Friday, July 18, 2014

Defining Risk for Retail Payment Hubs

We now have in hand a currency, a payment hub, and a design for connectivity. These are products of my imagination, but useful to consider a specific element of retail payment system risk.

I define risk as the value of a payment hub at an instant in time. I assign the symbol M to designate this value and

M = Onus + Onyou + Dv/Dt
Where Onus = value of payment hub funds on deposit
            Onyou = value of other payment hub funds on deposit
And     Dv/Dt = net velocity of payment flow value.

There are some unusual characteristics of M because anecdotally it appears that as it gets larger, its vulnerability changes. Wholesale hubs seem almost immune to attacks motivated by material gain because it is impossible to hide one trillion dollars. However, the interruption of payment flow from a wholesale payment hub causes economic disruption felt by all governments on the planet. Systemic failure of a wholesale payment hub has never happened but the consequences of such a failure will be severe.

Failure of a retail payment hub may cause local economic pain and the size of M is predictive of the economic shrinkage resulting from a failure. However seldom will the failure of a retail payment hub cause the collapse of a government. Typically insurance prevents the failure of a retail payment hub from a materialistic attack. It is the risk, M, of a retail payment hub, and the vulnerability to a materialistic attack I examined in this blog.  Materialistic attacks from outside a payment hub occur mostly on the dv/dt portion of M and so velocity value defines insurable risk for the purposes of this blog. It’s not that the Bernie Madoffs do not exist and that retail payment hubs are not vulnerable to a Madoff type risk; however, I want to design a retail payment hub that reduces the vulnerability of dv/dt to materialistic attack.

In the aggregate the US retail payment hubs moved US $79 Trillion in funds and suffered $8 Billion in losses due to materialistic attacks. So dv/dt = 79 Trillion/365 = $2,505,073.57 per second losing $253.68 to materialistic attacks or about .01%. That number however does not give the true story. There are two elements to one type of successful electronic attack:  intercept of transaction data, and use of the intercepted data for unauthorized transactions. The only other method of attack is to manufacture transaction data.  It is impossible to tell what the potential value of intercepted financial data is, or if a relationship exists between potential value of intercepted data and value of unauthorized use except to say anecdotally use seems to be a lot less than potential value intercepted. Regardless of the defensive posture of our payment hub we know that any tax on the funds for defensive mechanisms cannot exceed .01% of dv/dt because then we would spend more than we lose.

Next Blog: Spending Defensive Funds on the Model System

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