A 1925 bank run comes for DeFi

Sometimes, the best (and most fun) way to understand a highly technical event in decentralized finance is to find its closest analog from traditional finance. In the case of North Korea’s latest exploit (the $290 million exploit of Kelp DAO that’s caused a bank run across DeFi), it’s the Portuguese Bank Note Crisis of 1925. 

The instigator of that crisis, Artur Virgílio Alves Reis, had a history of financial subterfuge.

He forged a diploma, for example, claiming to have graduated from the “Polytechnic School of Engineering of Oxford University” (which didn’t exist) with qualifications in “Engineering Science, Geology, Geometry, Physics, Metallurgy, Pure Mathematics, Mathematics, Palaeography, Electrical Engineering, Mechanical Engineering, Applied Mathematics, Chemistry, Applied Physics, General Civil Engineering, Civil and Mechanical Engineering, General Engineering and Mechanical and Civil Design.”

In the more trusting days of the 1910s, that was believable enough to land Reis an engineering job in the Portuguese colony of Angola.

He did, in fact, have a talent for engineering (as well as a "boundless self-assurance"), but was too impatient to work toward a degree.

He was impatient about making money, too, so he tried to speed things up by investing with borrowed money. It did not go well, and then he made it much worse. To dig himself out of a hole, he bought a controlling share of the failed Angolan Ambaca Railway Company, which had recently received a £20,000 loan from the government. He used the loan to cover his personal debts — including checks he had written to buy the company.

The scheme was soon discovered and it landed him in prison, which gave him time to think up a much bigger one: printing Portuguese bank notes (real ones, not counterfeit) for his own use.

After leaving prison in 1924, Reis put his plan into action. With forged documents, he approached Waterlow and Sons, the London printing concern that had a contract to print the country’s currency, the escudo.

Claiming to be an authorised agent of the Bank of Portugal, Reis asked Waterlow to print a new run of 500-escudo notes (pictured above), ostensibly for a loan to the colonial government of Angola. 

Reis said the loan was politically sensitive and had to remain secret, so the firm should communicate only with him.

“An impressive array of contracts and authorisations” — all forged by Reis — convinced the printers he was legitimate. The notes were printed with the same plates used for earlier Vasco da Gama issues and delivered directly to him.

The notes were not forgeries. They were real notes, printed on genuine plates by an authorized printer. But they were something other than legitimate. Unauthorized, maybe? In any case, they needed to be laundered.

Reis spent some of the money on a house and exchanged some for British pounds. He deposited his unauthorized notes with regional banks, then withdrew genuine currency from their head offices.

(When a bank manager, suspicious of the sums being deposited, sent one of Reis’s notes to the Bank of Portugal, it passed muster.)

But it’s not easy to launder an estimated 0.88% of GDP, so Reis had to think bigger.

Employing “chicanery of the highest order,” Reis secured approval to open his own bank — the Bank of Angola and Metropole — which he used to put his notes into circulation by lending them out.

But Reis’s most ambitious scheme was to cover his tracks by taking over the Bank of Portugal. The bank was nominally private — its shares were publicly traded — and Reis quietly accumulated 10,000 of the 45,000 voting rights needed for control.

Before he could buy up the rest, however, a Lisbon newspaper published a series of articles questioning how the Bank of Angola and Metropole could be making such large loans without seeming to attract any deposits. 

The media attention prompted a bank teller to send notes received from Reis’s bank to a counterfeiting expert. Somehow, the expert noticed that some of the otherwise flawless notes had serial numbers that matched an earlier printing.

Reis and his scheme were exposed. Fearing for their deposits, there was rioting outside of banks.

At trial, Reis pleaded that he had good intentions. He planned to use the funds to finance “a great and prosperous Angola.” 

The judge nevertheless sentenced him to 20 years, of which he served 15.

Upon his release he was offered a job at a bank, which he declined.

Genuine fake

This weekend, North Korean hackers ran a modern version of the Alves Reis playbook: using forged instructions to trick a trusted issuer of currency into sending them newly “printed” crypto.

The first part of the scheme — creating the phony instructions — was more complex than Reis’s. It involved hacking into two RPC nodes (servers that provide blockchain data), swapping out their software for code the attackers controlled, and knocking many other nodes offline with a massive DDoS attack.

As summarized by 0xResearch, the result was that “a forged cross-chain message allowed an attacker to mint 116,000 unbacked rsETH worth roughly $292 million.”

(rsETH is ETH that’s been staked and then restaked.)

In other words, where Reis got Waterlow and Sons to send him unauthorized but otherwise real escudos, North Korea got Kelp DAO to send it unbacked but otherwise real rsETH.

(Technically, the rsETH Kelp DAO sent was “released,” but the economic effect is the same as minting.)

The second part was far simpler than Reis’s: the attacker deposited the funds on Aave.

Just as Reis deposited fraudulent notes with banks to withdraw legitimate ones, the Kelp DAO attacker deposited stolen crypto on Aave to borrow legitimate crypto (wrapped ETH).

To recap, then: North Korea is Alves Reis, Kelp DAO is Waterlow and Sons, and rsETH is Vasco de Gama escudos.

Much easier to understand! (For me, at least.)

Also, DeFi is now the financial system of Portugal c. 1926.

The Bank of Portugal took Reis’s unauthorized currency out of circulation by recalling all 500-escudo notes.

But they were exchanged for other denominations, no questions asked. So if you unwittingly got stuck with an unauthorized note, it was treated as good money. 

In effect, this socialized the losses of Reis’s scheme — by devaluing everyone’s money through inflation.

Reis’s notes inflated the supply of escudos by an estimated 5.9%, which created a roughly equivalent increase in inflation. 

Similarly, North Korea has effectively inflated the supply of rsETH by 18%, creating unrealized losses for borrowers, stakers, and restakers of ETH across much of DeFi.

As my Blockworks colleague explains, it’s now up to Kelp DAO to decide whether to socialize those losses or concentrate them.

History suggests the decision could be consequential.

In January, 1926 — just a month after the Bank Note Scandal was revealed — the Portuguese republic was overthrown in a military coup.

— Byron Gilliam

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