Oh, please… tax breaks for blockchain companies?

The news item from last week about the Spanish government contemplating tax breaks for companies using blockchain technology is frustrating. It buys into the hype, assuming the blockchain = the future, blockchain = good, blockchain = progress. What it will end up doing is encouraging businesses to throw a lot of money at blockchains they don’t need. Technology investment is increasingly the backbone of any company’s expenditure, and if a business gets that wrong… if, for instance, it implements a blockchain that then can’t scale or can’t protect the information or – gasp – ends up breaking any one of the multiple privacy, custodian and financial laws… It would make sense to also exempt companies using blockchain technology from the country’s bankruptcy laws.

Only, no, it wouldn’t. That would just provide a further incentive for businesses to add “blockchain” onto their IT specs. Even more vapid hype.

source: Giphy
source: Giphy

A more useful solution would be a “sandbox”, in which businesses that work in regulated sectors (finance, health, education, etc.) can experiment with the technology’s advantages without needing to comply with a long list of restrictions that were drawn up 25 years ago. A sandbox would encourage cautious investigation while not endangering systemic processes – and while there is always the risk that sandbox privileges will be withdrawn, it’s more likely that rules will be adapted once consequences have been examined. And, most important, the consumer would broadly be protected.

Not under the proposed Spanish system. Never mind the consumer, let’s get businesses using this technology that is still new and relatively untested, because hey, tax breaks.

What’s more, given how “easy” it is these days to issue digital tokens through initial coin sales, we could see traditional companies choosing this option – even if the token makes no economic sense – because it could help them pass as a “blockchain company”. This will add fragility to the system as hopeful investors put money in these tokens.

And, how can you offer tax breaks for potentially unregulated use cases? Sure, the government could decide which use cases get the tax breaks. But that is akin to deciding how to regulate the use of the technology – something that no government has wanted to touch with a bargepole. Not yet, anyway.

It should be a boon for blockchain consultants, though. They’ll be raking it in.

How about offering tax rebates to businesses investing in any type of technology? Why is the government favouring some types over others? And why does it think it has the sufficient expertise to be able to determine which technology is better for business? This push for blockchain shows that the ruling party 1) doesn’t understand blockchain technology, 2) is desperate to appear savvy and 3) is not thinking ahead to not-too-far-away time when blockchain technology has evolved to the point of blending with others, both current and yet-to-be-invented.

There are upsides, though: this move could encourage the hundreds of self-proclaimed blockchain experts in the country to actually start learning about real applications, rather than just spouting utopian platitudes that have little grounding in either history or economics (judging from media quotes and published work – I’m sure there are smart ones that do “get it”).

And, it could attract more blockchain businesses to Spain, which could kickstart an ecosystem that in turn could encourage broader, more sustainable development.

But it’s not enough to make a difference. To attract technology development, Spain needs to re-examine its entrepreneurship laws, remove the “exit tax”, further relax labour laws, reduce bureaucracy, and work hard at moving up from position #86 (!!!) in the World Bank’s Starting a Business Index.

Encouraging technology exploration is a good thing, especially for something as potentially transformative as blockchain applications. But making empty declarations with the sole purpose of window-dressing will end up accelerating and perhaps deepening the disappointment when unrealistic expectations are not met – and that won’t be good for anyone.

Bits and stuff: February 18, 2017

An awesome article from my colleague Marc Hochstein, with one of the best quotes I’ve read in ages, from Primavera De Filippi:

“You cannot assume that just because a technology dis-intermediates and is trans-national that it cannot potentially be used to reinforce existing social, political and economic structures.”

RIP, John Perry Barlow.

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In The New York Times, Peter J. Henning raises the issue of cryptocurrency regulation. Who should regulate cryptocurrencies in the US? Both the SEC and the CFTC appear to be in a game of “not me” – and they both have a point. The SEC regulates securities – cryptocurrencies such as bitcoin have not been defined as such (and to do so would defy logic). The CFTC regulates derivatives on commodities – and while it has labelled bitcoin a “commodity” (not totally unreasonable), its remit does not cover the cash market, just commodity-based derivatives.

“The C.F.T.C. “does not have regulatory jurisdiction over markets or platforms conducting cash or ‘spot’ transactions in virtual currencies, or over participants on those platforms.” To reach actual trading in cryptocurrencies, Congress would have to extend its authority to cover a cash commodity market, something lawmakers have not done.”

At the moment, cryptocurrency exchanges are loosely covered by a patchwork of state money transmission laws – but, cryptocurrencies have not officially been designated “money” – and having to get licensed in every single state is not practical. The result is a clunky, fragmented or off-the-radar network of exchanges that do not offer much protection to the user.

The article posits the creation of a new organization – a Cryptocurrency Council, for instance. This would not only be able to develop a national approach to cryptocurrency transmission and exchanges – but it could also further investigation into use cases, offer a focal point for fraud investigations and develop a comprehensive base of information on usage. Most importantly, it could offer an umbrella of respectability to the nascent field, while recognizing that a new concept deserves a new mindset.

In the end, trying to fit cryptocurrencies into one of the existing asset definitions for regulation purposes isn’t working out well for anyone. Time to re-think the paradigm.

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The FT’s Henry Mance gave us a brilliant tongue-in-cheek take on us vs. Big Tech:

“This week, 1m people signed an online petition protesting against a redesign of Snapchat, the adult-proof messaging app. They wish to express — I quote — a “general level of annoyance”. They have probably already slammed their bedroom doors. They might not come down for supper.”

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Here’s a blockchain use case: In Ghana, over 80% of landowners lack title to their land – and 2/3 of Kenya’s land is “owned” without title…

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Bloomberg reports that the UN’s World Food Programme expects to be able to cut millions of dollars from the costs of administering its food programme, just by moving the cross-border money transfers onto a blockchain system. While that is actually a tiny portion of the overall budget ($6 billion, according to the article), it does buy a lot of food… And it does mean less profit for the banks (although, again, a drop in the ocean…).

However, no details are provided on the type of blockchain to be used (a WFP programme in Jordan launched last year was built on ethereum), nor on timing – it sounds like more wishful thinking than actual plans.

And this quote by one of the directors – “Blockchain helps promote collaboration by providing enormous amounts of data.” – makes no sense whatsoever. Blockchain promotes collaboration by design, not by providing data. And it only provides data if it is programmed to do so. A strange thing to say.

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I’ve mentioned before that I’m a sucker for miniature dioramas… and I get an illicit thrill from dystopian fiction (if there’s a “survivor” theme)… so this made me gasp with delight:

Nix Gerber 1

Nix Gerber 2

Nix Gerber 3

– by Lori Nix and Kathleen Gerber

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Tyler Cowen bucks the trend with a bad review of Black Panther. I haven’t seen it yet, but have heard nothing but rave comments… which always makes me suspicious.

“So many spears and wild animals? How about holding a referendum every now and then?“

I grew up in Africa, and the way western culture attempts to portray what it thinks African culture looks like in a misguided attempt to appear inclusive has always irritated me. That said, I really like the bits of the soundtrack that I’ve heard, so…

“I would say the more you know about actual African cinema, the less you will appreciate this one.”

Then again, no way was this attempt at bridging divides not going to stir up some uncomfortable opinions.

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And speaking of Tyler, he interviewed Matt Levine – the best newsletter creator out there (original, pithy and witty comments on money and economics, for Bloomberg) – on his podcast. They had an interesting chat about cryptocurrencies (no, CryptoKitties are not derivatives), and about Buffy the Vampire Slayer. Definitely worth listening to.

“It’s a perfect example of dealing very intelligently with serious themes in a way that, on its surface, and particularly in its title, is silly and is not presented as serious, which I think is, obviously, something that I often aspire to do.”

(Apropos of absolutely nothing at all, Matt Levine has a much deeper voice than I expected.)

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I’ve just finished “The Defectors”, by Joseph Kanon. It reminded me so much of John Le Carré, only more American. Although it’s actually very Russian – about the lives of US spies who escaped to the Soviet Union. Written with a certain rhythm and poetry, with complicated villains that you can’t hate and heroes that are far from heroic, it zips along with a melancholic yet determined patriotism.

defectors

Bits and stuff – February 11, 2018

On to the media crypto highlights of the week…

Taking a step back, CoinDesk published an original overview of ICO trends, which include continued regulatory pressure, the awakening of traditional tech companies to the potential of tokens, and the increasing sophistication of consumers.

What I didn’t expect was the apparently widespread belief that token funding will continue to grow, while getting more complex. I was also surprised by the revelation that many ICO entrepreneurs have back-up plans in case ethereum’s scaling issues don’t get resolved.

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From VC firm Andreesen Horowitz, a list of cryptocurrency-related readings, well worth bookmarking.

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Pascal Bouvier has the audacity to draw parallels between the evolution of established religion, and that of cryptocurrencies… and pulls it off, with flair. A stirring read:

“Money creation is backstopped by taxes on the people and the state monopoly on violence ensures a more or less orderly collection of taxes. Remove the monopoly over money creation and the nation state starts to vacillate on its pedestal… Many pundits will rightly point out that all cryptocurrencies suffer from congenital malformations… If there is one thing we can count on, it is human ingenuity, and the crypto field will find solutions and solve these defects over time. What we all hear is the sound of inevitability in the form of fitter cryptocurrencies to come.”

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I get a huge kick out of seeing how different media sources report on the same event – it often leaves me wondering how many parallel universes there can be.

On this week’s Senate hearings on cryptocurrency, for instance. At the thoughtful end of the spectrum, you have:

ETHNews: What Was Missing From The Senate Banking Committee’s Hearing On Cryptocurrency?

The report urges greater consideration of volatility and systemic risk, to what extent newer cryptocurrencies are commodities, the self-certification of cryptocurrency derivatives and whether or not all tokens are securities (as Chairman Clayton hinted).

CoinDesk: Crypto Industry Reacts to US Senate Hearing Remarks

“Optimism aside, some market observers said they believe the hearing revealed the need for more clarity on the regulatory front – something that both agency chairs indicated may be necessary in statements that broached possible action from the U.S. Congress.”

TechCrunch: Senate cryptocurrency hearing strikes a cautiously optimistic tone

“In a week of plunging prices and bad news, the hearing struck a tone that coin watchers could reasonably interpret as surprisingly optimistic.”

Reuters: U.S. regulators to back more oversight of virtual currencies

“Both regulators have cracked down aggressively on bad digital currency actors… But the question of who is best placed to oversee the underlying cryptocurrency cash market remains unclear.”

At the other end of the spectrum, you have:

Forbes: Regulators May Need More Power To Control Bitcoin, Senate Banking Chair Says

A confusing, patchwork article that I gave up trying to make sense of. (“Control bitcoin”? C’mon, that is not at all what they said.)

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As cringe-inducing as the above article is, the week’s award for Most Egregious Reporting must go to that fount of financial wisdom, the Daily Express, whose headlines “Cryptocurrency bull run imminent with bitcoin to hit $50,000 in 2018“ and “Cryptocurrency CRACKDOWN: World leaders to plan REGULATION of Bitcoin at G20 meeting” are just plain irresponsible. I’m not going to put links to those articles because they don’t deserve the encouragement.

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If this doesn’t make your mouth water…

lauren-ko-12

lauren-ko-6

lauren-ko-2

By Lauren Ko… check out more of her pastry creations at Colossal

 

Lessons learned: Taurus and the ASX blockchain integration

image by Tamarcus Brown via StockSnap
image by Tamarcus Brown via StockSnap

London, 1993. A big decision was about to be made, that would send ripple effects across Europe and forward through time, acting as a warning against ambition and consensus.

For the past 10 years, the London Stock Exchange had been working on a significant upgrade of its securities settlement system. With paper-based systems groaning under the 1980s boom in share ownership, pressure was building not only from nimbler competitors but also from the regulators across the Channel. If London wanted to maintain its role as the continent’s money centre, it needed to upgrade.

The new system was called Taurus, and its goal was to remove as much physical documentation from the system as possible. It also planned a move to rolling settlement, reducing the payment period for equities from three weeks to three days.

Yet things were not going well. The first sign was the rhythm of missed deadlines.

From the outset, the project was complicated. It aimed to include as many sector stakeholders as possible, in spite of conflicting interests. Institutional investors wanted a fast, reliable service, while private investors wanted lower costs. Also, the existing registrars (dominated by large banks) were given a say in the development of a centralized registry, even though it would undermine their business model. Well into the development cycle, they torpedoed the idea.

What went wrong?

In the haste to get development off the ground, the project allegedly started without a clear roadmap. And delays gave more time for the various stakeholders to add requirements.

Even with clear and stable stewardship, that scale of development would have been tough. Yet the project management structure was not clearly defined, and the lack of centralized control meant that interlocking pieces were being developed out of sync, with sections of the process at different testing stages, while other functions had not yet been designed.

Also, given the long lead time (which ended up being more than double the initial estimate), the system – if launched – would already have been behind the competition from day one.

The final straw came when an investigation in 1993 revealed that completion would take another two to three years, at double the cost-to-date.

The decision was taken to scrap the whole project. The exchange’s investment of over £70 million (over £140 million in today’s money) was lost. The London Stock Exchange handed over responsibility for the development of a new stock trading system to the Bank of England, and its CEO resigned.

It wasn’t just the colossal waste of money and the damage to its reputation that made many fear for the exchange’s future. Hundreds of brokers had based their systems development on the assumption that Taurus would be the main platform, and thousands of employees had been trained. The total cost to London’s financial centre was estimated to be in the hundreds of millions of pounds.

Of course, it’s easy to see in hindsight where things went wrong. And it’s easy to believe that today, big systemic projects would be managed with different principles.

While that may be the case, the fate of Taurus serves to highlight the colossal complexity of introducing a new systemic platform. Throw in a technology that has yet to be tested “in the field”, and you have a potential powder keg of risk.

All change

I’m talking about the decision of Australia’s primary securities exchange, ASX, to upgrade its clearing and settlement platform to one based on distributed ledger technology.

Announced late last year, the news sent waves of excitement through the blockchain sector – it would be one of the first major public-facing applications of the technology, which many have touted as having the potential to decentralize finance.

Introduced with bitcoin, the blockchain offers a way of sharing data that removes the need for validation from a central authority. The elimination of redundancies and the speed with which information can be transmitted and acted on present significant cost reductions, especially intriguing in an era of diminishing margins and increasing competition in the financial sector.

It’s not yet clear whether the technology that ASX will use (developed with blockchain startup Digital Asset) will technically be a blockchain, in which information is stored in blocks that are irrevocably linked to previous blocks, ensuring data integrity. The official press release referred to “digital ledgers”, and while the two terms are often used interchangeably, some distributed ledgers don’t rely on linked blocks to share and verify inputs and outputs. However, since the boundaries of the new technology are being blurred as the concept evolves, the announcement was treated as a triumph by blockchain sector participants – official, public validation of the potential benefits.

Be careful

And yet, it is by no means the windfall that the headlines proclaimed.

First, it isn’t happening anytime soon. At the end of March, the ASX will reveal a potential live date for the new platform – it will most likely be years away. We won’t get a clear indication of the expected timing until the end of June.

And, as we saw with Taurus, in complex undertakings, deadlines are often extended. Hopefully the new system will be revealed within a much shorter timeframe than the failed British attempt’s estimated 13 years…

If it gets revealed at all. The ASX platform does need to be replaced – known as CHESS, it is 25 years old and is struggling to keep up with newer and nimbler competitors. But the decision to build on top of a relatively untested technology with uncertain scaling and bottlenecks is a brave one. And few development projects progress without setbacks.

It’s fair to assume that the planning will be meticulous and thorough. But will it manage to avoid the pitfalls of overwhelming systemic change?

Learning from the mistakes of Taurus will help. But the leap forward in technology with this development adds a new layer of complexity.

A large part of the problem will be managing expectations. While “blockchain” has been hailed as “the next industrial revolution”, we are not going to see a new decentralized stock exchange emerge before our eyes. As far as the public is concerned, things will continue pretty much the way they are.

For the financial and technology sectors, though, it is a big deal. If all goes well, back office costs will be reduced, new efficiencies will be explored and distributed ledger technologists will learn much from the real-world rollout.

The true change, however, will come years down the road, as other exchanges around the world take a look at their own clearing and settlement processes, as regulators encourage compatibility and connectivity, and as frictionless cross-border trading finally begins to look like a possibility.

But first, the ASX system needs to be successfully launched. And, as we’ve seen, it’s nowhere near as easy as it sounds. While the decision to migrate a country’s main securities settlement and clearing platform to a distributed ledger is good news for the blockchain sector, it is too soon to celebrate.

Bits and stuff – February 4, 2018

So, after a pretty dire January (my mother passed away), I emerge, blinking, into the crypto light again… Anything interesting happen in my absence? *checks bitcoin price* Oh…

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Have you noticed how bitcoin transaction fees are much lower now than a month ago? The rocketing cost of using bitcoin was the subject of several headlines recently, with fees holding at around $30 per transaction. That makes bitcoin economical only for large transactions (and perhaps not even then) – not exactly the original vision.

Now, however, they appear to have dropped to around $10. This is still too expensive for bitcoin to be useful, but since most of the transactions are from speculators, they don’t seem to mind. For real-world use, it’s a non-starter.

Bear in mind that these fees are on top of the substantial reward that the miners get for processing a block. Wasn’t the idea that fees would remain low as long as miners got paid through new bitcoins?

And, why the drop? Someone on Twitter suggested SegWit. Is that right? Anyone have a grasp on this?

 

bitcoin transaction fees
from bitinfocharts.com

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Good stuff:

Joi Ito’s article on the ICO mania for WIRED:

“Requiring companies to sell tokens only to accredited investors won’t solve the problem, because those investors will later sell them to speculators or, worse, to people who have seen the ads online promising to provide the secret of making a bundle on cryptocurrencies.

A lot of otherwise productive developers are devoting their expertise and attention to working on shallow, quick money ICOs rather than working to sort out the underlying infrastructure and protocols in academic and more open deliberative settings not fueled by warped financial interest.”

Kadhim Shubber’s take on the fundamentals of bitcoin in the FT:

“Someone comes along and tells you to imagine an electronic network, for moving money anywhere in the world, that no-one owns. It’s an intriguing idea. It’s an unprecedented idea. In the entirety of human history such a thing has literally never existed.

Would your response really be: ‘lol the true value of bitcoin is zero’?”

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Daft article of the week:

How to add to the already-high bullshit quotient in crypto Twitter, from WIRED… (I include this cringe-making article here, against my principles – it shouldn’t even exist, I mean, c’mon – to help you spot the fake experts).

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Smart…

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All conferences should have reporting like this:

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And, thanks Vitalik… sending you a hug for this…

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Colour and curves… Say no more…

via Colossal
via Colossal

Bits and stuff – January 7, 2018

After a whirlwind December and a good chunk of time offline, I’ve been trying to remember how to type. And catch up on blockchain news.

With so much to catch up on, I can’t stress enough the value of stepping back every now and then and taking a non-blockchain break. The trope that it helps with perspective turns out to be true. Catching up is tough but interesting, and surprisingly less overwhelming than I expected. And the feeling of loss in missing out on news and ideas is easier to bear when you realise that you’re going to feel that anyway, no matter how much time you put in – there is so much great blockchain-related content these days that it is impossible to read everything.

I’m back at CoinDesk now, working on new projects. More details to follow. There are some interesting things in the pipeline.

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Ripple was a big theme this week, with an excellent deep dive by Michael Castillo and Bailey Reutzel on the relationship between Ripple’s network and its token XRP. It seems that the company has not been as transparent as it could (should?) have been, although it doesn’t seem to have overtly misled anyone.

With Ripple and its token a touchy subject at the moment (exacerbated by its meteoric price increase of 1500% in the past month alone, as of Jan 4), Twitter has been ablaze with controversy and extremism. While some point out the dubious fundamentals behind the valuation, XRP holders scream FUD accusations. Meanwhile, the press tries to make sense of it. The Financial Times, the New York Times and the Wall Street Journal are just some of the big names covering this now. The CoinDesk article was the best I’ve seen. I also recommend Ryan Selkis’ lucid take on Medium.

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Stunning photographs of the neon stillness of Hamburg at night by Mark Broyer (via MyModernMet):

Mark Broyer, via MyModernMet
Mark Broyer, via MyModernMet

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This article highlighted the jurisdictional spaghetti that is US securities regulation: the securities regulator for Texas (not the federal SEC) stopped a token sale due to various infractions.

I confess that I didn’t realise the state authorities had the power to do that. Combine this oversight with that of the SEC, and the outlook becomes more reassuring for those of us concerned about the lack of regulation. Of course, it becomes tougher for would-be token issuers – but I don’t think that’s a bad thing.

And things could be just warming up. According to this article, 94% of state and provincial securities regulators (you mean there’s also provincial ones??) think that cryptocurrencies carry a “high risk of fraud”. Which implies that scrutiny will get tougher. Good.

Breaking rules in the name of innovation is one thing. Breaking laws is another.

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Here’s an intriguing shift: George Soros’ Quantum Fund invested $100 million (through the exercise of a warrant) in retail giant Overstock. According to Overstock’s CEO Patrick Byrne, much of this will be invested in blockchain development.

This is intriguing for two reasons: 1) it’s traditional finance – no digital token shenanigans; and 2) Overstock is an unusual blockchain play.
As well as a successful e-commerce business, Overstock owns Medici Ventures, which oversees the retail giant’s blockchain activities. Many of these are likely to benefit from the funding.

One of those is tZero, which is building a distributed ledger platform for capital markets and which is currently in the pre-sale phase of a token issue. Since my personal thesis is that capital markets will be one of the main areas of focus for blockchain efforts in 2018, this is worth keeping an eye on.

In a further twist, the firm’s CEO recently announced a desire to focus on his “personal mission” of developing blockchain-based property rights. $20 million of the funding will go to DeSoto Inc, a joint venture Byrne set up with Peruvian economist Hernando De Soto to further this end.

Since this is another compelling use case, with the potential to further financial inclusion and unlock value through reliable ownership titles, we could be looking at one of the most high-impact blockchain-related investments of the year. And it’s only the beginning of January…

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Daft story of the week:

You may remember that late last year the Long Island Iced Tea company changed its name to the Long Blockchain Corp., which probably makes sense to someone, somewhere (go figure). It turns out that it wasn’t just a naming exercise – they do actually plan to start mining bitcoin. I mean, it’s gotta be easier than making and selling iced tea, right? Of course, first they need to raise the money. And, no, they have not (yet) mentioned an ICO.

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More to come next week, although not as much as I’d like. All of my non-working time is taken up with physiotherapy – I’m SO looking forward to getting my shoulder back to normal.

I’ll leave you today with a taking-a-break recommendation: the second season of Dirk Gently. (If you haven’t seen the first season, that’s recommendable, too.) Totally weird and strangely enjoyable. One of those series where not understanding what is going on is part of the gleeful charm.

Dirk Gently

Bits and stuff: cathedrals and more… December 10, 2017

If any of you have ever taken a mooc (massive open online course), you’ll know the compelling power of having good quality teaching of a vast range of subjects at just a couple of clicks away. Access to that kind of wealth is intoxicating, and can be the black hole of time management. A couple of years ago I was a total addict, at one point enrolled in about 15, from institutions such as Harvard, Princeton, University of Edinburgh…

Needless to say, I didn’t complete them all, but I did get through a fair number. Most of my choices were in programming, economics and finance, but, surprisingly, the ones I enjoyed the most (and most remember) were the ones from “left field”, nothing to do with my training or profession. I especially recommend “How to Change the World” from Wesleyan, and “Digital Education” from the University of Edinburgh, if they ever put them on again.

I bring this up because today I started a new one, the first mooc I’ve felt brave enough to sign up for since I started work at CoinDesk. By “brave”, I mean willing to struggle with the time management issues – there are only so many hours in the day, and many things take priority over scratching a curiosity itch, however enlightening it may be. In so doing, I realized how much I missed scratching that curiosity itch, and how much more interesting the world is when we have the luxury of doing so. Also, how intertwined different disciplines are, and how big pictures emerge through seemingly unrelated connections.

The course I’ve started is “Cathedrals”, from Yale University, available on Coursera. I’m not religious, I’ve never been particularly fascinated with cathedrals before, but I’m married to someone who is and I’ve wandered around more than I can count.

So why did I sign up? I didn’t know at the time – it just felt like something that I needed to do. But now that I’ve started, I realize why: it’s the desire for context. Just two chapters in, it’s already about engineering, history, religion and philosophy. And already it’s tying in to reading I’ve been doing about economic development and how money evolved.

I’ve also realized that it’s one thing to gape in awe at the beauty and splendour of gothic structures. It’s another to understand how they came to be, what purpose they served and why so many are still standing today, centuries later.

So, while a course on cathedrals may sound fusty, it’s not. It’s modern and eye-opening, and I’m loving it.

notre dame

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The course also taught me a new word: cephalophore. It means “saint carrying his own head”. I challenge you to use that in a sentence.

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Angela Walch (@angela_walch) is serialising an update of The Christmas Carol, faithful to the original style but with modern characters and a moral that is disconcertingly not too different from the original.

Parts 1 & 2 here.

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Sticking with the cathedrals theme, take a look at this installation of stained glass “ribbons” in a San Francisco cathedral… Magical.

stained glass ribbons

(Installation by Anne Patterson, image by Fiestaban Photography, via MyModernMet)

 

Bitcoin futures and the meaning of finance – how did we get here?

Photo by Brandon Morgan on Unsplash
Photo by Brandon Morgan on Unsplash

One outstanding note in the cacophony of the bitcoin futures debate is an intriguing claim that I confess I didn’t understand at first: that bitcoin has no “natural sellers”. What’s unnatural, I thought, about people wanting to sell to realize profits? It turns out that’s not what the phrase means.

It means that nobody needs bitcoin. So why hedge it?

To go deeper, let’s look at why capital markets exist. They were developed to enable firms to raise money outside of bank loans. Bonds and equities pair those that need funds with investors who want a return.

Derivative markets emerged to protect cash flows. This both gives producers more security, and helps to raise funds – investors are more likely to “lend” to a company with protected income than to one subject to the vagaries of nature.

In essence, capital markets exist to help businesses flourish. Old-school capitalism.

Here’s where the “natural seller” part becomes important.

Farmers need to sell wheat. It’s what they do. Oil producers need to sell oil. Steel manufacturers need to sell steel. Gold miners need to sell gold. So, they all should protect those sales in the derivative markets.

No-one needs to sell bitcoin.

So what income flows are the derivatives protecting? Mutual fund redemptions, maybe. Pension plan payouts. But do we really think that mutual funds and pension plans should have significant exposure to bitcoin?

This question is important for whatever side of the bitcoin debate you’re on. If you’re a sceptic and think that it’s all a ponzi scheme, surely you don’t want institutional funds heavily invested in an asset that will no doubt crash. If you’re a bitcoin believer, do you really want the “money of the future” stuck in funds? Where’s the decentralizing potential in that?

So, it could be that the constructive purpose of bitcoin derivatives is to protect flows for funds that are either taking irrational risks or hijacking the finance of tomorrow. This is a far cry from ensuring that farmers can make a living and oil producers don’t go bust.

We could argue that all this started to go awry back in the ‘80s with the creation of synthetic derivatives that had as their sole aim to make a profit at the expense of others (trading being a zero-sum game). We could also argue that back then we got ahead of ourselves by letting markets run far ahead of the infrastructure. We know what happened next. (Ok, I’m simplifying, but the point still holds.)

And we could ask ourselves what good bitcoin futures will do the economy as a whole. To what productive use will their markets contribute? Are they adding stability, as per the original intent of derivatives? Or could they be adding yet another layer of complexity that masks a deepening fragility?

Of course, playing the long game, this could be what true bitcoin believers have known would happen all along. That the world will see (again) how unstable the current financial system is. And to what will people turn when widening cracks send central banks scrambling?

True, the bitcoin price would also likely tumble. But the technology would still work. People would still be able to independently transfer funds. And the advantage to having an alternative to an interconnected and unstable system would become more apparent than ever.

The threat of bitcoin futures

photo by Jesse Bowser on Unsplash
photo by Jesse Bowser on Unsplash

The financial press has been in a flutter of excitement over the launch of bitcoin futures trading on not one but two reputable, regulated and liquid exchanges: CME and Cboe.

CME Group (Chicago Mercantile Exchange) is the largest derivatives exchange in the world, as well as one of the oldest, with roots going back to the 19th century. It will launch bitcoin futures trading on December 18th.

Cboe Global Markets owns the Chicago Board Options Exchange (the largest US options exchange) and BATS Global Markets (the platform on which the Gemini-backed bitcoin ETF would have been listed had it been approved). It plans to beat CME to the punch by launching bitcoin futures trading on December 10th.

In theory this opens the doors to institutional and retail investors who want exposure to bitcoin but for some reason (such as internal rules, or an aversion to risky and complicated bitcoin exchanges and wallets) can’t trade actual bitcoin.

And that expected flood of interest is, from what I hear, part of the reason that bitcoin’s price recently shot past $11,000 (which, considering it started the year at $1,000, is phenomenal).

I’m missing something. I don’t understand why the market thinks there will be a huge demand for bitcoin itself as a result of futures trading.

First, a brief primer on how futures work: let’s say that I think that the price of xyz, which is currently trading at $50, will go up to $100 in two months. Someone offers me the chance to commit to paying $80 for xyz in two months’ time. I accept, which means that I’ve just “bought” a futures contract. If I’m right, I’ll be paying $80 for something that’s worth $100. If I’m wrong, and the price is lower, then I’ll be paying more than it’s worth in the market, and I will not be happy.

Alternatively, if I think that xyz is going to go down in price, I can “sell” a futures contract: I commit to delivering an xyz in two months’ time for a set price, say $80. When the contract is up, I buy an xyz at the market price, and deliver it to the contract holder in return for the promised amount. If I’m right and the market price is lower than $80, I’ve made a profit.

Beyond this basic premise there are all sorts of hybrid strategies that involve holding the underlying asset and hedging: for instance, I hold xyz and sell a futures contract (I commit to selling) at a higher price. If the price goes up, I make money on the underlying asset but lose on the futures contract, and if it goes down the situation is reversed. Another common strategy involves simultaneously buying and selling futures contracts to “lock in” a price.

Futures contracts currently exist for a vast range of commodities and financial instruments, with different terms and conditions. It’s a complex field that moves a lot of money. The futures market for gold is almost 10x the size (measuring the underlying asset of the contracts) of the physical gold market.

How can this be? How can you have more futures contracts for gold than actual gold? Because you don’t have to deliver an actual bar of gold when the contract matures. Many futures contracts settle on a “cash” basis – instead of physical delivery for the sale, the buyer receives the difference between the futures price (= the agreed-upon price) and the spot (= market) price. If the aforementioned xyz contract were on a cash settlement basis and the market price was $100 at the end of two months (as I had predicted), instead of an xyz, I would receive $20 (the difference between the $100 market price and the $80 that I committed to pay).

Both the CME and the Cboe futures settle in cash, not in actual bitcoin. Just imagine the legal and logistical hassle if two reputable and regulated exchanges had to set up custodial wallets, with all the security that would entail.

So, it’s likely that the bitcoin futures market will end up being even larger than the actual bitcoin market. That’s important.

Why? Because institutional investors will like that. Size and liquidity make fund managers feel less stressed than usual.

The bitcoin market seems to be excited at all the institutional money that will come pouring into bitcoin as a result of futures trading. That’s the part I don’t understand.

It’s true that the possibility of getting exposure to this mysterious asset that is producing outstanding returns on a regulated and liquid exchange will no doubt entice serious money to take a bitcoin punt. Many funds that are by charter prohibited from dealing in “alternative assets” on unregulated exchanges will now be able to participate. And the opportunity to leverage positions (get even more exposure than the money you’re putting in would normally warrant) to magnify the already outrageous returns will almost certainly attract funds that need the extra edge.

But here’s the thing: the money will not be pouring into the bitcoin market. It will be buying synthetic derivatives, that don’t directly impact bitcoin at all. For every $100 million (or whatever) that supermegahedgefundX puts into bitcoin futures, no extra money goes into bitcoin itself. These futures do not require ownership of actual bitcoins, not even on contract maturity.

Sure, many will argue that more funds will be interested in holding actual bitcoins now that they can hedge those positions. If supermegahedgefundX can offset any potential losses with futures trading, then maybe it will be more willing to buy bitcoin – although why it would allow its potential gains to be reduced with the same futures trade is beyond me. And, why hold the bitcoin when you can get similar profits with less initial outlay just by trading the synthetic derivatives?

That’s the part that most worries me. Why buy bitcoin when you can go long a futures contract? Or a combination of futures contracts that either exaggerates your potential gains or limits your potential loss? In other words, I’m concerned that institutional investors that would have purchased bitcoin for its potential gains will now just head to the futures market. Cleaner, cheaper, safer and more regulated.

So, if the market is discounting an inflow of institutional funds into actual bitcoins, it’s likely to be disappointed.

What worries me even more is the possibility that the institutional funds that have already bought bitcoin (and pushed the price up to current levels) will decide that the official futures market is safer. And they will sell.

Now, it’s possible that the demand for bitcoin futures and the general optimism that seems prevalent in the sector will push up futures prices (in other words, there will be more demand for contracts that commit to buying bitcoin at $20,000 in a year’s time than those that commit to buying at $12,000 – I know, but the market is strange). This will most likely influence the actual market price (“hey, the futures market knows something we don’t, right?”).

And the launch of liquid futures exchanges increases the likelihood of a bitcoin ETF being approved by the SEC in the near future. That would bring a lot of money into an already crowded space.

Buuuut… it’s also possible that the institutional investors that are negative on bitcoin’s prospects (and there’s no shortage of those) may use the futures markets to put money behind their conviction. It’s much easier to sell a futures contract with a lower-than-market price than it is to actually short bitcoin. These investors may well send signals to the actual bitcoin market that sends prices tumbling.

And the leverage inherent in futures contracts, especially those that settle for cash, could increase the volatility in a downturn.

That’s pretty scary.

Let’s not even go into the paradigm shift that this development implies. The growth of a bitcoin futures market positions it even more as a commodity than a currency (in the US, the Commodity Futures Trading Commission regulates futures markets). And even more as an investment asset than a technology that has the potential to change the plumbing of finance.

So, while the market appears to be greeting the launch of not one but two bitcoin futures exchanges in the next two weeks (with two more potentially important ones on the near horizon) with ebullience, we really should be regarding this development as the end of the beginning.

And the beginning of a new path.

Bits and stuff: panels, politics and pastry – December 4, 2017

And so a whirlwind November draws to a close. As predicted, Web Summit was intense – the best part for me was catching up with some great people, making new friends and having many memorable conversations. I thoroughly enjoyed the panels I was on, and hats off to the organizers for coordinating such a massive event.

websummit

Last week I was on a panel (there are soooo many blockchain conferences these days) at The Blockchain Summit in London. Although I lived in London for a few years, I’d never been to the Olympia center before. Big. Packed. I especially enjoyed the round tables, and recommend to all conference organizers that you set some up – small, intimate groups discussing predetermined topics.

blockchain summit panel

As I mentioned before, I no longer do the newsletters for CoinDesk – the Daily has been taken over by editor Pete Rizzo, and the weekly is in the capable hands of managing editor Marc Hochstein. He’s doing a brilliant job, and the takeaway essay in yesterday’s email is excellent – if you don’t get the weekly newsletters (what????), look out for it on the CoinDesk website.

I’m embarking on a month-long sabbatical to finish a research project, focus on reading and catch up on some learning. Already the month is going by too quickly.

In January I re-join CoinDesk to work on new products. It’ll be interesting…

— x —

The Financial Times is upping its blockchain coverage, both in quantity and quality. It used to be just the Alphaville team (specifically Izabella Kaminska) that produced insightful and original comment – but now a slew of sections are casting their gaze on the concept. Unsurprisingly, the focus is on bitcoin, the ingenuous darling of the investment market. And while they lack Izabella’s caustic aspersions on the blockchain hype, they are (in general) doing a fairly good job of conveying the surreal protagonism of cryptoassets.

Gary Silverman, Hannah Murphy and John Authers gave a good overview of bitcoin as an investment, conveying that even professionals don’t seem to understand it.

And capital markets editor Miles Johnson attempted to extract some political meaning from the tea leaves of bitcoin mania.

“Financial professionals who fail to comprehend why someone would risk their wealth investing in bitcoin when it appears to them so obviously to be a bubble can be compared with the political analysts who believed it was impossible the UK would vote to leave the EU.”

— x —

The South China Morning Post, however, misses the point completely by contrasting bitcoin’s “lack of residual value” with the utility inherent in copper, silver and gold.

True, metals can be used for things. But so can bitcoin: it’s a secure means of transferring information without relying on a central authority. That is useful, arguably more so than pretty jewellery (and most industrial uses are being innovated away by new synthetic materials).

— x —

When I head outside for some exercise these days, I’m listening to the audiobook of “Sapiens”, by Yuvah Noah Harari. It’s surprising how different the listening experience is from reading – I’m noticing totally different points. That could, however, just be down to my erratic attention span…

Anyway, last night the following jumped out at me – the conquistadors have just invaded Mexico, and the Aztec natives are perplexed as to why they keep jabbering on about a certain yellow metal:

“What was so important about a metal that could not be eaten, drunk or woven, and was too soft to use for tools or weapons? When the natives questioned Cortés as to why the Spaniards had such a passion for gold, the conquistador answered, ‘Because I and my companions suffer from a disease of the heart which can be cured only with gold.’”

This ties in with my previous point about intrinsic value. Metals have some utility, yes. But most of their market value comes from the fiction (by that I mean “invented reality”) that they’re pretty.

I think gold is pretty. But I think clear water is prettier. A sunset, a butterfly, an orange maple leaf… they’re prettier, also – in my opinion. Beauty is in the eye of the beholder, no?

It could be argued that metals are more durable, therefore they are a much better store of “prettiness”. And that’s a fair point, assuming that durability of “prettiness” warrants such a premium over utility.

But it’s not much different from the rationale that bitcoin’s premium is due to perceived value, not residual usefulness. So, why is one totally rational but the other is “market madness”?

As Harari explains, the Aztecs – who did not see gold as scarce – were puzzled by the aliens’ lust for it. So, while I don’t pretend to be able to justify bitcoin’s current market value, I would like us to stop holding gold up as an asset/safe haven/store of value that “makes sense”.

— x —

Bloomberg is also upping their crypto game, and that’s from an already high level.

As well as an argument for central bank cryptocurrencies and a summary of the positions of the warring bitcoin factions, the Gadfly column gave a good explanation of why the emergence of liquid bitcoin futures markets could explain the price buoyancy.

— x —

From the stratospheric to the sublime, Bloomberg also shows us how a renowned Parisian pastry chef is creating sweet delicacies that look like apples, and taste like apples, too.

image by Céline Clane for Bloomberg (click for link)
image by Céline Clane for Bloomberg (click for link)

I’m all for culinary experimentation, but I can’t help but wonder why, if what we want is something that looks and tastes like an apple, we don’t just eat an apple.

That said, they are gorgeous. I do love the spectacle. And I wouldn’t say no to trying one.