My notes of a presentation by Dr Ugo Bechini at the Int. Conf. on Digital Evidence, London. As it touches on many chords, I've typed it up for the blog:
The European or Civil Law Notary is a powerful agent in commerce in the civil law countries, providing a trusted control of a high value transaction. Often, this check is in the form of an Apostille which is (loosely) a stamp by the Notary on an official document that asserts that the document is indeed official. Although it sounds simple, and similar to common law Notaries Public, behind the simple signature is a weighty process that may be used for real estate, wills, etc.
It works, and as Eliana Morandi puts it, writing in the 2007 edition of the Digital Evidence and Electronic Signature Law Review:
Clear evidence of these risks can be seen in the very rapid escalation, in common law countries, of criminal phenomena that are almost unheard of in civil law countries, at least in the sectors where notaries are involved. The phenomena related to mortgage fraud is particularly important, which the Mortgage Bankers Association estimates to have caused the American system losses of 2.5 trillion dollars in 2005.
OK, so that latter number came from Choicepoint's "research" (referenced somewhere here) but we can probably agree that the grains of truth sum to many billions.
Back to the Notaries. The task that they see ahead of them is to digitise the Apostille, which to some simplification is seen as a small text with a (dig)sig, which they have tried and tested. One lament common in all European tech adventures is that the Notaries, split along national lines, use many different systems: 7 formats indicating at at least 7 softwares, frequent upgrades, and of course, ultimately, incompatibility across the Eurozone.
To make notary documents interchangeable, there are (posits Dr Bechini) two solutions:
A commercial alternative was notably absent. Either way, IVTF (or CNUE) has adopted and built the second solution: a website where documents can be uploaded and checked for digsigs; the system checks the signature, the certificate and the authority and translates the results into 4 metrics:
In the IVTF circle, a notary can take full responsibility for a document from another notary when there are 4 green boxes above, meaning that all 4 things check out.
This seems to be working: Notaries are now big users of digsigs, 3 million this year. This is balanced by some downsides: although they cover 4 countries (Deustchland, España, France, Italy), every additional country creates additional complexity.
Question is (and I asked), what happens when the expired or revoked certificate causes a yellow or red warning?
The answer was surprising: the certificates are replaced 6 months before expiry, and the messages themselves are sent on the basis of a few hours. So, instead of the document being archived with digsig and then shared, a relying Notary goes back to the originating Notary to request a new copy. The originating Notary goes to his national repository, picks up his *original* which was registered when the document was created, adds a fresh new digsig, and forwards it. The relying notary checks the fresh signature and moves on to her other tasks.
You can probably see where we are going here. This isn't digital signing of documents, as it was envisaged by the champions of same, it is more like real-time authentication. On the other hand, it does speak to that hypothesis of secure protocol design that suggests you have to get into the soul of your application: Notaries already have a secure way to archive the documents, what they need is a secure way to transmit that confidence on request, to another Notary. There is no problem with short term throw-away signatures, and once we get used to the idea, we can see that it works.
One closing thought I had was the sensitivity of the national registry. I started this post by commenting on the powerful position that notaries hold in European commerce, the presenter closed by saying "and we want to maintain that position." It doesn't require a PhD to spot the disintermediation problem here, so it will be interesting to see how far this goes.
A second closing thought is that Morandi cites
... the work of economist Hernando de Soto, who has pointed out that a major obstacle to growth in many developing countries is the absence of efficient financial markets that allow people to transform property, first and foremost real estate, into financial capital. The problem, according to de Soto, lies not in the inadequacy of resources (which de Soto estimates at approximately 9.34 trillion dollars) but rather in the absence of a formal, public system for registering property rights that are guaranteed by the state in some way, and which allows owners to use property as collateral to obtain access to the financial captal associated with ownership.
But, Latin America, where de Soto did much of his work, follows the Civil Notary system! There is an unanswered question here. It didn't work for them, so either the European Notaries are wrong about their assertation that this is the reason for no fraud in this area, or de Soto is wrong about his assertation as above. Or?
Cryptographers, software and hardware architects and others in the tech world have developed a strong belief that everything can be solved with more bits and bites. Often to our benefit, but sometimes to our cost. Just so with matters of law and disputes, where inventions like digital signatures have laid a trail of havoc and confusion through security practices and tools. As we know in financial cryptography, public-key reverse encryptions -- confusingly labelled as digital signatures -- are more usefully examined within the context of the law of evidence than within that of signatures.
Now here cometh those who have to take these legal theories from the back of the technologists' napkins and make them really work: the lawyers. Stephen Mason leads an impressive line-up from many countries in a conference on Digital Evidence:
Digital evidence is ubiquitous, and to such an extent, that it is used in courts every day in criminal, family, maritime, banking, contract, planning and a range of other legal matters. It will not be long before the only evidence before most courts across the globe will all be in the form of digital evidence: photographs taken from mobile telephones, e-mails from Blackberries and laptops, and videos showing criminal behaviour on You Tube are just some of the examples. Now is the time for judges, lawyers and in-house counsel to understand (i) that they need to know some of the issues and (ii) they cannot ignore digital evidence, because the courts deal with it every day, and the amount will increase as time goes by. The aim of the conference will be to alert judges, lawyers (in-house lawyers as well as lawyers in practice), digital forensic specialists, police officers and IT directors responsible for conducting investigations to the issues that surround digital evidence.
Not digital signatures, but evidence! This is a genuinely welcome development, and well worth the visit. Here's more of the blurb:
Conference Programme International Conference on Digital Evidence26th- 27th June 2008, The Vintner's Hall, London – UNITED KINGDOM
Conference: 26th & 27th June 2008, Vintners' Hall, London
Cocktail & Dinner: 26th June 2008, The Honourable Society of Gray's InnTHE FIRST CONFERENCE TO TREAT DIGITAL EVIDENCE FULLY ON AN INTERNATIONAL PLATFORM...
12 CPD HOURS - ACCREDITED BY THE LAW SOCIETY & THE BAR STANDARDS BOARD
This event has also been accredited on an ad hoc basis under the Faculty's CPD Scheme and will qualify for 12 hoursUnderstanding the Technology: Best Practice & Principles for Judges, Lawyers, Litigants, the Accused & Information Security & Digital Evidence Specialists
MIS is hosting & developing this event in partnership with & under the guidance of Stephen Mason, Barrister & Visiting Research Fellow, Digital Evidence Research, British Institute of International and Comparative Law.
Mr. Mason is in charge of the programme's content and is the author of Electronic Signatures in Law (Tottel, 2nd edn, 2007) [This text covers 98 jurisdictions including case law from Argentina, Australia, Brazil, Canada, China, Colombia, Czech Republic, Denmark, Dominican Republic, England & Wales, Estonia, Finland, France, Germany, Greece, Hungary, Israel, Italy, Lithuania, Netherlands, Papua New Guinea, Poland, Portugal, Singapore, South Africa, Spain, Switzerland and the United States of America]. He is also an author and general editor of Electronic Evidence: Disclosure, Discovery & Admissibility (LexisNexis Butterworths, 2007) [This text covers the following jurisdictions: Australia, Canada, England & Wales, Hong Kong, India, Ireland, New Zealand, Scotland, Singapore, South Africa and the United States of America]. Register Now!Stephen is also International Electronic Evidence, general editor, (British Institute of International and Comparative Law, 2008), ISBN 978-1-905221-29-5, covering the following jurisdictions: Argentina, Austria, Belgium, Bulgaria, Croatia, Cyprus, Czech Republic, Denmark, Egypt, Estonia, Finland, France, Germany, Greece, Hungary, Iceland, Italy, Japan, Latvia, Lithuania, Luxembourg, Malta, Mexico, Netherlands, Norway, Poland, Romania, Russia, Slovakia, Slovenia, Spain, Sweden, Switzerland, Thailand and Turkey.
Bruce Schneier writes about the classical technology / security view and how it applies to such oddities as the fax signature. As he shows, we have trouble making them work according to classical security & tools thinking.
In a 2003 paper, "Economics, Psychology, and Sociology of Security," Professor Andrew Odlyzko looks at fax signatures and concludes:Although fax signatures have become widespread, their usage is restricted. They are not used for final contracts of substantial value, such as home purchases. That means that the insecurity of fax communications is not easy to exploit for large gain. Additional protection against abuse of fax insecurity is provided by the context in which faxes are used. There are records of phone calls that carry the faxes, paper trails inside enterprises and so on. Furthermore, unexpected large financial transfers trigger scrutiny. As a result, successful frauds are not easy to carry out by purely technical means.He's right. Thinking back, there really aren't ways in which a criminal could use a forged document sent by fax to defraud me.
The problem that shakes the above comments is that signatures are not tools to make things secure, nor to stop fraud. Instead, they are signals of legal intent. The law has developed them over centuries or millenia not as tools to make contracts binding, as per the simplistic common myth, or to somehow make it hard for fraudsters, the above security myth, but signals to record the intent of the person.
These subtleties matter. When you send a fax with your signature on it, it doesn't matter that the signature can be copied; it is the act of you creating and sending the fax with signature that establishes intent. Indeed, the intent can be shown without the signature, and the source of the fax is then as important as anything else. For this reason, we generally confirm what you intended somehow. Or we should, as Bruce Schneier writes:
On October 30, 2004, Tristian Wilson was released from a Memphis jail on the authority of a forged fax message. It wasn't even a particularly good forgery. It wasn't on the standard letterhead of the West Memphis Police Department. The name of the policeman who signed the fax was misspelled. And the time stamp on the top of the fax clearly showed that it was sent from a local McDonald's.The success of this hack has nothing to do with the fact that it was sent over by fax. It worked because the jail had lousy verification procedures. They didn't notice any discrepancies in the fax. They didn't notice the phone number from which the fax was sent. They didn't call and verify that it was official. The jail was accustomed to getting release orders via fax, and just acted on this one without thinking. Would it have been any different had the forged release form been sent by mail or courier?
It's all backwards, according to the law. There should have been an intent, but there wasn't one. It wasn't that the policeman's signature established an intent, it was that the signature should have been a final step in confirming an intent that already existed. The point of phoning the policeman wasn't to check the signature, but to establish the intent. Which the signature would have nicely confirmed, but the check on intent isn't substitutable with the check on signature. As Jeff commented on the post:
Most people don't understand that signatures don't generally perform a security function, they perform a solemnization function. At least that was the case before the mathematicians got involved and tried to convince folks of the value of digitial signatures . . .. :-)
Before they got it totally backwards, that is. Your copied signature does not show intent by you, instead, it suggests an intent by you, that should be confirmed regardless. For you, this is good, as the principle of redundancy applies: you need something much more than one signature to lock you into a contract, or get you out of prison. And this process of showing intent bounces back to the signature in a particularly powerful protocol that is used in the legal world. This is a closely held secret, but I shall now reveal it and risk censure and expulsion for breaking the code:
Ask!
That's it, just ask the question. This can happen anywhere, but is best seen in a court setting: The judge says "Did you sign this?" If you did, then you say yes. (Else you're up for perjury, which is a serious risk.) If you didn't, you deny it, and then the court has a claim that it is not yours. The court now looks further to establish who's intent was behind this act.
It is for these reasons that digital signatures failed to make any mark on the real world, when cast as some sort of analogue to the human signature. Indeed, the cryptography community got it backwards, upside down and inside out. They thought that the goal was to remove the uncertainty and simplify the procedure, when in fact the goal was to preserve and exploit the uncertainty, and to augment the procedure. They were thinking non-repudiation, yet the signature is there to entice repudiation. They thought the signature was sufficient, yet it is no more than a signal of something much more important. They thought simplicity, when redundancy is the principle.
Digital signatures were presented as a new beginning and ending for electronci contracts, and users intuitively recognised they were neither a beginning nor an ending. Digital signatures were nothing, without a custom, and within a custom were shown to be more trouble than they were worth. Case in point: this is the reason why the digital signature on Ricardian Contracts is just cryptographic sugar: the intent is better shown by the server mounting the contract, by the issuer saying "I'm selling this contract", and by the system memorialising all these events in other signed records.
You might ask, why they are there, but I'll side-step that question for now :) Instead, let us ask, how then do we move forward and use digital signatures?
We should be able to see now that it is the wrong question. The right question is firstly, how do we establish intent, and the follow-up is, intent of what? Attest to a statement, conclude a negotiation, sell a house, contract for a road to be dug up, marriage with or without a shotgun? Once we have established that, we can construct a custom (techies would say a protocol) that captures the intent _and_ the agreement, suitable for the value at hand.
We might find a way to slip in some digsigs or we might not. That's because the role is to capture intent, not the signature. Intent is obligatory, signature is not.
(Indeed, this is why we say, in financial cryptography, the cryptography is optional, which causes no end of head-scratching. What then does a poor vendor of cryptographic digsigs do with them? Simple: define the digsig as meaning nothing, legally, outside an additional custom. Nothing, nix, nada, zip! And use them purely for their cryptographic properties, only. Which happen to be useful enough, if properly designed.)
Philipp pointed me to another issue that turns the good ship Digital Signature into yet another Nautilus, rapidly going down the whirlpool.
Consider compromise of my signing key. If my key is compromised, then it can be used to sign any document on behalf of the erstwhile owner (was, me). Now, a curiosity of this is that the signature can be backdated, so if I lose my signing key to you, then you can sign away my house, back date it to a few years back to when it was a valid key, and take my house for a buck.
Hence, when my key is compromised, I have to revoke the key, and also potentially revoke all the signatures. The revocation of a signing cert can result in signatures of all dates becoming invalid, or questionable, even back in time. (Apparently, some proportion of client software works this way, because once a cert is revoked, all signatures are deemed "unacceptable" and thus effectively revoked. Nautilus, meet whirlpool.)
This could even be used by myself, in a nefarious mood, to cast doubt over the my own validly-made signatures. If I was homesick, I could conceivably use this to deny a valid contract to sell my house. Hey presto, Grandma gets her house back! (For other woes in the use of public keys for signing purposes, see Signed Confusion)
So how do we solve this problem? Skip down to **** if you are fully informed on that invention known as the Ricardian Contract, which does solve this issue.
In the Ricardian Contract I solved it by taking the hash of the signed contract, making that the identifier for the contract, and then embedding that hash into every transaction that happens thereafter. So, in effect, all new transactions accept and affirm the contract; and therefore form part of the evidence over the signature; if we question the original digsig, we also question all the transactions in the issuance, which is not reasonable beyond the first few dozen transactions.What happens in more conventional PKI-land, where wisdom is writ, and standards are dusty? As is frequently pointed out, any human-meaningful use of digital signatures would then need to be confirmed with a secure timestamp, perhaps so that any later key revocation can avoid revoking that signature. Makes some sense, and indeed, every single Ricardo transaction sums to achieve that timestamp, as it builds up a tree of timestamped, signed transactions, pyramided on the original contract and its certificate.
We could then propose a rule in the use of public key digsigs for digital signing:
digital signatures cannot be relied upon over time without secure timestampingThe problem with this is that it undermines the very architecture of PKI; if we are assuming online, authoritive entities such as timestamping or digital cash issuers, then we don't actually need PKI, as it is written. Click on lynn://frequent.rant/ at this point... or for my version, in Ricardo as described above, the strength was the fact that strong evidence of the contract was kept over time, not the digsig. In this case, the evidentiary hash over the total document is what is kept, and the digsig added no more than the sweetness of headline confirmation of intent to the picture.
Because PKI (and in this case, OpenPGP cleartext signing) established a convention of signalling an intent with a digsig, it was handy to use that signal.
But we never relied on that, and a specific requirement was that someone could steal the signing key and create a bogus contract. The real strength that captured the signing over the contract was this: we took the hash of the document, and used that hash as the identifier for the contract. We are talking about Ivan, a person who is an issuer of value, and is purporting to the world that his contract is good. Them we arrange matters so that in every statement he makes to the world, he uses a strong identifier. By including the hash of the contract in every transaction, we establish Ivan's intent, understanding, liability on the basis of strong acts by the signer himself. The subtext is that the dominating evidence of intent on the document was the hash over the document, and the transactions that embedded that hash preserved and published that evidence [1].
**** The conclusion is that the hash is a better "signature" than a public-private-key digsig, if we are talking about evidence of time, leading to intent, etc; both need to be accompanied by an infrastructure that isolates the realtime of effect of the original event, and an environment where that intent is preserved. In which case, we can take the above, spin it and say that simple hashes are as good as public key digsigs at the application known as digital signing, and better because they are cheaper. Or, if the infrastructure is present, then public key digsigs makes a good carrier of hashes, as long as their use doesn't damage the application in other ways (which unfortunately it does, c.f. revocation).
What does a timestamped hash lack? It has no indicator of who the signer is. Hence, the hash does not quite defeat the digsig on the basis of Occam's razor.
But we need that in other ways anyway, as the pure cryptographic notion of a public key signature is no better than "this set of bits saw that set of bits" and we know from practical cryptography that there is no easy way to measure and control the distance from a human (intent) to a set of bits. PKI fails to achieve this because it outsources identity to a thing called Certificate Authorities, which so far have not shown themselves to be useful harbingers of your signatory, if in part because they are more expensive than the old pen&ink method.
Let's step back then, and place this in terms of requirements. We need these things to create any system of digital signing:
Public key signatures add very little if anything over hashes and timestamps, as the former needs independent timestamping and revocation, which means that their PKI claims of offline-checking are unravelled. Neither public key digsigs or simple hashes establishes who, easily (consider the cost of PKI infrastructures versus the low statements of reliance), and neither establishes intent.
Indeed, the requirements are so badly met that we can invent a system in 30 seconds that beats the incumbent "approved digital signing systems", hands down:
Iang is who Iang says he is.
Sha1:9dea25a24190bd2cb129cc0b8718b6cf046fe154
This is strong, because, it was me that said it, me that posted it, and this blog, google, the time machine and all the other net tricks will preserve it [2]. Oh, and the hash adds some precision.
Are public key signatures dead? In technical and legal terms, yes. Public key signatures are at least brain-dead, and should be terminated for lack of sentience. While they retain some residual value in marketing senses and in infrastructure senses, they cannot be relied upon as signatures. We'll continue to put in the cryptocandy of the OpenPGP signatures on contracts, but the strength is elsewhere.
Which also means that we do not need to worry about revocation in digsig signing applications: the PKI digsigs as signing applications already revoked themselves, and we shouldn't spend any time over the issue except to say that they are not reliable enough for reliance applications. Instead, if you want a reliable digital signing application, read the Ricardian Contract paper carefully, and construct a protocol that carries the cryptocandy of the existing infrastructure alongside a proper chain that evidences the perfection of the contract: reading/understanding/intent/delivery.
Notes [1]: To follow a digital issuance through in technical, accounting terms: in a digital currency, we start out with one transaction to create value. This is of necessity a double entry transaction that puts large positive value into a manager's account, against large negative value into a float account. Then, the freshly minted positive value is distributed to the users, resulting in more transactions. The value is probably split in the second transaction and further split and recombined in each succeeding transaction, resulting in something like a tree structure.
Each of these transactions evidence an intent to honour the contract, as they all point back by means of the same hash over the same document. Hence, the OpenPGP signature is crypto-icing over the real cake within the Ricardian contract; in this particular case at least, the OpenPGP signature adds little to what the evidentiary chain of transactions provides.
Note [2]: If you want to wrap some cleartext signing sugar onto it, try this:
----- BEGIN OpenPGP Hash-Signed Document -----
I am who I say I am.
----- BEGIN HashSIG -----
d51cb67e97ae815c662042950189c59784a1560d
----- END HashSIG -----
Note [3]: how did we do that hash? Like this:
$ openssl sha1
Hash-signing my contract is as easy as typing text and adding newline then control-D at the end
1100ff22b4e28f439c03a9557b8a88eb8a749235
$
Cut and paste the text line into a Unix terminal application, and follow the instructions. Don't forget to hit return, then hit ctrl-D. Don't include the spaces at the beginning.
Everyone is talking about Société Générale and how they managed to mislay EUR 4.7bn. The current public line is that a rogue trader threw it all away on the market, but some of the more canny people in the business don't buy it.
One superficial question is how to avoid this dilemma?
That's a question for financial cryptographers, I say. If we imagine a hard payment system is used for the various derivative trades, we would have to model the trades as two or more back-to-back payments. As they are positions that have to be made then unwound, or cancelled off against each other, this means that each trader is an issuer of subsidiary instruments that are combined into a package that simulates the intent of the trade (theoretical market specialists will recall the zero-coupon bond concept as the basic building block).
So, Monsieur Kerviel would have to issue his part in the trades, and match them to the issued instruments of his counterparty (whos name we would dearly love to know!). The two issued instruments can be made dependent on each other, an implementation detail we can gloss over today.
Which brings us to the first part: fraudulent trades to cover other trades would not be possible with proper FC because it is not possible to forge the counterparty's position under triple-entry systems (that being the special magic of triple-entry).
Higher layer issues are harder, because they are less core rights issues and more human constructs, so they aren't as yet as amenable to cryptographic techniques, but we can use higher layer governance tricks. For example, the size of the position, the alarms and limits, and the creation of accounts (secret or bogus customers). The backoffice people can see into the systems because it is they who manage the issuance servers (ok, that's a presumption). Given the ability to tie down every transaction, we are simply left with the difficult job of correctly analysing every deviation. But, it is at least easier because a whole class of errors is removed.
Which brings us to the underlying FC question: why not? It was apparent through history, and there are now enough cases to form a pattern, that the reason for the failure of FC was fundamentally that the banks did not want it. If anything, they'd rather you dropped dead on the spot than suggest something that might improve their lives.
Which leads us to the very troubling question of why banks hate to do it properly. There are many answers, all speculation, and as far as I know, nobody has done research into why banks do not employ the stuff they should if they responded to events as other markets do. Here are some speculative suggestions:
Every one of those reasons is a completely standard malaise which strikes every company, but not other industries. The difference is competition; in every other industry, the competition would eat up the poorer players, but in banking, it keeps the poorer players alive. So the #1 fundamental reason why rogue traders will continue to eat up banks, one by one, is lack of competitive pressures to do any better.
And of course, all these issues feed into each other. Given all that, it is hard to see how FC will ever make a difference from inside; the only way is from outside, to the extent that challengers find an end-run around the rules for non-competition in banking.
What then would we propose to the bank to solve the SocGen dilemma as a short term hack? There are two possibilities that might be explored.
This works because it is an independent and financially motivated check. It also helps to start the inevitable shift of moving parts of regulation from the current broken 20th century structure over to a free market governance mechanism. That is, it is aligned with the eventual future economic structure.
So outsource the whole lot of risk governance to specialists in a separate board-level structure. This structure should have visibility of all accounts, all SPEs, all positions, and should also be the main conduit to the regulator. It has to be equal to the business board, because it has to have the power to make it happen.
The existing board maintains the business side: HR, markets, products, etc. This would nicely divide into two the "special" area of banking from the "general" area of business. Then, when things go wrong, it is much easier to identify who to sack, which improves the feedback to the point where it can be useful. It also puts into more clear focus the specialness of banks, and their packaged franchises, regulatory costs and other things.
Why or how these work is beyond scope of a blog. Indeed, whether they work is a difficult experiment to run, and given the Competition finding above, it might be that we do all this, and still fail. But, I'd still suggest them, as both those ideas can be rolled out in a year, and the current central banking structure has at least another decade to run, and probably two, before the penny drops, and people realise that the regulation is the problem, not the solution.
(PS: Jim invented the second one!)
Second Life takes another step onto the slippery slope. They have previously banned gambling, and now they are banning finance.
Please read this if you operate, or have transferred L$ to, an in-world “bank” or financial company.As of January 22, 2008, it will be prohibited to offer interest or any direct return on an investment (whether in L$ or other currency) from any object, such as an ATM, located in Second Life, without proof of an applicable government registration statement or financial institution charter. ...
This is the slippery slope. By putting a blanket ban on the operation of financial services (or, passing the buck to the old-world regulators, which amounts to the same thing), they have exited from a large sector of commerce. Expect others to follow.
The reason? In short, it is not economic for them. Linden Labs have no economic / libertarian background to understand the theory, so they cannot see a forward path. Nor do they have the necessary regulatory background or friends, so they have inherited a big and powerful enemy (or more precisely, a horde of enemies who all look the same on first glance) with no way to deal with a war.
Also, it has been recently shown by one similar venture (eBay/Paypal) that taking the slippery slope has a quid pro quo: no financial downside, indeed success and profits. Other than a lot of noisy press ("traitors to the cause"), what's the problem? The process looks on track according to modern marketing theories (ditch the early adoptors as you move to the mainstream).
Under this cloud of exit stories, sad to some, there is at least a silver lining. We extract one data point from the experiment that confirms the theories developed in the 1990s for unregulated finance providers:
You probably haven’t heard of Joshua Zarwel (Second Life’s ‘Teufel Hauptmann’), but he was the very first person I thought of when Linden Lab banned banking last week. ‘Hauptmann’ doesn’t get a lot of press. He’s never been accused of insider trading or blackmail in the Second Life Herald, he doesn’t spend much money on his avatar, he SL Bank Logodoesn’t issue cringe-inducing press releases, and he doesn’t have his name in diamonds above his virtual door. In short, he’s the kind of guy you want managing your money.
Sounds like a scam already, right? Call the Feds? The USSS should be hovering as we speak? Read on...
The fund’s web site is plain, and its entire in-world presence consists of one tiny, unremarkable virtual building. ... When Linden Lab ended banking in Second Life last week, Zarwel did something I’ve not heard of any other banker doing: he quietly announced that every single Linden Dollar in his customers’ accounts was available for immediate withdrawal. ...
For those who have memories of the unregulated gold and dollars economy:
... we tried to be as transparent as possible. If you check our website and/or in world note card you will see that we provide our real world names, addresses, backgrounds, profitability, fund allocation, etc. We had nothing to hide, nor did we ever wish to be anonymous.
This is rhyme. Indeed, it's as close to repeat as you can get, to challenge Mark Twain. We can see everything, as indeed it should be in open governance:
The long and the short is that if Linden Labs had implemented the lessons of open governance, they would have likely knocked out (over time) the scams and been left with the gems (again, over time). This does not change the question of whether it would have been economic of them to pursue Austrian approaches to commerce (Hayek's open money, etc), but it does show that there was a forward path, and the place at the end of that path will stand up to scrutiny.
While we are on the finance business, let's check in to see where the regulated world are at in governing their activities:
The UK's HSBC is to use Identrust's Internet authentication network to enable its corporate customers to digitally sign electronic payments files. Identrus provides a secure digital certificate-based infrastructure for business-to-business e-commerce transactions and corporate-to-bank communications....A select number of HSBC corporate banking clients will be issued with Identrus digital certificates so that their staff can electronically sign payment files.
Identrust-backed digital signatures are used to guarantee non-repudiable and legally binding electronic communications between banks and their corporate clients. Only one Identrus digital identity per user is needed to interact with all of a corporate client's banks, which simplifies the transaction authentication process.
(Imagine here comments about Ricardian contracts, x.509 failings, x9.59 designs, transaction economics, and a whole host of lessons that simply can't be learnt at any price.)
This would be almost boring except for the numbers involved. The Economist writes:
TROUBLE had been expected but nothing like this. Widespread concerns that Société Générale, a large French bank, had more subprime-related problems to reveal were proved right on January 24th with the announcement of a €2.05 billion ($3 billion) write-down on its exposure to mortgage-related investments and to creaking bond insurers. But those numbers were a side-show to something far more shocking.The bank also disclosed that a single trader, Jérôme Kerviel, had racked up a further €4.9 billion loss by taking unauthorised bets on futures linked to European stockmarkets. Trading in SocGen's shares was temporarily suspended on January 24th, but punishment was bound to be severe.
How did this happen? For that we have to see what the FT wrote:
The trader joined the bank in 2000 and worked in Paris. The first three years of his career were spent in the bank’s so-called “back office” and “middle office”, where trades are settled and risk is managed. Though it did not name Mr Kerviel, SocGen said he had never worked directly in its risk control section, but remained in contact with people in those areas so he could be updated with the bank’s risk controls.“The reasons he could succeed was because the trader knew intimately the bank’s risk controls and swiftly shifted positions to evade detection at each level of control,” Mr Bouton said.
The fraud was discovered after the trader made an error with a fictitious counterparty. Its extent became clear over the weekend, when the bank‘s management interviewed Mr Kerviel.
OK, so rule #1 in governance is to separate the decisions from the implemention. Those on the decision side (in this case, traders) can not touch the money. Those on the money side (in financial lingo, back-office) cannot make any decisions. Seems simple, right?
The flaw here is that separation of roles also has to be backed up by more than mere words. Those in the back-office are supposed to check for valid trading by some metric or other, and supervisors are supposed to watch everything and make judgement calls. Those in the front-office (traders) are supposed to be rewarded for successful trades, and those in the back-office are supposed to be rewarded for safe trades.
As we know from the Barings case (and a thousand years of history) if a person crosses the border between front and back-office, there is trouble. Nick Leeson not only traded, he was also the guru that fixed or ran the accounting system in the Singapore branch. So he knew the back-office commands to create special or secret accounts, like 88888, which came in handy to hide losses.
The same will be true here: Kervial was trained in the back office, so almost certainly he knew how to do things that were under the covers. Which points to a crazy state of affairs: how is it at all possible to do things that are below the covers?
If you need a systemic reason, it would be because the system has evolved through centuries and is full of obscure rules, quirks, paperwork, oversights and so forth. It is too complex for anyone but a few to understand, indeed, it is quicker to build a complete new governance system from scratch than it is to understand a modern trading system (I know because I've done it). We can conclude that the modern systems are opaque, by history if not by design, and that therefore the real question to ask is whether it is plausible to even understand what happens under the covers, and to stop this weakness?
We know how to solve these problems in financial cryptography. My results were confirmed by others; but we all faced the same systemic blockages in getting systems deployed. Those same blockages will probably also work to save Société Générale from the real solution, which is sacking of the entire board at minimum and sacking of the shareholders at maximum.
Top tip from anonymous observer: watch Société Générale slide in a lot of other hidden losses into this one, so as to combine all the losses into one efficient hit. This is good news for shareholders, and bad news for everyone else, but that sort of high stakes poker playing with assets can also backfire if the losses threaten real closure.
I listened to an entire Second Life interview with Dan Miller from the Joint Economic Council, a thinktank for the USA government. Interesting stuff, because virtual world governance gives us a window on all-of-Internet governance.
On a slightly related question, I have one question on the efficiency of the new generation of podcasts and interviews and so forth. These new tools are seeking to simulate the old world of radio and TV as the channel of preference, but to my mind they are terribly inefficient. I had to spend an entire hour or so listening to the scratchy sound, with a drop out in a critical part, when I could have skimmed the same written content in about 2 minutes. The nice way of putting this is that it's not ready for recommendation to my business partners as yet, and a slightly less nice way is "who has time for that?"
Does anyone have any alternate experience in these podcasts, etc, that indicates it is finding a market place in real business?
(Addendum: cross-over to TV.)
CAcert has just approved rules for dispute resolution which, in brief, puts all before their own arbitration. (Disclosure: I was involved!)
The key in this process is the provision in the user agreement that asserts the agreement to arbitrate disputes, and the lock that matches the key is the Arbitration Act in most countries. To make it work, the Act generally says that courts must respect the intent to arbitrate. From the US:
Under the FAA, on the motion of a party, a court must stay proceedings and order the parties to arbitrate the dispute if the court finds that the parties have agreed in writing to do so. A party seeking to compel arbitration must show (1) that a valid agreement to arbitrate exists between the parties and (2) that the specific dispute falls within the scope of the agreement.
E.g., the courts will kick you back to Arbitration. But, there are some exceptions, and I took that above quote from one such, being Bragg v. Second Life, wherein Judge Robreno decided to kick out the Arbitration Clause, not the parties. As VB writes, this is a big deal. So, it is useful to check his logic, and find out if CAcert has made some of the same mistakes.
Bear in mind this is not legal writing; if you want the real story you have to read the full transcripts linked above. To stress that, I've stripped out the references, etc, so as to maintain the readability rather than the reliability.
Having said that, onwards! With some legal musing, the Court arrives at this:
Bragg claims that the arbitration agreement itself would effectively deny him access to an arbitrator, because the costs would be prohibitively expensive, a question that is more appropriately reserved for the Court to answer.
To answer the question, the Court decided to look at procedural and substantive components to the issue of unconscionability which is a get-out card generally written into Arbitration Acts, and construct a balanced view from those components. Here's a quick summary:
Contract of adhesion. The Second Life agreement is a contract of adhesion, because there is no chance to negotiate. It's a take it or leave it. Therefore, the contract meets a standard of procedural unconscionability.
"Surprise," meaning that the Arbitration intent is hidden. Again, SL has met the Court's standard of surprise, by (a) using an opaque heading and (b) not setting out the costs clearly. This is a second leg of procedural unconscionability.
"One-sidedness of the contract terms." This seems to ride on several issues:
The Court asserted that "the arbitration remedy must contain a “modicum of bilaterality." It also quoted a Paypal case which is likely as close as it gets in industry similarity. In short, Paypal was able to control the entire assets within by way of freezing, restricting, take ownership, and change the TOS, whereas the the user could only (presumably) arbitrate. Linden Labs had (has?) the same power:
The TOS proclaim that “Linden has the right at any time for any reason or no reason to suspend or terminate your Account, terminate this Agreement, and/or refuse any and all current or future use of the Service without notice or liability to you.” Whether or not a customer has breached the Agreement is “determined in Linden’s sole discretion.” Linden also reserves the right to return no money at all based on mere “suspicions of fraud” or other violations of law. Finally, the TOS state that “Linden may amend this Agreement . . . at any time in its sole discretion by posting the amended Agreement [on its website].”
Ouch! Which brings us to tricky issue of costs. For some reason, Linden Labs chose the ICC for Arbitration, with three Arbitrators. The Court estimated costs at $17,250 for an action of recovery of $75,000. However, the ICC rules say that costs must be shared by the parties, and that is apparently sufficient to make Arbitration unenforceable in California law. The trick here appears to be that the existence of a fee, imposed in excess of a similar court process, creates a supports the finding of unconscionability:
California law has often been applied to declare arbitration fee-sharing schemes unenforceable. Such schemes are unconscionable where they “impose[] on some consumers costs greater than those a complainant would bear if he or she would file the same complaint in court.” ... Here, even taking Defendants characterization of the fees to be accurate, the total estimate of costs and fees would be $7,500, which would result in Bragg having to advance $3,750 at the outset of arbitration. See Dfts.’ Reply at 11. The court’s own estimates place the amount that Bragg would likely have to advance at $8,625, but they could reach as high as $13,687.50. Any of these figures are significantly greater than the costs that Bragg bears by filing his action in a state or federal court. Accordingly, the arbitration costs and fee-splitting scheme together also support a finding of unconscionability.
As well as that, the Court found that all these factors helped to suggest that Arbitration was an attempt to shield liability rather than resolve disputes:
OK, so the court really went to town in striking down the Arbitration clause. When I read their agreement a couple of weeks ago, I came to the same conclusion, without the Court's care, and the tip-off was the choice of the ICC (a big, expensive French body?!) and three, that's THREE arbitrators. The ICC has to be expensive just from the name, and by Linden Labs choosing 3 times the price, it doesn't take a PhD in maths to realise this was a barrier not an aid.
It may be that Linden Labs have learnt their lesson, as the TOS has just been changed, which is what sparked this blog post. Benjamin of VB writes:
the new terms also create a special class of claims under $10,000 that are to be handled via non-appearance arbitration. This change is very good for users, as the new clause replaces one that required a full-blown arbitration proceeding before a three-person panel, which could easily cost more than $10,000 itself (that is essentially why the clause was declared unconscionable in the Bragg case). Non-appearance arbitration can actually be quite inexpensive, and, notably, it could even be conducted in Second Life. The arbitrator must be an established ADR provider, must have published guidelines for dispute resolution, and must be a “retired judge or attorney with legal expertise in the subject matter of the dispute.”
Two caveats: it seems to stop around the $10k mark, and I haven't looked at the new terms.
Now, to get back to CAcert and their new arbitration system. We can run the Court's ruler over CAcert's new user agreement (albeit, still in DRAFT). It's maybe a little premature as experience is new, and only one case has been heard. But let's see what we can find:
Now, with a nod to the other elements of the Court's ruling, and to the Appeals Court which needs to affirm the ruling, it should be borne in mind that this is a back-of-the-napkin calculation. Still, it's instructive. I'd say cautiously that CAcert made none of the mistakes that the Court found. Indeed, CAcert bent over backwards and tied itself in knots in order to present itself as approximately equal to the registered users.
(As I say, I had something to do with the process. Indeed, I have been hammering the desk for this policy, or any other, to be approved for more than a year now. The more excellent result of last week's conference, which I attended, is that CAcert is now firmly back on the rails.)
Over on Second Life, they (LL) are trying to solve a problem by providing an outsourced service on identity verification with a company called Integrity. This post puts it in context (warning, it's quite long, longer even than an FC post!):
So now we understand better what this is all about. In effect, Integrity does not really provide “just a verification service”. Their core business is actually far more interesting: they buy LL’s liability in case LL gets a lawsuit for letting minors to see “inappropriate content”. Even more interesting is that LL does not need to worry about what “inappropriate content” means: this is a cultural question, not a philosophic one, but LL does not need to care. Whatever lawsuits will come LL’s way, they will simply get Integrity to pay for them.Put into other words: Integrity is an insurance company. In this day and age where parents basically don’t care what their children are doing, and blame the State for not taking care of a “children-friendly environment” by filing lawsuits against “the big bad companies who display terrible content”, a new business opportunity has arisen: selling insurance against the (albeit remote) possibility that you get a lawsuit for displaying “inappropriate content”.
(Shorter version maybe here.)
Over on Perilocity, which is a blog about the insurance world, John S. Quarterman points at the arisal of insurance to cover identity theft from a company called LifeLock.
I have to give them credit for honesty, though: LifeLock admits right out that the main four preventive things they do you could do for yourself. Beyond that, the main substance they seem to offer is essentially an insurance package:
"If your Identity is stolen while you are our client, we’re going to do whatever it takes to recover your good name. If you need lawyers, we’re going to hire the best we can find. If you need investigators, accountants, case managers, whatever, they’re yours. If you lose money as a result of the theft, we’re going to give it back to you."For $110/year or $10/month, is such an insurance policy overpriced, underpriced, or what?
It's possible easier for the second provider to be transparent and open. After all they are selling insurance for stuff that is a validated disaster. The first provider is trying to cover a problem which is not yet a disaster, so there is a sort of nervousness about baring all.
How viable is this model? The first thing would be to ask: can't we fix the underlying problem? For identity theft, apparently not, Americans want their identity system because it gives them their credit system, and there aren't too many Americans out there that would give up the right to drive their latest SUV out of the forecourt.
On the other hand, a potential liability issue within a game would seem to be something that could be solved. After all, the game operator has all the control, and all the players are within their reach. Tonight's pop-quiz: Any suggestions on how to solve the potential for large/class-action suits circling around dodgy characters and identity?
(Manual trackbacks: Perilocity suggests we need identity insurance in the form of governments taking the problem more seriously and dealing with identity thefts more proactively when they occur.)