You register with Safaricom (The Telco) with your Identification Card Number/Passport Number. You get a 4-digit PIN to use as a password. After this your phone number is your 'account number', in a manner of speaking.

An M-Pesa application comes installed as a SIM application (I don't know the technical details, I access it from the "SIM Toolkit" menu in my phone) on all Safaricom SIMs. The application allows you to Send money, check your balance, and pay bills to registered corporate accounts. You need to know the account PIN to perform any of these actions.

To deposit money in your account, you need to go to an agent (these are numerous all over the place) and pay them. These are registered business who can deposit money in your 'account' (a normal customer cannot deposit money directly into another person's account), and you get a Text message confirming that the transaction was successful, and your account balance has been updated. When you receive money, you receive a text message, and you may withdraw it from any agent. You need photo ID to withdraw money from an agent.

-- edited for clarity.

So they don't need bank accounts, which were never required for cash purchases anyway and was a red herring, but they need government id numbers now to be tied to and track their every purchase.

Most banks require a Government ID to open an account, and additional IDs when giving out credit card. I don't see how it is different. And I think you can still use cash if you want to.

Is the value purely stored in the SIM? ie does this all work without any form of cellular connectivity, or is there some sort of synchronization over cellular.

How do they deal with rogue agents? Presumably a rogue agent can claim you have handed over a large sum of money but it would take a while to discover they have lied.

No value is stored in the SIM, the transaction record and balance is stored in Safaricom's servers. Agents have a registration number prominently displayed, and all transactions are immediately confirmed by SMS to both parties. I think agents also need deposit a (significant) amount of money to get registered. Daily transactions for individual accounts are capped at 70000 shillings (about 900 dollars), so is the balance in the account. It would be difficult to carry out fraud of any significant scale with the system.

So that means all transactions have to take place where there is cellular connectivity then?

I live in the US - our connectivity is highly volatile and connectivity concerns are still a major part of the cellular consumer experience.

I was on the lookout for lions in a wildlife park in Uganda while checking my email... It's all possible.