Tim Swanson’s looooooong article pointing out the lack of oversight, due diligence and inquisitiveness in the cryptocurrency sector has many good points. The space could use more scrutiny.
I don’t agree with the insinuation, though, that CoinDesk’s reporting on ICOs infringes securities laws. Not even in a physically challenging stretch of the imagination can informing readers of how much has been raised be interpreted as solicitation, any more than reporting on bitcoin’s price can be taken to mean a recommendation to buy. Also, any reader of CoinDesk would know that the journalists report the news, they don’t give opinions (except for me, but that’s my job, and I’ve never “promoted” anything – occasionally I’ll opine on end uses for tokens, but no market recommendations are given). And our opinion pieces from industry experts are labelled as such.
Tim is right, though, in that all of us who work in blockchain media need to be careful in our reporting, especially given the rampant hype. Some myth-busting is generally constructive. And it’s good to have thinkers out there who can call the sector to account.
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A group of Japanese banks plans to introduce a new digital currency – J-coin, of course – in time for the 2020 Olympic Games.
It’s not based on the blockchain.
Japanese bank MUFG has been working on their own blockchain-based currency, but is reported to be considering joining the J-coin consortium.
Does this mean that blockchain lost?
No, of course not. Let’s see how the non-blockchain version works before we decide. It almost certainly won’t have the same privacy features.
It is curious that Japan, with its technologically-aware populace, is so reluctant to go digital with payments. 70% of transactions are still conducted with cash, vs around 30% for most western countries… This would be interesting to unpack some more, and could teach us much about the potential progress of digital coins in less developed countries.
“It became increasingly apparent, to me anyways, that while books remained a fantastic medium for stories, both fiction and non, blogs were not only good enough, they were actually better for ideas closely tied to a world changing far more quickly than any book-related editorial process can keep up with.”
Like blockchain and business, maybe??
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A bookshop-themed youth hostel? Almost enough to make me want to be young again… (via My Modern Met).
And now on to the next riveting stage of our exploration of the impact of blockchain technology in capital markets. Welcome to interest rate swaps (IRSs), one of the most powerful risk-management tools in the market.
They’re not as complicated as they sound. There are several different types of swaps, but the basic “vanilla” variety works like this: if I am paying a fixed interest rate on my debt and I’d rather pay a variable rate, and if you have the opposite situation, then we swap. Not the actual debt, because that would be either complicated or downright impossible (cross-border regulations, collateral requirements, etc.). What we swap is the payment – I’ll send you the equivalent of your variable interest payments, and you send me your fixed payments. I’ll then use what you send me to keep my lender happy (he wants fixed payments – I pay him with your money), but my actual payout is to you at a variable rate. With that, I have converted a fixed obligation into a variable one.
Why would I want a different interest structure than the one I contracted with my lender? Well, maybe I have a fixed rate, but I think rates are going to come down so I want to switch (and, of course, you think they’re going to go up and so would rather lock in a fixed rate). Or maybe I want a fixed rate but my bank will only offer me a floating structure, and you have the opposite problem.
While mainly used by banks and other financial institutions to hedge their interest rate exposure, IRSs can also be used as a tool for portfolio management, taking positions on interest rates at various points in time. (It’s also possible to do this by going long or short Treasury bills, but interest rate swaps require much less capital outlay.)
The market is huge, trading almost $1.9bna day, which makes interest rate swaps one of the most actively traded instruments in the over-the-counter (OTC) market.
Interest rate swaps have traditionally traded OTC (directly between two parties) rather than via a regulated exchange – most contracts are drawn up to satisfy particular conditions, and are not standardised enough to list on exchanges. As with credit default swaps, the Dodd-Frank Act of 2010 radically transformed the market in the US, mandating that a wide range of IRS contracts (but not all) be traded on “swap execution facilities” (SEFs), rather than by phone. These newly-created trading venues aggregate order books (increasing market transparency), and allow participants to ask for quotes from several dealers simultaneously – they are similar to exchanges in function, but have a more limited scope and fewer listing requirements.
Also, all swaps traded on SEFs have to be cleared via a central counterparty (CCP). Once a trade is confirmed, the CCP acts as buyer and seller, taking on the settlement risk. This lowers the collateral required of the parties to the trade, but increases the trading costs.
And, all swaps trades have to be reported to swap data repositories (SDRs), providing volume and pricing information to the market. SDRs also enable regulators to gauge participants’ risk exposures.
In Europe, the changes are similar to those in the US. The European Market Infrastructure Regulation (EMIR) – passed in 2012 – mandates that certain classes of interest rate swaps clear through CCPs. Those that are not required to do so still have to comply with tighter risk compliance rules. EMIR also tightened the reporting requirements.
In the US, interest rate swaps fall under the jurisdiction of the Commodity Futures Trading Commission (CFTC), and in Europe under the European Securities and Markets Authority (ESMA).
The Chairman of the CFTC, J. Christopher Giancarlo, has often said in public that blockchain technology could have a big impact on how swaps are handled, helping to smooth the complexities brought about by Dodd-Frank (not that the market was straightforward before). However, the blockchain activity going on in this sector is relatively modest, compared to other types of derivatives, which is strange given its size and the potential impact on execution efficiencies.
While the pooling of risk aspect of central clearing would be a complicated area to automate (given the necessary level of flexibility), the redundant processes and documentation requirements could be streamlined via a distributed ledger. And the chaos of data reporting, especially given its systemic importance, points to this area as one likely to attract the attention of blockchain executives and developers.
Also, the actual agreements recorded on a blockchain could be largely automated using smart contracts. For instance, they could pull the interest rates for floating swaps from an established oracle and automatically calculate the relevant payment.
And, the current lack of transparency in the market due to the legacy of OTC trading could be alleviated by putting all swaps on a blockchain platform, and giving the relevant parties (as well as the regulators) access via their own node.
UK bank Barclays – together with blockchain consortium R3 and the International Swaps and Derivatives Association (ISDA), a trade standards body that has played a significant role in the standardisation of swaps – have trialled a similar solution. They developed a distributed ledger prototype based on Corda (which is not technically a blockchain, but that’s a different story) with the aim of recreating derivatives agreements using smart contracts.
The scheme envisions ISDA acting as a central repository for smart contract-enabled documents. Swaps dealers could use these to create new agreements, with all counterparties collaborating. The hash (compressed representation) would be uploaded to the distributed ledger, eliminating the need for all parties to store their own set of documents.
While the platform could ostensibly be used for a range of financial instruments, the first example tested was an interest rate swap.
Media giant Thomson Reuters also had interest rate swaps in mind when it designed a data stream (called BlockOne IQ) specifically to interact with smart contracts. The streams of both variable and fixed interest payments could be made much simpler with automatic calculations and adjustments linked to uploaded agreements.
While the firm’s more traditional APIs are available to market participants, a dedicated oracle would open up access to a growing range of decentralized applications. It is expected to reach a decision by the end of the year on whether or not to monetize the experiment.
It’s not just the incumbents that are taking a look at this segment. Synswap, set up by two ex-traders, hopes to challenge current post-trade processes by disintermediating central counterparties from the clearing process. Its initial focus is ostensibly on interest rate and credit default swaps, and a prototype currently in development will perform key post-trade functions such as matching, confirmation, collateral management and settlement.
In plain sight
I am surprised that there isn’t more IRS-focused blockchain activity going on, given its characteristics and needs:
They are easily automated
The market has a relatively limited number of participants
The data collection is complicated (and can be simplified)
The accounting is complicated (and can be simplified)
There is little overlap with other instruments (which means that dedicated solutions – which are easier to implement – could work)
The market is still relatively opaque, in spite of a push for greater transparency
Data collection is complicated (and can be simplified), and slow – the latest figures given by the Bank of International Settlements are from April 2016
The instrument is systemically important (which implies increased attention from the regulators)
Of course there are complexities that would be hard to integrate into a blockchain, such as the mutualisation of losses and the management of margin levels.
But the potential is significant, and worthy of investigation. It will be fascinating to see what other projects emerge in this space, especially given its importance to capital markets, and the lessons it could impart to the rest of the sector.
One of the more plausible and clear-headed articles I’ve read on tokens, by Michael Casey (who has joined CoinDesk as chairman of the Advisory Board!):
“Under this new model, all who share the interests of a community should, in theory, be acting in those interests whenever they exchange tokens. And as more people do the same, the token’s value should rise in line with its network effect.”
One paragraph jumped out at me as being especially applicable to the token scene today:
“The road to progress, as Chuck Yeager observed, is marked by great smoking holes in the ground. The fact that you have probably never heard of any of those scores of launches [of digital cash systems] should tell you how successful they were. I saw no reason to expect a nonzero valuation.”
Great smoking holes in the ground… At first I dismissively thought “but in the digital token space, the disappeared ones are largely due to spectacular speculation”. Then I realised that’s untrue. The failures, for whatever reason, are part of the journey. And from each, we learn (just look at what The DAO implosion gave us).
“It is interesting to note that the fledgling United States, which had strongly resisted the notion of a central bank (the Federal Reserve was not created until 1913 – a direct consequence of the banking collapse of 1907), was the home of the first great monetary experiment of the industrializing world and ended up with the world’s reserve currency.”
So, basically, we don’t even know what we don’t know. And what we do know perhaps just ain’t so.
“The place where the story happened was a world on the back of four elephants perched on the shell of a giant turtle. That’s the advantage of space. It’s big enough to hold practically anything, and so, eventually, it does.
People think that it is strange to have a turtle ten thousand miles long and an elephant more than two thousand miles tall, which just shows that the human brain is ill-adapted for thinking and was probably originally designed for cooling the blood. It believes mere size is amazing.
There’s nothing amazing about size. Turtles are amazing, and elephants are quite astonishing. But the fact that there’s a big turtle is far less amazing than the fact that there is a turtle anywhere.”
Alexandra Scaggs in the FT this morning expertly dissects a paper in the CFA Institute’s Financial Analysts Journal, in which the authors claim that profits are no longer important in company valuations.
As an ex-investment analyst, this is befuddling. I used to be pretty damn good at financial models, all of which were based on earnings projections. And as an entrepreneur, I cared a lot about cash flow.
However, times have changed. The stock prices of Amazon and Tesla do not reflect earnings forecasts (which no-one really has a clue about, anyway) – their price/earnings ratios are crazy. And yet, that does not mean that they are bad investments (this is not professional advice!).
This disconnect could well be why so few tech companies are going public – that, and the relative ease with which they can come by funding through other methods.
I have been getting increasingly concerned about the accounting standards for initial coin offerings (ICOs), and will wail about them more in another post.
But for now, let’s focus on asset value.
Research and development (R&D) costs are considered “expenses”, and hit the bottom line. Capital outlays and acquisition costs are considered “investment” and can be capitalized and amortized over time. So, it makes more sense (from an accounting point of view) to buy a research company than to do it yourself.
But then, assuming you consolidate the figures, and assuming your new R&D team keeps at it, you’re back to having high costs relative to the growth in assets.
Again, this could partially explain why tech companies are increasingly realising that IPOs are not for them.
ICOs, on the other hand… No-one seems to care about fundamentals such as future earnings there.
And in a free market, that is the investors’ choice. But it does represent a fundamental shift from the value-creating roots of corporate participation, which we should be aware of.
We also need to contemplate the long-term impact that this shift could have. When we focus on speculative gain (as with most of the ICO market today), we don’t really care what the company does, or how. We care about how “cool” it is, how “hot” the topic. We veer towards an alarmingly short-term bias which will, if it persists and spreads, affect the investment decisions of the companies themselves.
An economy focused on short-term deliverables and market appeal will become more volatile. This will give speculation a veneer of common sense. And, let’s go big here, possibly undermine the very essence of capitalism.
CNBC reported on a research document that places IBM ahead of Microsoft in the blockchain battle (according to a survey).
It’s not comparing like with like, though. Here’s something I wrote for CoinDesk a while ago that contrasts the tech giants’ blockchain strategies. IBM may have a greater mindshare now. But further down the road, who will have the greater flexibility?
(Actually, I think it’s IBM – Microsoft appears to be overly reliant on Ethereum, which is still very young. IBM’s blockchain platforms are also young, but much more flexible and malleable according to IBM’s criteria and goals.)
But, Simon Taylor of 11:FS wondered on Twitter about the number of “IBM is great on blockchain” articles emerging this week.
Anyone else seeing a lot of obvious puff pieces for IBM lately?
Paid media, spam on twitter, reports calling them "leaders"
But, here’s a report from a couple of weeks ago on how IBM needs blockchain to pull it out of its legacy slump.
I’m not saying there’s a connection…
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Outlier Ventures created a useful visual map of the token scene, grouping coins by sector. This will need more concentrated perusing, but at an initial glance, most of the action seems to be in “computing, verification and storage”, followed by “payments and banking”.
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From the New York Times’ article on what Jamie Dimon got wrong last week about bitcoin (because writing about what he got right would take up absolutely no space at all), a much cuter way to say “the genie is out of the bottle”: “the toothpaste is out of the tube”.
I hadn’t heard it before. Am I totally out of it?
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Mesmerising photos by Rune Guneriussen, via Colossal… I feel they should belong to a fairytale, only I can’t think of one that would be this interesting.
I don’t agree – the volatility comes (for now) from the relatively low fixed supply. Strong inflows can move the price. Gold is (sort of) fixed, too – but it’s more abundant.
And, if the gold supply turns out not to be fixed (if price shoots up, it becomes more profitable to search for gold everywhere), then the price will come down (and a lot of mining will stop being profitable, so supply will stabilize).
Also, market jitters.
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A good article in the New York Times on the charm of Dogecoin and the fragility of initial coin offerings (ICOs), with a delightful analogy:
“If you’re having trouble picturing it: Imagine that a friend is building a casino and asks you to invest. In exchange, you get chips that can be used at the casino’s tables once it’s finished. Now imagine that the value of the chips isn’t fixed, and will instead fluctuate depending on the popularity of the casino, the number of other gamblers and the regulatory environment for casinos. Oh, and instead of a friend, imagine it’s a stranger on the internet who might be using a fake name, who might not actually know how to build a casino, and whom you probably can’t sue for fraud if he steals your money and uses it to buy a Porsche instead. That’s an I.C.O.”
Catching up on reading from last week, I came across an article in the FT by Izabella Kaminska, who takes issue with economic impatience.
“While there is little doubt that too much short-termism has negative effects, one should not assume that it follows that extreme long-termism is always for the best. The latter can be dangerous when long-term thinkers fall for fanciful narratives or investor cults.“
She goes on to say:
“Nowhere is this mindset more clearly displayed today than in the realm of cryptocurrencies, where narrative trumps reality on a daily basis. “
To claim that happens daily is a stretch. But overall, maybe she’s right – the cryptocurrency space is full of hype and idealism, which doesn’t last long when the window of righteousness is opened and the obstacles of modern life rush in.
Although, the claim doesn’t make sense. The problem is with the definition of “reality”. No-one seems to have a clear idea of what it is anymore.
I’m not even sure if that is possible – because isn’t reality what we say it is? And these days, with so many channels of communication available to us, to import and export, reality is a mish-mash of interpretations, theories and facts distorted by bias.
We all have our own version of reality. My reality is not the same as a Texan truckdriver, Syrian teenager, or Nepalese grandmother. Nor can it ever be. So if “narrative trumps reality”, which reality are we talking about?
What’s more, as Yuval Noah Harari points out in his seminal work Sapiens, narrative is not only the unifying force of societies – it also creates its own reality. The forging of common myths bound groups together in imagination and tradition, giving us the internal organization necessary to conquer and invent. Objective reality is the ground we stand on, the bricks that house us and the food that nourishes. Subjective reality is our interpretation of their meaning, our understanding of our purpose and our determination of “obvious truths”. Narrative breeds subjective reality.
“Large numbers of strangers can cooperate successfully by believing in common myths. Any large-scale human cooperation – whether a modern state, a medieval church, an ancient city or an archaic tribe – is rooted in common myths that exist only in people’s collective imagination.”
So, “narrative trumping reality”? It’s a great soundbite. But is isn’t true. Narrative creates reality.
My article on CoinDesk this week, on why China’s ICO ban was drastic, but not unreasonable. What’s more, it’s almost certainly going to be temporary.
And I stick by that conclusion even after the news out on Friday that cryptocurrency exchanges in China are being asked to close down. That will most likely also be temporary, especially as the authorities realise that it is much easier to control what is going on with regulated exchanges than in the offshore or OTC alternatives that will replace the volumes.
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Investor Albert Wenger makes the very good point that until we have global regulation for ICOs and cryptocurrencies, we won’t progress much in their development. A technology that aims to transform global capital markets needs global regulation – the current approach, he argues, appears to be to stuff everything back into country-specific, siloed regulations which complicate the cross-border application of the advantages.
Regulation is important and necessary, yes. But unless we can establish a global standard, we won’t end up with the new system that many of us believe we need.
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And then you have Balaji Srinivasan claiming in a CNBC interview that the internet will become one big stock market, just like Google became one big library.
I don’t agree with the analogy. Libraries don’t need regulating. Stock markets do. And while Google can hand out books, you’re not going to buy securities from “the internet”. The internet may become the marketplace in which various exchanges work. But that’s a far cry from becoming a global exchange itself.
With decentralized tokens, it is possible for an automated platform (ie. code) to act as an intermediary between people that want to buy and sell. But not on current internet infrastructure – you would need some sort of blockchain technology for that.
And sure, maybe the whole internet will one day be run on a blockchain, as Blockstack and IFPS (among others) are working on. But full replacement is, let’s face it, a ways off.
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A TechCrunch article on blockchain and identity succinctly points out why the technology is not the solution to the management of personal data.
It quotes an analyst as saying:
“Identity is not going to move to the blockchain in any big way (not as we know it). Blockchains were designed to solve problems quite different from identity management. We need to remember that the classic blockchain is an elaborate system that allows total strangers to nevertheless exchange real value reliably. It works without identity and without trust. So it’s simply illogical to think such a mechanism could have anything to offer identity.”
The analyst has a point. But he fails to tackle the nature of identity – it’s just data. Your identity is made up of certain characteristics, depending on the situation and/or need. Name? A sequence of characters. Place of birth? Coordinates on a map. Age? A date. Address, profession, marital status, favorite movie… They’re just bits of information.
And if blockchain technology can safeguard and distribute data in a more robust way than any other technology out there, why is it not appropriate for identity?
The thing is, the information needs to be verified. Depending on the use case, the requester needs to know that you’re not making up your date of birth or social security number. It also needs (again, depending on the use case) to be flexible – you’re likely to change your address at least once in your life, and possibly also bank account, IP address, even your name.
Could a blockchain handle that level of sophistication? Data that only you control, but that requires inputs from third parties? Yes, it most likely could.
Yet with a greater attack surface, could a blockchain identity platform guarantee security? Ah, that might be more complicated. It looks like data security and privacy might be even more urgent problems to solve.
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If these photographs of stunning fireworks don’t take your breath away, then you have no soul (or maybe you just don’t like fireworks…)…
By photographer Keisuke (who is just 25 years old!!), via Colossal.
You should check the other photos out, they’re all staggering…
As we saw in the previous entry in this series, credit default swaps are ideal for blockchain testing because:
they’re complex yet with a “programmable” structure;
they’re increasingly standardised following recent changes in regulation; and
they operate in a self-contained market – although they reference other securities, they don’t actually link to them, and can operate solely on straightforward data inputs.
The largest project currently underway – not only in credit derivatives but also in the financial industry as a whole – is that of the Depositary Trust and Clearing Corporation (DTCC) in the US, which is working on rebuilding its credit default swaps processing platform with blockchain technology.
To appreciate how huge the launch could be, let’s take a closer look at the structure of the DTCC and what it does.
Too big to fail
Set up in 1999 to combine the Depository Trust Company (established in 1973 to hold security titles) and the National Securities Clearing Corporation (founded in 1976 to handle clearing and netted settlement), the DTCC is currently the largest securities processor in the world. It settles transactions of almost $1.7qn a year (that’s quadrillion, with 15 zeroes). There’s no point in trying to get your head around that large a number.
Since then it has acquired or created further subsidiaries to extend its services to include pan-European equities clearing, fixed income transaction processing, information management for trading institutions among other functions.
In 2006, the DTCC launched the Trade Information Warehouse (TIW) service, to centralize the storage of information regarding trades of over-the-counter (OTC) derivatives. One of its main functions is to maintain the “golden copy” − the unique, reliable and actionable record of transactions. It also manages post-trade processing such as payments and adjustments over the life of each contract (which, in the case of OTC derivatives, can be as long as 10 years). It currently handles the event processing services for 98% of the world’s outstanding CDSs.
Time for an upgrade
This is the platform that the DTCC wants to replace with blockchain technology. One of the main attractions is the possibility of making the “golden copy” accessible to all participants. Another is being able to automate the processing of lifecycle events via smart contracts (currently a largely manual process). Also, on the current infrastructure, settlement can take as long as a week to close, whereas on the new platform it could be almost instantaneous.
To this end, the DTCC started work on the redesign of TIW at the beginning of 2017, following a successful proof-of-concept executed in 2016. IBM is acting as project lead, blockchain startup Axoni will provide the technology, and R3 is acting as advisor. The platform is expected to go live in early 2018, at which time the underlying protocol will be submitted to opn-source blockchain consortium Hyperledger (of which the DTCC is a founding member) for others to also work on.
Given the systemic importance of efficient derivatives settlement, initially the new platform will launch in “shadow” mode and run alongside the current system. Participation will be optional, and participants will adapt their internal processes gradually, with large firms implementing their own nodes on the ledger while smaller ones hook in via the DTCC’s node.
To start with, the platform would only handle information and reconciliation. Payments would continue to move on traditional rails.
An interesting question is why the DTCC would do this. Are they not potentially writing themselves out of the picture?
What they are in effect doing is “disrupting” their own processes. As the largest CDS post-trade processor, they do have a choke-hold on the market. But the DTCC is a not-for-profit organization, owned by the industry. As such, its obligation is to the market participants, and includes future-proofing its service. What’s more, a reduction in reconciliation costs could boost transactions and liquidity, possibly helping to offset the post-crash decline in trading volumes.
Furthermore, its systemically important role gives it a clear view of how fast financial services can shift. By upgrading the principal post-trade platform and making it easier for derivates to be centrally cleared, the DTCC could be getting ahead of regulatory changes. With a node on the distributed ledger, regulators would have a complete and real-time view of the state of the market.
When the platform goes live (expected to be early next year), it will be the largest project to date to enter production. Its effects will not be visible to the mainstream market, but the financial sector will be watching this closely, not only to see if the technology works, but also to gauge the impact of the cautious implementation strategy.
Blockchain technology is not the answer to all of the problems, structural and otherwise, that currently plague financial markets. But its potential is intriguing, especially the opportunity to affect how information is handled. That in itself could fundamentally change how the markets work.
With many more projects in the pipeline – from the DTCC as well as other significant players in the field – the launch of the CDS blockchain platform could well be the tipping point that triggers a host of implementations. With that, we will finally be able to say that the next era of financial infrastructure has begun.
Popular Science explains a new calendar proposed by economist Steve Hanke, which would adjust our calendar to a less random, more efficient structure. We would have four quarters of three months, each with 30 or 31 days. January 1st would always be on a Monday, Christmas Eve and New Year’s Eve always on a Sunday. Every five or six years we would adjust for the orbital drift by having a work-free “Leap Week”.
It makes sense. We would waste less time jiggling calendars. But it is unfortunately unlikely to happen, since we tend to resist change. Getting rid of daylight savings time might be a better first step, to get us in the mindset.
“Woo is understood specifically as dressing itself in the trappings of science (but not the substance) while involving unscientific concepts, such as anecdotal evidence and sciencey-sounding words.”
He holds up ethereum as an example of “woo”, especially its claims to be “a world computer”.
It seems to me that this argument is beside the point, in that it depends on what your understanding of a “computer” is. If to you a computer is a device, then no, ethereum is not. Yet if you understand “computing” to be more of a function than a thing, then maybe. Either way, it’s not important – I, too, get pissed off with annoying and meaningless hype. But, beyond that, it’s not important.
“Whenever technological change has divorced the old forms from the new moving forces of the economy, moral standards shift, and people begin to treat those in command of the old institutions with growing disdain… This widespread revulsion often comes into evidence well before people develop a new coherent ideology of change.”
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These are cakes, not modern art sculptures… Cakes… Awesome. By Dinara Kasko, via Colossal.