There is a precedent for doing it legally, Paypal, Facebook Credits, etc are all digital currencies. They do it by getting licensed as a money transmitter and complying with all AML and know your customer laws. It's an expensive and long process but people are able to do it. Not sure I fully understand the last two bullets. In general I think you're right that this startup will have larger legal challenges/costs than most but building something that is 100% above board and shows you're making a good faith effort to comply/do the right thing buys you a lot of good will. You want to be YouTube, not MegaUpload.
Can you link to the paper? Happy to read it. My thoughts/plan in general though: basically do what facebook credits did. Get licensed as a money transmitter, collect info on all users to comply with AML and know your customer laws. It's a pain, and expensive but doable and there is precedent for it (Paypal blazed this trail as well). Then there will be a PR battle where you win hearts and minds by highlighting the benefit to small business owners.
I think Dwolla is a valid approach that is better in the short term (doesn't ask people to change as much) but is not as good in the long term. They are built on ACH which still takes 1-3 business days. The way I think of it is Credit card = fast and expensive, ACH = slow and cheap, digital currency = fast and cheap. So it's the speed of credit card at the price of ach. Also, ACH doesn't work internationally well so there is an opportunity there (Western Union, etc).
Paypal, Stripe, Square etc all use credit cards which cost 2.x% plus 30 cents. Bitbank uses a digital currency with low or no fees. It's more competing with Visa/Mastercard than with Paypal, Stripe, etc. Those companies could become partners actually if they decided to support it as another payment method.
Thanks! Fixed some grammar items, you're right about that.
For your dry cleaner I would say: How much do you pay now per transaction for credit cards? Would you like to pay x instead?
They probably won't care or think about digital currency, but they might think "low fees". There is value even if only a few people use it at first. Obviously that is just the tip of the iceberg, but for anyone interested happy to talk more.
It's a good point - I was trying to stay semi-anonymous.
For now I'll just say, I've built one startup previously to profitability and 20k users. Have also worked at 2 YC companies, one as employee #2 and the other in a role that is relevant to this idea. I have a masters in CS and studied economics undergrad.