Noteworthy stuff I stumbled upon #3, July 21
Crypto & political corruption; Crypto, Wall Street, and Main Street; VC value add; Two interesting trends from the US; 50 cognitive biases in the modern world
Crypto & political corruption
Oh, crypto!
First, a disclaimer: I'm a crypto-skeptic. I don't really follow what's happening in the crypto land – I find it neither interesting nor important. But I stumbled upon a couple of stories that are noteworthy.
The first story is about political corruption. Here is a recent piece by Matt Taibbi, a sharp journalist with a brazen style and anti-establishment bend: The Financial Bubble Era Comes Full Circle. He is looking under cover of the recent crypto sell-off. If you are interested in this topic, I suggest you read it and decide for yourself whether the author is practicing investigative journalism or trafficking in conspiracy theories. Either way, I found the story interesting.
Matt Taibbi starts by reminding us that the corruption-fueled financial bubble of 2008 was essentially the inspiration for Satoshi Nakamoto's idea and the cryptocurrency movement. Crypto infrastructure was supposed to be (a) decentralized and (b) transparent.
Alas, many crypto "success stories" are neither.
It’s the perhaps-insuperable paradox hanging over this $3 trillion market. Are these firms really beacons of a new form of cryptographically guaranteed transparency, or are they just less-insured, less-regulated, less-audited versions of the same take-our-word-for-it securities and banking operations that melted down the world economy fourteen years ago?
Financial bubbles always expand the same way. Before insiders start scooping up winnings to go shopping for Maseratis and private islands, they buy up all the questions. Read: they buy the politicians.
The incredible 5200% surge in political giving that this year pushed crypto past big tech, big Pharma, and even the defense sector in the realm of political contributions.
At a time when Republicans and Democrats seemed unable to agree on anything at all, a host of elected officials began making bipartisan shows of force on behalf of crypto companies."
Here are his examples, impressively bipartisan:
Former SEC Division of Trading and Markets chief Brett Redfearn joining Coinbase just before its historic $86 billion IPO
Trump hiring former Coinbase executive Brian Brooks to be the chief of the lead banking regulator, the Office of the Comptroller of Currency (OCC)
Republican Senator Pat Toomey going on Twitter to say basically that regulators should lay off doing anything at all about anything until Congress debated the issue “in full,” adding, “Why rush?”
Former Chuck Schumer aide Jonah Krane joined the financial consultancy Klaros
Former Ed Markey and Allison Lee aide Justin Slaughter joined Paradigm
Former Bart Chilton aide Salman Banaei joined Uniswap.
New Jersey Senator and former presidential candidate Cory Booker, along with New York’s Kirsten Gillibrand, is considered among the most “crypto-friendly” members of the upper house, and according to Fortune, near the top of the list of politicians who’ve taken donations from crypto interests.
Wyoming Republican Cynthia Lummis, who reportedly owns about $200,000 in Bitcoins, was quick to suggest TerraUSD was an outlier and not a systemic issue. “There are a couple types of stablecoins. The one that failed is an algorithmic stablecoin, very different from an asset-backed stablecoin,” she told CNBC.
SEC chief Gary Gensler began making noises about regulating the crypto world. Almost immediately, a group of House members nicknamed the “Blockchain Eight” sent a blistering letter slamming Gensler and demanding he justify asking crypto firms for voluntary submissions of information.
By early this year, with midterms firmly in sight, one saw politicians in every direction with their arms draped around crypto CEOs, sometimes literally. Just prior to the collapse of TerraUSD, for instance, the chair of the House Financial Services, Maxine Waters, invited a series of speakers to a panel on crypto. A photo was released showing Waters literally embracing some of the top heavies in the crypto market, including Circle’s Jeremy Allaire, FTX’s Sam Bankman-Fried, and Armstrong of Coinbase.
Some sources laughed when the subject of this photo came up, explaining that it sent a clear message to, say, a line investigator at the SEC or CFTC who might otherwise be thinking of investigating this or that company. The message is twofold: any attempt to elevate an issue with a key donor will not get your party’s backing, and moreover, you might find your funds cut in the next appropriations season. If you mess with Congress’s money, they will mess with yours.
He concludes:
The tragedy of a corrupted crypto universe is exactly the same story [as that of credit default swaps and collateralized debt obligations from 2008], of a “bespoke” financial market grown to fantastic dimensions in a regulatory dead zone, with a cash-fattened congress keeping questions to a minimum, and the same old insiders extracting billions before a crash that will inevitably be paid for by the rabble again. In fifteen or twenty years, maybe, crypto will evolve to revolutionize finance and eliminate insider corruption in the way its adherents hoped, much as the Internet eventually really did change everything from commerce to communication. But we’re still at the stage of clearing out the phonies, the Pets.com and eToys equivalents, and there are a lot still out there.
Ouch!
Crypto, Wall Street, and Main Street
The second story is by New York Times – How Wall Street Escaped the Crypto Meltdown:
As cryptocurrency prices plunged and funds failed, strict rules on risky assets helped Wall Street companies sidestep the worst. Retail investors weren’t as lucky.
It’s not that financial giants didn’t want to be part of the fun. But Wall Street banks have been forced to sit it out — or [...] approach crypto with ingenuity — partly because of regulatory guardrails put in place after the 2008 financial crisis. At the same time, big money managers applied sophisticated strategies to limit their direct exposure to cryptocurrencies because they recognized the risks. So when the market crashed, they contained their losses.
Unlike their fates in the financial crisis, when the souring of subprime mortgages backed by complex securities took down both banks and regular people, leading to a recession, the fortunes of Wall Street and Main Street have diverged more fully this time. (Bailouts eventually saved the banks last time.) Collapsing digital asset prices and struggling crypto start-ups didn’t contribute much to the recent convulsions in financial markets, and the risk of contagion is low.
But if the crypto meltdown has been a footnote on Wall Street, it is a bruising event for many individual investors who poured their cash into the cryptocurrency market.
This time, it's crypto and DeFi companies are doing fancy financial engineering. Wolf Richter writes:
[A number of] crypto platforms have now blocked customers from withdrawing their crypto deposits or collateral, or have limited the amounts: Babel Finance, CoinFlex, and Finblox.
We’re not talking hated and maligned fiat dollars here, but cryptos. They’re borrowing cryptos from each other, they’re lending cryptos to each other, they’re posting collateral in cryptos with each other, they’re paying interest in cryptos, they’re trading cryptos between each other, and they’re trying to bail each other out in cryptos.
And they have to pay each other back those cryptos, and the cryptos have plunged in value and are gone because of leverage that blew up, and because of the interconnectedness that is spreading those blowups around the system.
Leverage and interconnectedness, which were just in their infancy in 2018 when cryptos blew up last time, are now the dominating factors. Back then it was just folks selling their cryptos. Now stuff is blowing up because of leverage. That’s a much more insidious process.
The way Benedict Evans put it in his newsletter:
Crypto built its own defi version of capital markets, and now it’s having its own version of a capital markets crash, complete with margin calls, bank runs, frozen withdrawals, cascading collapses and, perhaps, some buyouts.
Oh, crypto...
In case you are curious what I think about crypto, I see it as a research project that broke out of academia prematurely and became a religion/movement for some and a breeding ground of Ponzi schemes for others. I'm sad to see the amount of passion, talent and energy that developers are pouring into crypto. I expect most of this intellectual investment to be wasted but perhaps something worthwhile will eventually come out of it 🤞🏼
VC value add
In his newsletter, Matt Levine reviewed an academic paper with the catchy title “Predictably Bad Investments: Evidence from Venture Capitalists” and unpacked it for laymen. The paper applied machine learning methods to a dataset of over 16,000 startups to evaluate the decisions of early-stage investors. It demonstrated that approximately half of the investments were predictably bad—based on information known at the time of investment. This sounds quite damning but... Matt Levin points out that
the value added by venture capitalists is not picking the right companies but rather getting access to the best deals.
venture capitalists aren’t great at picking the right companies; they make predictable mistakes. But they still outperform public-market indexes, since they get access to good early-stage companies and the successes make up for those misses.
One way to read that is: Yes, but they should outperform by more, by getting access to companies and then picking the good ones.
But another reading might be: Yes, but the VC funds have to invest in the bad companies in order to get access to the good ones.
It could work something like: “Founders choose their venture capital investors through some sort of reputational network; they talk to their founder buddies about which VCs are helpful and good to work with. If a VC rejects too many Stanford-dropout founders by saying ‘sorry my algo says that your company is bad,’ then the Stanford-dropout founders with good companies will hear about that from their Stanford-dropout friends, and won’t want to work with that VC. Making bad investments is a way to be part of the club, and being part of the club gets you the deal flow that gives you the good investments.”
This is noteworthy: “the value added by venture capitalists is not picking the right companies but rather getting access to the best deals”!
Two interesting trends from the US
The (sort of) bad news: People from elite backgrounds increasingly dominate academia, data shows. First-generation academics were always rare. Now they’re vanishing. This is particularly pronounced in economics. Two-thirds of U.S.-born Ph.D. graduates in economics have a parent with a graduate degree. Fifty years ago, that number was only about 20%, suggesting increasing difficulty for first-generation graduate students.
The (sort of) good news: The feeling that the top echelons of the US government are becoming gerontocratic (a la late Soviet Politburo) is not new when it comes to the presidency – US presidents are not getting older.
50 cognitive biases in the modern world
What an illuminating collection!