A simple solution to credit card fraud, part 3

This is part 3 of a long story.

One of the reasons this story is so hard to tell is that it's hard to know where to begin.  The situation I find myself in today can be traced back at least to 2006, and possibly earlier than that, but does anyone really have the patience to sit through a book-length memoir?  I wouldn't.

So I'll skip 2006 for now (though that makes a good story too, and timely too because that's when I worked with Jody Sherman) and start on March 20, 2008, when I sent out the following fateful email to a mailing list of ex-googlers interested in angel investing and other startuppy things:

I just got back from the Y Combinator Demo Day and there are more promising-looking early-stage startups there than you can shake a stick at.  We don't have enough money to invest in all the ones that looked good to us, which got me to thinking: someone ought to put together a fund or a syndicate so that you could diversify across a fairly large selection of YC startups so that you could diversify without having to invest a huge amount of money.  Is there any interest in this?

There was.  I was soon joined by a dozen other Xooglers, including Brian Singerman who became my co-founder in a small fund that we called XGYC (Ex Googlers investing in Y Combinator companies).  I volunteered to do the administrative work because I was very green and I thought I would learn a lot.  I did learn a lot, including the fact that administrative work sucks.  It's boring and it's repetitive, but it's necessary and you have to pay attention because if you miss a deadline or get something wrong then you have to go back and fix it and it's an even bigger pain in the ass.

By far the biggest PITA was (and remains to this day) actually managing the money.  The mechanisms that we in the U.S. have for moving money around are horribly antiquated, inefficient, and insecure.  I actually started learning this before XGYC, when a six-digit wire transfer was lost for two weeks because the sender had filled out the (paper) transfer form incorrectly.  And when I say lost I mean lost.  No one knew where the money was.  There was no way to track it.  The only reason it was found was because the person who received the money (some random stockbroker) contacted the sending bank and gave it back.  Yes, I know this is hard to believe.  I didn't believe it myself at the time.  Some day, if there's enough interest I'll write up the details.  (I keep telling you this is a long, complicated story!)

Anyway, for a high-tech entrepreneur there are no problems, only business opportunities, right?  I gazed into my crystal ball and saw a day when YC demo days would be much bigger, there would be a lot more angels out there dealing with the exact same problems I was facing, filling out the same forms over and over, dealing with the same accounting and legal BS over and over, and decided that there could be a market for a sort of "angel syndicate in a box" type product.  The idea was to integrate tools to simplify or automate all the standard repetitive tasks that I was doing by hand.  In particular, I wanted to streamline the accounting.  Standard SOHO accounting packages are not designed with investors (or even high-tech startups) in mind.  They're all about managing inventory, accounts receivable, yadda yadda yadda, and their UIs are a disaster.  Five years on and I still can't figure out how to make Quickbooks behave.

The key, it seemed to me, was to integrate the accounting with the money transfer somehow.  One of the biggest problems I was facing managing XGYC was keeping track of who had paid what when, particularly when wire transfers were involved.  An incoming wire would show up on the bank statement without any description of what it was for, only an indication of the bank that sent it.  Sometimes I could figure out what it was based on the amount, but often, particularly at the beginning when the syndicate members were making their capital contributions, there was no way to tell whose money had come in, and I had to send out emails asking people to send me the reference numbers for their transfers.  Later, after we started making money (The fund has done quite well, thank you very much!) I would send out distribution checks and people would fail to cash them.  Don't even get me started about the problems that causes!  (I will probably be writing a future entry about checks and the myriad problems they cause.)

The more I learned about how the financial world works under the hood the more shocked and appalled I became.  The whole system seemed (and still seems) to me like it was being held together with spit and bailing wire.  To this day I am amazed that it works at all, let alone that it works as well as it does, and it does work quite well considering how deeply broken it is.

Still, it was 2008, and there was (and still is) a lot of room for improvement.

I came up with a fairly detailed plan for an integrated banking and accounting service specifically targeted at startup companies and their investors.  I still think this would make not just a viable product, but a kick-ass company that could be the Next Big Thing.  But I gave up on it last March after working on it for three years.  The TL;DR version of why I gave up is that I was never able to find a satisfactory way of moving the money around.

Moving money turns out to be a very complex and subtle process.  It's conceptually very simple, and if you use cash it is very simple: I give you a dollar.  Now you have a dollar more, and I have a dollar less.  Alas, that is where the simplicity ends, because sooner or later that dollar ends up being deposited into a bank.  And that is where all the trouble starts.

(Some people think the trouble starts when you consider a piece of paper to be money in the first place instead of, say, gold, but they are wrong.  This is another tangent that I may write about some day, but for now suffice it to say that very few people actually seem to understand what money is or how it works, including many people who work in the banking industry.  But I'm getting way ahead of myself.)

Don't get me wrong, I think banking is a terrific idea.  The problem with today's banks is not that banking is inherently bad.  Modern technological civilization could not have been built without banks.  The problem with today's banks is that they have forgotten the business which they are supposed to be engaged in, which is to allocate capital and manage risk.  Notice that I said manage risk, not avoid risk.  To the contrary, when the banking system is working properly the banks willingly take on (managed) risk.  But today's banks avoid risk by any means necessary, including fobbing it off on third parties or the government.  This is great for the bank's bottom line, at least for a while, but it's an unmitigated disaster for society.  But again, I'm getting ahead of myself.

My plan was this: for every person or entity participating in my system, I would open an account for them at some bank who would become my partner in this business.  All of the initial capital would flow into this bank by traditional means.  But once the money was in the system, all "in-network" transactions could be conducted by initiating inter-account transfers within that one bank.  Moving money between two accounts at the same bank is a lot easier, safer, faster, and cheaper than moving money between banks.  Furthermore, it's a lot easier to undo mistakes.

The beauty of this business model is that it has a natural viral component: not only could investment syndicates use it, but the companies they invested in could us it too.  And their employees.  And their vendors.  And there could be a whole slew of ancillary services as well.  It could be Y Combinator, but on-line and with a nationwide or even global reach.  I called it Founders Forge.  And, of course, every participant would get a secret key with which to authenticate themselves to the system and authorize transactions. Eventually, as the user base grew we would gradually become the basis of a new, more efficient and more secure financial system that would eventually and stealthily squeeze out the older, less efficient system.

Now, those of you who like to shoot holes in people's ideas, before you take pot shots at this idea please keep in mind a couple of things.  First, what you have just read is a very abbreviated version of the actual plan.  In the interests of not turning this story into War And Peace I have left out a lot of detail.  Second, I am not an idiot.  I am well aware that banks operate under a very strict regulatory regime, that they are highly risk-averse, that they avoid innovation like vampires avoid the sun.  My plan took all this into account.  I had (still have) a detailed risk-mitigation strategy.  If you really want to know, I would be more than happy to go into excruciating detail.

None of that matters to the point I want to make with this story, as you will soon see.

I took this plan to my local Wells Fargo, which was the bank where XGYC has its account.  I figured it would be an easy sell.  I would be bringing them tons of new high-quality customers.  And it was an easy sell.  The idea got a very favorable reception from the branch manager, and the pitch started working its way up the chain of command.  I stopped worrying about the bank, and started writing code.

But a few weeks later something very peculiar and unexpected happened.  By that point I had been handed off to a regional management team, and I hadn't heard from them in a while, so I sent an email asking what was going on.  They replied that Wells had changed its mind and would not do business with me.

When I asked why, they said they couldn't tell me.  All they knew was that they had received marching orders to kill the deal.

Weird.  But OK, if at first you don't succeed...

Fast forward a year and a half, and half a dozen or so banks.  Same story, again and again and again: initial enthusiasm, followed by a sudden change of heart with no explanation.  The only exception was a small regional bank where I was able to pitch directly to the CEO.  He said he loved the idea, but was couldn't do it because their charter prevented the from having non-local customers.  That was the only time I got a straight answer out of a banker.

It gets worse.

By this point I was very discouraged, but far from ready to give up.  Still, I wasn't quite sure what to do because I didn't have a good model of what was going wrong.  I had no idea what to change to increase my chances of success.  I talked to everyone I knew who had even the remotest connection with the financial world and the reaction was always the same: This is really weird.  Your pitch sounds great.  I have no idea why a bank would not want to work with you.

I kept at it.  I tried everything.  I tried credit unions.  I tried Silicon Valley Bank (which turns out to be astonishingly backwards in its approach to technology even by banking standards).  You name it, I tried it.

Finally, I caught two breaks.  The first was a bank called Square1 (no relation to Square, which wasn't founded until a few years later) which was receptive to the idea.  For the nth time I worked my way up the food chain and got to the CEO, but before I could meet with him he had a heart attack and died.  No, I am not making this up.

My second break was First Republic Bank.  I got as far as face-to-face meetings with their CTO and other senior staff.  Then one day, many months in to the process, they all stopped returning my emails.  I found out later that everyone I was dealing with had left the bank.  As far as I know, all the departures were independent and had nothing to do with me.  I tried to resurrect the deal, and got as far as a face-to-face with the new CTO.  He told me he was interested, but was ultimately unable to convince senior management.

By now I was very discouraged, but still not ready to give up.  I tried one last strategy.  Maybe the problem was me.  Maybe I was too geeky.  Maybe I didn't know the secret handshake.  So I enlisted the aid of a friend of mine, a Harvard grad, a complete non-geek, strong business credentials, blue blood, comfortable in a suit and tie.  He had been interested in being a co-founder, so I delegated the job of closing a bank deal to him, and I gave him a strong lead.  We were both extremely careful, working our way step-by-step up the chain of command, getting everyone on board, until we got to the CEO.  We pitched him, and he said yes, but with one condition: he wanted us to be venture funded.

Up to that point I was self-funded, mainly because I didn't need the money, but also because the business case was immensely stronger with a bank on board.  The whole model lived and died on the ability to quickly, cheaply, and reliably move money around, and to do that we needed a bank.  (Yes, I know about ACH.  I'll write a whole nuther post on why that wouldn't work.)  But OK, if the difference between getting my key vendor and not was raising a round, I would raise a round.  I had good VC connections, and within a week I had lined up three of them.  I called the bank back and told them about my progress, and that these VCs would like to talk to them as part of their due dilligence.  That was when this bank, too, pulled out.  No credible explanation.

That was March of 2012.  That was when I decided to fold up the tent.

But, of course, that is not the end of the story.

[UPDATE:] Responding to some comments over on Hacker News, I am not drawing this story out because I'm trying to be cagey.  I don't know why all the banks did what they did.  It's a mystery to me.  That's one of the reasons it's hard to write about.