Case 39: Blockchain Can Transform The Way We Pay, Trade and Sign

Alastair Brockbank, British Embassy Tallinn

Experimenting with block chain technology was a logical step for Estonia. By providing a distributed and unalterable ledger of information, it has ideal qualities for the storage and management of public keys. These are a form of encryption key, provided by a designated authority, which can be combined with a private key to effectively encrypt messages and authenticate digital signatures. Estonia now has the most regularly used national Public Key Infrastructure (PKI) in the world.

Moreover, as a decentralised solution, a block chain is inherently more portable and scalable. It is capable of computing vast amounts of data every second and seamlessly working across borders. For companies in a country of just 1.3 million people, block chains thus offer a way for national solutions to more easily become global solutions. Their computational power also makes them faster, and in certain cases the technology has the disruptive power to make existing intermediaries redundant.

The three case studies below — profiling a bank, a start-up and a cybersecurity provider — show the transformative power of block chains for a wide range of transactions. All three examples underline that block chains must be made userfriendly. The customer need not know that they are trading in coloured coins, nor that their ID card login uses hash-function cryptography. In this sense, a block chain acts as a silent, more efficient workhorse behind a solution that looks familiar: a mobile payments app, an online crowdfunding and trading platform, or a login portal.

As in the UK, the need for and extent of regulation is a key issue for the Estonian authorities. They understand that hesitation and indecision can be as damaging to innovation as strictness. The risks of innovators moving to new and less tightly regulated jurisdictions — specifically, the loss of revenue from failing to capitalise on commercial opportunities, and the potential for criminal activity — are patently clear.

A pioneering bank issues cryptocurrency securities

Earlier this year, LHV Pank — the largest independent Estonian bank — became the first bank in the world to experiment with programmable money when it issued €100,000 worth of cryptographically-protected certificates of deposits. The experiment followed the establishment of a new LHV subsidiary, Cuber Technology, focused exclusively on Bitcoin-based digital securities. Cuber’s work comprises two strands: CUBER securities and the Cuber Wallet. CUBER (Cryptographic Universal Blockchain Entered Receivable) securities are simply bank certificates of deposits recorded in the Bitcoin

CUBER (Cryptographic Universal Blockchain Entered Receivable) securities are simply bank certificates of deposits recorded in the Bitcoin block chain. They are denominated in euros, may pay interest and are suitable for various purposes — as a store of value, medium of exchange, trust and escrow services, and even for machineto-machine transactions, opening potential applicability in the Internet of Things (IoT). LHV views CUBER securities as the Lego building block for their future financial innovation.

The Cuber Wallet is the first demonstration of CUBER usability. It is a piece of software for mobile phones, enabling instant and free peerto-peer euro transactions, and low cost instant payments for merchants and consumers, using underlying CUBER securities.

Users store their private keys on their smartphone to enhance security and mobility. To protect against server compromises, Cuber Wallet decentralises trust from the server and makes the users themselves the Bitcoin clients. The app uses SPV (Simplified Payment Verification) — a type of ‘thin client’ security — which means the user never has a complete copy of every block in the chain. Instead they download a smaller amount of data, the ‘blockheaders’, which link transactions to a place in the chain. This allows them to see that a network node has accepted the transaction, while blocks added after it further confirm that the network has accepted it.

The wallet uses bitcoins as a data carrier, which they ‘paint’ by adding unique markers to them. This then represents a claim in fiat currency against LHV Bank, as the entry into a database represents a claim against the traditional bank system. By using fiat currency, the wallet can be used not just for personal transfers, but also for retail payments — the merchant has to approve this payment method just as they have to approve credit cards. LHV is currently testing it in a few physical locations, but anticipate wider utility in online business, particularly for smaller payments.

The use of fiat currency undoubtedly makes the app more user friendly. LHV asserts that the underlying technology is the bank’s concern: the user and merchant do not and should not need to see, nor know, that Cuber uses Bitcoin.

Cuber’s open source code and application program interface are available to third parties online, inviting other cryptocurrency exchanges and developers to tap into the technology. Both LHV and its development partner, ChromaWay, prefer to drive usable innovation with smaller software developers and start-ups, rather than large banks.

When pressed on their challenges, LHV is clear: regulatory uncertainty risks killing Cuber’s transformative power by severely limiting its reach. The bank urges regulators to embrace block chain technology and adapt, rather than run scared from it.

On the face of it, being backed by a bank affords Cuber huge advantages, because transferring money from a conventional bank account to a digital wallet (and back again) is simplified. CUBER is technically still a security — the foundation of bank trading — albeit with decentralised record keeping. But in reality, being a bank remains a regulatory obstacle, because they are typically subject to more legal arbitrage than new innovators. Similarly, EU Know Your Customer (KYC) rules that require a face-to-face meeting to create a bank account disadvantage Cuber when other online payment services such as TransferWise and Holvi only need a quick online sign-up. If banks are to compete effectively in this market, regulation will need to impose no additional barriers to banks, nor reduce their mobility to reach and recruit new users.

Admittedly, LHV is in an unusual position: an ‘innovation-friendly’ bank doing it themselves, but whose forward progress is currently restricted by regulatory uncertainty. With no positive movement, Cuber will either have to be distanced from LHV’s license and the advantages that being tied to a bank bring, or look at moving outside Europe to another jurisdiction.

Developing a simple, secure and legally compliant bridge between crypto and traditional banking continues to prove exceptionally challenging for all players. But none are closer than LHV.

A liquid aftermarket for start-up investments

The illiquidity of start-up investment is a common complaint from angel investors and founders alike. Backers typically need to part with at least €10,000, and must often wait 5 or more years to exit.

Funderbeam — a reputed business intelligence platform for investors — may well have found a solution to this problem: a block chain-based investment marketplace, to buy and sell coloured coin stakes in start-up syndicates.

Investors will soon be able to use Funderbeam’s online platform to create an investment syndicate for one or several start-ups. Investment can be in any configuration, and there is no limit to the size of a syndicate. A £100,000 stake could comprise one lead investor and 99 backers investing £1,000; a lead investor on £75,000 and five backers on £5,000; or any other combination. Similar to crowdfunding, this diminishes the threshold to invest in start-ups.

What differentiates Funderbeam from the crowdfunding alternatives is the issuance of ‘coloured coins’ representing syndicate members’ stakes, which can be instantly bought, sold, or traded with other investors. This enables more fluid management of investment portfolios, and expedites financing for start-ups. The Bitcoin block chain underpins the aftermarket, allowing for fast, effective and transparent asset ownership tracking.

Every syndicate is paired with a microfund. Once a syndicate is complete, and the start-up is funded, Funderbeam’s aftermarket uses coloured coins to give all members of a syndicate a digital representation of their share in that microfund, which is immediately tradable. Backers can thus sell their whole share, or a proportion of it, once they have made a decent return or want to cut their losses.

Flexibility for investors is not the only benefit the block chain solution affords. Kaidi Ruusalepp, CEO of Funderbeam, also points to the efficiencies that a distributed ledger offers through bypassing bureaucracy. “We don’t need a business registry, central depository, or another formal authority to confirm the integrity of a transaction,” he says. “With the block chain, every investment, every ownership change has a secure, distributed audit trail.” Jaan Tallinn, co-founder of Skype and an investor in Funderbeam, lauds the additional layer of security and verification it offers for online transactions. By being decentralised and unalterable, block chains can create more transparency in the equity market, without compromising anyone’s privacy. Funderbeam’s offering — providing flexibility, speed, security and transparency — shows how distributed ledgers can provide an alternative but wholly viable basis for small and medium-sized enterprise (SME) financing to expand in the 21st century.

Jaan Tallinn, co-founder of Skype and an investor in Funderbeam, lauds the additional layer of security and verification it offers for online transactions. By being decentralised and unalterable, block chains can create more transparency in the equity market, without compromising anyone’s privacy. Funderbeam’s offering — providing flexibility, speed, security and transparency — shows how distributed ledgers can provide an alternative but wholly viable basis for small and medium-sized enterprise (SME) financing to expand in the 21st century.

Funderbeam’s offering — providing flexibility, speed, security and transparency — shows how distributed ledgers can provide an alternative but wholly viable basis for small and medium-sized enterprise (SME) financing to expand in the 21st century.

The next generation of public-key infrastructure

Since 2013, Estonian government registers — including those hosting all citizen and businessrelated information — have used Guardtime to authenticate the data in its databases. Their Keyless Signature Infrastructure (KSI) pairs cryptographic ‘hash functions’ (see below) with a distributed ledger, allowing the Estonian government to guarantee a record of the state of any component within the network and data stores.

This is no small undertaking. Estonia has the most regularly used national PKI in the world. Using their ID card, citizens order prescriptions, vote, bank online, review their children’s school records, apply for state benefits, file their tax return, submit planning applications, upload their will, apply to serve in the armed forces, and fulfil around 3000 other functions. Entrepreneurs use the ID card to file their annual reports, issue shareholder documents, apply for licenses, and so on. Government officials use the ID card to encrypt documents for secure communication, review and approve permits, contracts and applications, and submit information requests to law enforcement agencies. Ministers even use their ID cards to prepare for and conduct cabinet meetings, allowing them to review agendas, submit positions and objections, and review minutes.

Digital authentication is thus critical to government, business and public services alike, from drafting policy and legislation, to declaring finances and registering property and inheritance rights. Over 200 million digital signatures have been made using the ID card: some 39 per capita per year and rising. It is thus imperative for the government to know its records are the right records, and that they have not been altered from the inside, or by a cyber attack.

So how does a block chain help? It helps because every alteration of a piece of data is recorded. By providing proof of time, identity and authenticity, KSI signatures offer data integrity, backdating protection and verifiable guarantees that data has not been tampered with. It is transparent and works to the user’s benefit too: citizens can see who reviewed their data, why, and when; and any alterations to their personal data must be authorised. Moreover, through using hash functions, as opposed to asymmetric cryptography used in most PKI, KSI cannot be broken by quantum algorithms. It is also so scalable that it can sign an exabyte of data per second using negligible computational and network overhead. It removes the need for a trusted authority, its signed data can be verified across geographies, and it never compromises privacy because it does not ingest customer data. It is clear that the system marks a major advancement in PKI.

Ultimately, the KSI block chain means that while the Estonian ID Card may never be immune to a breach (although there have been none so far), the government is assured that rogue alterations to public data will be 100% detectable.