Steve Schear wrote:
Here is the situation. An on-line financial service, for example a DBC (Digital Bearer Certificate), operator wishes his meat space identity, physical whereabouts, the transaction servers and at least some of the location(s) of the service's asset backing to remain secret. The service provides frequent, maybe even real-time, data on its asset backing versus currency in circulation. The operator wishes to provide some assurance to his clients that the backing and the amount of currency in circulation are in close agreement. The mint's backing need not be in a single location nor in the sole possession of the operator.

The servers are not so relevant, as long as you have created legally firm transactions. Although, in the event of collapse, the data trail suddenly becomes of critical importance, so there are limits to that.

The reserve assets' location(s) is fairly important from a customer trust perspective. People look at the overall safety and make their own judgements. One person might decide that New York is safe and another will find that a horrible thought (for those who follow this arcane field, there was a big bust of a dodgy operator in NY some months back). Having said that, once a system is up and running, and is robust, it seems that moving the assets from one continent to another has not been a source of concern to many users.

The issuer himself is pretty important. His physical location isn't so important -- everyone flies around these days -- but nobody has ever been able to gain trust in a system to date without reference to a real meatspace hook. And for good reason ... how do you take him to court? (And if you are thinking of extra-jurisdictional transactions, how do you beat him to a pulp with a baseball bat?)

I realize this is a governance question but I suspect that crypto/data security may play a key role.

It does ... but only after the full governance story is put into place. Then, we can look at ways to solve certain governance problems with crypto.

E.g., Ricardian contracts (my stuff) take the user agreement as a document and bind it into each transaction by means of the hash of the contract; they also ensure various other benefits such as the contract being available and readable to all at all times, and the acceptability of same, by the simple expedient of coding the decimalisation into the contract. Ensuring that the contract is readable, applicable and is available to all is a huge win in any court case.

Other governance tricks: the usage of signed receipts can be used to construct a full audit of the digital system. Also, signed receipts are strong evidence of a transaction, which leads by some logic to a new regime which we call triple entry accounting. This dramatically changes the practice of accounting (which feeds into governance).

With DB side, one trick is to use psuedonym accounts for the basis, and this allows no-loss protocols to be created. Again, this is useful for governance, because if you have a lossy protocol, you have a potential for fraud.

Some questions:
If independent auditors are used do they need to know the operator's identity?

The essence is the contract. In a classical online financial offering, this contract defaults to the user agreement. This contract offers things to the user, and it offers it in the name of the Issuer.

If the contract offers nothing, you don't care who the Issuers is. (Some contracts do offer you nothing...)

An Independent Auditor (of a valuable contract) would need to know the pedigree of the Issuer. In evaluating the contract that is extended between the issuer and the holders of value, there needs to be some "meatspace mass" that says that the various clauses in the contract can be met. E.g., If the issuer is totally anonymous and the contract says that the issuer will be good for a million of personal assets backing then this is a difficult clause to believe in.

What aspects of good governance can be brought to bear on this situation so that the operator's interests are more aligned with its clients?

Well, one of the things that is normally done is that the assets that reserve the contractual promises can be audited in some fashion. For the gold people it was commonly suggested that cameras be used; another possibility was to conduct an audit of reserves from time to time with a person of known integrity and independence, a different one each time, under the cameras.

Has anyone explored this from a math-crypto view?

It's well explored in Ricardo (my stuff). The digital side is capable of being fully and completely audited (not that it is, but the signed receipt structure allows it). 5PM and the balance sheet approach tie the numbers to the contract and then across to the physical assets. 5PM can also be used to control the physical assets to a lesser extent, but there we find more need for physical auditing. It's hard to go totally digital and cryptographic with a pallet of gold, unless we're in one of those Neal Stephenson novels.

If the backing is distributed among a multitude of holders (e.g., in a fashion similar to how Lloyds backs their insurance empire), who's identities are kept secret until audit time and then only a few, randomly selected, names and claimed deposit amounts are revealed to the auditors, might this statistical sampling and the totals projected from the results be a reasonable replacement for 'full asset' audit? To protect the identities of the holders could a complete list of the hashes of each name and claimed deposit be revealed to the auditors, who then select M of N hashes whereupon the operator reveals only those identities and claimed deposits work cryptographically?

The Independent Auditor is likely to demand the whole list and then to sample and test. If not, he has to audit your formulas, and Auditors don't place much faith in crypto blah blah as a matter of principle.

With something like physical assets, it is hard to gain long term trust if you do not identify the location of the assets to some extent, at least in the early days. Short term trust can be gained, this has been shown empirically, so if you are operating a transient payment system then that has more of a chance of getting away with missing elements of governance. The smaller transactions cycle is completed so quickly that people know when things aren't working more quickly.

Bear also in mind that the classical audit approach is designed for a static, snap-shot, long-distance approach. This is all topsy turvy these days. You need to look more for open governance, rather than employing auditors, as otherwise you're wasting your money.


PS: disclosure, I write these things, and am also a auditing a non-FC system at the moment.

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