The Blockchain Is Not the World
(Bloomberg View) -- Why crypto?
I am late to this, but Steven Johnson's New York Times Magazine cover story this past weekend, about what is potentially at stake in the rise of Bitcoin and Ethereum and blockchains and cryptocurrencies, is excellent, maybe the best introduction that I've seen in any general-interest publication to why people care so much about this stuff. Money Stuff readers are, I hope, familiar with the basic ideas -- that cryptocurrency creates a way to fund and incentivize a new generation of open protocols for the internet -- but for anyone who is trying to figure out what this is all about, Johnson's article is a great place to start.
But one bit of the explanation drove me a little nuts, for reasons that are I think instructive. Johnson correctly points out that much of the core work of the Internet is done over open protocols, like the ones underlying email and the web, and that the dream of many token startups is to extend those open protocols to other important Internet functions like, for instance, file storage. So he spends some time on Filecoin, and its inventor's dream for more open file storage, and so forth, and that is good.
But then he goes on to discuss another example that comes up a lot among token enthusiasts: What about an open Uber?
Imagine some group like Protocol Labs decides there’s a case to be made for adding another “basic layer” to the stack. Just as GPS gave us a way of discovering and sharing our location, this new protocol would define a simple request: I am here and would like to go there. A distributed ledger might record all its users’ past trips, credit cards, favorite locations — all the metadata that services like Uber or Amazon use to encourage lock-in. Call it, for the sake of argument, the Transit protocol. The standards for sending a Transit request out onto the internet would be entirely open; anyone who wanted to build an app to respond to that request would be free to do so. Cities could build Transit apps that allowed taxi drivers to field requests. But so could bike-share collectives, or rickshaw drivers. Developers could create shared marketplace apps where all the potential vehicles using Transit could vie for your business. When you walked out on the sidewalk and tried to get a ride, you wouldn’t have to place your allegiance with a single provider before hailing. You would simply announce that you were standing at 67th and Madison and needed to get to Union Square. And then you’d get a flurry of competing offers. You could even theoretically get an offer from the M.T.A., which could build a service to remind Transit users that it might be much cheaper and faster just to jump on the 6 train.
Imagine if email worked like that! Imagine if you tried to send an email and a rickshaw driver showed up at your office offering to deliver it. Or a notification popped up saying "I see you are trying to email your mother, wouldn't it be nicer to pick up the phone?"
Part of what is going on here is, perhaps, a fanciful notion of how these protocols would work. But another part of it is that it is hard to put a computer protocol on the physical universe. If you want to send an email, or store a file, it is pretty easy to specify what needs to be done, and all of the steps of that specification can be performed by computers and wires. If you want to go from here to there, someone has to show up in a vehicle, and you want the vehicle to move fast, but not too fast, and it should smell good, and the driver should have gotten enough sleep, and there are just a lot of questions and uncertainties that go into it. Perhaps one day all of those things will be computer-specified -- one day the computer will drive the car, after all -- but at least today, the physical universe contains a lot of confounding variables that are hard to inscribe into a computer protocol.
You might call this the Juicero Problem: You can build a computer ecosystem and associate it with bags of fruit, and encourage people to use the computer ecosystem to squeeze the bags of fruit, but not everything that happens to the bags of fruit in the real world can be completely controlled by your computer ecosystem. You can't prevent people from squeezing the bags with their hands. The world exists, and it is messier than your protocols want it to be.
You see this a lot in discussion of smart contracts. You know what's ripe for smart contracting on the blockchain? Interest rate swaps. An interest rate swap is: My computer will send your computer some bits representing money, and your computer will send my computer some bits representing some other money, depending on what some other computer tells them about some number called an "interest rate." Nothing needs to happen in the physical world for the whole life of an interest-rate swap. But people often get excited for smart contracts that address the real world, smart contracts for employment or divorce or venture investing or sexual consent, and those seem much harder. They can be very neat, if you just look at the computer protocols. But the whole problem is the interaction between the protocols and the real world, which is sprawling and messy.
Elsewhere in technology companies imposing themselves on the physical universe, Facebook has invented a new unit of time.
Elon Musk has a new compensation plan with Tesla Inc. that will give him a lot of shares for hitting some ambitious goals for Tesla's market capitalization, revenue and profit, or nothing if he fails to meet them. Andrew Ross Sorkin calls his comp plan "perhaps the most radical in corporate history," and quotes Musk:
“If all that happens over the next 10 years is that Tesla’s value grows by 80 or 90 percent, then my amount of compensation would be zero,” he said. (His calculations were based on the stock price at the beginning of this year when the company was worth about $50 billion.)
Ehhhhh. If Tesla's value grows by 80 percent (from $50 billion) over the next 10 years -- a growth rate of about 6 percent per year, a bit less than the S&P 500 Index's growth rate over the last 10 years -- then Musk's current 21.9 percent stake will be worth an extra $8.8 billion. Seen in one light, his "compensation" -- the amount of additional wealth he will receive if he grows Tesla at a slightly below-average rate -- would work out to about $2.4 million per day over those 10 years. It's not the worst possible outcome for him.
In general I am skeptical of equating the rising value of a manager's equity with "compensation." But you have to think about what you are measuring, and why. Here, Tesla wants Elon Musk's interests to be aligned with those of shareholders; it wants Musk to want to increase the value of the company. One way to do that is with a bunch of milestones to give him more stock if he hits ambitious targets. Giving him large nonlinear payouts like that encourages him to take risks, to swing for the fences. That's good. It's how lots of compensation plans, and stock options, work; Musk's version is just a somewhat bigger and bolder version of the usual.
But the other way to do it is to just have him be a huge stockholder. That precisely aligns his interests with those of other stockholders. (Well, except that he is less diversified than they are.) If Tesla's board just voted to give Musk $11 billion worth of Tesla stock now to align his incentives, that would be awkward, but fortunately there is no need for that. He already owns $11 billion worth of Tesla stock. He is a founder of Tesla; he owned a third of it when it went public. It is nice and laudable and sensible that Tesla's board is thinking about how to compensate him in value-enhancing ways; it is nice that they are not giving him a huge salary but instead linking all his pay to performance. But you shouldn't overthink it. In general the problem of compensating a founder/major-shareholder/manager to align his interests with those of shareholders is not that difficult. He is a big shareholder! He should want Tesla's stock to go up because he owns a lot of it. The extra billions would be nice, but the billions he already has really ought to be an incentive.
After a series of bad years at Pershing Square Capital Management, Bill Ackman is laying off some people (including his driver) and re-focusing on the investing part of running an investment firm:
Ackman plans to curtail all of his own marketing and public relations meetings associated with running a big hedge fund, said the people familiar with the matter, who were not authorized to discuss the changes publicly.
Instead, Ben Hakim, a partner who joined Pershing Square in 2012, will do the traveling and bulk of talking to clients. Ackman will stay in the office, concentrating on financial analysis.
I don't know! I have in the past expressed admiration for Ackman's ability to retain assets while losing money. "The measure of success as a hedge fund manager," I said, "is, roughly speaking: Can you keep managing a lucrative hedge fund?" Being good at that is a skill, a skill related to making profitable investments, but certainly not identical to it. There is an argument that if you have a series of horrendous losing years, but still have a huge public profile and a lot of money under management, then what you have discovered is that you are (1) really good at marketing and being the public face of a hedge fund but (2) indifferent at actually making the investment decisions.
Perhaps the thing to do with that discovery is to focus on marketing and being the public face of a hedge fund, but hire someone else to make the investment decisions? Rather than the opposite? I realize though that this is not done, not only because it is a little embarrassing -- making the investment decisions is, for some reason, considered the prestige job at a hedge fund -- but also because it is a bad marketing move. Investors want the public face of the hedge fund to be the star manager. If that star manager renounces being the public face of the fund and goes back to managing investments, well, that is paradoxically a nice move for him as the public face of the fund. If he renounces managing the investments to focus full-time on being the public face, that is a bit too cute.
Here's a good top-of-the-market quote from Uber Technologies Inc. Chief Executive Officer Dara Khosrowshahi:
"Business is actually surprisingly good for everything that the company went through," Dara Khosrowshahi said Monday, speaking at the DLD18 conference in Munich.
Yes, but: "The part of the business that is not going well is the profitability part. We have some details to work out."
Business is great, except we're losing money! That makes sense. It turns out that if your business consists of giving people rides and charging them way less than it costs you to provide those rides, your business will be popular. My business of baking cookies and giving them away for free is also worth $50 billion.
A glass box.
Lloyds Banking Group Plc is taking new rules to isolate its trading operations literally. Some traders will soon be physically separated from their colleagues and placed in a glass box to comply, according to people with knowledge of the matter.
About 120 staff at the Lloyds Bank Corporate Markets division, which includes foreign exchange and rates, will be put in the partitioned rooms to be finished over the next three to four weeks, said the people who asked not to be identified because the matter is confidential.
Next they will pump the air out of the box, and the ring-fencing will be complete. No, I kid. Honestly I feel like glassing in different sorts of traders to protect confidential information is ... a pretty normal and longstanding banking practice? A bank is a big multi-tentacled beast. Some of its tentacles reach deep into what we call the "private side" (confidential discussions with public-company chief executive officers, potential mergers and acquisitions, etc.), while others touch various bits of the "public side" (stock trading, etc.). If information flowed seamlessly between the tentacles, it would be a mess, so banks are full of metaphorical walls to keep the traders from talking to the bankers and the bankers from talking to the analysts and the rate submitters from talking to the swaps traders and the syndicate from talking to the salespeople and (formerly) the prop traders from talking to the flow traders and so on. Often the easiest and most reliable way to build a metaphorical wall is to also build a physical wall. Modern open-plan office design often dictates that that wall is glass.
Securities and Exchange Commission Chairman Jay Clayton is not impressed with all of the people hanging around the cryptocurrency ecosystem:
My first message is simple and a bit stern. Market professionals, especially gatekeepers, need to act responsibly and hold themselves to high standards. To be blunt, from what I have seen recently, particularly in the initial coin offering ("ICO") space, they can do better.
His complaint is that lawyers are letting companies get away with a surprising amount of nonsense in ICOs, offering tokens that are clearly securities but being coy about admitting that. He is also unimpressed with public companies that are casually pivoting to blockchain to pump their stocks:
I doubt anyone in this audience thinks it would be acceptable for a public company with no meaningful track record in pursuing the commercialization of distributed ledger or blockchain technology to (1) start to dabble in blockchain activities, (2) change its name to something like "Blockchain-R-Us," and (3) immediately offer securities, without providing adequate disclosure to Main Street investors about those changes and the risks involved. The SEC is looking closely at the disclosures of public companies that shift their business models to capitalize on the perceived promise of distributed ledger technology and whether the disclosures comply with the securities laws, particularly in the case of an offering.
I hope Toys R Us Inc. quietly scrapped its pivot-to-the-blockchain contingency plan on hearing that.
Elsewhere, here is Grub Street on Bananacoin. Bananacoin! Sure. It's a cryptocurrency linked to bananas. Each token is worth one kilogram of bananas, why not. "Bananacoin’s goal is laudable," says Grub Street, incorrectly, as you can tell by reading the white paper, which is a string of babble laced with promises of huge investment returns:
Bananacoin is blockchain project aiming to achieve a core modification of the global banana production industry, similar to how Uber has revolutionized the taxi industry or how Upwork has brought freelancing to a new level. In short, the initiators of the project create processes in the production of organic bananas through the implementation of an economic element in the seemingly completely understood export relations of the product.
Bananacoin is using the proven TGE crowdfunding model, allowing backers to invest in expansion of production and become holders of Bananacoin tokens (BCO), which can be exchanged after project launch for goods or funds and are expected to more than double in value in 18 months’ time.
Hi, quick tip, real investments don't come with prospectuses saying that they "are expected to more than double in value in 18 months' time." (Also ... if the tokens are ... worth ... one kilogram ... of bananas ... wouldn't ... banana prices ... have to double ... never mind.) The rest of the white paper is similarly silly, though I particularly enjoyed this bit:
Bananacoin is being developed as an easy to use token with an understandable fiat equivalent (in the form of 1 kg of bananas). It does not require specialized knowledge in cryptography or blockchain technology
What do you think "fiat" means in that sentence? Are bananas a fiat currency?
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Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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