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.

How Cuber Wallet works

The Cuber Wallet is the first demonstration of CUBER usability. It is a piece of software for mobile phones, enabling instant and free peer-to-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 confirms 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.

The challenges of adopting digital wallet

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.

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