Trust, Blockchain and Cryptocurrencies for Fund Directors

Sara YerkeyMutual FundsLeave a Comment

The relevance of blockchain and cryptocurrencies to the mutual fund industry can be easily understood once the similarities are recognized between the “trust technology” of 1940 Act mutual funds and that of cryptocurrencies. Just like law or technology degrees aren’t needed for trust in today’s mutual funds, you don’t need a mathematics degree to trust cryptocurrencies.

The technical jargon surrounding cryptosecurities impedes the fundamental understanding needed and obscures the important psychology underpinning their acceptance. Understanding how the technology of Bitcoin and other cryptocurrencies works allows the director to trust the underlying blockchain technology, and the impact on the oversight of their funds, no matter what the future of Bitcoin per se.

When those first mutual fund advisors set up shop in Boston, why did anyone write them a check? When you are asked to invest in a virtual stranger today, why are you compelled? Or as a director, feel confident in trusting your shareholder’s money with a service provider? We can tell you why we would. First, we are given a contract which we would read, then decide if it was written by someone who values what we value; facts and logic, goals and ideals, English composition, the law, etc. We would then ask questions. If answered to our liking, we would then assume that these shared values would be respected and upheld by those we invest in, the courts, and every other person who understood the legal statements of that document. Legal documents were and are the first technology of business. Most people feel they can trust them.

We often hear the word “trust” thrown about in financial services, to the point that it has been hopelessly diluted. Trust is simple and can even be ethically blind. Trust can be based on legal technology, family relationships, a shared love of the same sports team and, yes, the mathematics between prime number factorization in the world of cryptocurrencies. Trust is typically based on things we understand.

Dollars are trusted because they are managed by legal technology, both government and private. However, government interests have been eroding the trustworthiness of that technology for some. Fueling this was the event in 2010 when the U.S. Government allegedly tried to block a payment to WikiLeaks. It essentially stepped in and subverted legal technology. This and other developments drive some people to seek another means of entering trust relationships that can’t be interfered with. Enter blockchain, cryptocurrencies, and all the mathematical “trust” technologies that come with it.

Bitcoins, and other cryptocurrencies, are trusted by some because they are managed by people who trust computational technology to protect their interests. Today there are large populations of tech owners/workers who trust each other more (their shared knowledge of data privacy/encryption) than the legal technologies that govern their wealth based on national interests.

When we send a check to a fund transfer agent, we’re trusting in the legal system to protect the ownership of our investment. When we buy a Bitcoin, we’re trusting in computational technology to protect our ownership. Often the changing value of Bitcoin is irrelevant to our trust in the system (as with mutual funds).

The current mutual fund arrangement is one of trust in legal technology. Typically, as the average investor, we gloss over the legal technology every day. As a trustee, you read through reams of compliance documents, regulations, and data. It does not predict the future of the fund, yet you would not stop having it produced or reading it. It isn’t what’s in the documents that’s important, it’s what the documents validate in everyone’s need to maintain shared trust. We don’t give money to anyone who can’t create or understand the principles laid forth in these documents.

Regarding Bitcoin, many are less accepting, seeing only the problems, like the days of the first mutual funds. They can’t see the benefits of the technology, are blocked by their anxieties of something new and difficult to understand.

At some point, it is most likely that even the general population will store some value in cryptocurrencies. If only because, just like mutual funds, they see others doing it. Further, and more specifically for fund directors, blockchain has the potential to transform the industry, including providing operational efficiencies that will change the business of transfer agents, custodians and bookkeeping. The implications of that will be front-and-center to boards sooner than they expect.

In conclusion, Bitcoin, or computational trust, is no different than legal technology. Once you understand the basic principles, you generally forget how it works and focus on where best to store and manage your wealth and your secure information.

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