Underflow | 9
In this episode: Money is pouring into the bank accounts of Talcow Capital Partners — and out again, thanks to an automated banking app devised by CEO Lars Lipp and coded by cryptocurrency pioneer Toomas Peters. According to Lipp and his Russian boss, Pavel Gudichev, Talcow Capital's commodity-trading business is booming. But only Gudichev knows what their real business is.
November-December 2012 — Tallinn, Estonia
THE SOFT LAUNCH of their new banking app was a quiet triumph for Lars Lipp and Toomas Peters. After thousands of trial transactions during three months of beta-testing, the first live transactions went perfectly smoothly.
Thanks to the new app, which Lipp had christened "Chiasso" (as an acronym for "Client Has Instant Authorisation to Send Sums Overseas"), customers of Bank Livonia could transfer money to other banks around the world without any action on Bank Livonia's part. Chiasso sent payment orders to Bank Livonia which were executed automatically by the bank's own computers.
This was made possible by the magic — or, rather, the mathematics — of public-key cryptography. Peters built Chiasso using "hashes" — encrypted versions — of commands which Bank Livonia's computers could recognise, decrypt, and validate. But the hashes in themselves were worthless. The original commands were unknown to Peters. The bank's security was unimpaired.
It would be an uphill struggle now to persuade Swift, the international banking clearing-house, that Chiasso was secure. But getting Swift on board had become less urgent after Denmark's Dansflur Bank, which had branches around the world, had agreed to trial the system.
Dansflur's involvement had been Lipp's initiative, of which Bank Livonia had quickly seen the logic. Lipp pointed out to Dansflur that, since Dansflur had a large international network while Bank Livonia had none, the banks' interests were complementary, and if Dansflur were to become the recipient bank for payments via Chiasso, then it would also become a principal international bank for Talcow Capital Partners and perhaps for the whole of Vantor, Gudichev's oil-trading business. Dansflur promptly opened accounts for Talcow Capital Partners at its international branches, forty in all.
Lipp's Russian boss, Pavel Gudichev, spent the early part of November in Tallinn. He conferred intensively with Lipp, charmed and congratulated Peters, and paid several visits to Bank Livonia and to Dansflur Bank.
Gudichev explained to the two sets of bankers that Talcow Capital Partners' commodity-trading business had been growing rapidly, and would grow even more rapidly now that it had solid relations with Russian producers and exporters. He named three large mining and smelting companies quoted on the London and New York stock exchanges.
Already, he noted, the Tallinn office, under Lipp's management, was settling contracts worth tens of millions of euros each week for physical cargoes of coal, copper and aluminium exported from Russia.
There were days on which Talcow Capital Partners' liquid balances with Bank Livonia and Dansflur Bank approached one hundred million euros. Were the banks confident, asked Gudichev, that they had the structures in place to handle such business?
"Most certainly", said Bank Livonia's chief operating officer, Helmut Kirov. "Most certainly", said Enrik Enrikson, Dansflur Bank's regional CEO for the Baltic countries. "Then we have a green light for growth", said Gudichev.
In the course of the next four weeks the value of contracts for purchases of physical commodities settled through Talcow Capital Partners increased to an average of one hundred million euros per day. Talcow Capital Partners' cash balances with Bank Livonia and with Dansflur Bank increased to one billion euros at each bank. Kirov and Enrikson were, to be fair, not only gratified, but also a little perturbed. Two billion euros was ten per cent of Estonia's annual GDP.
Kirov and Enrikson talked separately with Lipp. To each of them Lipp gave the same reassurance. This was what happened when you did a good job, when you had the right contacts, when you had the confidence of Russia's biggest commodity producers. They gave you their business. Would Estonia prefer that the business went elsewhere?
"Of course not", said Kirov, who knew that Bank Livonia's profits in 2012 would be twice those of 2011, thanks largely to Gudichev. "Of course not", said Enrikson, whose numbers in Estonia were the wonder of his bosses in Copenhagen.
"Excellent", said Lipp. "And please allow me to give you a heads-up that there will be another step-change in our business — upwards, of course — no more than one or two weeks from now. We are about to start buying and selling derivatives. We should have been doing that from day one" — he smiled disarmingly — "but it has taken me a few months to learn the ropes".
Two weeks later, the frequency of transactions in Talcow Capital Partners' bank accounts exploded overnight. Programmes on Lipp's computers, written for him by Peters, began executing thousands of orders per day on financial markets in Europe and America. The transfers were routed through the Chiasso app; there was no way that Bank Livonia could have handled such a volume of business by conventional means.
For Lipp, the move into derivatives was something for which he had long been impatient. By managing his company's cash balances actively in the derivatives markets he hoped to generate returns far exceeding the trivial interest that was paid by the banks, and eventually to be entrusted with Vantor's far larger balances.
For Peters, automated derivatives trading was a chance to compare two sorts of intelligence: human intelligence and artificial intelligence.
His human intelligence came from Cicada_3301, a network of high-IQ outliers which he had assembled by seeding the Internet with dizzying logical puzzles. A hundred or so had stayed the course. Now, under the guise of another extended puzzle, he was feeding them with sequences of numbers and asking them which number came next. The numbers were daily changes in commodity prices.
Peters's artificial intelligence came from NepoAI, the Silicon Valley start-up to which he was an adviser. He was sending the same streams of numbers to neural networks which he had configured on NepoAI's instances, and asking them the same question: What number comes next?
The master-programme which Peters had written for Lipp made one-third of its trades based on Cicada's predictions, one-third on NepoAI's predictions, and one-third on Lipp's intuitions. A few days into the experiment the Cicada network was ahead.
Everybody, in other words, was perfectly happy. Even Gudichev was happy. The plan which he had been painstakingly executing was about to enter what he thought of as its "kinetic" phase.
One day in early December Gudichev called, as he did from time to time, a certain person in St Petersburg, using a certain phone which he reserved for that purpose. Even so, they used code-words for third parties because, in the end, who ever could be sure. "Office A" was Bank Livonia. "Margarita" was Gudichev's personal assistant. "Next door" was Geneva. "The new place" was Tallinn. "The boy" was Lipp. "Bimbo" was a criminal authority so terrifying in reputation and physique that even Gudichev's interlocutor in St Petersburg, who was no slouch in either of those departments himself, was an angel by comparison. As to what "The Big House" was, you can doubtless guess.
Gudichev: We are ready to go. You can tell Bimbo now. Use Office A. We've got at least two weeks before Office A reacts.
Person: Where will you be?
Gudichev: Next door. Margarita will be in the new place.
Person: I will have eyes on the boy. What about the Big House?
Gudichev: Mine. I've briefed the relevant person.
One might say that in the next two weeks all hell broke loose, which it did, but nobody noticed. Using the Chiasso app, a total of two billion euros was sent from Bank Livonia to thirty separate branches of Dansflur Bank, from where the money was transferred to banks in Jersey, Monaco, Cyprus, the Netherlands, London, Andorra, New York, South Dakota, the Cayman Islands and Bermuda. The largest transfers went first to Dansflur's largest branches. Lipp had taken the precaution of warning the senior account officer at each Dansflur branch to expect activity in the Talcow Capital Partners account over the coming fortnight, and to each he gave a plausible business reason.
It was Bank Livonia's chief economist in Estonia who first raised an eyebrow; not because he had any idea what was going on inside his own bank, but because he had been looking at the Estonian Central Bank's daily figures for flows of funds within the banking system. These were bland enough as tables of numbers, but if you charted them, you saw spikes with no obvious relation to the real economy. He raised the point, for information purposes only, at a morning meeting for senior staff, chaired by Helmut Kirov.
"I will ask the Central Bank for clarification", said the economist.
"Perhaps you and I could have a private word", said Kirov to the economist when the meeting was over.
Kirov became, at that exact moment, the first outsider to guess what Gudichev had been doing.
To be continued ...
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