the restaurant's account.
Carrier-independent, the system has also been adopted for paying salaries direct to mobiles and online gambling, and will soon be made available in taxis in 25 cities in Norway. Contopronto currently claims 10,000 active users in its home territory.
The company recently opened its first office abroad in London and is in discussion with Norwegian and UK airlines about the possibility of using the system for the sale and delivery of flight tickets.
The new e-money licence will open up the application for international money transfers says Contopronto CEO Morten Hofstad.
"Contopronto users only send a text message and within a matter of seconds, rather than days, the transaction is completed for a fraction of the cost of a traditional funds transfer," he says. "Funds can be sent in any currency. For example a person in Denmark can send either kroners, pounds, euros or other currencies to someone in London."
Funds to a maximum value of EUR1250 can be sent to anyone, even if they are not Contopronto members, says Hofstad. Once a payment is accepted an account will be automatically opened.
http://www.finextra.com/fullstory.asp?id=10880
Long time comrade from the dynamic payments market of the Netherlands, Simon Lelieveldt, runs a blog on Dutch retail payments at
http://www.simonl.org/blogger.htm to brand and establish his growing consultancy business.
Simon worked for the Dutch Central Bank (DNB - De Nederlands Bank) for time immemorial in the electronic payments area. It's no exaggeration to say that the Dutch market was possibly the original melting pot for electronic payments - they were the most advanced in smart card money, and DigiCash BV was based there. It is maybe one country of a very few where everyone has a smart card money product (although use remains low) and has serious competition in non-bank payments products.
This core background led Simon on to the BIS Task Force on the Security of Electronic Money - their blue report was notably one of the very few documents produced by regulators that was worth chopping trees down for.
FCers will recall he was one of the key note speakers in Anguilla, 1997 , representing all of the Central Banks.