My proposal to create a new Banking System

Published July 2nd, 2009 edit replace rm!

Last week I gave my talk on Agile Banking at Reboot 11. This week I have taken my talk and turned it into a series of blog articles that I will post here once a day.


We should create simple limited banks or funds. These should only be allowed to do one thing.

A fund has accounts signifying value. Value could be just about anything: Cash, gold, stocks, bonds, loans, insurance, service credits.

Ecurrency banks should replace current accounts. An Ecurrency is a non interest bearing cash mutual fund. No fractional reserve no risk. They could make money on transactions or subscriptions. They could even be implemented as a cooperative of account holders. SWIFT is a cooperative of banks, I say get rid of the middlemen.

Mutual funds fit right into this model for investments.

Loans could be handled like the Danish mortgage system. Danish mortgages are bonds issued by house owners underwritten by the Mortgage institutions. The Mortgage Institutions themselves aren’t allowed to invest in these loans to reduce risk.

In my proposed system borrowers issue bonds into the loan fund. Each loan fund specialize in specific types of loans. Borrower buys back bond to repay.

There are lots of opportunities for small startups to invent new services:

  • p2p lending
  • micro lending
  • community currencies
  • micro stock offerings

Be transparent

Offer realtime data feeds. The technology is even better for this now than when e-gold did it. We have no excuse not to. This would allow third parties to dig into our data and analyze the data, which again allows mass auditing. Problems will be found much quicker than regulators ever would be able to.


Only offer one type of service (payments, savings, loans, insurance – pick one). Limit size of accounts, limit amount of accounts.

To ensure transparency and avoid non core vested interests be focused:

  • NO IT department
  • NO customer service staff
  • NO branches
  • NO internal accounting

All of these can and should be outsourced to trusted third parties. This creates trust in a way that a small startup never would be able to do alone. Owners can’t cook the books.

You could take this to the extreme. Imagine 3 different service providers for the same payment service. They all process the same transactions. Differences can be flagged (twittered) instantly and automatically.

What about regulators?

Right now they are truly an obstacle to innovation. They go by the belief that big is safe. They make it hard for small innovators to register.

An electronic currency service needs a minimum of €350,000 minimum capital reserves in the EU. Try bootstrapping while following their rules. Banks need much higher. They just reduced this from €1,000,000 as they themselves noticed that only a couple well capitalized people had registered under the law.

A reserve is simply speaking the cash that is meant to ensure the value of your financial products to your customers.

Formula over arbitrary limits

Technology and simple math provides us a much better way

reserve = circulation

The circulation of a currency is the amount of it held by it’s users. So if we have a small bootstrapped community system of 10 accounts with an average €100 balance:

10 accounts *100 euro = €1000 reserve

This is simple, scalable and has zero barrier to entry.

Terrorists, drug dealers, tax evaders, oh my!

Are you aiding and abetting evil money launderers? Regulators say “know your customer”. You are legally obliged to verify who they are and where they live.

But how do you check id online? The most common approach for online services is to fax/scan and submit id’s. Individual countries might provide country specific approaches.

This is a huge barrier to entry. You need to worry about it as you really don’t want to end up like Doug. I believe the solution is a common sense approach:

The smaller the account, the less you need to know.

How do I know you anyway? How do I know you’re not a bad guy? How can I trust that your faxed ID isn’t fake? Your national ID number does not tell me anything. The unsaid truth about “Know Your Customer” regulation is that it is meant to protect you from regulators and not you from bad people.

Why not use social networks? Experiment with page rank like algorithms and webs of trust. It could turn out better than national id’s
One thing to remember though is

I know you!=credit

Just because I would be happy to tell facebook or my bank that I know you, doesn’t mean I want to lend you $1000. However as long as we remember this we could use it to bootstrap an alternative credit rating system.

What about risk?

We must accept but limit it. People will eventually lose money. However the design of this system firewalls the risk into certain areas.

If an ecurrency goes bust you can’t lose your money as it is held in the reserve. Government bank guarantees are no longer necessary. Bank runs are not possible as anyone who wants their money can always get it out.

Risky investments only affect their direct investors.

In tomorrows post I will cover practicalities of to implement this including ideas on technologies to use.

Earlier this week I wrote about Risky Business the core problem in todays financial services industry, Benches, Coffee and Bubbles about the origins of financial innovation and about Douglas Jackson of e-gold who has been one of the most innovative people in the financial services space.

These were all based on my Talk about Agile Banking that I gave at Reboot 11

Lets talk about Doug

Published July 1st, 2009 edit replace rm!

Last week I gave my talk on Agile Banking at Reboot 11. This week I have taken my talk and turned it into a series of blog articles that I will post here once a day.

Douglas Jackson was an oncologist from Melbourne, Florida. He was an idealist and thought the world would be a better place with a strong private currency away from the control of any government. So he created e-gold back in 1995.

E-gold is an electronic currency backed by real gold bars. Some people use it to invest in gold, but more commonly it was used like a regular currency to make and accept payments.

Doug was a true innovator. E-Gold created an easy to use API before PayPal allowing all sorts of small businesses around the to accept payments. At this time it was very hard for small businesses to get merchant accounts. E-Gold provided a real solution to this.

They let their users audit them

How much gold is in the system?

Where is the gold physically located?

What are serial numbers , exact weight and brand of individual gold bars

Real time usage statistics showing amount of transactions, transactions by size and statistics about account sizes

The e-gold mailing list kept them honest. People were analyzing the stats, theorizing and asking explanations from E-Gold staff for any thing out of the ordinary. Like this 10% drop in gold from the balance sheet in October 2001, where SnowDog performed analysis of why this was happening:

There are 11,161 accounts in the E-Gold system with over 10 grams of e-gold, (about $90 US in e-gold). This is almost the same number that E-Gold has supported for the past 6 months. So, it appears that most of the people with any significant balances are NOT selling their e-gold. The 10% drop in gold, in the past month, seems to be due to gold sales from small-balance accounts. E-Gold mini run

The community started creating tools to scrape and analyze e-gold

Craig Spencers E-gold revenue calculator

This was a mashup of the data on the above mentioned statistics page and their published fee structure. Note the sharp dip in 2007 (we will come to that soon)

Trust the system hate the man

Then Doug started acting like a bit of a bastard. Started suing several very nice people who were well known in the community. The mailing lists went berserk, Doug was called all sorts of names (very few of them good) and an alternative mailing list was set up in case E-Gold started censoring their own list.

Yet a funny thing happened. People continued to use e-gold. As a matter of fact the use grew and grew until at its peak there were $85 million dollars worth of e-gold in circulation. Not bad for a single activist entrepreneur from Melbourne, Florida.

Black helicopters

In 2007 the US government caught up with Doug. He was arrested and last year received a guilty verdict for “conspiracy to commit money laundering”. Doug was not performing “know your customer” a legal requirement in most countries that financial services institutions check the identity of their customers.

People are still kind of using e-gold. People are buying and selling black market auctions on their balances.

For more background on E-Gold check my article How the man finally brought e-gold down as well as Wired’s article Bullion and Bandits: The Improbable Rise and Fall of E-Gold.

In tomorrows post I will cover specific steps I think we could take as small entrepreneurs to innovate banking.

Earlier this week I wrote about Risky Business the core problem in todays financial services industry and Benches, Coffee and Bubbles about the origins of financial innovation.

These were all based on my Talk about Agile Banking that I gave at Reboot 11

Benches, Coffee and Bubbles - The origins of Agile Banking

Published June 30th, 2009 edit replace rm!

Last week I gave my talk on Agile Banking at Reboot 11

This week I have taken my talk and turned it into a series of blog articles that I will post here once a day.

In the beginning was the bench. The word Bank comes from the Italian word for bench “Banca”.

Rather than a modern bench these were more like the above modern lottery stalls in Panama and were manned by money exchangers found in markets going back to roman times. By the middle ages the Banca’s in Italian trading centers like Venice and Genoa were not just exchanging money, but also lending and storing money to local traders, whom they probably new very well.

Genoa is famous today as the home of pesto. Very delicious indeed. However they were also home to the first modern company.

These always had a limited purpose, so investors like individual traders and Banca’s would know exactly what they were investing in. Such as conquering and taxing the Greek island of Chios:

Nowadays companies more than often attempt to be general purpose. Most normal company founding documents say something like “This company may perform any legal business”. Bank companies generally do have some limits and say something like “This company may perform banking business”, which really could encompass just about anything.

The above people are the kind of web 2.0 hipster you will find in San Francisco’s Blue Bottle Coffee everyday. If you follow anyone from San Francisco on Twitter, you have no doubt heard tweets like “Heading down to Blue Bottle for Coffee” or “Just bumped into at Blue Bottle”. Besides really good coffee it has become kind of a real world alternative to Twitter. Kind of like Jonathan’s…

These people were the hipsters of their time. They are seen here at Jonathan’s Coffee House. Jonathan’s was one of many popular Coffee Houses in the City of London in the late 1600’s and early 1700s. These places were where all the smart (and not so smart) business people hung out all day long. Drinking coffee, gossiping and most important buying and selling shares in the cool companies of their time. I don’t know if he was bored or what, but this guy John Castaing started to keep a list of trades happening during the day in what may be one of the worlds first mash-ups.

Jonathan’s and John’s list became what is now the London Stock Exchange.
In reality none of our financial institutions and instruments were thought up by think tanks, university professors or government employees. Rather smart entrepreneurs thought up solutions to the problems of the day.

Yet there were problems…

Many people think bubbles as being modern. We remember the dot com bubble and are now living in the immediate effects of the housing bubble. But really they have been around for many centuries. One of the coolest things about these early bubbles was that they were always documented by really cool cartoons.

Tulip mania hit the Netherlands and over a couple of months the whole country had gone tulip mad. Everyone The price of tulip bulbs started shooting up in November of 1636. Right before the bubble popped the following february, the price had risen 20 times.

“Many individuals grew suddenly rich. A golden bait hung temptingly out before the people, and, one after the other, they rushed to the tulip marts, like flies around a honey-pot. Every one imagined that the passion for tulips would last for ever, and that the wealthy from every part of the world would send to Holland, and pay whatever prices were asked for them. The riches of Europe would be concentrated on the shores of the Zuyder Zee, and poverty banished from the favoured clime of Holland. Nobles, citizens, farmers, mechanics, seamen, footmen, maidservants, even chimney-sweeps and old clotheswomen, dabbled in tulips.” MacKay

The South Sea Company was a really cool British company founded in 1711. They had the official monopoly for trade with Latin America. The stock price grew to crazy levels (no doubt people were drinking lots of Coffee at Jonathan’s) when at last the bubble burst. Spain was at war with UK and the Latin American trade dwindled. This became known as the South Sea Bubble and was probably the first time the word Bubble was used to describe such an event.

John Law was a very slick Scottish guy. Maybe the Bernie Madoff of his time. John was an ardent gambler and escaped a death sentence in Scotland after killing a guy in a duel. Somehow John, who obviously was a talented salesman, managed to become the treasurer of France. During this time he created his own private bank and pioneered the creation of Paper Money. The bank bought the Mississippi company, who’s job was to colonize and trade with French Louisiana in modern day US.

John then proceeded to convince the king to make his bank the Banque Royale endorsing all his paper money with a royal guarantee. At the same time he started a strong marketing campaign selling Mississippi Company shares.

People of all classes went crazy and the bubble was created. In 1720 when people realized that Louisiana wasn’t quite the Eldorado he said it was the bubble burst and the king was left printing worthless money to solve crisis. John himself escaped France and spent the rest of his life gambling in Rome, Copenhagen and Venice.

Why this history?

Innovation starts with people, it starts small, it starts limited. Bad stuff still happens.

In tomorrows post I will cover e-gold and how it relates to my idea of Agile Banking. Yesterday I wrote about Risky Business the core problem in todays financial services industry.

Risky Business

Published June 29th, 2009 edit replace rm!

Last week I gave my talk on Agile Banking at Reboot 11. This week I have taken my talk and turned it into a series of blog articles that I will post here once a day.

The world is in serious trouble. Recession is hitting most parts of the world. While many people debate the exact reasons for it, most agree that the reason it has grown to the current extent is due to structural problems with our banks. We have become too reliant on them and they have grown so intermingled that our politicians believe they are too big to fail.

While we can talk about all kinds of things, such as sub prime mortgages, monetary policies etc. etc. The real problem is one of risk.

Risk is not a number

Imagine you going to a horse race to bet on a horse that is such a sure bet that it is only 1/10 chance that it will lose. The horse is faster than all the others, has a great jockey, you are set to win. You take out all your cash, take out all the money from your credit cards and remortgage your house to make a huge bet. After all there is no way you can lose. You make the bet and 10 meters before the finish line the horse falls. Against all odds you have lost all your money and are now in incredible debt.

This is essentially what has happened to the worlds financial system. It is irrelevant (but interesting) to discuss why the horse fell. The real issue is the lack of understanding of risk that made you put all on that one horse.

The banks of the world all went together and borrowed all of our money and all at the same time made the same really, really safe bet. After all it was a sure thing. The only problem was that the impossible happened and now everyone is trying to hide from the bookmaker.

Banks like most other people don’t understand risk. In many cases Banks don’t even understand themselves. Most very large banks have no clue of their own liquidity (how much cash they have) at any given time.

Imagine if you started writing checks like crazy without really having an idea how much money you have in your checking account. Banks frown on it if you do it, but they themselves are for the most sake guilty of this.

Because of this you get situations where you have one risky trade and they’re gone. We have seen this before with individual banks, however this time all of them made the same bet and most of them are in serious trouble.

Traders love risk numbers. What I mean by risk numbers is a number generated by some magic formula that condenses certain factors about an investment. This makes it easy for them to compare how risky an investment is.

Regulators also love risk numbers. It makes it easy for them to regulate the banks. They can specify what risk formula their banks should use and then look at a spreadsheet and see quarterly risk numbers for each bank. If a banks risk number is too high, they can send scary letters to the banks saying you need to take less risks.

The Black Swan

The only problem is what Nassim Taleb calls the Black Swan. Before the discovery of Australia Europeans thought there was no such thing as a black swan, it was impossible. Yet they were in for a surprise when they discovered it in the land of the Koala.

In other words the improbable will happen. The Black Swan is an unforeseeable event, that nevertheless happened. If you can’t imagine something happening you can’t calculate the possibility of it happening, thus any particular risk number can never take a black swan in to account.

Nassim states that Black Swan’s happen all the time. Sometimes they’re good, sometimes they’re bad. Yet in most cases they have had much larger influence on the world than anything we ever planned for or predicted.
The current financial crisis could not be seen in the analysts risk numbers. Yet it happened and the banks were not ready.

Risk numbers are good for black jack and other casino games, where all different outcomes can be calculated. But they can never be trusted if you can’t 100% guarantee you have taken into account all outcomes.

Outside the casino there are very few areas where you can calculate all outcomes, thus they are useless in the real world.

In short “shit happens”.

For more on the Black Swan check out these quite entertaining two podcast interviews with Nassim:

Any fix to the banking system must accept this. Risk can be managed through limits and real diversity, but not by relying on a single number or forumla.

So, who is going to fix our banking system?

You would think the banks would like to fix themselves. They might but most are too big to fix. I am willing to bet they even know this themselves. The only way save them without huge fundamental changes is through some sort of artificial protection.

Who will protect them? The same people who are meant to keep them under control of course, the regulators. The regulators are the government agencies looking after the banks. In the US the FDIC and Federal Reserve. Every country has one or more government regulators.

So far the regulators have been very busy. They’ve given us lots of words, spent lots of our money and not made any real changes.

The problem is that regulators are not innovators. Their solution? Besides limiting the bonuses of high level bank employees, which has absolutely nothing todo with any of the causes of the current crisis, their gut instinct is to regulate harder.

They raise limits and increase reporting requirements. In reality they are not physically capable at the moment of doing anything but raising limita and telling people off after the fact.

What this actually does is that it raises the barriers of entry for new banks or banks trying to innovate. Large established banks can easily afford to pay themselves out of this by building up larger compliance departments. Regulators think this makes their job easier and it also allows them to say to the public that they are getting tough on banks.

What we really need is innovation. The system is broken and we need to think differently. We as entrepreneurs are stuck with the job. Innovation can only come from small startups and activists. These are the only ones without vested interests in keeping the system the way it is. But as I mentioned the regulators make it very hard to innovate in banking.

I have a plan!!!

Where in we go back to basics, but lets rewind things a bit first.

In tomorrows post I will cover some history.

Agile Banking Talk

Published June 25th, 2009 edit replace rm!

Updated with video. I gave my talk earlier today at Reboot 11 about refactoring the banking system:

Anyway I’m interested in any comments.

Read my 5 part blog series based on this presenation here

About me

Pelle gravatar 160

My name is Pelle Braendgaard. Pronounce it like Pelé the footballer (no relation). I live in wonderful Managua, Nicaragua. I work with Clojure, Bitcoin and Ethereum.

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