BlockChain

B A LT I C B U S I N E S S Q U A R T E R LY | S U M M E R 2018

BalticBusiness Quarterly S U M M E R 2018

www.ahk-balt.org

10 | Startups in the focus Volkswagen visits Riga 14 | My Office Martin Gauss (AirBaltic) opens his doors 46 | We Build Parks Rising Star JÄ nis Jansons about his success formula

26 | Interview

Breaking The Chains How Blockchain Technology Inspires Baltic Businesses MIKE GAULT, GUARDTIME

20 | B LO C KC H A I N

The new Buzzword or the biggest Invention since the Internet?

In just a few years, we all have learned words like Blockchain, Bitcoin, and even initial coin offering. The new innovations in Fin Tech space are spreading like wildfire around the world and companies from Baltic countries are punching well above their weight in this field.

BY TARMO VIRKI

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T

hese days, most FinTech firms and many others are marketed as blockchain companies, but the technology is relatively specific, it gets its name from blocks of data, which are cryptographically linked with distributed consensus protocol.

Already, before the mysterious Satoshi Nakamoto implemented blockchain in 2008 for the use in cryptocurrency Bitcoin, Estonian company Guardtime, which has been named the largest blockchain company in the world, was working on using this technology in corporate environment.

And Guardtime is just one of the examples of blockchain pioneers from the region.

Estonian Funderbeam, founded in 2013 by ex-head of Tallinn bourse and HawaI Ironman, is building the first blockchain-based startup exchange in the world.

Next door, in Latvia, the 2011-founded Bitfury, the most-funded Latvian startup ever, having raised around $100 million of capital, creates software and hardware for Bitcoin-miners around the world.

Basically, the firm is selling picks and shovels for the miners at a time of gold rush.

While Latvians and Estonians are working on global leading technology firms in the field, their southern neighbour Lithuania is the third largest country in the world, when counted by the money raised through initial coin offerings. Last year it was second only to China and the United States.

“In Estonia, we see that the blockchain technology is used more strategically, whereas Lithuanians have been fast on jumping on the ICO wave as an alternative to traditional fundraising,” says Egita Polanska, Chairwoman of the Board of Latvian Startup Association.

Latvia is falling in between big Estonian stories and massive Lithuanian ICOs. However, it has recently seen a number of blockchain activitiespre-accelerator programs, conferences, meet-ups and blockchain sections and panels in most important tech events, also the Blockchain Development Association of Latvia has been founded. “If you look at the activities in the Latvian ecosystem, for sure Blockchain and ICOs

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are one of the trending topics. However, if you look particularly at the startup scene, then the activity is rather low,” says Polanska.

A LOT OF MONEY

As one of the most high-flying examples, blockchain-based Lithuanian banking solution Bankera raised in a single ICO $152 million, as much as all Lithuanian startups have ever raised venture money in total. And it’s almost as large as the country’s largest ever initial public offering of telecoms group, going public in the 1990s.

Bankera was founded all the way back in 2017. In total, Lithuanian startups raised around $500 million last year in 35 ICOs. Mike Gault, founder of Guardtime, whose core business today is in securing data for military and corporate clients in U.S., Estonia and elsewhere, is in general critical on the state of the blockchain industry in the region and the ICO climate, where scam artists have been able to raise millions. “I am very skeptical because the technology is the wrong technology. If all you have is a hammer, then everything looks like a nail,” he says, referring to the current situation where almost everything new in the technology sector is called blockchain and the technology is being implemented for many situations where it’s totally unsuitable or gives no benefit whatsoever.

“Unfortunately much of what is labelled as blockchain in the public is a scam. Looking at the ICOs, I have not seen a single one that makes sense, that I would invest in. It is a bubble, and there will be people who will make money in that bubble. Is it going to have any long-lasting benefit to the society? I doubt it,” Gault says.

The comments are not surprising from a profound tech company whose roots are deep in cryptography. Still he might have a point there.

CHANGING THE WORLD

However, there are several sectors where blockchain technology could change the world as we know it. As the element of security is built into the model of blockchain technology, the industry is looking for opportunities to use it for any process where recording of events is of high-

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importance , like medical records, identity management or transaction processing. This means, there are also plenty of opportunities for blockchain in the industrial production, as part of the so-called Industry 4.0 movement.

Guardtime’s Gault defines blockchain technology as a perfect tool for protecting integrity of any digital process. Guardtime, who works with global heavyweights like SAP; Maersk or Ernst&Young, is making also strong bets on insurance industry and on healthcare.

“The one vertical that I am incredibly excited about right now, because if we get it right, it really has the potential to advance human race, is healthcare. Healthcare fraud in the United States is measured in $200 billion a year. Nobody has figured out how to share healthcare data, we think we figured it out,” says Gault.

Guardtime started its healthcare exploration from Estonia, where its technology is in use at the Estonian healthcare foundation, which is totally different from the rest of the world as health care records are centralized and digital. In the Estonian model, the patients own their data and give

You should do your due diligence, whether it‘s shoes or whether it‘s tokens consent to family members or to doctors to access their data. “That got us thinking,” says Gault.

“We went on the road and we travelled the world saying: ”How do we produce this technology, so that the customers will pay for it, so that it solves a real problem in healthcare. It really has the potential to change the healthcare.”

Photo: Blockchain Centre Vilnius

PLAYING WITH FIRE IN LITHUANIA

In Estonia, the government has been playing with the idea of an own Ethereum token — called Estcoin, in an ICO, to accelerate and facilitate investment and startup activity in the country.

When the news of such a plan by Estonia was released, Mario Draghi, the head of the European

Central Bank, saw the need to oppose it, as he saw it competing with the single currency of the Eurozone.

Despite Estonia’s state-token plans, the token country of the Baltics is Lithuania. There is no question about it. It is globally the third largest ICO country.

Egle Nemeikstyte is Chief Executive Officer of Blockchain Centre Vilnius, the first-ever blockchainfocused co-working space in the world

While many of the token-projects are pure FinTechplays, there are some more diversified projects around. For example, WePower Network starts from tokenizing massive energy contracts, splitting them into smaller pieces and making them tradable.

It is also getting Blockchain to power grid management, increasing transparency, while digitalizing some of the current analogue solutions.

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Or take Desico, which plans to launch in the world first security ICO crowdfunding platform, aimed at creating a safe and legally regulated environment for startups and investors to develop Fin Tech and blockchain technologies. It seeks to raise up to $32 million through its ICO this year, and sees strong backing from state officials through Lithuania.

Desico says it is the world’s first platform to issue, buy, and sell security tokens in full compliance with the law, something it believes will enable it, to disrupt the global $155 billion venture capital market.

“Lithuania needs a transparent and regulated crowdfunding platform in order for it to fulfill its plan of becoming a future Fin Tech leader of the Baltic-Nordic region. “Lithuania already has an exceptional regulatory advantage,” Finance Minister Vilius Sapoka said in a press release.

“It is the first European Union member state to already legally regulate ICOs, and have a Law on Crowdfunding. Meanwhile, other EU countries, as well as the United States, Canada, and China are only just changing their legislation to legally regulate ICOs,” Sapoka added.

Lithuania hopes that Desico will foster its ambitions, as the Fin Tech and blockchain hub by promoting the settlement of global blockchain and Fin Tech businesses in Lithuania, while it should also solve many practical problems, including customer identification, money laundering prevention, investor protection, and high ICO costs.

VEHICLE TO MONEY

At the same time Lithuanians see it mostly as an alternative vehicle to raise capital. And if tokens are lost or the business is not there…. eventually the hype is always up to the investors and their urge to invest anywhere in the current zero-rate climate.

ICO is a crowdfunding model, where digital tokens are sold to investors in exchange for legal tender or other cryptocurrencies such as Bitcoin or Ethereum.

These tokens are then becoming units of tradeable currency, when the funding goal is met and the project launches.

Regulators in many countries are cautious with ICOs, but Lithuania has embraced the funding

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model on the state level and is helping to build credibility in funding mechanism, which many see as a scam or a perfect way to launder money.

“You should do your due diligence, whether its shoes or whether its tokens,” says Egle Nemeikstyte, Chief Executive of Blockchain Centre Vilnius. The centre is possibly the first-ever blockchain-focused co-working space in the word.

From the level of Minister of Finance politicians have played a role in the adaptation of the technology. When trying to explain the phenomenon, government officials stress the regulatory conditions, ease of doing business and speed at where a license can be obtained, entrepreneurs admit this has played a role, but there is more to it.

“When this new funding mechanism came about, everybody was very excited.

Funding is always a challenge, when you come from a small country,” says Mantas Aleks, business development head at WePower Network, which raised $40 million earlier this year in the largest ever ICO in energy sector.

“We are still in very early stages, a bit like investing in internet companies in 1990s,” Aleks said, adding that he sees ICOs as the equalizer in the startup funding scene, which has been very much beneficial for the U.S., and especially West Coast startups.

“It’s just a better instrument than the VC money.

Of course, most of these projects won’t succeed, but also most of VC-invested companies won’t succeed.

It’s a very good development for non-Californian companies,” he said.

In a small country, there is also a snowball effect.

2017’s 35 successful ICOs mean, that almost every entrepreneur knows personally somebody who raised millions last year. “If my neighbour can do it so can I,” Aleks wrapped the situation.

Blockchain is a massive innovation in the technology world, and Baltics are surely on the frontline of implementing it, but the real business opportunities for the new technology might lie rather in verifying processes in healthcare or industrial production, not necessarily in bitcoin mining, different to what the bit currency hype in the media coverage suggests.

26 | B LO C KC H A I N MIKE GAULT is founder and CEO of Estonian Blockchain Technology provider Guardtime. The platform is used in production around the world for enterprise, telecom and government solutions, especially as an underpin of Estonian digital society.

Solutions the company has built include GDPR compliance as a service, physical anti-counterfeit, marine insurance data exchange, physical supply chain track and trace and critical infrastructure protection. Mike Gault has a PhD in the “Numerical Analysis of Advanced Semiconductor Devices�. Prior to founding Guardtime he spent ten years in financial services as an analyst and trader.

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B LO C KC H A I N | 27 P H OTO: R EN E T Ü R K - L U MIER E S T U DI O

Blockchain Will Ultimately Be A Completely Universal Technology The Estonian technology firm Guardtime has been named the biggest blockchain company in the world. We sat down in Tallinn spring with Mike Gault, founder and CEO, to find out how this has happened and what the development paths have been for the firm, which was founded in the aftermath of the 2007 cyberattacks on Estonia and whose first big break was in the defense industry. Guardtime introduced KSI, which, besides X-road, has become a basis for e-Estonia.

What was in the beginning?

How did Guardtime start?

In 2007, we started thinking about information veracity. We were not thinking about cryptocurrency, we were thinking of how to use distributed consensus protocols in order to ensure the veracity of information.

The Estonian government wanted to find a way to guarantee the integrity of information without having to rely on trusted parties. How do you know if the land registry document is the right land registry document? You can either trust the land registry or, ideally, you want that the citizens would be able to verify the veracity of that information without having to trust the government.

This was the initial goal of Guardtime. We succeeded and we got some early traction through the Estonian government.

How did you grow from an Estonian government supplier into a global technology company?

We had a couple of lucky breaks. One was the Snowden impact. Matt Johnson,

who is now our global CTO, visited us as a representative of the US Air Force.

He was looking for a technology, which would not only enable government organizations to use Cloud, but also to audit Cloud without just having to trust the service provider managing the cloud infrastructure. The very day when Snowden news broke out, Matt was in Estonia, learning about e-Estonia and how e-Estonia works and he realized, that our technology would help to solve this problem. He helped to get us to the United States. Today our customers are defense contractors, who use our technology for various applications. That was our first big break.

The second one was all this hype about Blockchain. We were sitting in the meeting room, looking at each other , saying - wait a minute, isn’t this what we do?

You are from Ireland and have been living in the Nordics How did you end up founding a company in Estonia?

I did a post-doc in Japan researching how to build quantum computers.

This was in the early 90s and I met Estonian cryptographer Mart Saarepera. We became friends.

I became aware of Estonia and what Estonia was all about. That was in 95.

Then I joined a bank, like any PhD in the mid-90s … you were guaranteed a job on Wall Street, so I spent 10 years as a quant and derivatives trader for various financial institutions and then in 2007, Mart came to me and said: I have this idea, I have been working on this. I studied his idea, and I realized its implications.

How would you describe yourself as a leader?

Empowering. If you want to bring creative people in and you want them to create value - you want them to tell you what to do as oppose to telling them what to do. We are trying to create this entrepreneurial culture, where people can come in and execute ideas, and we give people the freedom to do that.

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Mike Gault was visited in is Tallinn Office by Baltic Business writers Tarmo Virki and Florian Maass

How big is the company now?

We have a bit less than 200 people now. What I have learned in the last 10 years - researchers don’t understand engineering, engineers don’t understand marketing, marketing does not understand sales - you need to have everybody lined up doing the right thing and understanding each other, or at least understanding the next layer.

We do not have any external investors, so we can really think for the long term. What we look for is entrepreneurs. If someone has an amazing idea for the auto industry, we say “Great, here is our technology stack, build the product and go sell it”. You would essentially be an entrepreneur. To continually grow, you need to find people to grow businesses with you.

Baltics are often mentioned as the IT paradise of Europe.

Would you agree?

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We think that the fundamental problem, that blockchain solves is the integrity of process

Guardtime has left. The engineering culture in Estonia is really strong and it has not been difficult to hire people, we get a lot of applications from across Europe as well.

I think that there is still a big gap between having ideas and how you sell them, commercially. That gap has to close. There is a lot of great ideas, a lot of creativity, a lot of desire. Estonia is absolutely the world class country in cryptography, protocols, security and networking. Not in marketing – yet.

What has been difficult?

The biggest challenge for Guardtime is focus, because there are so many things we could be doing. We could be creating 100 products. We have a roadmap of thousands of things we could be doing, but we have to focus in short term on getting our most important products to the market.

Someone just said to me that the hard part of finding Mark Zuckerberg in Baltics is, that people have to be able to say no to a billion dollar offer.

Why is that so important?

Could you give an example?

Companies succeed partly by luck and partly by persistence. The single most important factor in the company success is timing. If you are too early, nobody knows what you are talking about or wants to buy your product.

If you are too late, IBM is already out there with their million-personsalesforce selling the product and it’s very hard to get in. You have to come up with an amazing idea and survive long enough for the market to care.

Many tech companies suggest that the lack of staff is a challenge – how difficult is it to find staff in Estonia?

Almost no one who has joined

At what do you focus?

We are a technology and product company and we don’t have the domain expertise to go into multiple verticals.

That’s why Guardtime’s business model is to partner with companies that are leaders in their field. We have

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I think that there is still a big gap between having ideas and how you sell them, commercially. That gap has to close. There is a lot of great ideas, a lot of creativity, a lot of desire. a joint venture with Ernst & Young in insurance, and Maersk (the World’s Largest Shipping Company) is our partner, giving us input on how to build products that solve industry problems.

The one vertical, that I am incredibly excited about right now is healthcare, because if we get it right, it really has the potential to advance the human race. Healthcare fraud in the United States is measured in 200 billion dollars a year. Nobody has figured out how to create a global brain for healthcare data – instant access for medical research to all the world’s health data. We think we have figured it out.

Access to healthcare data is a problem around the world, for technical reasons, for privacy reasons - how did you find a solution?

We are building a GPDR compliance product with a large CPG company. The new European privacy law has come into effect in May and companies are like deer in the headlights. How

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do you comply with this regulation?

This is a process problem and a great use-case for blockchain.

We have our technology in production with the Estonian healthcare foundation. It is of course different from the rest of the world, because their healthcare records are centralized.

They do not have the problem with interoperability, but they have the right model: patients own their data. And they give consent to family members, to doctors, to whoever, to access their data. That got us thinking and we went on the road and travelled the world trying to productize the technology so that it can be applied in general – across different health-care systems.

Insurance is another great example.

A vertical that desperately needs innovation. The joke in insurance is that the first insurance contract was agreed in 1694 in Lloyds of London and they are just getting around to settling the claim. It is a very inefficient process. The market for

commercial insurance is 500 billion dollars a year in premium and the cost base, the inefficiencies to connect the risk to the capital is something like 40%.

Where does blockchain start and where does it end?

There is no formal definition. If you are a crypto-anarchist, blockchain means the protocol behind bitcoin.

Nothing else is acceptable. If you take it literally, it is a chain of blocks. I think a good definition is a distributed append-only database in which each entry is cryptographically linked to the previous entry and the database itself is updated by distributed consensus.

I draw a line behind the cryptography, as opposed to just pure marketing. If you just go for the marketing perspective, then any chain of blocks we can call blockchain, and therefore it is mainstream. But if we say it is cryptographically linked together, achieved by a distributed consensus protocol, then it makes more sense to me. We think that the fundamental problem that blockchain solves is the integrity of processes.

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With your secure hardware offer, are you kind of savior of old-school a banking?

Banks are not going away, they have a very nice business model. I am quite happy putting my money in the bank, as opposed to tokens. For people that want to convert their money in tokens, they need a place to put them, and that is what we offer.

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How do you see the relationship between banks and cryptocurrencies?

Banks have to follow all the regulatory compliance rules; cryptocurrencies are a way to bypass that. There is a reason why those regulations exist.

It is because people don’t want to get scammed. People don’t want to have their money stolen. I think the financial industry jumped on blockchain, because they saw it as a threat to their business, but in reality blockchain can really help them by eliminating the inefficiencies of the process in their back-office. We have avoided financial services, because it will take 10 years for them... I mean

they are still using IBM mainframes!

The time it takes to go from that to use blockchain is measured in years.

Is bitcoin a threat to banks?

I think the bigger threat to the banks is coming from companies like Transferwise, which are trying to stay within the regulatory regime, but are trying to build more efficient, better customer service. I think banks are much more worried about that than about bitcoin merchants. Bitcoin is great if you want to buy drugs online, but it’s never going to be part of the mainstream economy.

What are the next big things you are going to work on?

One thing we are super excited about, as I already mentioned, is healthcare.

It is just so fundamental, if we solve the healthcare problem, nothing else matters. Telecom is a great industry for blockchain. We have a partnership with Verizon, we are launching a series of products with them. The telecom industry is slow, it’s very conservative,

but they understand the importance of scalable, reliable services and if you can get into that industry it can bring massive scale. We have an end to end story in energy. We have a contract with United States Department of Energy to create what we call self-aware grids. Security is critical for energy companies and if you can create resilient grids, then you have real situational awareness about what is happening. We teamed up with EDF on smart meters and are able to guarantee the process of extracting data from smart meters. And then we have a contract with the Dutch government for distributive energy, where people are putting energy into the grid. Everything comes down to process. A business and a government are basically a set of processes. How do you guarantee the integrity of process?

The audit, compliance, security functions exist because of the lack of an immutable process. That is the ultimate use case for Blockchain and it will ultimately be a completely universal technology, once we get past of this bubble of ICOs. ICOs are a gold rush and in gold rush, you want to be selling picks and shovels. FM / TV

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By Lars Björn Gutheil

What is Blockchain?

Everybody talks about blockchain, but hardly anyone understands how the system works. The attempt of an explanation.

What's the problem?

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Up to now, many digital transactions have not been fraud-resistant.

This is mainly because third parties (e.g. hackers) can manipulate data on servers. The blockchain changes this by distributing a database onto many computers. The blockchain is not located on regular servers. Rather, each user receives his own complete copy on his own computer.

Additionally, all data is stored in encrypted form. Altogether, this prevents corruption and manipulation effectively. The entire network legitimizes itself mutually and becomes its own "source of truth".

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Where does it come from?

The blockchain was invented by an unknown person who appears under the pseudonym Satoshi Nakamoto. He or she came up with the chain for the virtual currency Bitcoin. Satoshi needed a web-based, decentralized, public accounting system for all users. Something like a huge Excel file, which would only allow new entries and no possibility to delete or change older ones. However, blockchain goes much further than bitcoin, which is only one possible application. Nevertheless, the crypto currency is still the best-known example of blockchain technology. Each computer connected to the Bitcoin network, which generates new bitcoins and manages the previously generated ones, also manages a 1:1 copy of the complete blockchain, which comprised already 50 gigabytes in size back in 2015.

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How does it work?

In a blockchain database transaction records are stored in a list. This data record expands chronologically with each transaction. Data is appended to the first data block (“creation block”) in continuously new blocks. This is like an everlengthening chain, at the end of which new elements are added all the time.

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A block consists not only of the actual data, but also of cryptographic data, which should ensure its integrity.

Each new block in the chain is linked to the previous block and contains the history in the form of its checksum. This means that a new block contains a value derived from the data of the previous block. This value, also called “hash”, is calculated by cryptographic means and is therefore unique.

Who will be affected?

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Thanks to direct peer-to-peer communication, musicians and other artists will be able to make differentiated use of their digital rights themselves in the future. Blockchain may thus question the sales systems of publishers, agencies and event organisers or in any case change them significantly.

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If you changed a block somewhere in the chain, its hash would also have to change in the following block - and its hash in its successor and so on. This means that each block automatically verifies the data of all previous blocks, and it becomes virtually impossible to secretly change records, as all users would notice this immediately.

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Another security measure: A complicated, nonmanipulable procedure among the participants of the block chain in a lottery determines who may add a new block to the respective chain. So-called miners have to perform complex calculation tasks and are rewarded (also for a fee) if they add a new module.

What does it do?

Transactions or information stored in a blockchain are in general unchangeable and therefore “real”. For this reason, they no longer need intermediaries to administer or authenticate them. This has had the greatest disruptive effect to date in the financial and legal sector. Thanks to the blockchain-based peer-topeer communication, e.g. trading shares or securities without banks or real estate purchases without a notary are possible directly between the contracting parties. “Smart contracts” with programmed rules and functions could soon replace conventional paper contracts - with serious consequences for the relevant sectors and professions. Today’s banks’ expensive IT infrastructures are also becoming redundant.

Since all transactions can be managed via block chain, the system simplifies communication not only in the financial world, but also in the logistics sector, for instance. This allows, for example, direct communication between the transmitter and receiver, where a truck, a container or a ship’s cargo is located.

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Blockchain is already being used in Estonian e-government, for example. The technology enables a hacker-proof data stream in many public areas.

This is used, for example, in health care, registers, all administrative procedures and in Estonia even in case of elections and votings.

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The Most Courageous Central Bank Out There?

When cryptocurrencies like Bitcoin have started to impact the financial industry seriously, some banks and central banks try to fight it, while a few others, among them Lithuanian Central Bank, are embracing the technology and currencies, which could have a massive effect on the central banks as we have known them.

The

central bankers are clearly implementing the teaching of Michael Corleone from Godfather II – “keep your friends close, but enemies closer.”

The implementation of blockchain technology in the financial system is removing the need for one central authority controlling the system, and the goal of the crypto-anarchists is to outplay the banking system.

But more and more banks follow the godfather’s suggestion. Many banks, including UBS, Credit Suisse or Banco Santander, are using blockchain technology in order to streamline processes and cut costs. Some are even opening up for alternative currencies.

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At the start of 2018 the central bank unveiled a plan to create a sandboxed blockchain platform LBChain, to help Lithuanian and international companies to test blockchain-based services in the financial sector. The Bank of Lithuania would provide LBChain participants, a technical platform and consultations on applicable regulations.

“Giving room to regulated development of this technology would provide our country with particularly favorable opportunities for investment and attraction of talents as well as acceleration of advanced innovations”, Marius Jurgilas, Member of the Board of the central bank, said, when the news was released.

The central bank has been also one of the key drivers for enabling initial

coin offering (ICO) in Lithuania.

The tiny country was the third-largest country in the world using the new funding mechanism. Only the United States and China raised more money through ICOs in 2017.

Digital tokens issued in ICO is often a dubious instrument for serious investors, but for Lithuanian companies it has created unparalleled route to raise investments.

Lithuanian startups have raised in total just around $150 million through their history. This equals to one single ICO of Bankera, a 2017-founded Lithuanian startup building the blockchain-based bank of the future, which raised $152 million, at a time in the sixth largest ICO ever globally.

In total, Lithuanian firms raised $500 million through ICOs in the last year alone.

The central banks mission, on fuelling the innovation in the FinTech field, is clearly fulfilled. FM

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In just one picturesque example, to mark Lithuania’s 100th birthday this year, the Bank of Lithuania, the country’s central bank, said it would break new ground in numismatics issuing a digital collector coin, saying it would use blockchain or other equivalent technologies.

The issuance of the digital collector coin is one of the latest steps in the central bank’s strategic road to fuel innovation in Fin Tech.