Building a (legitimate) Bitcoin & Blockchain payment system

Reforming a dubious past

Can the notorious, high-flying, volatile, and unpredictable Bitcoin system be gainfully deployed for legal and legitimate business models that have the potential of disrupting the existing world of banking and finance? bitcoin_hat

This article explores an interesting attempt by a start-up called Abra to develop a master plan for a global payment system not by using bitcoins directly as the exchange currency but by using the Bitcoin system as the reserve currency to hold and exchange value.

Abra claims to be the answer to the reductive and rhetorical question, a favourite of hack writers and professional conference presenters: “Who will be the Uber of banking and payments?”

Legitimate businesses have stayed away from investing in Bitcoin (embracing instead, all too enthusiastically, the underlying blockchain technology that forms the backbone of the Bitcoin system). This is because of Bitcoin’s central role in many a shady enterprise.

Today’s high valuation, crossing the $4K mark, unimaginable even just a few days ago, is driven by the naked forces of demand and supply and not by the good or bad policies of a government or central bank. That is a good thing.

But this upward trajectory has been motored mainly by illegal and illicit activities. Gathering momentum, the increasing valuation is further helped by a feeding frenzy of speculative market sharks.

Making a criminal

Bitcoin, a cryptocurrency system, designed to operate in decentralised environments without the need for a central authority, has served as the primary payment instrument for all sorts of dodgy digital deals.

It was the de-facto settlement currency for the Silk Road, the dark web marketplace that was the ebay for illegal products (drugs, armaments, false identities, and stolen credit cards), and services (hackers for hire, the occasional hitman).

The site shut down when its founder, Ross Ulbricht, a.k.a Dread Pirate Roberts, was nabbed in the San Francisco Public Library running his billion-dollar empire from a humble laptop.

Silk Road was taken off the dark grid but others appeared: Silk Road 2, Silk Road 3, BMR, Pandora, Hydra, Agora, Evolution, AlphaBay etc. Law Enforcement authorities in the United States have been playing cat and mouse with these sites shutting them down only to find others popping up elsewhere. None would have been able to operate without Bitcoin.

Added to the long list of criminal activities, there is also a relatively new one called “ransomware”, described as “cryptoviral extortion” in which malicious software is used to block access to a distant computer or destroy data, unless a ransom is paid.

In the wake of its remarkable success, other newer and lesser known cryptocurrencies are appearing on the scene as alternatives and substitutes to Bitcoin. In 2016, Monero, a cryptocurrency which possesses “significant algorithmic differences relating to blockchain obfuscation” make it virtually untraceable, has gained popularity and saw its value increase from 50 cents to $12.

Reforming a criminal

One start-up that is attempting to develop a legitimate Bitcoin based business (and in the process to change the world of payments) is a start-up called Abra so named, presumably, because of its magical business model.

At a very high-level, Abra is a Bitcoin exchange and a device based digital wallet. Its initial focus is on international remittances and particularly the significant United States to the Philippines corridor. Ultimately it wants to be a low cost universal provider of global money remittance services.

Like the proverbial onion, Abra aims to provide services in several layers – each with an increasing level of complexity and difficulty.

Layer 1: A (simple) Bitcoin exchange and wallet

Abra is a Bitcoin exchange and provides a digital wallet to its customers. Users can transfer funds from a bank account in the US to buy bitcoins which they can hold in the wallet or send to another Abra wallet. The wallet holder can monitor their bitcoin balance. A receiver in the Philippines can sell the incoming bitcoins credited to their wallet and transfer the money to their bank account.

Assuming there are no legal and regulatory wrangles (KYC, AML etc.) the model should work fine provided the sender and receiver want to exchange bitcoins and the transaction can be completed within an intuitive user interface and in a simple manner. Abra’s CEO Bill Barhydt emphasises Abra wallet’s simplicity. In a recent interview he said, “My mother cannot use an off-the-shelf, pure bitcoin wallet app, but she can use Abra [with] no problem.”

Layer 2: A (real) currency wallet

This is where Abra thinks it has made a breakthrough. Wallet holders will also be able to hold funds in “fiat” currency (such as dollars or any of the other currencies supported by Abra). So, if a customer transfers $100 from their bank account, their Abra wallet will show $100.

Simple as this sounds, only licensed financial institutions such as banks, are allowed to take and maintain deposits. Abra plans to do this without being a bank. It will leverage the Bitcoin system and its blockchain technology. Abra will buy bitcoins worth $100 for the customer which will be stored on their wallet. The customer does not need to know any of this or that their wallet balance is represented by bitcoins. They only need to know that their wallet balance of $100 is guaranteed.

Because the value of bitcoins can fluctuate widely, there is a problem. If the price rises, the customer will continue to have $100 in the wallet and Abra and its partners will pocket the difference. But if the price drops, the $100 in wallet will be backed up by bitcoins worth less than $100.

Abra says its partners will “hedge” the price drop through smart contracts (hedging is common in commodity and currency trading). This is the clever piece of financial engineering that Abra says it has cracked.

Layer 3: An agent network

This is where Abra gets ambitious (and possibly delusional).

Abra is developing a network of agents or “tellers”, M-Pesa style, who will facilitate cash top-ups or withdrawals. Tellers are free to charge any fee they like but must pay a percentage to Abra. Abra says it will not regulate what tellers can charge. Ultimately in a free market, inter-teller competition will drive fees down but whatever they charge is likely to be a lot lower than what the traditional money remitters charge.

Here is the inevitable comparison to Airbnb’s disruptive business model which empowers anyone with a car to take on the organised taxi industry.

Challenges ahead

The growth idea is that as agents will be able to earn income for rendering deposit and withdrawal services and practically anyone with a small investment can become an agent, the network will grow by itself making Abra’s services readily available wherever needed.

However, coming up with an idea that has an incentive based growth model built-in is great. But developing it into a self-sustaining network and a growing eco-system is an all-together different proposition.

Some of Abra’s strategic challenges and operational risks presented below can be applied to any start-up that aims to disrupt banking and payments. Others such as hedging through smart contracts are peculiar to Abra.

Strategic Challenges:

  • Where is the problem?: The strategic blind spot of many promising “customer facing” technologies and innovations, at least in banking and payments, can be best described by the proverbial “solution seeking a problem”. If there isn’t anything that a new service offers that significantly makes life easier (or cheaper) for the customer, it is likely to be treated with apathy. Will a clever crypto mobile remittance service make customers switch their existing providers (keeping in mind that there are several layers of competitors in the market ranging from large banks to disruptive Fintech companies), is a gargantuan challenge that an innovator like Abra can only ignore at its peril.

Some innovators have rightly focused on solving a known problem. Take for example, Flywire, a company which targets international payments made for education (international student fees) It makes it easier for colleges to keep track of and reconcile student tuition fee remittances. This has resulted in colleges instructing international students to pay via Flywire rather than normal bank transfers which carry very little ancillary information and are difficult to reconcile.

  • Trust and familiarity: International remittances represent a unique industry with some very specific customer dynamics at play. Migrants who need to send money often use the services of those they trust or those who have connections with their community which is why there are a number of small country specific remittance companies that profit from loyal customers who speak the same language and understand the culture of the migrant community. The market is hotly contested. There are Fintech companies such as Transferwise, Transfast, Azimo, and Remitly targeting the remittance sector as a whole but none has had real success. Banks from the receiving countries also offer remittance services free of charge (they make their money by adding a margin on currency conversion). Abra may do things entirely differently but ultimately it is vying for the same consumers that the established incumbents and their potential Fintech disruptors are targeting. Celebrity endorsements such as Sir Richard Branson’s investment in Transferwise or in Abra’s case, Gwenyth Paltrow acting as an “advisor” helps raise awareness but changing customer habits and engendering trust is the really difficult bit that takes time.
  • Critical mass: Perhaps the greatest challenge any new payment system faces is whether it will be able to reach critical mass. M-Pesa, the most famous agent-based cash transfer system in the world achieved success for several reasons. It was pushed by the dominant mobile operator in the market which held a near monopoly position; the regulator decided not to interfere; the agents had a financial incentive to sign up other agents; and of-course, it was and still is dangerous to carry cash in Kenya. This led to the agents working as “human ATMs”, a description used liberally by Abra in describing its business model. However, even M-Pesa has not succeeded in international remittances nor has it achieved material acceptance outside Kenya.

Operational risks:

  • Hedging contract fulfilment: The least tested and riskiest part of the business model is Abra’s hedging system that will shield wallet holders from Bitcoin’s price volatility. First, it will not be easy to scale this type of hedging. Then there is significant risk that the whole system could potentially be compromised if the bitcoin price nosedives. A potential price crash scenario may result in Abra’s hedging partners finding themselves unable to honour their part of the deal – smart contract or no smart contract. That would sound the death knell for the entire Abra system.
  • Falling foul of regulation: Any business model linked to Bitcoin carries inherent regulatory uncertainty. Abra is unclear on the compliance side of things and suggests that tellers do their own legal homework. It encourages them “to talk to a lawyer who is knowledgeable about your local laws concerning p2p bitcoin sales.” Not very helpful because even the top and most expensive lawyers are unsure of how regulators in their markets treat, or will treat, Bitcoin based money transfer systems.
  • Money laundering: The transfer values are expected to be low value but those laundering money have always used the old “bundling” technique – breaking up a large value transaction into several small value transactions. If money launderers or those wishing to pay for illegal goods and services, find Abra a useful utility, Abra may have a problem on its hands. Theoretically, there is no way Abra will be able to police if its customers use the wallet to pay or receive funds for illegal activities undertaken on other sites. The Bitcoin system itself is beyond the reach of regulators but any system that uses it is not. If regulators find evidence of illegal activity, they are likely to shut it down for good.


The Abra wallet may remain confined to niche applications. The idea, that Abra does not hold customer deposits but guarantees them but uses bitcoins as the reserve currency guaranteeing the funds in the wallet, will work provided there is no bitcoin price crash and its plans to hedge price fluctuations is feasible.

Somehow amazingly it must also pass unscathed through regulatory head winds which are always present.

The underlying guarantee of value is derived not from the central bank of a country or any other centralized authority but from the forces of demand and supply as experienced through a decentralized self-sustaining mathematical commodity like Bitcoin. But it is the inherent volatility of this mathematical commodity that puts every idea and business edifice built on it susceptible to an unpredictable and catastrophic upheaval in the future.

But if Abra is able to surmount these challenges, even in a handful of remittance corridors, it may become a takeover target of an established money transfer operator such as Western Union or Moneygram even before it turns a profit and investors will be able to generate substantial gains on their investments in Abra.



The Bilateralism of Blockchain

Blockchain-Icon.jpgMost of us by now have heard, read, and wondered aloud about the idea and impact of blockchain in its various forms and manifestations on how things are done today. Countless commentaries appear in the media. There is detailed analysis by digital pundits every day. There are news and articles about exploratory industry consortiums and pilot projects. A vanguard of startups is already offering various platforms and software solutions.

Most people position blockchain as a change agent so revolutionary that it will, very soon, redefine industries by changing the business models and the underlying business processes. They see immediate and far-reaching consequences especially in banking and payments.

Yet others dismiss it as yet another hyped-up fad, brainchild of ultra-liberal-authority-hating-techno-geeks, with little sense of the pragmatic. It is staple nourishment served at industry conferences, the idea du jour, until it gives way to something more alluring and emblematic.

Is it “disruptive innovation”?
The idea of blockchain cannot, strictly speaking, be classified as disruptive innovation. Strategy theorists, charged with the task of policing the abuse of strategy labels frameworks, and two-by-two matrices, do not classify blockchain as disruptive innovation.

The idea of disruptive innovation in its original sense postulated by Clayton M. Christensen, the famous Harvard Business School professor, who coined the term, and shaped the thinking around it, relates to “a process whereby a smaller company with fewer resources is able to successfully challenge established incumbent businesses”. This is done by meeting the needs of specific customer segments “frequently at a lower price.” These segments are ignored or overlooked by industry incumbents.

Please do not, instruct the strategy police, call it disruptive.

It is a breakthrough
Blockchain may not be disruptive in the strategic sense. But it represents breakthrough strategic thinking as far technology is concerned. If it lives up to its promise, it has the potential of completely rewriting industry business models and rewiring the workflows to put them on solid digital foundations.

Two Harvard Business School professors in a recent article, compared blockchain to something as fundamental as internet messaging.

Traditional messaging worked through the establishment of a dedicated connection between two points. If I wanted to have a voice conversation, send a message, or a fax, my telecommunication company flicked a switch to establish a direct and dedicated connection with the person I want to communicate with. But the internet introduced a different kind of messaging technology called TCP/IP. This did not require a dedicated connection but instead split the content of the message into several smaller digital packets, pumped across over inter-connected networks, and assembled back at the destination. This was how email worked. The technology provided a new “foundational layer” which enabled all the great internet apps and services we use today to be developed.

The “Dao” of blockchain – bilateral applications
Similarly, blockchain provides a new foundational layer for the digital economy.

But blockchain enthusiasts have already identified countless industry applications in every industry sector. Very few have strategic merit and are far from economic realities.

Those who see its potential understand that it will take a long time for business infrastructure to change from what it is today, still highly manual and driven by intermediaries and technical interpreters, to a more inclusive, automated, autonomous, and decentralised infrastructure platform that will allow business to be conducted directly between two transacting parties.
While blockchain can work in many situations with multiple parties and stakeholders, the “dao” (Chinese for the key or the way) of blockchain, so to speak, is “bilateralism” that enables two parties to deal with each other directly without the need for intermediation.

Its first bilateral applications are to be found in finance and payments.

Bilateral payments
Bitcoin is based on blockchain foundational technology. Bank account transfers, credit card payments, PayPal, and all the various payment services that are available across the world require intermediaries to transfer money or exchange value between two parties. Most transactions are completed using clearing and settlement processes. Payments over banking networks, for example, are first cleared (clearing or netting off outgoing against incoming transactions) and then settled (settling the net balance).

Blockchain technology does away with such intermediary-assisted mechanisms of clearing and settlement. Instead of a central processing entity, digital tokens or “coins” that carry intrinsic value are exchanged between the two parties. Like exchanging physical cash or coins this does not involve a third party. Stand-alone or “autonomous” blockchain based eco-systems reward “proof-of-work” generating digital cryptocurrency to reward those who help maintain the system. Coins are “mined” by those who “solve complicated cryptographical puzzles in order to validate transactions and create new blocks” by allocating computer resources to these tasks. Such enormous amounts of computing resources are now dedicated to mining activities and so much power is consumed by these computers that there are now legitimate concerns being raised by environmentalists. Some calculate that by 2020, Bitcoin dedicated computers will consumer as much as energy as a small developed country like Denmark.

There is already discussion of using “proof-of-stake” instead of proof-of-work. Those with greater stake in the system will have better chance of starting a new block. In way of analogies, this approach will “forge” digital wealth rather than “mine” it.

Blockchain technology also ensures that a cryptocurrency unit like a bitcoin cannot be used twice by the same person. It records a payment transaction in an unalterable distributed ledger that can be accessed by anyone so that they can check if the token was transferred legitimately to its present owner and is authentic and valid.

Bilateral stock trades
Stock markets facilitate the purchase and sale of shares that are traded on the exchange. Blockchain technology will not entirely displace conventional stock market processes but can facilitate cheaper and faster execution of trades. Once completed such trades will be available to all those who have access to the system to review. New digital assets created as part of digital platforms including virtual commodities could be listed and traded very quickly. More importantly, stocks and digital assets could be traded and the paperwork completed digitally between individuals from different geographical markets. Currently it is not easy to acquire securities that are listed on exchanges operating in markets other than one’s home market without going through several intermediaries. Blockchain will help automate global stock market deals and can trade in all types of securities or specialise in certain sectors without the need to settle and fulfil security transactions.

Bilateral asset verification and transfer
Blockchain technology can help record transfer of asset ownership whether digital or physical. Again, in today’s analogue world, transfer of an asset, such as property, is usually recorded by third parties, often the government. The process can take an inordinate amount of time and is often riddled with bureaucratic bottlenecks at least in the less efficient economies around the world. Blockchain can be used to record asset transfers and validate ownership which makes it particularly valuable in countries where central government property records are not worth the paper they are written on and loans or mortgages cannot be arranged due to lack of verifiable evidence of ownership.

The world is flat
While blockchain technology facilitates bilateral trade, there is no reason why multilateral contracts or other forms of pre-programmed logic to manage relationships across multiple parties cannot be completed.

These applications, or smart contracts as they are popularly termed, will do the work of lawyers, implementing and executing contracts as and when required. Such platforms will eventually lead to flat-structured widely-distributed organisations that will work by automatic execution of pre-agreed rules. Not all organisations will function like this but such platforms will fit in well with highly collaborative ventures such as software development initiatives where people involved will be able to focus on developing code and content and the platform will take care of the processes and procedures and rewards required to run the venture. There will be issues of-course. Decision making will slow things down as it will be driven by consensus.

It is early days for an autonomous flat organisation to develop and thrive but there are experiments already underway. Ethereum is a platform that provides the foundations of developing such autonomous digital entities. Indeed, one such venture with the generic name of “Digital Autonomous Organisation” or DAO for short was developed by the founders of Ethereum and attracted $150 million in its first fund raising attempt. It has had a bumpy ride with a massive hack that exploited its rules forcing it to divide itself known in blockchain jargon as developing a “hard fork”.

But whether it is “The DAO” or another venture that will truly follow the “dao” of the blockchain remains to be seen, but there is a new birth of bilateralism in the digital world. It provides further proof that the internet continues to bring people together directly making intermediaries redundant or less relevant.

The Mobile World Congress 2017

Most Old Some New

The world’s largest industry event, the Mobile World Congress (MWC) takes place annually in Barcelona and for a week it takes over the city when even the cheapest of the worst hotels sell out well in advance, restaurants are jam-packed, and taxis are hard to find. New products are rolled out by the world’s top mobile device manufacturers, innovations are proudly displayed, new initiatives are unwrapped, and in general, there is ample opportunity for everyone to grab the world’s attention.

This year, there were recurrent themes from last year such as connectivity and the Internet of Things, wearables, driverless connected cars, and of-course, breath-taking virtual reality demos with different experiences on offer for those with the time and inclination to line up and wait their turn to get inside the latest shining connected Jaguar, the space flight VR Samsung simulator or, my favourite, walk the virtual plank with wobbly knees.


A driverless connected car


Walking the VR plank


This year, there was added emphasis on artificial intelligence and machine learning. Exhibitors showcased the latest connected wizardry from intelligent platforms and data flow management systems to contextual conversational chatbots to all types of robots, from app controlled impressive drones to cute-and-cuddly pet robots or petbots.


Want a petbot, anyone?

Of course, most of the show is devoted to the mobile industry. Network efficiency, superfast data pipes, intelligent routing, operator hardware, and the latest phones and gadgets and other elements critical to the mobile industry are discussed and displayed at the giant booths, some so big, that they look like huge futuristic cities rather than conference pavilions. It is in these futuristic pavilions that relationships are cemented, mega deals are made, and contracts are signed, all in the process of one energy-packed week of organised innovation.

IMG_3829.jpgConference pavilion or a mini-city – The Huawei Pavillion.

But this is the event for everyone. Besides the mega mobile network operators, hardware and software vendors, handset manufacturers, and technology giants, the event provides an excellent opportunity for the smaller suppliers and those excelling in niche areas, to showcase their technical wares. One pavilion featured resilient phone casings that could withstand liquid damage by placing them in mini fish tanks complete with tank-like air bubbles where the phones sat happily charged.

IMG_3800.jpgLiving in liquid


Finance and Payments at the MWC

Mobile devices are now widely used to access financial services and make payments in both the developing and developed parts of the world. Visa and MasterCard and other payment services providers were present in full force at the Congress and though the interest in payment services from mobile network operators has waned a bit, the handset manufacturers have redoubled their efforts to take a lead in mobile digital wallets leveraging the tokenisation solutions from Visa and MasterCard. But progress has been slow as consumers still cling to the familiarity of plastic cards for payments but now have a wide choice of connected gadgets and wearables for making payments.

Disruption in Digital Finance

I moderated a panel discussion on disruption in digital finance. The auditorium, as always is the case at the Congress, was full and the session was oversubscribed. I opened the session with some perspectives and set the scene for the debate and discussion that followed.

Samee MWC17 1Starting the debate on disruption in digital finance at the Mobile World Congress 2017 in Barcelona on March 1

The financial services industry has been more resilient than other industries and the process of disruptive innovation has been slow to take root in banking and finance. This is because of three reasons:

  • Regulatory Protection: The banking sector has been protected by regulation and quite rightly so because regulators must look after consumer interests so they don’t allow just anyone to setup shop as a bank and start accepting customer deposits
  • Ownership of Infrastructure: Banks have traditionally owned the core assets that facilitate both local and international payments such as domestic Automated Clearing House (ACH) systems, international clearing and settlement operations, and the global payment card networks. Access to these networks was traditionally restricted to the financial sector only; and finally,
  • Information Access: Banks never shared customer data nor have they ever allowed anyone to make transactions on behalf of customers directly from accounts held by them

These industry advantages that banks and financial services providers have traditionally enjoyed, have acted as barriers to entering the industry for non-bank players. These barriers are now being eroded by regulatory measures emanating out of Europe which are also being adopted elsewhere. Open banking APIs – standardised and interoperable connectivity interfaces – that make it easier for other providers to connect and exchange data with banks, and the Second European Payment Services Directive or PSD 2 are allowing registered and regulated third parties to access customer bank accounts (with their permission) to use the data for making credit decisions and initiating payments on behalf of consumers. These measures are likely to relegate the banks to infrastructure providers but it is not all gloom and doom for the banking industry. In fact, banks are looking at these changes from a positive perspective and as drivers towards innovation helping the banking industry evolve to the next level of technological excellence. It is making banks rethink their business models and the value they provide their end-customers and develop new ways to serve their customers. Infrastructure ownership and access is also opening up. Both Visa and MasterCard are now publicly traded companies.

Full panelThe Disruption in Digital Finance – at the Mobile World Congress 2017 in Barcelona – March 1 – with (L – R): Pere Nebot (CIO of CaixaBank); Rocky Sopelliti (Global Industry Executive,  Telstra); Speaking – Gulru Atak Gundem (Head of Innovation Lab Citi); Dror Oren (CEO of Kasisto); and Samee Zafar (Director, Edgar, Dunn & Company) moderating.


Rocky Sopelitti, global industry executive at Australia’s largest mobile network operator Telstra, discussed the details of his research on key global trends relating to Millennials, Mobiles and Money, the forces reinventing financial services. He highlighted some important results from Telstra’s extensive survey. The rise of the millennials – those aged 18 – 34 – who now constitute 1 out of every 3 consumers and are projected to own 28% of global wealth by the year 2030. The Fintech industry – the challengers and the disrupters – those who are and will be competing in digital finance – have invested billions in new ventures. But despite 90% of the bankers believing that Fintechs will have significant impact on the industry, only 50% report their institutions have created value through digital partnerships with Fintechs.

Pere Nebot, CIO of CaixaBank, one of Spain’s largest and most respected financial institutions, talked about disruptive innovation from a bank’s perspective. CaixaBank which calls its new model branches “stores” always take a customer oriented view of change. He said that in 2004, only 18% of the bank’s customers accessed the bank over the internet. But today a majority – 53% – do so over digital channels. CaixaBank has also rolled out an exciting new digital only bank called “imagin” which is designed for the millennial consumer and does not charge any fees. He also spoke about how the bank uses data to analyse customer behaviour and identify needs and is now implementing AI tools to help it understand its customers better.

Anuj Nayar, Head of Global Initiatives for PayPal, talked about the company’s strategy and how fundamentally it is linked to enabling the Fintechs and the innovators in the field of payments. PayPal could be called the original disruptor of the payments world when it started operations around 20 years ago. Today, PayPal’s subsidiary Braintree provides the platform and the necessary API’s over which some of today’s key innovators such as Adyen and Uber have developed their services. PayPal owned Venmo has been a phenomenon in person-to-person payments in the United States. Another successful acquisition for PayPal was Xoom which signalled the company’s participation in the international remittances industry. Recently it also acquired TIO networks for $233 million. TIO is a “bill-payment processing service for those who don’t necessarily use bank accounts for their financial transactions. With its API, you can pay your utility and telecom bills from your phone, computer, or a self-service kiosk without having to go through a bank.” TIO will also enable consumers without bank accounts or payment cards to fund and make payments using PayPal.

Dror Oren, co-founder and CEO of Kasisto, a San Francisco based start-up originating from the same group that developed Siri and later sold it to Apple, has developed a platform that provides a natural language interface which helps banks, mobile network operators, and other companies automate many of the services through conversational interaction via a mobile device. It goes beyond voice recognition and voice activated commands such as those offered by Siri or Amazon’s Alexa but provides a contextual interface that is very nearly like talking to a human being on the other end of the digital conversation. A natural language interface will automate many of the tasks that collectively cost banks and other providers billions of dollars each year in employment costs of customer services / call centre staff.

Gulru Atak, the newly appointed head of Citi’s Dublin based digital labs, part of its global treasury division discussed the importance of trust and compliance, two requirements for corporate customers, and two reasons why big banks add significant value to global trade and finance. Citi has developed open APIs that enable its customers to connect with its platform and directly integrate their treasury applications with backend systems. Gulru provided insights from the perspective of a global institutional services provider on the impact of Fintech innovation and stressed the importance of partnerships between Fintechs and banks for mutual benefit.

One thing that all the panellists agreed with was that Fintechs and disruptive innovation in financial services and payments is a good thing for everyone. While some incumbents will fade away or struggle to provide value, the process of experimentation and innovation will continue to contribute fresh ideas and help to propel the industry forward. Interestingly, there is a significant collaboration between incumbents and start-ups. Many start-ups are financed by banks or other financial services providers.

Even though the session duration was a generous 70 minutes, it seemed that the audience felt some disappointment when it finished because the discussion was alive and strong and could have carried out for another hour keeping every one focused and engaged. But then there were eight mega halls with thousands of exhibitors to talk to and an overall attendance of over 100,000 delegates to network with. There was just so much to discover and do.

Fake It Till You Make It

fake it image

The Art of Start-up Deception

A confidence game

The most important thing for a new business is to generate and maintain investor (and customer) confidence.

Take out the confidence, the money and prospects dry up.

To create interest and grab attention, entrepreneurs learn early-on to generate an air of unbridled optimism, push their vision of the company’s value assertively, hype things up, and get ready for the next round of funding.

Not surprisingly, to maintain the hype, some misrepresent their achievements to keep up with the high expectations they have themselves created. This is where they cross the line from the real world to one built on deceit and delusion.

Fake it till you make it

Start-ups pursue ambitious goals. They don’t know if they will ever be able to deliver on their plans or accomplish what they set out to do. This is fine. Taking risks is at the heart of every new venture. But that does not mean a start-up should engage in wilful misrepresentation. It is acceptable to aim high but it is not acceptable to mislead.

The culture of avoiding the truth or pursuing a policy of: “fake it till you make it” – remains prevalent among ambitious entrepreneurs. It is tolerated and even encouraged by investors. But some entrepreneurs take it too far.

The “fakers”, who engage in calculated deceit, often simply withhold the truth rather than lie outright arguing for the need for secrecy for competitive reasons even from investors. This further perpetuates the falsehood while at the same time gives the non-existent or over-hyped product, a further boost by enhancing the aura of mystery around it.

Three case studies illustrate the point.

The poster child: Theranos

The most talked about example in the last few years, the poster child of start-up deceit, remained shrouded in secrecy for years. Theranos, a company said to have invented ground breaking blood testing technology claimed its small testing machines could complete several medical tests from a single drop of blood drawn from a finger prick. It promised to empower ordinary people and put them in control of their own health or as the company’s CEO put it, “the individual is the answer to the challenge of healthcare.”

Over a decade its youthful CEO, Elizabeth Holmes, given to wearing only black, Steve Jobs style, and kept up the confidence of everyone. At the peak of its hype, the company was valued at a whopping $9 billion. It had over a thousand staff and was buring $20 million a month.

In late 2015, the Wall Street journal began investigating the company and revealed that only a small minority of the tests carried out by the company were conducted on its own Edison machines and even those were mostly inaccurate. In around mid 2016, Walgreens, the large drug store chain in the US ended its agreement discontinuing the 40 Theranos Wellness Centres in its stores in Arizona. Since then Walgreens has sued the company for $140 million. Holmes has been barred from running a lab for 2 years and Theranos has closed the company’s California lab.

The company’s focus now is on developing and marketing a table-top blood-testing product called the mini lab as it continues to survive on dwindling funds. Even if Theranos can battle the growing “army of lawsuits”, TechCrunch thinks the product is nothing new, let alone revolutionary. It is hardly likely to save the company from inevitable extinction.

Too good to be true: Lily Robotics

In January this year, Lily Inc. – the developer of a quadcopter drone based camera – which took the selfie craze to a whole new level, decided to shut down operations finally revealing that it had been accepting pre-orders for a product that did not exist.

In a promotional video in 2015, the company showed off a proto-type. A drone mounted camera, launched by hand, following its owner down a ski slope shooting high quality video, switching direction on command to shoot from the front, or take in a 360-degree view, and finally returning to the outstretched hand that launched it. It identified its owner from a wrist worn gadget. The product was so intriguing that the Wall Street Journal put it on its front page in late December 2015 as part of “tech that will change your life in 2016”.

Sadly, the whole thing was not real. The promised technology just wasn’t there. In any case, the core technology allowing a drone being tossed into the air, stabilise itself, and follow a programed path is not unique to Lily. It is now being developed and featured by other drone companies. Lily’s promotional video showed how seamlessly and effortlessly the drone camera worked. But it was shot using a drone from DJI, a competitor, with a GoPro camera mounted on it. Worse, the company had already accepted advance orders to the tune of over $25 million from 60,000 customers.

Investors are not stupid and are not easily duped by someone pedalling unachievable dreams but they are under pressure and there is little time to do a detailed due diligence. It is still odd though that none of the investors asked for a real-life demonstration of what they had seen in the company’s promotional video. In emails released in relation to a lawsuit, the company’s CEO wonders: “I am worried that a lens geek could study our images up close and detect the unique GoPro lens footprint. But I am just speculating here: I don’t know much about lenses but I think we should be extremely careful if we decide to lie publicly.”

A suit filed on behalf of the people of California accuses the company of intentionally misleading its customers with the promotional “jaw dropping” video which was faked.

Pure Mayhem – Powa

In payments and financial services, there was the supernova of a high-flier start-up in London last year that grabbed headlines. Powa, a company that was at one time valued at $2.7 billion claimed to have major multi-national clients for its payment platform and products and was opening up sales offices across the globe to keep up with a non-existent demand for its products.

The alleged deceit was phenomenal. The company led by its colourful CEO was plainly misleading everyone by announcing confirmed contracts with customers that had not been signed. The Financial Times, followed the story over several months and published several articles which demonstrated that creating hype and overselling the company was an organised, deliberate strategy and one in which, at one point, even investment bankers were involved. It published a leaked document developed in September 2015 that put “a preliminary enterprise value of $16 billion to $18 billion as a base case” on the company describing it as the “tech investment of the decade” with a “clear path to $50 billion””. Elsewhere the document described Powa’s strengths in terms that any business school professor would have been proud of. The company was described as having “clean sheet innovation”, offering “competitive checkmate”, and “next generation incumbency”. Powa came down in flames when it ran out of cash and its investors pulled the plug.

Tell the truth

There is no easy way forward. Start-ups can set their ambitions high even if they don’t have prototypes and are hoping to develop one. Start-ups can over-sell their dreams but what they have at any moment cannot be hyped beyond reality.

Entrepreneurs and investors should know there is not a fine line between hype and deceit. The line is well marked and clear. Dreams can fly high but achievements must be tied close to the ground in down-to-earth reality.

(Image source:

How Not To Digitise


A noted historian once observed that history is nothing but the unfolding of miscalculation. If this is true, then the Indian Prime Minister Narendra Modi made history on November 8th when he ordered two large denomination banknotes to be withdrawn from circulation and replaced.

No one doubts that criminals, corrupt officials, dodgy businesses, and tax evaders, purveyors of the so-called the shadow or “parallel” economy, prefer to deal in cash. Cash payments cannot be tracked or traced. Cash is also counterfeited. Electronic or digital payments, on the other hand, provide an effective way to weed out these evils and bring greater transparency to the workings of the economy, reduce corruption, fight crime, and ensure everyone pays their fair share of taxes.

If cash could be taken out of circulation, would it help? The answer is yes. Provided the reduction in cash is permanent and if there are electronic alternatives easily accessible to everyone for migration to digital means. Developed markets have done this before. The European Central Bank (ECB) acknowledged that large value currency is convenient for criminals and has decided to withdraw the €500 note by 2018. Because of high availability of digital infrastructure, high incidence of electronic payments, high penetration of bank accounts and credit cards, high percentage of tax payers, and (relatively) honest tax payment collection, developed markets can afford to gradually phase out large denomination notes.

In a developing economy such as India where digital infrastructure is rapidly developing but still in early stages of development and where a majority of citizens do not have access to financial services, taking cash out of circulation, has created untold havoc on ordinary people especially the poorest and most vulnerable who are heavily dependent on cash for wages and earnings.

Bold assumptions

In India, 98% of payments are made in cash. The government decided to withdraw 500 and 1,000 rupee notes which make up 85% of cash in circulation, announcing a 50-day period for people to deposit or exchange the banknotes. The premise is that most illegal transactions and illicit wealth are represented by large denomination banknotes. Banning the notes, so the argument goes, will make it very difficult for corruption to thrive in the economy as it does so today.

The move was designed as shock-therapy but its intended targets seems to have largely escaped the consequences. Instead it has delivered some unintended consequences by hitting the country’s most vulnerable the hardest who had to queue up for hours and even days to exchange their money losing wages which are already at subsistence levels. According to Bloomberg, “[Prime Minister] Modi’s cash decision has forced many families to spend as many as four days a week lining up to withdraw money or exchange old bank notes, costing them an estimated 615 billion rupees in lost business.”

Badly planned

A surprise attack, by definition, is privy to only to a select few. But this secrecy can result in inadequate preparation which is exactly what happened in India. Reports indicate that a “group of 5-10 people – a young team of researchers working in two rooms at Modi’s New Delhi residence”, developed the monetary medicine and the method for administering it.

To make matters worse, the Prime Minister also famously takes advice from a widely popular multi-millionaire yoga guru with interest in politics and loads of home-grown ideas to improve the country’s economic health. He had previously threatened the government by his intention to fast indefinitely to force the government to take action against corruption. He now believes that the move was not been implemented properly and has gone one to assert that corrupt bankers are somehow hampering the drive to weed out corruption.

Badly done

What is obvious to most, but not perhaps to the demonetisation apologists, is that in any country, especially one with significant inflationary conditions, a majority of the black” or illicit wealth is stored away in tangible assets which appreciate over time such as jewellery or real estate, and not in paper currency. Estimates place only 5 – 6% of black money in India to be represented in currency notes. In other words, the demonetisation plan was built on a false premise.

Badly anticipated

A central motive behind the whole thing was that if a substantial amount of cash representing black money was not deposited before the deadline and, therefore, voided – the central bank of the country, the Reserve Bank of India (RBI), would be able to reduce its currency liability and pass the gains on to the government. That too, did not happen. In-fact more than expected cash has circled back into the banking system. Over 80% of the withdrawn currency notes have been deposited or exchanged.

In another bewildering move, the government has announced it will introduce a 2,000-rupee banknote – of significantly larger denomination than those voided. If the idea was to void large value banknotes because they are more convenient for criminals, why replace it with an even bigger banknote? Sceptics think the 2,000 rupee banknote is a bait which will be cancelled a few years from today in a similar demonetisation move.

Tax amnesty

Economists have explained the net effect of the demonetisation drive as a “de facto” tax amnesty. The government amended the law relating to taxation to include a clause which says that unaccounted-for cash deposited before Dec 30 will attract a tax rate of 50% (along with other restrictions regarding funds withdrawal timeframes). It is now believed that the tax on such funds realised by the government in the short term is likely to be relatively small. There is also likely to be litigation relating to unpaid taxes on such deposits which will take a very long time to resolve.

More opportunities (for money laundering)

Ironically, the economic misadventure has resulted in new opportunities for money laundering which a whole gaggle of unscrupulous entrepreneurs has capitalised upon. Bloomberg reports that these include flying plane loads of cash to the north-eastern states of India which are exempt from restrictions; brokering the services of high-turnover businesses who will “absorb” the ill-gotten currency charging premiums ranging from 10 to 50% “depending on the difficulty”; or offering jewellery or real estate in desirable locations around the capital at considerable premiums. In other words, the move designed to curb money laundering and tax-evasion has created more of the same.

Even religion is seeking ways to profit from the debacle. A television channel filmed a local priest offering to whiten money in exchange for donations which are exempt from the currency ban.

Trying to plug the widening leak, the government is taking further measures to stop these practices which include, believe it or not, asking for police approval for flights “taking off from airfields not controlled by the government,” requiring pilot and passenger “screening”.

Its catching

No serious government, after seeing India’s demonetisation adventure, is likely to repeat the measure. The government of Venezuela, a country perennially on the brink of economic collapse, however, decided to do something similar.

In December, it withdrew the 100 Bolivar bank note causing riots and chaos. Those who managed to deposit the notes were puzzled when the same banknotes were dispensed by ATM’s. The new banknote has failed to make an appearance. Civil disorder has forced the president to postpone the move.

Doing it the right way

The good news is that away from the initial idea of catching criminals, counterfeiters, and thwarting corruption, the government is changing its tune to moving towards a cashless economy which is more credible and welcome. New bank accounts have been opened and even alternative payment platforms such as the paytm wallet linked to a major e-commerce website has seen significant new accounts on-boarded. The government is taking active measures to provide discounts and other incentives to bolster digital payments.

As a result of this, there are many consumers who will switch to digital payments. But for many more, the whole episode will be a painful memory that achieved nothing. They will continue to use banknotes – smaller denomination banknotes or new ones – not as a mark of protest against but simply because that have always used cash. Cash is embedded in people’s daily lives and the government has not provided them with compelling reasons to go digital nor a wide enough digital payment acceptance footprint.

For criminals and the corrupt the move may be a temporary set-back but they are not likely to change their behaviour and become honest simply because now there are new notes in circulation.

The process to bring greater transparency to the system in order to erode the parallel economy and introduce the fruits of digitisation – is a gradual one, it takes time. It requires making it worthwhile for consumers and offering very clear reasons and benefits for people to switch to electronic payments wherever possible.

Only 17% of Indians own a smart phone. Compare this to other BRIC countries – Brazil 41%; Russia 46%; China 58%. Another indicator: Adult % with access to the internet – India 22% (only 13% in rural areas);  Brazil 60%; Russia 72%; China 65%. Compare credit cards: 2.1% Indians have credit cards – in developed markets the figure is around 52%. When it comes to payment acceptance – measuring the penetration of electronic payment acceptance – “Brazil – with a population 84% lower than India – had nearly 29 times as many POS terminals”.

The government’s efforts and money should have been better spent to bolster these numbers. Also, money should have been spent to bring more people within the tax-paying segment and root out corruption in tax collection. Only 5% of Indians declare their incomes and 1 % pay income tax.

Shock-tactics offer the lure of a magical end to endemic problems. Putting penalties on the use of cash or applying shock measures may inconvenience criminals temporarily or provide a welcome short-term impetus to digitisation, but its side effects on a developing economy as a whole are too damaging. Even the uptick in digital accounts may prove temporary as people revert back to using cash for precisely the same reasons as before.

An empathy deficit

Political bribes are rife in India. The law requires political parties to declare only high value donations. Donations to Mr Modi’s party doubled in the year of his election made by those hoping to profit by his success. Of these, more than two-thirds came from undeclared sources. Calling for transparency from everyone while keeping one’s own funding sources private warrants some serious self-correction.

Listening to economic quacks and not possessing the experience to foresee the economic misery inflicted upon the poor and the vulnerable, leads a New Delhi based prominent Indian author and journalist to describe Mr Modi’s problem as an “empathy deficit”. Effective modernisation and rehabilitation should be based on better planning and a concern for all segments of society, not just on the fruits of hurried research or the ill-advised recommendations from quick-fix gurus especially where one of the most important economies of the future is concerned.

Undeterred and unrepentant, Mr Modi spoke about his early life experiences of being a tea vendor and that he continues to brew a strong cup of tea even where larger matters of the economy are concerned. But he has also developed the practice of breaking down during speeches to emphasise the sincerity of his plans and his good intentions. This brings to mind an ancient saying which is relevant: Any man can make mistakes, but only an idiot persists in error.

Image source: DNA India

Blockchain and the future

10-terrible-tech-predictions-136402490489303901-151130131501Pollsters whose job it is to talk to people and predict the outcomes of elections, sometimes  get things badly wrong: the general election in Britain in 2015 when Labour performed unexpectedly poorly; the Brexit vote this year which took everyone by surprise; and finally, the US presidential election, which shocked the whole world.

Pollsters got these so wrong because they rely on sampling and extrapolating techniques. Statistical analysis is accurate only if the sample is representative of the whole. In the US presidential election, for example, voter samples excluded entire voter segments such as white working class voters and were also disproportionately skewed towards other segments such as politically conscious urban voters (who don’t get fed up of being called again and again considering there were many of these polls just before the elections). Yet another problem was that voters were not entirely honest and may have held back their choice for whatever reason.

Surveys from Princeton Election Consortium that used statistical “Bayesian” model developed by Professor Sam Wang, Neuro / Data Scientist, and Professor at Princeton, the model which correctly predicted 49 of the 50 states in the 2012 election, confidently rated Hilary Clinton’s chances of winning at 99%.

Predicting the unpredictable

Provided the sample is statistically relevant, determining which way people will vote is still the easier thing to do.

Predicting the outcome of events that do not entirely depend on individual decisions is far harder. In such cases, polling is useless. No one who is polled has any specific information to share. When something is unknown, it does not matter how many people you ask, the larger the poll, the larger the pool of guesses.

Collective Wisdom

But for events that are not entirely random there are different bits of relevant information that may be known to different people. Some people believe that asking a group is more accurate than asking a single individual.

James Surowiecki, the author of the best-seller “Wisdom of Crowds”, argues that “under the right circumstances”, a group of people is better able to estimate, forecast, or predict than single individuals in that group.

Economists believe that the best way to predict the future, particularly where politics are concerned, is to let the markets do it for you. Betting companies have been doing this for years relatively successfully.

But betting or “prediction” markets failed to predict the Brexit vote. Polls and markets shifted towards “leave” in early June but not enough to overtake “remain.” On the day of the referendum, markets priced “an 85% likelihood” for Britain to remain in the EU. Markets also failed miserably to predict Trump to win the Republican nomination. But perhaps bruised from these miscalculations, markets clearly predicted the outcome of the US presidential election.

Prediction markets are considered more accurate than polls because they take into account the “weight individuals’ beliefs by conviction as well as frequency”. This means that people who are convinced of the outcome often place high wagers than others who are simply just placing a bet. These punters can also adversely influence the market if they are driven by closely held biases rather than rational judgements something known as “cognitive bias”.

Specialised predictive markets, set-up for the purpose of trading the outcome of future events, are exchange-traded markets best positioned to benefit from aggregate individual predictions.

The Iowa Electronic Market is an academic market dedicated to elections and limits the positions its members can take to $500. iPredict operates out of New Zealand and trades in a number of political events relating to that country. NewsFutures counts major corporations such as Siemens, Renault, and Pfizer as its customers. Microsoft launched its own predictive markets and Google uses the concept internally to identify “discontinuous product ideas.” Other large companies that use predictive markets internally include France Telecom and Hewlett-Packard. The Hollywood Stock Exchange, now part of Cantor Fitzgerald, trades in the prediction-shares of movies, actors, and directors and has made many accurate Oscar predictions.

Decentralised wisdom

The caveat Surowiecki inserted in his argument about the wisdom of crowds: “under the right circumstances”, is made up of 4 conditions:

  • Diversity of opinion – each individual must have some method or information which they leverage to arrive at their decisions
  • Independence – Opinions of individuals are their own. Unlike crowd behaviour where people follow the crowd or where the crowd speaks as one voice after conferring, individuals must make their decisions independently and on their own. Voting preferences are heavily influenced by opinions and biases of others such as the media. Even stock markets, where investors do their own research, are heavily influenced by media buzz and rumours that lead to bubbles and crashes
  • Decentralisation – Individuals are able to do their own research and use their own resources to acquire whatever information they need
  • Aggregation – some method or mechanism is available to aggregate the individual decisions accurately

It seems that the conditions for the wisdom of crowds to work are almost tailor-made for blockchain based distributed ledger (DL) systems.

DL systems can be developed to aggregate individual opinions that have been arrived at independently by a very diverse range of people. That is exactly what distributed ledger based systems do.

DL systems are designed primarily for decentralised aggregation of diverse but independent input in order to arrive at collective consensus-driven decisions enabling some processes and even organisations to operate autonomously.

Of course there is no way to ascertain how independent these opinions are because everyone is exposed to public opinion or influenced by general market sentiment, or worse, collective biases which often override reason, but certain questions may work better than others.

Online betting exchanges are not all,owed to operate in the United States but they are available elsewhere such as the world’s largest exchange market, Betfair.


Augur is an exchange prediction market that uses blockchain concepts to predict the future set to go live in 2017. The way it works is simple. Individuals on the platform can make predictions by trading shares in event outcomes such as the outcome of the presidential election. If the odds are even, the share is bought at 50 cents, if you win, you get back $1. If you lose, nothing. Just like other prediction markets.

The key difference with Augur is that it is entirely open-sourced and decentralised and allows for the execution of contracts on the Ethereum platform. This means that anyone, anywhere can set up a prediction market of their choice and it will manage itself autonomously.

Notable supporters of the project include Intrade co-founder Ron Bernstein, the Thiel Foundation and Vitalik Buterin.

While prediction markets are usually better than other methods of divining the future, these will provide the ultimate test for blockchain concepts to offer an open-for-everyone method for assembling collective wisdom and if the Augur project delivers results, it may end up as the most useful application of blockchain technology – more so than its currently discussed uses in others sectors such as finance and payments.

Photo credit:





Can Blockchain Prevent Money Laundering


(Photo credits: ibtimes)

Money laundering crimes, when discovered, are dealt with a heavy hand by law enforcement authorities. Record penalties and fines have been imposed on some of the world’s largest institutions held responsible for supporting money laundering in any way, knowingly or not, and violating laws relating to money transfers and payments.

Could the blockchain concept, in its extended application – more precisely, distributed ledgers, do better?

Sure there are some big breakthrough cases and record penalties inflicted on some of the world’s largest financial institutions. But these cases are the products of painstaking detective work undertaken over a long period of time and often involving insiders / whistle-blowers. Despite the AML controls that must be complied with and exemplary punishments, global money laundering flows are estimated to be as high as 5% of the world’s GDP – just over $2 trillion.

Critics claim that Anti-Money Laundering (AML) rules and regulations are outdated and pretty much ineffective. The approach favoured by regulators is to encourage banks and other financial entities to hire more people and invest more money to implement AML controls and impose penalties. Yet the effectiveness of these controls has never been empirically established. No serious studies have been undertaken to determine the results these procedures produce.

Exemplary Punishments

When discovered, money laundering cases can be seriously damaging for the financial institutions involved. Money laundering, aiding and abetting anyone involved in illegal transfer of funds, non-compliance with AML controls, attract criminal prosecution in most markets, hefty fines, and this also means losing the privilege to continue all or some of the legitimate business activities such as currency trading or payment facilitation.

In 2012, HSBC Bank was fined a whopping $2 billion by US authorities for violations of AML regulations in Mexico. The bank had allegedly been the partner of choice for Mexico’s Sinaloa cartel which counted Guzman “El Chapo”, the drug lord who was recently arrested and extradited to the United States. In a 300-page report to the US Senate, the Mexican office of the bank was shown to be a willful partner of the Sinaloa cartel. Other money laundering violations involved the Colombia Norte del Valle cartel. A drug lord was on record saying that HSBC Mexico “was the place to launder money”. Despite all this and the issues relating to money laundering in the country, the bank assigned Mexico its lowest risk rating and reportedly excluded hundreds of billions of dollars from AML monitoring reports.

The US Senate investigation into the matter said that the bank acted as a conduit for “drug kingpins and rogue nations”.

In addition to aiding and abetting criminal businesses, facilitating international payments for “rogue nations” which are on a country’s sanctions list are also classified as money laundering by the US authorities. Banks who violate these sanctions can be heavily fined or else risk losing the privilege of taking part in dollar denominated international transactions (if they violate US sanctions). Whether one agrees with the political arguments or subscribes to a different definition of what constitutes a rogue nation, a bank or any business for that matter must not violate the sanctions imposed by the nation in whose jurisdiction or with whose currency the organisation runs a significant part of its business.

In 2014, the French bank BNP was charged by the US authorities for undertaking, “through a series of egregious schemes to evade detection and with the knowledge of multiple senior executives, BNP employees concealed more than $190 billion in transactions between 2002 and 2012 for clients subject to U.S. sanctions including Sudan, Iran and Cuba”. The bank was said to be “essentially functioned as the central bank for the government of Sudan… [and] concealed its tracks and failed to cooperate when first contacted by law enforcement.” The penalties and related fines later imposed on the bank amounted to a record $9 billion.

Outdated AML Controls

Industry observers believe, notwithstanding the high profile prosecutions, most of illegal money flows continue to pass through the preventive network of anti-money laundering rules and regulations, undetected.

The Financial Crimes Enforcement Network (FinCEN) in the United States or internationally, the Financial Action Task Force (FATF) or several other organisations in regional or domestic jurisdictions including central banks set out rules and guidelines that must be complied with.

There are specific laws that must be respected such as in the US, the International Emergency Economic Powers Act (IEEPA) and the Trading with the Enemy Act (TWEA) which BNP had been accused of conspiring to violate. In the EU, the Money laundering Directive has to be applied to develop laws and rules at the state level.

Critics say that there are a number of serious problems with the Anti Money Laundering systems and procedures that are in place today. But AML compliance requirements are so far entrenched in the financial infrastructure that it will be difficult to displace without disrupting the whole system.

Some of the problems with today’s AML controls are discussed below:

Brawn Not Brains

Reports and papers authored by academics have found systemic flaws in the AML guidance and in the form of controls and rules that exist today.

Regulators seem to encourage banks to spend more by hiring more and more employees to comb through an institution’s financial transactions and to check compliance with the rules and regulations.

In a paper published in the Notre Dame Law Journal, the paper’s authors observe that no tests have been carried out nor has any data been collected and analysed to understand how effective AML controls are in the first place. Just spend more and hire more seems to be the message from the regulators (Lanier Saperstein, Geoffrey Sant & Michelle Ng – Notre Dame Law review).

The present compliance frameworks set out by authorities focus on processes and not on performance or the unintended consequences of the threat of punishment that brings untold suffering on many people. For example, the abandonment of money transfers to Somalia by most banks over the last few years because of fear of heavy fines has created intense humanitarian hardship in the war torn country and has sent money transfers underground.

Silos Environment

Though the prosecution of cases against some of the world’s largest financial institutions as described above does happen, a majority of money laundering channels remain undetected and when they do get discovered, the perpetrators simply move to new means and new partners to continue the monetary traffic. There is little sharing of information across governments and regulators.

For The Sake Of Compliance

Banks and other institutions are fined for non-compliance not because there was something illegal or irregular that took place but simply because AML rules had not been complied with.

Standard Chartered Bank was fined $300 million a few years ago not because there was evidence of money laundering available to the authorities but simply because the bank’s compliance was considered to be below par and there were supposed weaknesses in its New York branch in relation to AML systems and controls.

There are other cases like that.

In the Notre Dame Law Journal paper the authors argue that, “the regulators have been punishing the banks not because of any actual money laundering, but rather because the banks did not meet the regulators’ own subjective vision of the ideal anti–money laundering or counter–terrorist financing program.”

False Positives

Most of the time international banking transactions that are caught in the preventive net of automated controls and sanctions lists are flagged as suspicious are only missing some necessary information.

These are sent back to the originators who complete the information and resubmit. The red flags are thus raised in an overwhelming number of cases for regular transactions making the personnel overseeing these, view these as just ordinary transactions.

Wasted Effort

Every institution engaged in transfer of funds is obliged to prepare and submit detailed reports such as, in the US, Currency Transaction Reports (CTRs) for transactions above $10,000 and Suspicious Activity Reports (SARs) relating to what could be illegal activity.

Reports are filled out in such huge numbers, hundreds of thousands, that it is impossible for an entity with even with vast resources of a governmental agency at its disposal to process and review and identify potential illegal activity.

Often after a high profile case such as those described above, the filing of SARs suddenly goes up as people become over-cautious to ensure compliance.


Lost Trail

The international money movement system is complex and criminals often channel transactions through multiple accounts so that the origination and termination of transactions cannot be fully tracked or understood. In the BNP case, the bank admitted to setting up elaborate “structures” to route payments through other “satellite” banks in order to disguise the point of origination for such transactions.

Risk management systems as they are available today are not always able to track complex transaction trails especially when the practice of “information stripping” has been deployed where some key information is deliberately left out by those in the know so as not to trigger any key words in sanction list databases.

Can Distributed Ledger (DL) Systems Help?

Two things to note: First, this article is focused on money laundering via international value transfers only, which are usually high value  not on the variety of activities that fall in the broader definition of money laundering. Second, references to blockchain in the context of this article relate to distributed ledger systems and not necessarily to blockchain as envisioned within the Bitcoin system.

A little context around blockchain and distributed ledgers repeated from a previous blogpost:

  • The concept of blockchain was developed to support a virtual decentralised currency system called Bitcoin but the world’s financial systems work with centralised or “fiat” currencies, those issued by governments and considered legal tender in the country of issue. Decentralised systems are essentially “trust-less” systems since there is no central “trusted” authority or a single entity so decisions are driven through logic and consensus programmed into the system.
  • The blockchain is an irrefutable and unchangeable record of past transactions and as such serves to establish ownership and the right to transfer bitcoins. It also guards against a rightful owner spending bitcoins twice. A Bitcoin transaction is validated by consensus by a network of computers or nodes participating in the virtual currency system and not by a single centralised authority responsible for record keeping. The blockchain ensures the Bitcoin system is “permissionless”, requiring no central authority approval or decision, and therefore autonomous.
  • Distributed ledger systems encompass a much broader definition. While a blockchain as originally envisaged by its creators works essentially within the Bitcoin system, distributed ledger architecture can support all types of systems. In financial services a distributed ledger system is likely to be permissioned and therefore less autonomous. It can be deployed with varying levels of control and flexibility.

Distribued ledger systems can provide the basic infrastructure and tools for various areas within risk management and money laundering. Of-course developing a DL based system will require incurring costs and pooling shared resources and will take time to come to fruition.

In the context of AML activities, there are some clear benefits of following a DL approach:

Point-to-Point Legitimacy

The legitimate credentials of the two primary parties to a transaction – the originator and the beneficiary – must be verified. A DL system can provide a digital certificate that can be checked quickly by any participating entity to ensure the credentials are verified and also to review the types of credentials verified at the time of onboarding (and check if any information is missing).

DL systems will not revolutionise the Know-Your-Customer (KYC) process but enable banks and other financial entities as well as law enforcement officials to check credentials of parties involved in a value transfer transaction in a quick and timely manner.

An additional element could be added to the KYC process which is the reputational score or track record of the financial intermediary undertaking the KYC check. There is already talk about multi-market KYC “utilities” that provide more robust proof of identity. But such utilities are likely to be controlled by technology vendors while a distributed architecture would benefit everyone provided they are eligible and meet the criteria for joining the network.

A distributed ledger approach will not be able to discover or prevent KYC fraud where individuals or entities use fake or stolen credentials to open bank accounts as was the case with the Bangladesh Bank heist when hackers stole millions from the bank’s accounts with the NY Fed earlier this year and routed the funds to account opened with fake credentials at a Philippine bank.

Maintaining Audit Trail

A fundamental feature of a DL architecture is that it validates and authenticates the chain of value transfers in an open and transparent manner so that each transaction is checked and validated by anyone participating in the system without the need for centralised oversight.

In the DL approach, funds transfers can be recorded using private digital keys by both the originator and the beneficiary. While this may not be feasible for smaller money transfer transactions, the large funds transfers between institutions and corporates will be digitally recorded and verifiable by those who participate in the distributed ledger system.

In other words, it will be much harder to lose track of the source and destination of a transaction simply because criminals undertake several transactions and deploy multiple “satellite” banks to break off the trail. This type of transparency does not mean that all bank transactions will be out in the open for everyone to examine.

In fact, the DL system, unlike the blockchain which is inherently open and transparent, will be confidential and only accessible to those involved in the transaction to validate the potential risk of a transaction without revealing to third parties the details of that particular transaction. The transaction trail could also be checked by those responsible for risk management in an organisation or the authorities and law enforcement officials.


Speed of Discovery and Intervention

In a fully deployed DL system, participants whether banks, central banks, or corporates or any other related entities, will be able to share information on all transactions by contributing to the extended distributed ledger. Algorithms built in to the DL system will be able to identify patterns and analyse data on an aggregate level. Regulators will be able to monitor activity at many levels and determine the risk of a specific transaction channel in a much more scientific and meaningful manner.

Arguably, a mega centralised system will be able to do the same but in the DL environment, local databases will be leveraged so there will be no need to construct and maintain a monstrously big centralised authority complete with its own army of compliance staff and special technology and infrastructure. The work of individual entities and specific markets will be taken into consideration and the system will be updated for law enforcement authorities both at local and global levels in a very timely manner.

Today this sharing of data across institutions is at a very rudimentary level. Information that is shared is not readily available to everyone in the system.

DL systems would better determine the probability that a certain corridor or institution or even specific transactions have been compromised. This will reduce, if not eliminate, the ease with which criminals are able to send money over international payment systems. It will also help one institutional system to alert another of a transaction or set of transactions that potentially could be illegal or on the borderline requiring further checks.


Can Blockchain Prevent Cybercrime?


Can blockchain or distributed ledger technologies help prevent attacks on the world’s critical financial systems?

Banks use standardised electronic messages, made up of codes and identifiers, a sort of a common financial language, to make international payments and move money around the world.

There are checks and balances, policies, and procedures in place to comply with legal requirements, validate the parties involved, detect irregularities, and looking out for anything suspicious, anything out of the ordinary. Transactions are checked against special databases such as those containing information on blacklisted individuals and entities or those under government sanctions. Hundreds of billions of dollars are at stake so it is hardly surprising there are so many controls built into the system.

But even with all these financial fortifications in place and armies of back-office staffers monitoring money movements, now and again hackers manage to get way with very large sums of money.

Earlier this year, a massive heist took place. Someone stole around $81 million from the account of Bangladesh Bank, the country’s central bank, with the New York Federal Reserve. The audacious plan was to steal a whopping $1 billion from the account but the NY Fed caught most of it in its preventive net mainly due to an unexpected piece of good luck.

Here’s what happened.

The Heist

Investigations are still underway but so far each party involved has been busy laying the blame on others. The NY Fed argues that it flagged and declined a majority of the fraudulent requests it received. Cybercriminals had sent 35 messages to the NY Fed pretending to be from Bangladesh Bank totalling nearly a billion dollars and only a few got through. The NY Fed handles $800 billions in international money transfers every day so in this context $58 million seems a relatively small amount.

The NY Fed should have caught the fraud in its entirety as the pattern of the requests to transfer money was highly suspicious, so argues Bangladesh Bank. Over the past year Bangladesh Bank had only requested around 2 transfers per month mostly to institutions, not 35 in one day addressed to individuals.

SWIFT, the bank owned entity responsible for the messaging protocols, the necessary software and hardware, and management of the secure network, is under fire too. The network handles 25 million communications every day for around 10,000 banks and corporates. Critics say that over the years SWIFT has not done enough to improve the security environment around its network. SWIFT should have been invested in the latest technologies to make communications over its network completely bullet-proof.

Bangladesh Bank has also a lot to answer. Its systems were compromised, some say due to the lax security controls deployed at the bank. Hackers were able to install malware a month before they struck which enabled them to prepare and plan the attack in February. Bank officials did not monitor their transactions online and the only way to review communications on the system was to physically print out the messages they receive over the SWIFT network. The hackers had disabled the print function and it was not fixed until the next day when the bank discovered the communications from the NY Fed and the fraud.

Lastly, the timing of the theft was deftly planned. The hackers sent the fraudulent instructions on a Thursday and by the time the NY Fed got back to them Bangladesh Bank employees had gone off for the weekend which is Friday and Saturday. By the time they discovered what was going on (after fixing the print function) it was the weekend in New York. When on Monday the NY Fed tried to stop the transfers they discovered it was the Chinese New Year holiday in the Philippines, the ultimate destination of the stolen funds.

Total Fluke

The 35 fraudulent messages to transfer the billion dollars first came with some vital information missing and were rejected by the NY Fed’s system. The hackers soon corrected the error and re-submitted. This time the NY Fed cleared 5 of them. The others were rejected – according to early reports – by a piece of unexpected luck or a “total fluke” as someone described it. The destination for the transfers, a bank branch in the Philippines, happens to be located on Jupiter Street. This triggered an alert in the Fed’s system as Jupiter was also the name of an oil tanker and a shipping outfit from Iran under sanctions from the United States. The coast was otherwise clear.

Global Networks Vulnerable

The truth is that the all global networks especially those that deal with money transfers are a primary target for cyber criminals who have reached new heights of technical sophistication and are more organised than ever before.

These criminals now boast access to vast resources, even patronage of rogue governments and plenty of motivation to perpetrate multi-million dollar frauds. To compound the problem banking industry veterans also point to a culture at banks of keeping things quiet in case of breaches or thefts if they can help it. They should be sharing information and undertaking investigations in a spirit of openness and cooperation so that the points of vulnerability are identified and corrected.

The Bangladesh heist was the work of confident criminals who knew their way about the system, avoiding the strongest defences and targeting the weakest links in the international payments network. It is possible that the hackers were also responsible for an earlier theft of $12 million from an Ecuadorian bank’s account with Wells Fargo. The two banks are now fighting each other in the courts.

Symantec, the security company, believes the group called Lazarus, the one said to be responsible for the attack on Sony Pictures back in 2014 and sponsored by the North Korean government, may have been behind the attack.

Blockchain and Distributed Ledgers

The concept of blockchain was developed to support a virtual decentralised currency system called Bitcoin but the world’s financial systems work with centralised or “fiat” currencies, those issued by governments and considered legal tender in the country of issue. Decentralised systems are essentially “trust-less” systems since there is no central “trusted” authority or a single entity so decisions are driven through logic and consensus programmed into the system.

The blockchain is an irrefutable and unchangeable record of past transactions and as such serves to establish ownership and the right to transfer bitcoins. It also guards against a rightful owner spending bitcoins twice. A Bitcoin transaction is validated by consensus by a network of computers or nodes participating in the virtual currency system and not by a single centralised authority responsible for record keeping.  The blockchain ensures the Bitcoin system is “permissionless”, requiring no central authority approval or decision, and therefore autonomous.

Distributed ledgers encompass a much broader definition. While a blockchain as originally envisaged by its creators works essentially within the Bitcoin system, distributed ledger architecture can support all types of systems. In financial services a distributed ledger system is likely to be permissioned and therefore less autonomous. It can be deployed with varying levels of control and flexibility.

Enhanced Risk Management Through Distributed Ledger Architecture

A fraud prevention system based on a distributed ledger approach with multiple databases working in sync can be deployed to combat fraudulent incidents of this type very effectively. Such a system would first, maintain a confidential record of past transactions for reference and verification but without disclosing transaction details to everyone in the system (unlike the blockchain where transactions are in the open). Second, the system would store and update authenticated credentials of legitimate and verified senders and receivers.

Individual banks and financial institutions today operate their internal risk management systems and consult common information on blacklists and sanctions. The responsibility of developing robust risk management controls is left to individual banks resulting in inconsistent approaches and widely varying quality of risk controls and procedures. A distributed system would be beneficial for everyone in the international marketplace not just the large banks but also the smaller banks who have less sophisticated risk management systems in place.

Often a bank’s systems will generate a high number of “false positives”, transactions rejected by the system as suspicious or fraudulent. But an overwhelming majority of such transactions are found only to be missing some information which is corrected before resubmission. Such a high percentage results in transaction monitoring staff to consider most alarms as harmless. A distributed ledger system could be maintained by the leading stakeholders such as the major central banks and large commercial banks. In the long term, it is debatable whether a central network entity such as SWIFT would be necessary in such a scenario. Indeed, with standardised ISO formats, the distributed system could work on its own or just skeleton staff with the help of the leading players.

Collaborative Hybrid Approaches

Central banks are rightly exploring hybrid systems where a single authority manages records maintained centrally but also encourages and helps maintain a wider distributed ledger system to ensure network security and integrity. Such a system could work on several levels – global, regional, and local or domestic, to enable centralised authorities in multiple jurisdictions to develop an additional layer of shared decentralised systems.

But while a made-for-purpose distributed ledger based international value transfer system would take some time to build and incur substantial costs, internal collusion and compromise of private digital keys means that no system in theory is immune to cleverly thought out cyberattacks. Still, a hybrid system will be able to identify fraud or money laundering transactions a lot quicker for more immediate remedial action.

A parting caveat: It is important to note that new technical approaches cannot absolve banks from deploying robust operational and risk management controls. Hackers often use tried and trusted but simple techniques for perpetrating fraud such as installing malware, disabling viewing or printing features, and simple observations, how people work and their weaknesses and choosing the right time to make a move lining up weekends and national holidays to their benefit.

Graphic credit: International Bankers Association of Japan