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In this episode: Cryptocurrency pioneer Toomas Peters and former banker Lars Lipp propose a banking app enabling users to execute instant international bank transfers. They see it as a great commercial opportunity; so does Bank Livonia, where Lipp used to work. Lipp's current boss, Russian billionaire Pavel Gudichev, marvels that even the smartest people can be fooled, if handled correctly.

June 2012 — Tallinn, Estonia

"SO YOU ARE proposing that we give the customers the keys to the bank?"

This question came from Helmut Kirov, Bank Livonia's chief operating officer, one of six executives from the bank who were attending the presentation by Toomas Peters and Lars Lipp.

Peters and Lipp had agreed that Peters would handle purely technical questions, Lipp any other questions. Lipp responded:

"We are proposing that Bank Livonia allow certain preferred customers greater agency in particular transactions with the bank, always under the bank's ultimate control. Specifically, we are talking about international transfers of relatively large sums of money.

"In the case of such a transfer, it goes without saying that the customer knows to which account they are sending the money. They know how much money they wish to send. They know which account is to be debited because it is their own account.

"Even so, the customer must go to the bank, or more commonly to the bank's website, or to a dedicated terminal; they must complete a form requesting the transfer; the bank will review the request, turn it into a coded message, and send the message to the recipient's bank, via the Swift clearing system. The recipient bank will then act on the message with whatever degree of urgency, or lack of it, that it deems approriate.

"As a customer of Bank Livonia I can tell you that time taken to complete such a transfer can often be quite frustrating — and the opacity of the process only makes this worse. Why can an entire day elapse, sometimes more, between my account being debited and the recipient's account being credited?

"We are proposing a new protocol which will allow the sender to encode the entirety of a transfer request including an executable instruction to debit the customer's bank account and an executable instruction to credit the recipient's account. Initially the messages would probably be sent via the Swift clearing-house, but in due course they might be sent directly. There would some cost-savings for the banks involved, more importantly there would be immense gains in speed and satisfaction for the customer. I, as a corporate customer, would certainly change my bank to get access to such a service.

"I can imagine your most pressing question: Can this be done securely? Yes it can. Banks around the world rely upon secure encryption for almost all of their operations. Every international transfer is encrypted securely. Therefore a transfer originated by a customer can be just as secure as a transfer originated by a bank. It can use the same encryption. Or better."

Next to speak, after Kirov had nodded his satisfaction, was Sigrid Kesta, Bank Livonia's chief technology officer:

"On purely technical level, I am persuaded that something of this kind might be feasible. I can also say, without exaggeration, that Mr Peters is a legend here in Estonia. The fact that he will build the app is a major factor. So Mr Peters, if I may ask: Are you confident that you can write an application which requires no new coding on the bank's side, no changes in our core operating systems?"

"Yes", said Peters. "I may have some questions about optimising the code for the particular use of Bank Livonia once we are approaching a beta version, but our intention is to create an application which can be adopted and integrated by any bank anywhere. Bank Livonia will have a first-mover advantage, but the ultimate aim will be to establish this protocol as an industry standard."

"To control an industry standard would confer a great deal of market power", said Kirov. "Who would own the intellectual property?"

To this, Lipp responded:

"A newly incorporated company will own the intellectual property and the rights to all fees and royalties. The company will be owned one-third by Mr Peters, one-third by my company, Talcow Capital Partners, and one-third by Bank Livonia. But Bank Livonia's shares will be non-voting shares. This will make our product more acceptable to banks who are otherwise your rivals. And for some time at least we will offer new shares to each additional bank that joins our network, diluting our own shareholdings."

Kirov did the summing-up. "Obviously we will need a great deal more technical discussion. For the moment let me confirm my understanding of the general principles. You will create the product, as specified in this presentation, at your own expense. Talcow Capital Partners will partner with Bank Livonia in testing and proving the product. Talcow Capital Partners will unconditionally guarantee Bank Livonia against any loss or damage which might arise during those trials. Bank Livonia will have one-third ownership of the product. But it will not have voting powers, and its interest may be diluted over time."

"Exactly so on all points", said Lipp.

"In which case, we shall aim to give a you a decision directly", said Kirov. "Thank you for a most intriguing presentation."

Two days later Bank Livonia accepted the proposal, subject to conditions and clarifications which amounted to little more than boilerplate. While Lipp was finalising the contract, Peters was getting down to work in his temporary home at the Radisson Hotel, just across the street from Talcow Capital Partners.

The more Peters thought about it, the more he foresaw the inevitable disappearance of Swift, the international clearing-house founded fifty years earlier by European banks. Nowadays, any clearing-house was a risk in itself. Hack it and you hacked the whole network. Direct transactions using hash-based encryption and blockchain architecture were not only faster and cheaper, they were also more secure.

That was endgame, but to reach the endgame you had to make the right opening moves. First, they would get Bank Livonia on board. Then, they would get other banks on board, lots of banks, one by one. Then they would change the game.

The key feature of the new app would be its capacity to debit the user's bank account directly via the bank's own operating system. For this to be allowed, there would have to be absolute certainty that no customer could debit any account other than their own.

Peters knew that this could be accomplished using public-key cryptography. He knew that his code could be future-proofed against foreseeable advances in computing power. But he also knew that he would have to persuade others that the app was bullet-proof, which might be the hardest task of all.

No doubt Peters would have seen the situation somewhat differently if he had been in a position to overhear a short telephone conversation later that same evening between Lars Lipp's boss in Moscow, Pavel Gudichev, and a certain person in St Petersburg. But then he might not have lived to tell the tale.

The conversation went like this:

Gudichev: The Estonian bank is on board. Time horizon: Three months. We produce an app that moves big money, they test it, we make the tests work, and then they launch it.

Person: Let me know what resources you need. Unbelievable, isn't it? If anybody came to me and offered to fiddle around in my bank accounts they'd get one on the snout.

Gudichev: We all have our skill-sets.

Person: Is all well with the boy?

Gudichev: He sees only a great business opportunity. And not the same one that we see.

What Gudichev saw was a back-door into the international banking system, being built for him by a person uniquely qualified to do the job, and with the active assistance of a European bank of impeccable reputation. The Big House would be pleased.

To be continued ...

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