This is very strange indeed, but I had a similar issue...probably something to do with the slight difference between the STAReBOOK and the Cybook Gen3.
However, I can guarantee that it works and once you have managed the conversion it works flawlessly.
Have you tried formatting with a different tool, the HP USB formatting tool for example? Maybe a chkdsk scan of the internal memory would also help? I did all sorts of stuff and never really knew what really helped in the end.
Maybe I'll try to go back to the stage you are on now and see whether I can get it to produce the error again and then try to fix it again.
No idea whether that is possible, but I'll try.
UPDATE: Try this:
When you are at "Checkerboard Stage", format the internal memory, copy the files over onto the Cybook (maybe just copy the System folder with the icutdl file for now) and then don't restart the device but unplug the USB cable. Now wait. It should restart itself, but not from the very beginning but from the second bootscreen. That just worked for me, but I can't guarantee that it will work for you, worth a try though...^^
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