Financial Cryptography

e-gold under attack

Troubles come in threes for e-gold, the gold payment system that dominates the field (by transactions if not reserves). On the 19th of December, the G&SR offices in Melbourne, Florida, were apparently raided by the FBI and US Secret Service. At the beginning of that month, Nevis revealed that e-gold Ltd, the company that holds the accounts for all users and metals, was struck off some 2 years ago. Ouch! Now there is a BusinessWeek feature with not one, not two, but 5 articles on the subject, to be published this coming week:

Law enforcement officials worry that the little-known digital currency industry is becoming the money laundering machine of choice for cybercriminals. On the evening of Dec. 19, agents with the Federal Bureau of Investigation and Secret Service raided the Melbourne (Fla.) office of e-gold's parent company, Gold & Silver Reserve Inc., and the nearby home of its founder, Douglas L. Jackson. Agents copied documents and computer files, but so far no charges have been brought. The Secret Service and the FBI declined to comment on the raid. Jackson has denied any wrongdoing, though the raid isn't the first indication that federal investigators view e-gold as a magnet for online misdeeds. The FBI separately is pursuing about a dozen probes in which e-gold appears as a "common denominator," a senior agent says.

(The above was copied from here but BW has now opened up the article to the public. See also a related story on WebMoney.)

My conclusion - the BW spread is a hatchet job. Reading between the lines, they had access to the federales' material to the extent that they published this article about the raid before anyone else was in the know, and to this day, some 2 weeks later, it is not formally confirmed. They were told from on high what the message would be, and the questions asked of people and the articles' focus point in that direction (disclosure: I was asked some of those questions and did not respond). Read it with that in mind.

Notwithstanding that, this "correction" has been a long time coming. October 1999, as it happens, when the first scams started to use the e-gold system. Then (more disclosure!) I was engaged in a 6 month long effort to craft a way forward in the light of this surprise customer, the Ponzi scheme.

We started off by debating the right of adults to participate in games where they knew that the point was to scam each other. Make no mistake, the victims in Ponzi schemes are under no illusions where the gains come from and go. Who then is a payment system to police these adults, when these self-same adults are engaging in self-fraud? Furthermore, it is a matter of record that the SEC - the agency with primary responsibility for scams - does not properly regulate this patch.

This was a debate of much heat, and in the face of such arguments, I carefully constructed my input based on what it would do to the system. I took advice from legal and regulatory experts who knew the islands (Nevis, and Anguilla where I was living at that time) and considered the issue from the point of view of threats to the system - the e-gold system. My main point was that regardless of what we thought or moralised or policed, if the policy brought heat in on the system, it was a risk to the system. Therefore, I asserted, e-gold should shut down the scams as a risk to their own system. (As an aside, it was stated to me that the islands would simply strike the company off the registry, a prediction that was borne out!)

To their credit, e-gold did close down the first couple of scams and this is where the learning began. It was exceptionally costly to close them down and reverse all the payments. Probably too costly, and remember that it isn't the scammers that bear the cost of the massive reversal operation, but the other users.

I was therefore wrong with my original assessment and advice. The experience also put the lie to the notion that a payment system has to police its users, at least, all the users all the time, and something more subtle was called for.

e-gold then adopted a policy of treating all complaints as disputes and deferring to court orders. This was a stroke of genius to my mind although by then I was out of the loop. By outsourcing the customer complaint as a dispute resolution before courts, they actually managed to solve the costs problems that derive from frauds. (Ask how many customer support reps Paypal employs and you will see the light!) Also, this is more or less the same thing that the SEC and the other agencies do - they do not act without a complaint. And the SEC does not shut things down without a court order. So what's the difference?

Probably not much in terms of policy but likely more in the implementation. Did e-gold treat all complaints and court orders equally? Did they try to keep clear of the worst business, or did they turn a blind eye in the quest for transaction revenue?

Also, one other point, one which continues to bug me: e-gold reputedly never lifted a finger to make filing court orders easy for the small victims. There are plenty of stories about how people tried and failed.

Could they have done better? Oh, yes! They sponsored, attended and presented at not one but two conferences called LexCybernetoria, the second of which we held at Nevis shortly after these scams turned up. At these conferences, the emphasis was on low cost dispute resolution in an open governance world. Internet disputes for unregulated payment systems, in other words! Arbitration, as is written in the terms of service, and an intent to give the small guy access to fair systems.

What remains a mystery is why they did not adopt small arbitration model that was so talked about at the time. WebMoney went on to pioneer this very model in Russia, and it works for them.

Posted by iang at January 3, 2006 03:45 PM | TrackBack