Hypocrisy on Fiduciary Rule in Bitcoin Age

  Source: Federal Bar Association - Fifth Circuit

Source: Federal Bar Association - Fifth Circuit

The financial services industry seems lost without a moral compass, like a tin man searching for his heart. On the one hand, take the role of financial advisors. During the Obama administration, the Department of Justice put forward a "fiduciary rule" that implicated financial professionals selling investment product to behave as a fiduciary on their clients behalf, if that investment product somehow reached into retirement assets. Of course, most investment product does reach into retirement assets, and by association extends to brokerage assets. Acting as a fiduciary generally means charging the lowest-market fee reasonable for funds, not getting paid additional kickbacks, not promoting proprietary products, and planning for the client's future. A federal appeals court (Fifth Circuit) just overturned this attempt to legislate the standards in the industry, but the rule was out of favor anyway as Trump's officials in the DOJ kept postponing enforcement.

Why do we need something like the fiduciary rule? The answer is that financial professionals selling investment product are kind of like doctors in a lab coat. Their self-branding creates the impression of professionalism and knowledge, which in turn persuades retail investors to purchase investments. Abusing that power by delivering inconsistent or biased advice (i.e., clients with similar needs getting different prices and products) is a social negative, which is why the SEC is now looking into creating some alternative to the DOJ fiduciary rule. And the SEC regulates investment advisors, making it more likely that they have jurisdiction over the standards. It is generally believed that such a rule helps roboadvisors and augmented financial advisors, because technology can record the standard to which advice is given, and all the legal documents and financial recommendations are tracked and can be compared to client circumstances. Not having the rule excuses choppy behavior and implementations and the inconsistent behaviors of brokers. Deregulation lowers the need for technology to keep us honest.

And yet, look at the inanity of the congressional hearings on crypto currency. Senators unfamiliar with the underlying software or the drivers of innovation in digital assets are spouting judgments about what investors should and should not be able to purchase. Representatives are claiming that they will not sit idly and "fail to protect investors". While it is certainly true that investor protections, and especially clear and transparent information should exist, there is a deep hypocrisy here. Deregulating the sale of traditional financial asset such that the sales processes can be biased is fine, while allowing for a self-funded global ecosystem of digital assets that is literally building its own capital markets is dangerous.

A consistent policy for Fintech would favor the efficiency of financial technology over the human status quo, which would mean distribution through software platforms of modern packages of a variety of investment vehicles. Financial professionals (and their software extensions) should be selling reality to their clients. But if individuals want to shoot for the moon based on personal decision making, the best we can do is global financial literacy and transparent data. Instead, we have a circus.

$275 Million from Experian for 6 Million ClearScore Users

  Source: ClearScore, Banknxt / Atom Bank

Source: ClearScore, Banknxt / Atom Bank

Neobanks, like roboadvisors, are still trying to make sense of the wilderness. On the one hand, there are stories of fast, massive success. For example, credit bureau Experian just splashed $275 million on ClearScore, a 3-year old fintech startup with 6 million users that provides a credit tracking dashboard and refers users to financial products. How is this still a market opportunity that banks missed, when Mint.com did personal financial management right in 2007 (and sold for $170 million) and Credit Karma, an American version of the same, has 70 million users and a reported $500 million in revenues? Or, as another example, Smart Asset, which offers financial calculators that help people decide whether to rent or buy, has 35 million monthly users. Other examples of clearly working neobanks are Revolut and Transferwise, each with over a million users benefiting from reduced pricing on international money transfers.

We are being loose with definitions on purpose. Anything digital- or mobile-first, customer centric, and related to personal finance and depository or lending products looks like a neobank in our book. This is because banks are supposed to help us with these functions. They are supposed to help people save for the future, have convenient access to their money, and pay quickly and easily. And instead, most banks are either buying fintech companies that manage to grab a large chunk of digital users, or are investing so much into challengers as to effectively own them. See for example, Atom Bank's £149 million round, where BBVA will own 40% of the company. Atom's got a loan book of about £1.3 billion -- does the financing makes sense on its own merits, or does it make sense when you apply Atom's customer experience across the entire BBVA footprint?

  Source: ClearScore, Banknxt / Atom Bank

Source: ClearScore, Banknxt / Atom Bank

But something is off about the story. We know that the first round of neobanks -- Simple (also acquired by BBVA) and Brett King's Moven didn't really work out. Some, like Seed, are now focused on providing online account opening solutions to existing banks. This is the identical pivot we saw in digital wealth management, as roboadvisors turned into workflow automation tools for financial advisors. So what's the trick that makes some neobanks and PFMs worth hundreds of millions with massive traction, while others scrape at building a software-as-a-service business?

The answer lies in how clearly and quickly value accrues to the user. Credit tracking solves an immediate problem somebody is having, costs nothing, and has an engagement model. Cheap international transfers are instantly actionable, and immediately deliver value over what a traditional bank charges. SoFi's student loans sell themselves, reducing student obligations by thousands of dollars on sign-up. Building a pipe big enough that prospects know you exist is where the $100 million in venture capital has to come in, but then the product can have a positive viral loop. That's different from trying to sell an undifferentiated mortgage, or checking account, or retirement 40 years in the future. The benefits of such financial products are outweighed by the pain of having to interact with them. The questions to ask are: how much demand is there for this thing today, how bad is the current experience, and does your customer know the experience to be bad?

The GDPR Battle over Data and Identity - IBM or Crypto

  Source: Text of GDPR,  Truata   (click to enlarge on both),  Pillar Project

Source: Text of GDPR, Truata  (click to enlarge on both), Pillar Project

GDPR is about to hit Europe. The regulation is designed to reverse the power dynamic between large tech and finance companies, that gather and save user data, and the individuals whose data is at stake. The regulation creates a right to be forgotten (on the Internet!), the right to move personal data between companies, data protection standards, and other consumer-friendly amendments. The implementation of such regulation is massive, and IBM and Mastercard are teaming up by creating a company in Ireland called Truata to deal with the change.

Mastercard has immense amounts of financial data. IBM has cloud, blockchain and artificial intelligence capabilities. Will it thus be the tech and finance giants that solve the very problem the industry has created? Or can this be done better by the Crypto economy? Open source movements have for decades tried to solve the data question in favor of consumers -- see for example the FreedomBox project or the Ello social network. But there was not the financial leverage to re-engineer the entire direction of power and information on the web.

  Source:  Truata

Source: Truata

Crypto projects like Pillar, on the other hand, are motivated to create user-controlled wallets of private data which can be tokenized and then submitted as part of some particular economic activity. This can include medical records, financial activity, KYC/AML and government data, attention and browsing information, and so on. When such information sits at an address controlled by a particular owner with a particular wallet on a blockchain run by a decentralized, shared, distributed network (rather than one company), the promise of what GDPR is trying to accomplish becomes technically trivial. Of course the user can allow or revoke access to her data at will, and move it between different services securely! We think regulators would be well served in understanding this data architecture instead of being upset about the enabled rise of digital assets.

  Source: Text of GDPR,  Truata   (click to enlarge on both),  Pillar Project

Source: Text of GDPR, Truata  (click to enlarge on both), Pillar Project

Fintech AI Kensho Sells for $550M

  Source: Kensho / Forbes

Source: Kensho / Forbes

Big news is big. Finance startup Kensho has just become one of the largest artificial intelligence acquisitions in history. What is even more impressive is that the acquirer S&P, is also a financial services firm, and not the ever-present boogeyman of Google, Apple, Facebook, Amazon. Forbes claims this is the most expensive AIacquisition to date, though we see you Otto (self-driving trucks) at $680 million in Uber equity.

There's a nagging question around the acquisition price. Pitchbook shows a bit over $100 million raised into the company to date, with the last check being $50 million, led by S&P, and with a post-money valuation of $595 million in March 2017. So the acquisition price is essentially identical to that of a year ago, with none of the investors taking a downround, and S&P effectively not paying for their own slice. Across all rounds, it looks like the company sold about 50% of the equity. Why exit now without an uptick for control -- the other investors from last March, like Goldman, JPM, Bank of America, etc., can't be happy to just get their toys back.

Anyway, wat does Kensho do that is valuable? According to Goldman, which was one of the original investors, the answer is not that the AI manufactures investment product. Instead, it augments human analysts so that they are more powerful and can get more done -- like running a quantitative analysis in seconds rather than days. "It never disrupted the underlying business model". That's a lot of exit money for something that didn't disrupt any business models. Also not a surprose -- very few fintech companies are standalone businesses, but many will work when levered up 1000 times on a large incumbent client base. This was the logic behind BlackRock's $150 million spend on FutureAdvisor, a company with about $3 million in revenue. And a similar logic must animate the need to have the industry's best known AI asset to distribute to thousands of S&P institutional clients. 

Crypto Index Fund from Coinbase still not ETF


One of our key predictions for 2018 was the rise of vanilla investment product packages for digital assets. That means we would get to see ETFs and boring-old portfolios, rather than the wild contortions of 2017, where public companies pretended to always be into blockchain to get a crypto halo. And in large part, we put the responsibility for irresponsible retail investment behavior squarely at the feet of American regulators. Instead of a 5 bps ETF with some crypto exposure, we continue to see coin mania and sentiment-driven speculation. 

Coinbase is not standing still, and has announced a subsidiary called Coinbase Asset Management that will oversee a Coinbase Index Fund. While Coinbase has never been one to list a lot of assets, it is disappointing to only see 4 crypto currencies (BTC, ETH, BCH, LTC) in the package. Not to mention that this product comes with a $10,000 minimum and a 2% annual management fee. Looking at crypto assets, 2% may not sound like much given 1000% returns last year. Looking at digital investment management, 2% sounds like 10 times the price of the entire Betterment service. That price is expensive and inefficient, and is another reason why we need an ETF structure.

Last, investors have a track record of experience with the Bitcoin Investment Trust structure (about $2 billion of GBTC), which shows some of the disconnect between holding a crypto asset directly, versus through a wrapper. The wrapper can trade at a discount or a premium to the actual assets it holds. Below you can see that depending on the time period, you would have had quite different return profiles investing in Bitcoin directly versus the investment trust. And at times, you would be buying the fund where the net asset value was 20-30% higher than the value of the holdings in it. The solution for better pricing is more liquidity, not less, and lower fees, not higher.

  Source: Autonomous NEXT analysis, Coinmarketcap, Yahoo

Source: Autonomous NEXT analysis, Coinmarketcap, Yahoo

Amazon's "Checking Account-Like Product"

  Source: Edelman

Source: Edelman

Lots of chatter last week about how Amazon is in discussions with JPMorgan about partnering on a "checking account-like product". This is right on the heels of similar discussions with Bank of America about putting capital behind its SME lending business. So since when are banking products or lending products or investment products just a "-like" product. Meaning, don't you have to have a bank to offer the trusted service of a bank account? Don't you have to have a trusted banking brand to hold on to people's money? Quaint questions for the last century.

Not really. According to a study from Bain, 74% of 18 to 24 year-olds and 68% of 25 to 34 year-olds expect to buy financial products from technology firms. And according to the Edelman trust barometer, people still trust Finance less than absolutely every other industry, while trusting Technology more than any other industry. There goes your core value proposition.

The implication of a GAFA sector that offers all the financial products without manufacturing them isn't the safe passage for the financial services industry to the future. Rather, it is the full commoditiziation of financial services, as the main manufacturers of financial products squeeze themselves into the customer acquisition and engagement channels of the big tech AI companies. When the AI knows clients better than anyone else knows clients, financial services are mere features within the rich tapestry of services called Amazon Prime. Why would anyone choose the pain of shopping for and opening a third-party bank account, if one comes pre-installed in our virtual assistants?

So you can see how puzzling it can be to read that JPMorgan is investing $20 billion in 400 new branchesDoes 75% of deposit growth really come from customer visits to those branches? Do 60% of Americans still prefer to open an account at a branch, rather than digitally? Maybe, but these are decreasing data points in time, part of a larger trend towards digital. As shown below, each year these numbers go down, not up. Or, maybe, JPMorgan recognizes a corporate responsibility for its employees in a world that is moving towards automation and unemployment, and is doing its part in trying to stabilize local communities and the industry's reputation?

  Source: Bain

Source: Bain

  Source: Edelman, Bain, Tradestreaming/Cuebiq

Source: Edelman, Bain, Tradestreaming/Cuebiq

$10 Million In Crypto-Games per Week

  Source: DappRadar

Source: DappRadar

We've talked before about how important CryptoKitties was to the new web -- with all sorts of technologies like artificial intelligence, augmented reality, streaming video and online commerce getting their start from pictures of cute animals. Content is the killer app of the Internet. And putting aside adult content, video games have been a key driver for the development of online communities (e.g., MMORPGs), virtual economies (e.g., Second Life), video technology (e.g., Twitch), bandwidth development (e.g., Battlenet), hardware that runs AI and Bitcoin mining (e.g., GPUs), and many other key pieces that are responsible for innovation across the web.

It's not a surprise to see that, when analyzing the spending volume in decentralized apps on the Ethereum blockchain, over $10 million of economic activity is happening weekly in gaming, according to tracker DappRadar. So if we put aside the financial speculation in crypto currencies, i.e., trading them as assets or launching fundraises, what's most vibrant in the public ecosystem is video games. From CryptoKitties to EtherIslands or CryptoCities or EtherBots, developers are creating software that functions like a toy around digital assets. In a case of imitation being a source of flattery, decentralized gaming Chinese blockchain TRON launched a Crypto Puppies game for Chinese users and now has $3 billion marketcap.

And this, in our view, is the key insight about the space. What matters most is not the network or the mining, but the ability to make digital assets scarce and transferable. If it works for digital toys, it will work for digital equities, attention tokens, land titles and so forth. Games are the perfect proofs of concept for ownership and designing economic systems, as they are starting from scratch, and are not entangled with existing regulatory and legal regimes. How games turn into reality however, is a matter for the sovereigns. See the latest actions from the SEC, the Milken Institute's report on Fintech legislation, of the German Federal Financial Services Supervisory Authority's statements to see how we are progressing.

 S ource: Tron Games

Source: Tron Games

$400 Million Acquisition of Crypto Exchange

  Source: Circle

Source: Circle

Fintech startup Circle bought crypto exchange Poloniex, allegedly in a $400 million transaction. What's Circle? It's a mobile wallet / neobank that let's users text money to each other, with technology rooted in Bitcoin payments. Think about it as a combination of Venmo and WePay. According to Crunchbase, Circle has 50-100 employees and raised $136 million from Goldman Sachs, IDG China, Breyer Capital, Accel and General Catalyst. There is no way these guys have $400 million cash on hand, so we would expect this to be in large part an equity deal. And the latest Circle post-money valuation is about $500 million, so this was a big gulp if the reported numbers are correct.

What's Poloniex? Poloniex was an early exchange in the space that was quick to list new alternative tokens. It provided access to Ethereum before Coinbase did. In the process of getting popular, it acquired more users than it could handle. It was well known in the ecosystem that the company’s customer support took a very long time, and that conflict resolution processes were overwhelmed. This transaction should benefit Poloniex customers with new features and support services, while giving Circle a larger revenue base in the crypto economy.

One angle that gets lost in all the ICO talk is equity checks into blockchain and crypto companies by venture investors. About $1 billion was invested into the ecosystem from the venture side in 2017, of which $400 million was from Corporates; and over $300 million was invested in the first 2 months of 2018. In terms of the $400 million acquisition price, this would put the Poloniex below Coinbase’s $1.6 billion valuation, but well above that of enterprise blockchain unicorns like Chain ($130 million) or R3 ($250 million). So it is certainly motivational to see a transaction that bridges that public and private crypto worlds, and values tokens as an asset class rather than a mere operating improvement.

Some are also focusing on the fact that Goldman has a stake in Circle. As security tokens gather steam, with projects like Polymath raising $60 million and air-dropping their tokens to a large community base, traditional investment banks need to think about the future of their business. This is an existential question for the securities industry, and building correct exposure will be key over the next 5 years. Or the investment banks will end up like the music labels.

  Source: Circle, Autonomous NEXT (Pitchbook data)

Source: Circle, Autonomous NEXT (Pitchbook data)

Most ICOs Have Already Failed - But So What?

  Source: Autonomous NEXT, TokenData, CB Insights, Mattermark

Source: Autonomous NEXT, TokenData, CB Insights, Mattermark

An article on Bitcoin.com discussed some rough metrics for ICOs to date, claiming that of the 902 ICOs from last year according to Token Data, already 46% have failed. That's $104 million down the drain -- not to mention the opportunity cost of token appreciation and the funds that disappeared through various scams. So are things as bad as the article makes them out to be? We dove into the numbers, and came away with the opposite conclusion.

In looking at the Token Data underlying data set, there is an important distinction. And that is the difference between failing to raise capital and failing to execute on an idea after having raised capital. The Bitcoin.com article combines these two into a larger headline. But when we look at the "failing to raise" stats, things are not so dire. In 2016, that number is 14% and in 2017 it is 28%. This is in line with the intuition that it is now harder to raise money in crypto than before as investors become more discerning. But it is still far easier than raising money on Kickstarter, for example, which sees a 64% failure rate.

And second -- if we do the math on operational failure in 2017 ICOs, the answer comes out to 18%. That may seem like a lot in a short period of time. But we can compare this to the percentage of Seed stage startups that fail to raise Series A, thereby failing to achieve enough operational traction to move to the next round. A Mattermark data set suggests that 68% of early stage companies wipe out without going to the next round, and CB Insights shows similar numbers, with 40% failing to raise and 14% exiting the market. Runway for venture-backed companies is usually 18-24 months. If ICOs continue to fail at their current pace, perhaps the numbers will look even more extreme than traditional startups. But today, 18% is far below the 60-70% comparison.


New Solutions for the Attention Economy

  Source:  Newsweek / Slate

First, the attention economy is the lifeblood of large tech firms. They ingest human attention through social or entertainment ecosystems, and sell that attention, targeted through personal data, for advertising revenue. According to eMarketer, Google and Facebook generate over $100 billion in net revenue from digital ads. That's about as much as Alibaba, Baidu, Tencent, Microsoft and everyone else combined. Most tech platform building activities from these companies is a way to grab personal data and repackage it as a product, rather than charging a consumer for the product. None of the privacy initiatives to undo this, like Ello, have worked until now.

The law of conservation of energy prevents people from creating perpetual motion machines. In a similar way, attention is a limited resource. Attention has scarcity, and can be turned into a digital asset that is traded and used as currency. Projects like Steemit, Zappl, and LBRY are networks with consumers and producers. Consumers have mechanisms for rewarding content with their interaction, and producers get paid in native tokens. The source of the currency is based on proceeds from an ICO, or from speculation on the attention coin. Others, like Brave / Basic Attention Token or GazeCoin have a mechanism for capturing attention as part of their product. Whether it is powering micro-crypto transactions through a browser, or by recording the view of a user on a particular piece of content, these projects automate the curation aspect. And then there is the swath of ICOs, like Kodakcoin or Poet, that are trying to build crypto aspects into the content itself. All three approaches challenge algorithmic advertising as a the default monetization model of the web.

Quantifying this at such an early stage is tough. Facebook has over 2 billion monthly active users, while Steemit has 150,000. If we rewind back to look at young Facebook, it had 1 million users in 2004 and 6 million in 2005. So crypto social media usage is .01% relative to current Facebook and max 10% of Facebook at the same stage. From a value perspective, one crude metric is to look at the implied marketcaps -- STEEM around $1 billion, BAT at $400 million. We can think of these as aspirational market prices for the value of the attention economy that can be enabled by these systems. If global digital net advertising revenue is $200 billion or so, at a 10% discount rate, it represents an asset of $2 trillion. This implies about 0.1% of expected attention economy value, as priced by the markets, is in crypto .

But there is another solution, and it is the answer to the question posted at the start -- browser-based crypto currency mining. On visiting a website, the user's browser is hijacked (or willingly given) for the purpose of mining the privacy oriented coin Monero. Because Monero is CPU and not GPU intensive and is untraceable, it is the perfect candidate for sites like The Pirate Bay (already doing it) or the New York Times (should be doing it) to monetize their content. In a sense, this is a frictionless, effortless way to actually get readers to move away from the assumption that content is free, and also reduce the friction inherent in paywalls, adoption of blockchain-based software, or re-engineering of content packages. We never gave consent for the big tech firms to take our data -- do we need to consent to hand over our CPUs?

Should Roboadvisors Maximize Assets or Accounts?

  Source: Autonomous NEXT

Source: Autonomous NEXT

Here is an interesting property of digital wealth management and B2C Fintech startups building brands in the space. We took a look at the most recent regulatory filings of the first wave of roboadvisors (e.g., Betterment, Personal Capital) and the following wave of micro-investing services (e.g., Acorns and Stash). And there seems to be some invisible tradeoff between devoting resources to gathering assets versus gathering users. 

Betterment has $11 billion or so in assets under management with a $40,000 average account size. Personal Capital is at $4 billion ($6.5 billion according to their site), with a $150,000 average account size. From an attention economy perspective, the numbers of accounts is quite modest -- 400,000 and 30,000 respectively. In the tech world, less than a million users is not particularly impressive. Their audience however is an order of magnitude greater than that -- the Personal Capital freemium model has 1.6 million registered users, which is about a 2% conversion rate.

When looking at the micro-investing services, we see around 1.3 million users for both Acorns and Stash. This is an impressive metric on its face, until we dig into average account sizes - between $100 and $600 per client. So the overall assets under management are really quite small at $200-500 million. If this were a single advisor team at Goldman Sachs, with a $50 million budget for marketing (i.e., VC money), they would have been fired for under-performance on asset gathering by this point. But from the point of a tech play, they are similar to a more modern Mint.com (25 million users), with a monetization option bolted on that is attached to workflow automation.

Similar things can be said about digital banking and lending. For example, take the multi-million user bases of Venmo, Digit, Transferwise or Revolut which maximize for engagement. The transactions and balances are all small. But their account totals will be much higher than that of neobanks trying to gather assets and underwrite loans, like Bank Simple or Moven. We don't think this is just a matter of going downstream in a market to smaller customers. Instead, it is about focusing the product to behave like a media/tech company or a finance company. There is an exception to this trade-off today, and that is Coinbase and other crypto startups. There, we see both a massive number of users and the associated economics behind the business. Coinbase custodies $9 billion in assets from 13 million users -- that's not quite the $5 trillion of BlackRock, but certainly a win both for the operating business and the attention economy. No surprise then that Robinhood is betting on crypto as well -- digital wealth will collide with digital assets.

Getting Used to Mixed Reality

Virtual reality is still missing its killer app, though VRChat is showing some real potential with 3 million downloads and 7,000 daily users. The app is an open environment where users can render both their world and their avatars. Think about a rudimentary version of Ready Player One that looks like Second Life. The app has had success for three reasons: (1) user generated content and thus endless variety, (2) the ability to use it even without VR on a regular desktop computer, and (3) video streaming of the app on popular video site Twitch, with nearly as many people watching the the virtual world as are actually in it. 

  Source:  Steam / RoadtoVR

VR games are essentially behavioral training for augmented reality commerce. If users build and value objects and experiences in a virtual world, users will value them when overlaid on the physical world. Think about how video games from the 1980s and 90s became the blueprint for gamified mobile interfaces in the 2010s (see Mary Meeker's thesis on this here, pp 103-155). And we already see this happening. One sign is the planned entry of Magic Leap into retail. Another sign is fashion brand Chanel investing into tech company Farfetch (which had already raised $400 million from Asian fintech JD.com). Chanel is explicitly not interested in distributing through mass online retail, but are moving towards creating highly personalized augmented reality shopping experiences. 

Weaving together some crypto projects in the space can also help us see ahead. AR glasses manufacturer Lucyd has partnered with Gaze Coin, so that interactions with objects rendered in AR can be monetized. Similarly, there's a partnership with gaming network Gizer and algorithmic advertiser Advir.co. Combined with a rights-management overlay like Bubbled, you get a coherent integration of services that replicate digital advertising and commerce infrastructure in the physical world. Because in reality, we search for things not by typing or speaking, but by looking.

  Source: Lucyd

Source: Lucyd

Jan 2018 ICO and Crypto Fund Numbers


2018 is off to a bumpy start for the trading of large cap crypto assets. But we hold the view that pricing accuracy of $100B+ tokens isn't particularly meaningful for the technology progress in the space. It measures sentiment, which perhaps reflexively prices the market, but isn't all that helpful for figuring out what's happening in the world. On the other hand, the flow of resources -- from capital, to human, to corporate -- indicates something more real. When people choose a new way or a new product, the super structure may change. 

We updated our ICO and crypto fund data as of Jan 2018. The first finding is that ICO funding, which is a metric for the early stage entrepreneurship in the space (like Angel and Series A funding), is looking quite healthy. 2017 ended with $5.4B of ICO proceeds going to projects raising over $1mm+, and the one month of January already has $1.4B in flows. That doesn't include either Telegram's $1B+ planned ICO, or Overstock's $250-500mm raise, so we expect this level to continue through the year.  It may be harder for an individual ICO to raise capital given higher standards and competition, so in that sense, the market is equilibriating with the Venture Capital market. Vesting schedules, performance targets and covenants are becoming standard as the early crypto funds are joined by mega venture like Andreessen. Traditional early stage investors are writing equity checks into blockchain companies, but those numbers are less than 20% of the overall equation.


Coindesk makes the point that in Ethereum terms, actually the funding levels are fairly stable and not increasing. From our view, that's the whole point! The crypto Cambrian explosion was driven by capital gains in Bitcoin relative to fiat. Of course people are taking risk at the edges, using their winnings to fund more work. But there is indeed some danger that if the smart token platforms collapse in value, ICOs will have less purchasing power and thus facilitate less development. This is a real risk. And given that an increasingly large proportion of the ICO proceeds are funding utility tokens (magenta in the graph) and fewer platforms/currencies, actual economic activity within the apps has to appear for investment value to exist. 

The second data point is that the number of funds continues to grow. We point to crypto capital markets volatility as a positive for the plethora of trading, quant and index funds entering the market. In total, we are tracking 225 crypto funds across 7 strategy types (hey there Salt's credit fund), and see assets in the space being between $3.5 billion and $5 billion. The diversification of strategies point to an earlier observation that crypto has collapsed all asset classes into software, putting hedge fund managers and venture investors into the same exchange. No wonder there's pandemonium.


If you would like to have your fund added to the list, or to get access through an institutional subscription, please reach out here

Amazon and Bank of America

  Source: Amazon

Source: Amazon

Remember how Amazon has a lending business line that makes loans to merchants on its platform for up to $750,000, competing with OnDeck, Kabbage, Square and Paypal? We've discussed before how the online retailer has proprietary data that indicates company revenues before those revenues even materialize -- the traffic on product pages by consumers on the Amazon website. The key advantage in underwriting is the reach of your data and the quality of your algorithm, so having a data set broader than payments and an AI smarter than one built by a bank should allow the company to drive a wedge into financial services.

Except it doesn't really want to. CNBC reports that Amazon's lending activity has been purposefully capped at an annual $600 million, and that the firm has partnered with Bank of America for future capital. My colleague Brian Foran at Autonomous Research put this in context. Even if Bank of America doubles the Amazon program to $1-2 billion, it will not be material for the bank in the context of a total loan book for $930 billion. And second, by outsourcing the capital to a bank, the tech giant is (1) side-stepping regulatory financial oversight, and (2) is using capital more efficiently in higher-growth businesses than just lending. Like robo-retailing and augmented commerce.

Compare this with China. Alibaba's commercial bank MYbank, Tencent's WeBank, and 6 other private lenders that were started in 2015 now have a loan book at over 80 billion yuan ($12 billion). Still a drop in the bucket for BAML, but quick expansion for a technology-first financial institution that faces more favorable regulation.

Or take the even more interesting example of Microsoft and Bitcoin. The tech firm is building an off-chain layer on top of the public blockchains to re-invent identity services, and find a way to give at least some data back to the user. Solving an old problem with a solution on new infrastructure (paper > database > chain) gives room for the solution to breathe. A $1 billion in loans may be peanuts for Bank of America as part of a $1 trillion business. But in Crypto, $1 billion in loans through something like SALT could be a market leader. Combine that with the Microsoft user base, and why do we need banks?

  Source: SALT

Source: SALT

Inequality, Unethical Robots and Unemployment

  Source: KKR

Source: KKR

Something's going on when MITKKR and Bain & Company all publish on inequality, automation and ethics breaches resulting from technology. The KKR report highlights that GDP growth is likely to slow in the West resulting from an aging population and a displaced worker force due to declining manufacturing employment. Productivity may go up on average as augmented humans become more efficient the work place, but the long tail of regular people who do not have gainful (i.e., cyborg) employment will increase. Re-skilling has not kept up, and the down-case is that 30% of all activities across 800 occupations can be replaced by software. We have argued before that digitization results in 50% revenue declines in industries that are fully transformed. 

The Bain study reiterates the main points -- automation of the US service sector has the potential to be a catastrophic event in terms of human employment (20%+ down), a conclusion previously reached by McKinsey. The corollary is that this will happen much faster than the transitions out of farming and manufacturing. Therefore, volatility in capital markets will increase, driven by the the middle-class being hollowed via the power laws of software and capital rents, thereby negatively impacting many industries targeting them as consumers. And the headline takeaway is a $5.4 trillion GDP shortfall by 2020. Yikes.

And the robots we make aren't even nice to us! In a study of image recognition artificial intelligence systems, top three commercial software packages had an error rate of 0.8% when determining the gender of a light-skinned man, and a 20-24% error rate when analyzing pictures of dark-skinned women. This bias comes from the underlying data, which does not have enough diversity to correctly teach the software, and the bias in the data comes from bias in the development team and organizational culture. Now imagine that such systems are used by police to identify criminal suspects, the way China is doing today. Would discrimination go up or down, if all people of a certain type are imprecisely profiled by software? Or imagine connecting these data sets to access to financial services? 

So what solutions can we imagine to this dystopian television series? Well, one idea is Universal Basic Income, which is being explored in Finland, Scotland, and the UK. Or maybe Amazon and JP Morgan will save us.

 Source: Bain

Source: Bain

  Source: Bain

Source: Bain

The Value of Centralized Vision

  Source: SpaceX

Source: SpaceX

Elon Musk launched the Falcon Heavy rocket into space with a Tesla car carrying an astronaut dummy, blasting David Bowie. His competitors spend about $500 million per launch, because the very expensive boosters which get the payload away from Earth's gravity fall back down and explode. Musk's boosters are smart -- they can land and be re-used. As a result, his cost is $90 million per launch. Good luck competing against a 5x advantage. 

We don't bring this up to point to the cult of personality, but instead to the power of a determined, clear vision backed by well-funded and functional organizations. While Fintech has been about democratizing access to financial services for customers, Crypto has been about decentralizing production to the community. Decentralization is useful and can create certain desired attributes, but it is not always strictly better. The Falcon Heavy did not come from design by committee, crypto consensus mechanisms, or votes from survey groups about what features customers would like. It came from reverse-engineering the future based on a purpose, levered with human and financial capital.

In Finance, the West is failing to have any coherent vision of the future. Few of our financial leaders have articulated anything close to an artificial intelligence or crypto strategy that coordinates across divisions to build a coherent future. Nobody has bet the farm. Compare for example with China. Hyperledger's executive director Brian Behlendorf recently discussed why operational progress in blockchain adoption among existing industry is far ahead in Asia. Money is moving through productions systems. $2 billion is being spent on artificial intelligence research and education. Americans are still debating coal.

In that light, we have to give credit to Overstock, which continues to move in the fintech direction that Amazon is avoiding for now. The online retailer has 40 million unique visitors per month. They can buy goods using Bitcoin, and now for $9.95 a month they can get a roboadvisor offering. That's right -- in addition to launching it's own blockchain-based trading system tZero and pursuing an ICO, the company is offering investment product portfolios constructed from baskets of stocks. The custody comes from Apex, and the algorithms from FusionIQ. And who knows -- maybe Bowie's playing in the background.

Chatbot Zombies in a Consumer Wasteland

  Source:  Digit

Source: Digit

Conversational interfaces are one of our most watched platform shifts. With (1) Amazon's sales of Echo devices exceeding expectations and 30,000 Alexa skills built by a growing developer community, (2) messaging app Telegram launching a $1 billion ICO, and (3) Apple about to enter the smart device market, it seems that voice and chat are strong theses about the future. But could we be wrong?

In an eye-opening interview with Inc.com, Digit founder Ethan Bloch talks about his conclusion that chatbots are overrated. As a reminder, Digit is a mobile-first app that focuses on automated savings using a chat interface, one of the top apps in mobile finance. This company bet heavy on chat as the native interface for Millennials, similar to Lemonade doing the same for insurance. His argument that designing for chat-first actually created more work for the user, and that the messaging experience is like a frustrating DOS command prompt. Bots are just not smart enough to hold a conversation. In response, Digit will adjust its design closer to an app with simple menus, rather than a chatbot that doesn't understand you.

And yet. TD Ameritrade is launching trading functionality through a chat interface on Twitter, using direct messaging. Or see SoftBank building conversational capabilities into its physical robot, Pepper. Bank branches full of Pepper bots are already in the wild (i.e., in Canada). So how should we make sense of the growing number of smart devices that can remember faces, understand emotions, speak with users, and support branching decision trees of financial account actions -- and the conflicting first hand experience of the entrepreneur who tried it and says it doesn't work.

The answer is always with the customer. Just like you can't sprinkle Augmented Reality on a complicated user experience and hope for magic, you can't add chat to a well-designed experience and make it less well-designed. The reason Digit works isn't because it can talk back to you, but because it does the homework of automated savings. Bots should do the financial homework, not just talk about it.

Which Financial Black Swans Are Scariest?

  Source:  SeattleBubble

Source: SeattleBubble

Remember when the markets took a dive of 5% last week and everybody said it was a "correction"? 5% is not a correction, it's a haircut. We reproduce below a few examples of market crashes to give context for what's in store at the end of a poorly managed bullish market cycle sporting several asset bubbles -- let's call it 20 to 40%.

But for the few wizards out there, it's hard to know where the fire starts. So we instead want to point you to three places where there's kindling and smoke. First, the volatility trade. Read this spectacular piece on why the world is far more exposed to being short volatility that may seem. It argues that in addition to the explicit $60 billion shorting volatility instruments like VIX, there is $1.5 trillion in implicit volatility shorts through strategies like risk parity (i.e., assuming we can trust historic correlations and standard deviations), and another $3.8 trillion in share buy-backs that create the illusion of growth and stability. As we saw last week, volatility may not be correctly priced, after 9 years of rising equity markets and low interest rates. During crises, correlations across asset classes go to 1, because end of the day we are just humans trading perceived value.

Second, and this could be a long shot, inflation and unemployment could be much higher than measured according to ShadowStats. This is purportedly due to changes in the approach to measuring CPI in the 1980s and 1990s, which had the net result of keeping entitlements payments in the US lower. Most economists disagree with ShadowStats, and modern efforts like the MIT Billion Prices projects finds that data from large online retailers tracks CPI fairly closely. But there is a non-zero probability that politics has impacted macro economic data. This type of argument supports the gold-bugs and the Bitcoin maximalists. But guess what, Bitcoin's 50% value drop was pretty correlated with the overall market, so it does not appear to be a great hedge in the short run. Because the short run is an ocean of inexperienced sentiment.

And last, younger generations are more heavily indebted than prior ones, especially with persistent student debt. Carrying around this burden implies an additional tax on Millennials which they pay to the government before buying a house or spending on consumption. The cost of this debt is 600 bps higher than the price banks get at the discount window. No wonder Millennials are printing their own money in the form of crypto currency, hoping to inflate away the debt through lottery. What other options are there?

Enjoy the tinfoil hat!


Why Bitcoin Falls Down

Remember the mantra. Tech innovations swing between the extremes of meme and electricity. Memes are human sentiment, the animal spirits of the market shooting up and crashing down. Yahoo message boards, Reddit posts, Telegram communities, excited media articles. Electricity, however, is real. It's discovery and taming led to an industrial revolution, light and progress. Today's laundromats might be boring and tame, but imagine the first robotic clothes washer animated by electric powers unseen. All tech innovations have a bit of each. Crypto is enjoying its meme moment. Why is Bitcoin going down, after it went up? Let's talk about the factors that are adding up to the current sentiment.

(1) The first is definitional -- Bitcoin (and all crypto) is a volatile early stage technology asset and these massive run-ups and falls are a feature of the asset class, not an exception.

(2) The second is that data points about hacks and Ponzi schemes have been dominating the news. From Tether (which may be trying to print billions of sovereign currency) to Bitconnect (likely Ponzi scheme with a proprietary coin falling from $2.6 billion in marketcap)  the Coincheck hack ($500 million Japanese exchange hack), to Arise Bank ($600 million ICO shutdown by the SEC), billions of USD equivalent value keep are literally evaporating from the crypto economy due to bad actors. These issues are not new in the space, but now there is mainstream attention with nearly at trillion at stake, and the regulators are starting in enforcement actions.

(3) The futures market that so many crypto natives were excited about allow professional investors to actually take a bearish view. Oops. This sentiment should reflect back into the price mechanically.

(4) Decentralized systems will supposedly erode the control of centralized systems. So we should not be surprised when centralized systems fight back when coopted for this purpose -- from Facebook's Bitcoin ad block and regulator crackdown on fake bots, to the refusal of credit card issuers and banks to keep financing crypto purchases, to asset managers like Vanguard announcing they won't create vehicles for the asset class.

None of this should be new information. If in 2002 you asked the music labels whether they like Napster, not only would they answer with a resounding NO, but they would talk about Digital Rights Management and all their plans to fight back. Welcome to creating product-market fit.

Wells Fargo Forbidden From Growing by Federal Reserve

  Source: CNN Money

Source: CNN Money

In the legal tradition, civil courts can do one of two things: (a) make a party pay damages for injury resulting from a particular action by that party, or (b) prevent the party from taking an action in the first place through an injunction. Meaning, they can make you pay for your mistakes with money, or put you in time-out. The Federal Reserve has just put the entirety of Wells Fargo in time out by forbidding it from growing until it fixes the mistakes that led to its scandals (like opening 2 million fake accounts, aggressive sales tactics, etc). Wells has already paid $185 million in fines, so this is a cherry on top. The firm can add no more assets over the level it had at end of 2017.

This move is a potent reminder of sovereign power, and how it could be effectively used. All this noise about scams, fraud, crypto, and Ponzi schemes -- all this can hit a wall. Every exchange can be shut down. Every bank can be unlicensed. Sovereigns have teeth, and they should not be afraid to use them (for the right reasons of course). This is far easier to do with well regulated centralized entities, like one of the world's largest public banks; decentralized crypto may survive even such an attack. Other examples of sovereign power can be seen in the transformative European legislation of PSD2GDPR and MiFID II. These regulations force open bank data into accessible APIs that support fintech, create a personal right to be forgotten that forces a company holding your data to delete it, and separate investment research from trading to prevent inducements. 

Similar force could be used to deal with propaganda bots and the overreach of the big tech companies. We know that GAFA are dealing with millions of fake accounts (not unlike Wells). But these accounts manipulate information, public opinion, commercial outcomes and financial investment. From this point of view, Facebook's block of crypto-related ads is self protection, trying to prevent the system from being coopted for financial manipulation and regulatory response. See how the New York state Attorney General is going after the firm that manufactured fake accounts. We can also look at the healthcare alliance between Amazon, JP Morgan and Berkshire in this light -- a way to start remedying social unrest resulting from automation and increasing concentration of wealth, a first step to universal income.

One solution is fairly simple. Until Facebook, Google/Youtube and Twitter get their social news problems under control, they could be restricted from adding new accounts over the level of 2017 year end. Now that would be one way to fix the attention economy.