Financial Innovation

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The sorry state of payment standards

Published February 4th, 2010 edit replace rm!

Since my talk last year at Reboot on Agile Banking the Agile Banking Mailing List has been quite active with lots of different ideas. One of the most important yet also simple products of the list has been OpenTransact which I now realize I haven’t even mentioned on my blog.

OpenTransact aims to be the worlds simplest technical standard for transferring some sort of value between 2 accounts. We wanted it to be so simple that there wouldn’t be a good technical excuse for not implementing it and also make it extremely simple to build all sorts of new value added services on top of it. You can find out more at the OpenTransact site and I will post a detailed article about it tomorrow.

In this article I will focus on what we’ve got. Current payment standards and bank business processes are incredibly complex and I don’t pretend to understand all of it, but I will try to present a much simplified version of what goes on.

What is wrong with existing Payment Standards?

Complex messages

The big issue with most of them is that they are ancient (SWIFT the standard banks use to transfer funds internationally dates back to the mid 70s). Most of them are designed for ancient technology like mainframes with batch processing as well as ancient business practices such as delayed settlement and bank opening hours.

Most of these standards are message based and extremely complex.

SWIFT has 25 standard data elements and 79 types of messages with strange names like MT542. People make good money specializing in specific message types. You often see programmer jobs in the financial industry calling for 3 years of experience in eg. MT530.

ISO 8583 which is used for handling most payment card transactions dates from 1987 is a little better in that at least it does expect to be able to send one or two small messages online, but still most of the heavy lifting is done after the fact in the settlement phase.

Most countries have their own electronic banking clearing systems with their own set of standards and procedures. The largest US clearing system ACH won’t even let you at their online rules website without buying a $79 book.

Security nightmares

Any non cash financial transaction consists of one or more entries known as book entries into various companies databases. By definition any act of creating a financial transaction is delegated by you to someone else. Whenever your transaction involves another bank your original delegation gets delegated onwards to x number of other institutions. Unfortunately the transactions are often unauthenticated. Whether you are sitting in a bank office ordering a wire transfer or handing a waiter your credit card you are delegating authority to transfer funds out of your account. This is why a check says “Pay to the order of…”.

Card payments do support some level authentication from pin to signing via an onboard smart card. But they aren’t used when performing an internet payment. This is obviously where much of the fraud goes on. Credit Card or ACH fraud essentially boils down to convincing (delegating) someone to transfer funds from the victims account.

Since you can’t satisfactorily secure the payment message most of these standards come with complex reconciliation standards that make up most of their complexity and even larger and more complex rule books. These rules are what allow you to deny a transaction when you get your statement a month later after the fact.

Enter PayPal

PayPal’s original Website Payment API while not a standard was a big step up over the actual standards in that it was born of the web. Web 1.0 yes but still the web. So rather than using REST to hide some of the complexity it uses a single URL with lots of different fields including optional non payment fields such as address and shipping details.

A big issue that PayPal had was that they still had to interface with the traditional banking world with their settlement times and insecure payments. To make it economical for them they need to use ACH and similar slow low cost national payment networks guaranteed by credit cards if these don’t go through. This is where much of the complexity of dealing with their Instant Payment Notification comes from.

Most of PayPal’s competitors use similar API’s to PayPal’s, but there hasn’t been any real standardization on it yet.

Their new Adaptive Payment API is much clearer. Yet still fairly complex for a new developer faced with it. And no it’s still not REST.

Why is it like this?

Closing Time

There are many reasons why banking related standards are complex. Most of them are historical. For example banks still operate 5 days a week with close of business at some time like 6pm decided many decades ago by gentlemen in top hats. Of course they do work 24 hours but all their processes are still based on this pre online world.

This means there is still a lot of batch processing going on in that last hour before closing. Most banks have a cutoff time a couple hours earlier than their official closing time to give them time to batch up and reconcile the days business. This is why you have to rush to the bank with your checks before 3pm on a Friday or it won’t get credited until Monday evening.


Settlement is another important issue that all of these ancient standards have to deal with. Once you’ve bought that dry martini in the bar after work with your debit card, the money doesn’t actually leave your account yet. Your bank basically puts a hold on your money first. Then over the next couple of days they settle it through a network of banks and institutions depending on the country. Most of the settlement processes is done through batch processes once a day, the more step between your bank and the bars bank the longer settlement takes.

Most of these settlement (clearing) times are standardized by rules set out by central banks or banking associations. The holy grail for many of these systems is to reach what is known a T+0 clearing, which is fancy banker speak for instant clearing. It will take a long time for this to happen in most large economies like the US as there isn’t really a demand for it from anyone except consumers and small businesses.


Any new standard or API that attempts to deal with the existing banking standard is very difficult to simplify. You need to account for each countries settlement and fraud prevention rules. SWIFT was updated to a fancy smancy new XML standard, which didn’t do anything to simplify it besides making it easier to parse.

Any kind of innovation in this needs to be designed for an online world with 7 days, 24 hours and clear simple standards that only aim to solve a simple need. We have had this magic new technology now called HTTP thats been here for close to 20 years now and it’s been kind of successful. OpenTransact is only a very thin layer on top of HTTP and uses OAuth for its authentication, I think it is going to be big. But I will write more on that in my next post.

Liberia's blackboard blogger

Published September 8th, 2009 edit replace rm!

Alfred has set up his own information business on a busy street in Monrovia. He posts a compendium of news on a blackboard. His sources are local news papers and a network of correspondents throughout the country.

I was quite fascinated that the most prominent information is current market prices for a whole range of different commodities as well as currencies. It shows how important good price data is in any society.

His business model? Advertising.

Liberia’s Blackboard Blogger from WhiteAfrican on Vimeo.

Entrepreneurs, coders and activists we need you to help reboot banking

Published July 3rd, 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 of which this is the final one. I have links at the bottom of the article to the previous articles.

How do we build this?

Open web standards are the way to do this. A lot of great work has been done in the past couple of years.

OpenID may provide us a better alternative to account numbers. OpenId is a universal id. It replaces username/password on many different sites.

We may need guidelines for high security open id’s. A voluntary certification of trusted opened providers.

Oauth is a new web security standard. It lets all your applications talk together. You could use it to provide your accounting system access to your accounts. It could also be used for one off or subscription payments.

We also need new simple financial standards.

WideLedger is a simple financial exchange format. It contains only very basic transaction information embedded in a normal web page. It can be implemented in less than an hour for any financial web application.

Together with OAuth it makes it very easy for you to bring your financial info together. Startups will create all sorts of cool and useful financial mashups.

Finance isn’t just about reporting transaction but also performing them so we also need a very simple standard for performing a transfer from one account to another.

After that a slightly more complex standard for performing an exchange between two different parties on two different financial service providers. A simple application would to buy shares in a mutual fund with money in my electronic currency account.

We need Open Source Software to run this new generation of financial software.

  • Ledgers are the foundation of any financial application.
  • Exchange Software to manage transactions between financial services
    There are lots of opportunities for hosting providers to run the above software in a secure manner.

We also need online auditing services to keep an eye on the new financial services companies but also on the hosting providers.
But what about the regulators?

They mean well but need pushing. Change has to come from the grassroots.
We need brave financial rebels, who believe it is better to ask forgiveness than permission.

This doesn’t mean being stupid (always remember what they did to Doug). Limit your risk as a rebel – think small, think community:

  • small community currencies
  • community lending
  • projects with a purpose

If we are forced to I say be the Christiania of finance. Force regulators to think small and learn from you.

Once you have a little bit of momentum engage them publicly. Show them it works and in the end it makes their job easier. Then scale.

Similar proposals

Most of the above ideas are refreshed versions based on work I did from 2000-2004 in the NeuClear project. However I have noticed some interesting new mainstream proposals.

Limited purpose banking a proposal by Kotlikoff and Goodman

It seems very similar but without worrying too much about barriers to entry and know your customer.

Call to action

Programmers, entrepreneurs, activists, lawyers and accountants we need you. I want to hear from anyone with an interest in this. Please write me at [email protected] if you have any thoughts or ideas or want to get involved.

Join the agile-banking google group or attend a BarCampBank .

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, Douglas Jackson of e-gold who has been one of the most innovative people in the financial services space and my proposal to create a new banking system.

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

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

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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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