Would a Global Crisis Make E-Gold Glitter?

That's the idea behind this awkward online currency. But fans use it for digital transactions -- even in these stable times

The U.S. economy could hardly be stronger. The world's financial markets are as stable as they've ever been. But the founders of Web site e-gold.com hold the paranoid view that the full faith and credit of the U.S. government may not always sustain the worth of the almighty dollar. E-gold's creators, a Baltimore lawyer and a Florida doctor, have quietly established an ambitious alternative world currency backed by gold.

E-gold is one of the more radical experiments in Internet finance. It's a legal and mostly aboveboard private currency that can be used for conducting financial transactions online. While it has a growing number of enthusiastic fans, it's a complex system that is hardly ideal for the majority of U.S. consumers. E-gold also operates outside the radar screen of federal regulators and the world's financial establishment. While that offers some advantages, it also opens the door for potential abuse.

MARKET RISK. What is e-gold? At one level, it's a simple service. A customer opens an online e-gold account and funds it with a check or cash. E-gold sells the customer gold, silver, platinum, or palladium -- whatever the customer chooses -- at a price determined by e-gold, which is roughly the going spot price for each precious metal. Via e-mail, the customer can then use the metals-based currency -- e-gold -- to send it to someone, pay a bill, or buy something. It works easily if the recipient has an e-gold account. If not, e-gold will cut the recipient a check and send it through the mail for a 90-cent fee.

E-gold is an awkward currency. Customers risk losing money if the value of the metal in their account falls in the open market, or they can gain money if the metal in their account rises in value. Customers incur capital gains or losses by constantly buying and selling the metal underlying their account -- usually gold. But the company that operates e-gold, Gold & Silver Reserve Inc., is not required to file anything about these transactions to federal authorities. So it's up to consumers to voluntarily report the results of their trades. It's an open door for tax evasion.

In addition, Richard W. Rahn, a prominent Washington economist who has written a book advocating the use of digital money, says the currency's existence outside the banking system means "of course, it could be used as a vehicle for money laundering." Barry W. Downer, the Baltimore lawyer who co-founded e-gold, says e-gold is not aimed at helping would-be thieves. The site encourages its customers to file capital-gains reports with the IRS and provides customers with detailed data to do so, he says. He also claims e-gold is not a safe way to launder money because his firm keeps meticulous transaction records that federal regulators could easily obtain through court order. And as with any U.S. business, it has to report all customer transactions involving $10,000 or more in cash.

Why e-gold? Downer says it's rooted in an economic philosophy that worries about the stability of dollar-denominated currencies around the globe. The theory is that a major financial crisis will sharply devalue the dollar, and a gold-based currency will be safer in the long run. As stated on e-gold's Web site: "e-gold cannot be rendered worthless by a financial crisis, whereas paper money can."

The folks who run the site emphasize that e-gold entails "no financial risk" because the currency is backed by gold. But clearly, market risks exist. Gold, silver, palladium, and platinum fluctuate daily in world markets. And in recent years, gold has been a lousy investment.

SMALL-BIZ CONVENIENCE. E-gold has spent nothing on advertising, but its account base is already larger than some Internet-only banks that lay out millions of dollars on marketing. In the first three months of 2000, customers bought $4.5 million in precious metals.

That its customer base is growing rapidly is no surprise. The digital currency has advantages over existing payment systems. For one, it avoids the problems of credit-card fraud. Precious metal, at whatever value, backs every transaction. E-gold can also be used by small businesses abroad that don't qualify to accept credit cards or don't want to pay credit-card company fees of about 3% per charge.

E-gold's antigovernment message, along with the apparent privacy of e-gold, have created some rabid enthusiasts. Many customers are members of libertarian and antigovernment groups, lawyers specializing in privacy and offshore trusts, or small-business owners who don't like to pay credit-card fees. One such fan, an Australian who sells CD and DVD players on eBay, conducts business with customers in Britain, South Africa, and the U.S. using e-gold. He says in an e-mail message: "It works seamlessly, it's very private, and the government here in Oz doesn't know about it." He adds, "I love the privacy factor."

The operations behind e-gold are exceptionally complex. It's built on a web of companies with operations around the globe. I may have some details wrong -- Downey explained that the corporate structure is constantly changing. But it goes something like this:

Gold & Silver Reserve's headquarters is in Melbourne, Fla., with about 10 employees. G&SR acts as a "market maker," buying and selling precious metals in the open market. (The price G&SR pays to buy metals is not disclosed to customers.) A separate Delaware corporation, Omnipay, serves as an "exchange provider" and directly handles, or will soon directly handle, customer transactions. Another company, E-Gold Ltd., is a trust based in the British West Indies island of Nevis, a noted tax haven, and holds actual ownership of G&SR's gold and other metals. Two Bermuda-based lawyers at the firm of Mello, Hollis, Jones & Martin, serve as trustees for E-Gold Ltd. The gold is physically held by independent companies in Canada and Switzerland.

All this, Downey says, is designed to protect customers in case the parent company in the U.S. goes bankrupt or gets sued. What happens if the trustees refuse to turn over the gold? Downey says the company is writing an arbitration clause into a new customer agreement.

NEXT GENERATION. Sounds complicated, and it is. E-gold may appeal to those who share the company's philosophy about the value of gold as currency. It may also be useful to a small business that can't get accepted to take credit cards -- some 40% of e-gold's customers are based outside the U.S., including some small African merchants.

Those aiming for completely private financial transactions may want to wait for the next iteration of e-gold. An Anguilla-based service called DigiGold will use both e-gold and sophisticated encryption technology to allow totally anonymous financial transactions anywhere in the world.

Most U.S. consumers can find easier alternatives. One example is PayPal, recently acquired by x.com. Simply fund your account with a credit card or a bank account, and you're off. An even simpler service, e-cash, is already available through Deutche Bank in Europe and may soon be available through major U.S. banks.

If you've used e-gold or another Web-based payment service, send me an e-mail and let me know what you think.

You can find the original article at Business Week Online