On Friday I wrote about a hack at the Distributed Autonomous Organization, the odd venture capital fund built on top of the Ethereum smart-contract blockchain. In particular, I wrote about the possibility that the hack was not a "hack," and that the $60 million that the hacker stole was not "stolen," because the DAO's governing documents, its terms and conditions, were set out solely in its code. If the code allowed someone to take $60 million, then that's just how the DAO worked, and whoever took the $60 million got it fair and square.
It is an odd view, and not one that I exactly endorse, either as a matter of law or as a matter of, like, how to run a system. But you know who does endorse that view? The hacker! Or, at least, someone claiming to be "The Attacker," who wrote this:
I have carefully examined the code of The DAO and decided to participate after finding the feature where splitting is rewarded with additional ether. I have made use of this feature and have rightfully claimed 3,641,694 ether, and would like to thank the DAO for this reward. It is my understanding that the DAO code contains this feature to promote decentralization and encourage the creation of "child DAOs".
I am disappointed by those who are characterizing the use of this intentional feature as "theft". I am making use of this explicitly coded feature as per the smart contract terms and my law firm has advised me that my action is fully compliant with United States criminal and tort law.
And, oh yes, he or she threatened to sue if the funds are frozen or seized. In real court, I mean, not blockchain court.
The hacker is not alone in thinking that all of this is just fine. Nathaniel Popper explains the debate:
Programmers working on the Ethereum network, which hosts Ether, were debating on Friday whether to make a one-time change to the code to recover the frozen money. That faced immediate opposition from many virtual currency purists who were attracted to the technology because of its ostensible freedom from human meddling.
“The strength of blockchain tech is that it is a ledger, a statement of truth,” Bruce Fenton, a board member with the Bitcoin Foundation, wrote on Friday. “That ledger is only as good as its resistance to censorship, change, demands or attack.”
I have DAO tokens. I prefer that the “hacker” keep whatever ether I lost. The great thing about smart contracts is the predictable risk allocation. I signed up for the risk of losing my ether. I did not sign up for third-party adjudication.
I find this all a bit depressing. This is not the future of finance; it is the past of finance. It is a harsh world of naked caveat emptor; it demands the enforcement of trickery just because it was tricky enough to trick people. Consumer protection is a relatively new idea in finance; it has caught on because it is a good idea. You can debate how far the law should go in protecting people from the consequences of their own mistakes, but a world in which at least some mistakes are fixable does seem nicer than the alternative. I also like what reader John Preston said via e-mail:
I do not think we are in a position yet to view smart contracts as production mission-critical systems. Ideally, they should be solid, but even in mission-critical systems it is likely that there will be changes to the code base: it is impossible to test for all bugs, functional changes nonwithstanding.
As such, I do not see the need for a code change as a failure, it's no different to the updates I install on my computer each week.
My point on Friday was that modern legal systems understand that you can't always trust 100 percent to the immutable terms of the contract. Preston's point is that software developers also understand that you can't always trust 100 percent to the immutable terms of the code. It would be a bit strange if smart contracts, which are a combination of contract law and software engineering, did place 100 percent reliance on the immutable terms of the smart contracts.
Elsewhere, here is Albert Wenger of Union Square Ventures on reversibility:
The power of blockchains are that they give us logical centralization (aka consistency / consensus) while being organizationally decentralized. To achieve this we need a certain level of irreversibility. For instance, if in the DAO everyone could have individually reversed their original contribution at any time and without a new consensus being computed, well then there would not have been an actual pool of capital in the first place. But does that mean things should be completely irreversible even by say a fork? I don’t think so. If the consensus protocol is sufficiently decentralized, then a fork is a way of voting to reverse. And there is huge value in any system from ultimate reversibility.
Here is Steve Randy Waldman on the meaning and social dynamics of blockchains:
A blockchain, like a parliament, is much more a social institution than a technological one, although very clever technology was necessary to design blockchain systems that could become socially credible. Like political systems, some mix of continued legitimacy and path-dependent coordination equilibria (“network effects”) determines how durably and powerfully blockchains will be able to shape social facts into the future. Continued legitimacy may depend on continued adherence to widely shared norms, on perceptions of fairness and representation, and on how effectively the blockchain’s decisions serve the actual interests of the community that relies upon it. Ethereum's is the most interesting and ambitious widely deployed open blockchain, a parliament whose job is to enforce the behavior of social institutions and financial contracts inscribed as directly consequential computer programs rather than in human habit or legal text. That was never going to be straightforward, and the DAO hack has beautifully surfaced some the difficulties and contradictions inherent to the enterprise.
Here is Ethereum founder Vitalik Buterin:
Developers, cryptographers and computer scientists should note that any high-level tools (including IDEs, formal verification, debuggers, symbolic execution) that make it easy to write safe smart contracts on Ethereum are prime candidates for DevGrants, Blockchain Labs grants and String’s autonomous finance grants.
And here is "Safer smart contracts through type-driven development." Be safe out there, smart contract writers.
Earlier this month, I enjoyed reading an article by a woman whose children do not allow her to say the words "Stife, Clutch, Fire, Dope, Swag, Fo’ Shizzle and Chill," though "'Chill' is borderline." This is sensible. Some words, when used by parents, put their teenage children at imminent risk of death by embarrassment. In that vein, Goldman Sachs "published its third annual list of buzzwords last week." Sadly the list does not include "stife" or "on fleek," though it does include "space congestion," "peak stuff," "mobots," "eSports," "craft," "infinite shelf," "immersion," "V2X" and, for some reason, "yield to worst." If you like your buzzwords with a side of other buzzwords, here's "craft":
There is no one definition of craft, but craft offerings are viewed as artisanal products typically made in small batches that often support local communities and provide an authentic experience through premium ingredients, unique flavors and higher perceived quality. The rise of “craft” across categories exemplifies many of the “mega-trends” that are shaping the current generation of consumers. In particular, Millennials, who represent the largest age cohort in the US, are more experimental, seek bolder flavors, and have a high propensity for things that are perceived to be more “authentic.”
Speaking of the bold flavors and authentic experiences beloved by millennials, how's Goldman Sachs's retail bank doing?
While new accounts do not come with free toasters, GS Bank, started in April, does promise “peace-of-mind savings” and “no transaction fees.” In short, it is aimed squarely at ordinary Americans — a clientele the company scrupulously avoided during the first 147 years of its history, favoring instead tycoons and plutocrats.
At least one millennial is satisfied:
“Of course they get blamed for stuff,” said Daniel Sigal, a 24-year-old college student in the Los Angeles area who calls himself a Wall Street hopeful. But “Goldman Sachs is the Nike of finance,” he said — a brand everyone knows. Its foray into banking is “very, very positive,” he said.
Disclosure: I used to work at Goldman, and I have a Goldman savings account myself, because they are not stife with the interest rate.
Elsewhere in millennials, they are apparently "set to embrace micro-investing." And elsewhere in client service, private banks are now offering concierge services that will plan your bachelor party for you. GS Bank seems not to offer bachelor-party planning services. Yet.
Mergers and acquisitions.
We've talked a bit before about Guy Hands's (now dropped) lawsuit against Citigroup, in which he accused Citi of misleading him when it sold EMI to Hands's private equity firm, with disastrous results. I pointed out that "the job of a sell-side M&A investment banker is to try to get the highest possible price for his client," and that perhaps bending over backwards to be transparent with buyers might not be in the client's interests.
Anyway here is a fun story about how Meg Whitman, the chief executive officer of Hewlett Packard Enterprise Co., hates Frank Quattrone and George Boutros of Qatalyst Partners, for sort of obvious reasons. I mean, for a couple of reasons, dating back to Whitman's time at eBay, but this reason would be sufficient:
Then in 2011, Qatalyst advised software maker Autonomy PLC on its $11 billion sale to HP. The deal, which was struck under Ms. Whitman’s predecessor but while she was on the board, became a disaster for HP. The company took an $8.8 billion write-down and accused Autonomy of inflating its results.
If you buy a company that ends up being worth $8.8 billion less than you thought it was, it is natural to blame the bankers who sold it to you. "Meg spoke with conviction and emotion over dinner that they were guilty," e-mailed the CEO of another Qatalyst client after meeting with Whitman. "Qatalyst will argue the reverse but it does not matter."
All of the calls by regulators and politicians to make banks less risky by tinkering with bonus pay rules leave me a bit uneasy. On the one hand, it makes sense. It is just economics; you get what you pay for, and if you give bankers and traders lots of asymmetric upside in the results of their decisions, they will make riskier decisions. On the other hand, it feels wrong. The pay incentives are intermediated through culture and individual decision-making; no one actually sits around thinking "well this trade has a 50 percent chance of blowing up the bank, but if it does all I'll lose is my job, while if it works I'll make millions." Or I guess some people do, but not many.
Anyway here is kind of a weird study:
Remuneration accounted for a maximum of 4 per cent of the difference in how bankers in similar situations behave, while factors such as education and age accounted for less than 5 per cent of the differences, according to a study by academics in the US, Germany and the UK. ...
“Style”, a category including a banker’s personality, talent and work ethic, accounted for as much as 72 per cent of the reasons banks behave differently.
This feels more psychologically realistic. Some people are risk-takers; others are risk-averse. You can manipulate their preferences with bonuses or clawbacks or whatever, but that's going to affect them by, like, 4 percent.
The big question then is how you get more people of the style you want. And the answer is ... probably through compensation? Like, banks historically tried to attract risk takers by offering relatively low base compensation with the possibility of very large bonuses for people who did well. And now regulators want bank compensation to be driven more by base salary and less by bonuses, and bonuses to be deferred for a long time and subject to clawbacks. (Also, implicitly: They want the total compensation to be lower.) That in itself should drive a change in style at the big banks.
Speaking of style, here is a revealing look at the fight between Yahoo Chief Executive Officer Marissa Mayer and activist investor Starboard Value LP. Yahoo and Starboard reached "a secret truce in April 2015," after which Mayer was pretty dismissive about Starboard:
At an employee meeting later, Ms. Mayer played down the threat from Starboard. One person at the meeting recalls her saying: “Some of our investors think they own more of the company than they actually do.”
Oh those pesky shareholders, always thinking that they own the company. (In the event, Mayer's planned turnaround went terribly, Mayer "failed to produced the pledged cost savings," and Starboard ended up "taking nearly half of Yahoo’s board seats and helping to force an auction of Yahoo’s web properties.") Mayer took a different view of the power dynamics:
“Her core mistake was this belief that she could reinvent Yahoo,” says a former senior executive who left the company last year. “There was an element of her being a true believer when everyone else had stopped.”
There are companies where the CEO is allowed to be a wild-eyed visionary who ignores shareholder skepticism and charts her own path. Typically those CEOs are founders and controlling shareholders. It helps if the companies are doing well, too. Mayer grew up at Google, a lucrative and founder-controlled company that doesn't spend a whole lot of time worrying about shareholder activism, or shareholders generally. It's possible that Yahoo -- a mess with no controlling shareholder and a new CEO hired from the outside -- called for a different managerial mentality. And yet she was hired to be a visionary, not a bureaucrat, and to turn the company around. It's a tough spot to be in.
Insider trading enforcement.
When we talked about the Visium insider trading case the other day, I briefly mentioned the other charges against two former Visium employees, for mis-marking some bonds in their portfolio. I said:
One possible moral of the story is, if you are mis-marking your book, don't also do a little bit of insider trading on the side. When the SEC comes for the insider trading, they'll also get you for the mis-marking!
Well, it turns out that it was the other way around:
What turned into one of the biggest insider-trading cases at a hedge fund in recent years started out as something entirely different: a probe into whether some portfolio managers at Visium Asset Management were mismarking securities and inflating returns.
And that probe also turned up the insider trading. I guess I stand by my advice, though. Don't multiply your schemes. Don't give the authorities multiple ways to catch you. If you must do something illegal, specialize: Do one illegal thing, and be really good at it. It goes without saying that this is not legal advice. Anyway Visium is shutting down -- selling one fund to AllianceBernstein and liquidating its other three -- because of the investigations, which is a bit of a surprise:
The announcement is a stunning and unexpected outcome from the investigation. It is rare for a hedge fund to shut down over a government investigation when the founder has not been accused of wrongdoing.
I wonder if Visium could have survived the mis-marking case or the insider trading one, but not both.
People are worried about unicorns.
Here is kind of an amazing story:
In early March, Kickstarter quietly sent shareholders a dividend. In the wider world of business, such an action would be unremarkable. More than 80 percent of the companies in the S&P 500 pay dividends, and many smaller companies do, too. But divvying up quarterly profits with shareholders is unheard of among tech startups. People who follow the venture capital industry were hard-pressed to come up with a single example of a VC-backed startup that has ever paid regular dividends.
Of course Kickstarter is different from most venture-backed startups: It's a "public benefit corporation" that doesn't particularly plan to go public or sell itself. Instead, it plans to be self-supporting -- you know, make money, like a business -- and reward its shareholders not by cashing them out in an initial public offering but by giving them a share of the profits.
That is the absolutely normal way that most small businesses work. Your local hardware store probably isn't going to do an IPO, but if it makes money, its investors get a cut. But its investors aren't Silicon Valley venture capital firms, and the hardware store doesn't have a billion-dollar valuation. Tech unicorns, driven by the limited lives of their investors' funds and by their employees' need for liquidity, have to eventually go public or sell themselves. Kickstarter is a rare exception, a unicorn among unicorns.
I half-joked the other day that my dream for Uber is that it stays private forever, becoming big and profitable enough to run a normal public-company capital structure while never actually doing an IPO. For that to work, though, it would probably need to start paying dividends. You can have a company that never goes public (Kickstarter, Koch Industries), or you can have a company that never shares profits with shareholders (Amazon), but it's hard to do both.
People are worried about bond market liquidity.
One popular mode of liquidity worrying is that of nostalgia: Things were better back when heroes roamed the earth, when market makers took heroic risks to make markets in all conditions. This is the predominant mode of liquidity worrying in equity markets, which have mostly replaced bold cheeseburger-eating floor specialists with flighty computers and "phantom liquidity." It is also popular in the corporate bond market, where shrinking balance sheets and reduced risk appetites have left banks disinclined to heroism. Apparently the Treasury market has a version of the equity-market worry, in which the rise of electronic principal traders, and the declining market share of primary dealers, will make markets worse because the electronic traders aren't obligated to make markets in the way that the primary dealers are. Except that isn't true. Here is Alexandra Scaggs calling this bit of misplaced nostalgia a "common bit of Treasury-market misinformation": "Contrary to Deutsche’s note, US primary dealers have no obligation whatsoever to provide continuous liquidity in that market."
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