How blockchain solves scams in finance: a story from Switzerland
From Charles Ponzi to Bernie Madoff, financial con men all have one thing in common: obscurity. They operate in the dark.
This article makes no assertions about wrongdoing by any party.
Investors now have a technology that can help protect them from being conned: it is called the blockchain. Not tech-savvy? Well, it is just a traditional record-book for the information age. With three improvements:
- It is transparent[1]
- It cannot be changed[2]
- It is available in real-time
This blockchain record-book brings light to the old world of financial obscurity, for the benefit of investors.
The Ruvercap disaster
As the War on Savers continued, two businessmen in Zurich set up a private debt fund called Ruvercap to offer a 2–3% return to investors. In a low yield environment they had a lot of takers. PIMCO put in money. At one time, Ruvercap oversaw about CHF 700 million.
The transparent structure that they put in place is set out below, in comparison to a blockchain record-book structure.
It is actually more complex than this; I have simplified it.
One of their loans was to a Swiss firm, which lent to a South African firm secured against receivables from a company in Zimbabwe. Seems reasonable for a fund that operates in euros, dollars and francs. Unfortunately, there was a problem with the currency in Zimbabwe and the loan didn’t get paid back. Now there is a real Black Swan event.
Another loan was in relation to the purchase of a Serbian battery manufacturer. KPMG, called in to try to understand the situation, cannot even determine how the funding was structured[3], but most of the money appears to be lost. The company was subsequently sold to Cyprus-based entity; the details are murky. Again, seems a reasonable risk to take for a 2–3% return.
To make a long story short, the current asset value of the funds cannot be established. Investors suspect that up to CHF 500 million is missing. KPMG has said that Ruvercap has not helped with the audit and failed to turn over documents. Lawsuits have been filed in several countries. PIMCO is no longer dealing with Ruvercap.[4]
Ruvercap is an embarrassment to Switzerland and to the sophisticated investors involved. Fortunately, there is a solution so it never happens again.
Two information architectures
The biggest aspect of due diligence for any investment is information. Information is trust. The only healthy relationship that can exist between two parties must be based on a transparent information exchange.
In the financial world, this comes down to your architecture: either it is open (a blockchain record-book) or closed (a traditional in-house database). There are broadly two technology architectures for managing information, set out below.
The blockchain record-book solution
Ruvercap would never have happened with a blockchain record-book in place. Same for Bernie Madoff. Same for Charles Ponzi. Here is why:
- The location of the money is recorded at all times
- Investors would have seen the use of funds in real-time and could have put an end to it
- The numbers are transparently recorded; you cannot cheat and take money from one account to another
- The funds are legally in your name, not the name of the finance company
Perhaps the biggest advantage of a transparent record-book like blockchain is that it encourages managers to be honest. People act differently if they know that others are watching.
Of course, it is not a perfect solution. Losses happen and some people behave inappropriately; that is life. But, it is vastly better than not knowing what is going on.
Future generations will look at us and ask: did you really just blindly trust people with your money? With no way to know what they were doing with your funds?
Swiss institutional investors should take the lead in insisting on the protections offered by a blockchain record-book. Blockchain technology is almost as Swiss as cheese and chocolate: ETH in Zurich and EPFL in Lausanne train some of the world’s best computer scientists in this field; FINMA is one of the most supportive regulators globally; Swisscom is implementing a blockchain-based signature system; and cantons like Geneva are putting their entire corporate registry on a blockchain.
In the future, smart investors will ask: am I putting my money into a black box or into a blockchain?
I write about money, banking and cryptocurrency.
Twitter: https://twitter.com/res_crescofin
LinkedIn: https://www.linkedin.com/in/robert-sharratt-1887a4129/
[1] So, investors can see what managers are doing with their funds. Of course, only permitted users can see investment details.
[2] So, managers cannot manipulate the information.
[3] But, they have only been working on it for 6 months.
[4] A call to PIMCO’s investor relations office inquiring about how they could be so naïve as to invest in such a black box structure wasn’t immediately returned.
