(Bloomberg Opinion) -- Crypto money markets.
Cryptocurrency markets keep rediscovering financial history for themselves, I keep saying every day, and now they have discovered money-market funds:
A new startup called Compound Labs Inc. is creating money markets for crypto assets, which generally are held in exchanges or wallets but remain idle and don’t earn anything.
To address this, San Francisco-based Compound has set up smart contracts on the Ethereum blockchain that would earn interest on crypto assets for exchanges, consumers and investors. It would work like overnight money-market sweep accounts.
“Every dollar you have that’s not paper gets swept into an overnight rate somewhere,” said Robert Leshner, founder and chief executive at Compound. “That’s exactly what we’re trying to create.”
So, first of all, what is your numéraire? Money-market funds aim to achieve a stable value, but in what currency? One assumes it is whatever gets swept: If you have 100 Bitcoins that get swept overnight on Monday, you’d hope that they’d come back worth like 100.01 Bitcoins on Tuesday, even if those 100.01 Tuesday Bitcoins are worth twice, or half, as many dollars as the 100 Monday ones. Leshner explains by email:
You have 100 bitcoins, and you send them to Compound's smart contract.
They get loaned to traders who want to buy even more volatile investments (like other tokens) using the bitcoin, or to short-sellers who hate bitcoin, and want to sell it for dollars. Those borrowers have to maintain an excess of collateral (any other tokenized asset) at Compound.
The next day you have … 100.01 bitcoins inside Compound.
Okay sure but … “even more volatile” is … pretty volatile? Like, if I borrow $100 from you to buy three magic beans, and I overcollateralize that loan by leaving six magic beans with you, you are still exposed to the vagaries of the magic-bean market, you know? I worry that a Bitcoin money-market fund that makes its money by, like, margin lending to initial-coin-offering speculators might run the risk of breaking the buck (the Bitcoin) with some frequency.
But there is a deeper conceptual strangeness to this. I used to design derivatives for a living at an investment bank. Occasionally in derivatives design you need to put a pot of cash somewhere, and it was a dumb slow revelation to me how hard it is to … just … have ... a pot of cash. You can keep $20 in your wallet, but if you want to hold $20 million, then you will face a series of agonizing choices. You can keep it all in literal cash—in boxes of $20 bills in the corner of your office—but that is not very secure and not very convenient; if you want to send it to someone you have to put the boxes on a plane with a security guard. And there is no convenient electronic form of just, in the strictest sense, cash. You can put your dollars in a bank account, but the bank could go bust. (Deposit insurance has limits.) You can buy Treasury bills, but those mature, and meanwhile can lose (a tiny bit of) value as interest rates change. You can put your money into a money-market fund, but that could, however improbably, lose value too. None of these risks are all that material over an overnight time horizon. But if you have a lot of dollars, and your quite modest goal is “I want to have always exactly this amount of dollars on every day in the future, accessible anywhere, with absolutely no credit or market risk of any kind,” you can’t do it.
It is a little boggling, honestly. The reason all of everyone’s dollars are always getting swept up into an overnight rate somewhere—it’s not just because people have a deep desire to get paid interest; it’s also because those dollars have to go somewhere. They can never rest; even your most idle savings-account dollar is constantly being blasted through the economy, being put to use by someone else while you sleep. The interest compensates you for the uncanniness of having to hold your dollars through someone, some not-perfectly-riskless entity. It tells you something about the nature of dollars: that they are not pure entities that you can just conveniently own, that they are instead always somehow obligations of someone else, that they exist only as some form of debt.
That is the thing that Bitcoin is solving. Bitcoin is a form of cash that can be held directly by anyone in purely electronic portable transferable form without a bank. (Or a money-market sweep account.) “A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution.” The reason the cash in your brokerage account gets swept into money-market funds every night is that it’d be idiotic for your broker to keep a bunch of $20 bills in an envelope with your name on it. The reason the Bitcoins in your Bitcoin-exchange account don’t get swept into money-market funds every night is that it’s easy for a Bitcoin exchange to hold onto those Bitcoins electronically, because that is the whole point of Bitcoin.
I mean, that is one reason; the other reason is that no one thought of a crypto-money-market sweep account yet. Now they have! Now instead of just directly owning Bitcoins in decentralized form, you can own them through an exchange, and it can own them through a Compound smart contract, and the contract can lend them to some ICO speculator or Bitcoin short-seller, and your Bitcoins can bop off around the blockchain doing productive work in weird places while you sleep, and the whole regular financial system can be recreated in a slightly skewed way.
The U.S. Securities and Exchange Commission, to demonstrate the risk of unregistered initial coin offerings, launched its own fake ICO for “HoweyCoins.” I mean, they were not especially committed to the premise; as far as I can tell they put up a website for HoweyCoins and also simultaneously a different and better publicized website explaining that “If You Responded To An Investment Offer Like This, You Could Have Been Scammed – HoweyCoins Are Completely Fake!” Anyway like 20 of you sent me this story; I don’t think I’ve ever had more readers mention anything to me. It does make sense that the audience for Money Stuff and the audience for SEC pranks would overlap perfectly.
The prank is, I don’t know, fine I guess? The white paper has some good parody blather like “By undercutting the monopoly role of the national governments in creating currency, savings that you may not realize are being kept by the elite and the government will flow to you—the consumer.” But it is missing all the … like … crypto-blather? There are no incomprehensible sections on technical implementation, no funny diagrams explaining how the coin works, no bios of the technical team. The word “blockchain” appears only four times in eight pages; the words “hash” and “ERC-20” don’t appear at all. It’s just a little thin. We talked a while back about a prank that the Alberta Securities Commission pulled, in which they ran a fake investment seminar “to educate Albertans about the realities of investment fraud.” “Everything about the fake investment opportunity – from the company's name and logo, to Jonathan Fisher's bio and the colour of his tie – was extensively researched,” read the story, and I mentioned that running prank investment frauds for a securities regulator would be a dream job. Next time the SEC wants a prank ICO I’d be happy to help!
Also guys the name. I get it. SEC v. W.J. Howey Co. is the Supreme Court case that created the modern test—widely referred to as the “Howey Test”—for what counts as a “security,” a question of significant interest to people trying to figure out which ICOs need to be registered with the SEC. If you are a securities lawyer who works on ICOs, you probably got a teeny grim chuckle out of that. But it doesn’t make sense within the world the SEC is building. HoweyCoin’s pitch is vaguely about travel benefits. It should be called TravelCoin or TripBit or CryptoVoyage, something that makes the reader think “oh yes this was named by someone who thought it was a coin for travel benefits,” not, like, “oh yes this was named by securities lawyers playing a prank.”
There is a common but erroneous belief that securities fraud is only securities fraud when it involves publicly traded companies. “If a public company did this, it would be securities fraud,” people sometimes say about stuff that private companies do that is in fact securities fraud. There is nothing particularly in the law to support this view, but there is an understandable intuition behind it. Regular people buy shares of public companies based on information provided by the companies: Mom-and-pop investors can read a company’s securities filings and decide to buy its stock on the stock exchange, and if those filings are full of lies then the company is entirely to blame and the investors are innocent victims.
But private transactions are a little different. Private companies, of course, disclose less information publicly than public ones do. But when venture capitalists buy stakes in private tech companies, or when private-equity firms do leveraged buyouts, they tend to get a lot more information about the companies than regular public investors do when they buy stock on the stock exchange. This is called “due diligence,” and the idea is that sophisticated private investors who are writing very large checks are supposed to be able to ask good questions, and get satisfying answers to those questions, before writing those checks.
In practice this often isn’t true—big sexy tech unicorns can raise money with essentially no financial information—but it actually matters that it is true in theory. If you are a sophisticated private-equity investor writing a $100-million check to buy a company, and you have the opportunity to do due diligence and interview company management and review the financial statements and talk to the auditors and examine the customer lists and so forth, and the company sends you a pack of lies, and you don’t catch them and buy the company anyway, then yes, of course, that is the company’s fault, and the company did a bad thing, but it is also your fault too, in a way that it isn’t a public investor’s fault. Your job is to notice that stuff!
And so for instance Theranos Inc.’s private investors, who were victims of a “massive fraud,” get quite unsympathetic press: They were rich and sophisticated and had every opportunity to do due diligence, and if they got hoodwinked then that reflects almost as badly on them as it does on the hoodwinkers. It is embarrassing to be the victim of securities fraud when you are a sophisticated large investor who had the opportunity to do due diligence, which means that these frauds are less likely to be pursued than frauds against public investors. Who would want to report them?
Yesterday the Securities and Exchange Commission and the Department of Justice brought civil and criminal securities-fraud cases against three former executives of Constellation Healthcare Technologies Inc. Constellation was actually a publicly traded company, but the fraud charges are not about its public trading—which occurred on the London Stock Exchange’s AIM market and is therefore none of the SEC’s business—but about a going-private transaction that it completed in early 2017. The buyer was Chinh Chu, who left the Blackstone Group LP to start his own buyout firm, and who put up $82.5 million of equity and borrowed $130 million from banks to do the deal. “Sources who have spoken with Mr Chu say he’s ‘comfortable’ proceeding, having spent $7m and three months work on due diligence alone,” reported Paul Murphy at the time.
It didn’t work! Constellation went bankrupt this March, and according to the SEC it was kind of fake. For instance, the SEC tells the story of Constellation’s acquisition of MDRX Medical Billing LLC for $30 million:
In reality, MDRX too was a fabrication that Defendants had created based on a genuine Akron, Ohio-based medical-billing business (the “Real Medical-Billing Business”). In October 2015, CHT was contacted by an investment bank about a potential acquisition of the Real Medical-Billing Business.
CHT entered into a non-disclosure agreement with the investment bank, which in turn gave Defendants a Microsoft PowerPoint presentation pitching the Real Medical-Billing Business. …
The Defendants then altered the investment bank’s PowerPoint presentation pitching the Real Medical-Billing Business to create a sham MDRX “Due Diligence Findings Draft Report” dated October 20, 2015. The sham MDRX report essentially left the entire description of the Real Medical-Billing Business, including the company’s organizational chart, untouched, but inflated the company’s financials and simply changed the company’s name to MDRX, an entirely fictitious entity.
Emails among Defendants evidence their fabrication of MDRX. On October 22, 2015, Chivukula forwarded the MDRX PowerPoint to Parmar and Zaharis, noting, “Attached is the updated internal document and presentation. I am not able to remove the background image of [the Real Medical-Billing Business] in the presentation.”
And the executives allegedly provided all sorts of fake stuff during Chu’s due diligence; the SEC says that he “relied on Defendants’ materially false and misleading statements and false and fabricated documents in determining whether to enter into the transaction.” You would hope that, in a nine-digit transaction led by a top-tier buyout expert and financed with bank loans, with months of due diligence, someone would notice that, you know, the company’s medical billing business was plagiarized from a real business and still had the real business’s logo in the background. “The filings give us the impression the alleged fraud was less ‘large, complex and brazen’ than the bankruptcy declaration makes it sound, and rather more maladroit and hapless,” writes Alexandra Scaggs, and while I am not sure I completely agree, really you never want to be suckered as badly as this, even by a complex fraud. If the allegations are true then the perpetrators are bad and might go to jail, but it is hard to escape the feeling that the victims look bad too.
CBS v. Redstone.
We’ve talked over the last two days about the terrific drama over CBS Corp.’s board of director’s effort to get rid of its controlling shareholder, Shari Redstone’s National Amusements Inc., by diluting away its voting stock. A lot happened in that case yesterday—first NAI amended CBS’s bylaws to take away the board’s power to dilute it, and then a Delaware court ordered NAI not to interfere with CBS’s preparations to hold the board meeting today to vote on diluting NAI—but in another sense nothing really happened. CBS still wants to dilute NAI, NAI still doesn’t want to be diluted, what will happen still turns entirely on the decision of the Delaware chancellor hearing the case, and he still hasn’t decided. But he’s supposed to decide today, before the 5 p.m. board meeting, so that is something to look forward to.
I actually think this case is extremely straightforward: No, obviously, a board of directors cannot get rid of a controlling shareholder just because they are worried that she might fire them! She’s allowed to fire them! That’s what being a controlling shareholder means! But I am not a Delaware chancellor. And I guess if I were I would draw out the suspense a little. Why not? I bet it’s the most fun he’s had in years. “I've never seen anything like what's transpired here in terms of moving parts,” he said, at the end of yesterday’s hearing.
Here is a word cloud or whatever from SumZero of common features of hedge-fund names, if you are looking for inspiration for your own fund. “Popular themes that popped up on their word chart included nautical terms, alcoholic drinks, and cities in New England,” so please invest in my new fund, Swampscott Tequila Yacht Capital LP.
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