What We’re Reading (Week Ending 12 September 2021) - 12 Sep 2021
Reading helps us learn about the world and it is a really important aspect of investing. The legendary Charlie Munger even goes so far as to say that “I don’t think you can get to be a really good investor over a broad range without doing a massive amount of reading.” We (the co-founders of Compounder Fund) read widely across a range of topics, including investing, business, technology, and the world in general. We want to regularly share the best articles we’ve come across recently. Here they are (for the week ending 12 September 2021):
1. Josh Williams: Building Infrastructure Technology for Blockchain Games – Aaron Bush and Josh Williams
[Aaron Bush] What convinced you that the realm of play-to-earn and blockchain games was worth committing to? What does this underlying technology enable for the first time that made you think this was worth changing your career to focus on?
[Josh Williams] I got so excited about building Forte as an enabling platform for game developers around the world. Players around the world, including myself, spend lots of time, energy, and money in games today in the virtual worlds that they create. But, economically, games are pure entertainment experiences. All of the purchases that players make in games today, to the tune of close to $200 billion a year, are just entertainment expenditures from the players’ perspective. Even if you spend a lot of time and money in games, you don’t own anything or have any economic opportunity.
As the world becomes more digital and our experiences become more virtual, it’ll be more important to have real economies and property rights in virtual worlds just like we do in the physical world. What blockchain technology unlocks for the first time is a safe, sound, and secure way for you to be able to own digital goods. It can prove the provenance, scarcity, and ownership of goods that are purely digital. While the cost of copying a good is negligible, you can still have a true history and provable scarcity for digital goods so that they can become commodities and have real value.
That was the big change that blockchain technology unlocked. It was so exciting to me, and I’m still excited today. I get out of bed every day to work on this stuff and hopefully pull the future forward a little bit…
…Tackling one more criticism that some people have towards blockchains in games, what would you tell those who say that you can build player-owned economies and marketplaces with more standard development tools and bypass blockchains altogether? What in your mind does a blockchain add that literally couldn’t be done without it that more developers should be excited about?
This is maybe a subtle point, but I think it’ll become increasingly clear: The big difference that blockchains enable is an open but secure database. Instead of just the game developer operating the database and being the only authority that can write to the database and authorize transactions, players themselves can own the assets. Anyone in the world can write to the database and submit bids and transactions.
The underlying innovations in blockchain are pretty powerful. This idea of an open database isn’t new. It’s been a concept in computer science for a long time. What Bitcoin and now blockchains more generally did is they introduced some mechanisms that make it possible for the first time to have this open database that anyone can write to. You can be assured that all the transactions in the database are secure and sound. That was the core innovation ten years ago, and it’s the reason why you can do things like have an open blockchain that not just a developer controls, but anyone in the world can participate in and be assured that the developer or no one can take away the digital goods that they’ve purchased…
…You mentioned that over the long-term Forte is planning to decentralize its platform and potentially even dissolve itself as a company. Is that latter part true? If so, how does that work, and how are you thinking about that playing out over time?
That’s true. We want to open up our platform. I think that we’ll create sources of value for the ecosystem over time and potentially spin out companies that provide services that are in no way proprietary, but maybe are just really important. Those things that we spin out could have revenues, profits, and operate like traditional companies (where it makes sense to do that).
Other aspects of what we do today might be split up and be purely open source technologies where anyone can contribute to them and, hopefully, also earn value for their contributions. When people in the blockchain space talk about decentralization, it’s this umbrella term. It’s like a panacea for everything, but there’s many dimensions upon which you can decentralize. We try to be super thoughtful about the way we decentralize while still providing great services for publishers and developers. How do you stand up this ecosystem that could be self-supporting and rewarding to everyone? There’s an economic reason to improve the technology, or write more code, or provide a better and faster service, or create more liquidity.
You can have these economic incentives in the system. We, or companies we create, may participate in those too, but the core principle is to make it an ecosystem, not a walled garden that only we have access to. It’s the publishers, the developers, the players, and their communities that create the value here, and we’re just creating enabling technologies and services.
If it leads to Forte dissolving and decentralizing as a company, it’s pioneering a new type of business model, especially in the realm of games. I’m curious how that jives with raising venture capital. Does Forte turn into a decentralized anonymous organization (DAO) and get tokenized? Many people in games are starting to understand how decentralization and tokenization can work on a games level, but can you elaborate more how that plays out at a company level?
As blockchain technologies take off, they’re incorporated into more real applications that use them in fundamentally important ways. More companies will shift to trying to figure out how to best align with the underlying technology and the users either in their marketplace or on their platform. A lot of that will result in people thinking less about companies and more about decentralized organizations of various kinds.
Just to zoom out a bit, the idea of a corporation is pretty new in human history. What it is in most jurisdictions around the world is this legal construct where you can have joint ownership and a common interest, but it’s a very bounded legal entity structure. What I think is so cool about blockchain technology is it creates a new technology-oriented way to create economic organizations where anyone can participate. Even internally at Forte we really try to be careful about calling ourselves an organization, not a company. The idea over time is there may be companies that spawn in and around the ecosystem we’re creating today.
We call ourselves Forte Labs for a reason: we can create this technology, spin up businesses around it to enable the ecosystem (if necessary), but in other instances do the opposite and create technologies that anyone can use and get access to. It’s all new, and it’ll be increasingly important for many companies to think about this. There’s a lot of this research and thinking going on in the crypto space around DAOs and tokenizing things. That’s one aspect of what’s possible, and it’s sometimes (but not always) the right thing to do. However, the idea that you can incubate technologies, foster an ecosystem, and then either create companies or protocols that provide services, and create value over time, will happen more and more.
2. Inequality, Interest Rates, Aging, and the Role of Central Banks – Matthew C. Klein
Auclert et al argue that population aging—and slowing population growth—is partly responsible for the global drop in interest rates because slower population growth reduces investment. There is less reason to reward those who put off spending when there are fewer people trying to build factories, houses, or other types of capital.
This effect should only get bigger if the United Nations’ forecasts pan out:
There will be no great demographic reversal: through the twenty-first century, population aging will continue to push down global rates of return, with our central estimate being -123bp, and push up global wealth-to-GDP, with our central estimate being a 10% increase, or 47pp in levels.
In the 1960s, total population growth in the major global economies (the “high-income countries” plus China) averaged almost 2% a year. That slowed to just 1.2% a year by the 1980s, 0.9% a year by the 1990s, 0.6% a year by the 2000s, and just 0.4% by the eve of the pandemic. The combined population of these economies is projected to shrink starting in the 2030s, eventually falling nearly 20% from the projected 2030 peak by the end of the century.
Put another way, the number of children aged 0-14 in these economies fell from a peak of more than 600 million in the mid-1970s to about 465 million now. The number of children is projected to plunge almost 30% from current levels to just 335 million by 2100.
That pushes down interest rates, according to Auclert et al, because fewer people means there is less need to provide for the desires of future generations. This effect outweighs the fact that older people have much lower saving rates than everyone else. An aging society might produce less, but demand falls even further and faster. The process began in the 1980s and could continue for decades to come.
That’s consistent with what I noted almost six years ago when writing about Japan. There, population aging in the 1990s and 2000s pushed the household saving rate to zero during a period of sustained government budget deficits—yet interest rates went down. The reason was that households are only one piece of the broader economy. In Japan’s case, the decline in business investment and the rise in corporate profitability (which in turn was partly attributable to lower pay for workers) were more than enough to offset what was happening in the rest of the economy…
…Mian, Straub, and Sufi, in a paper presented at the Federal Reserve Bank of Kansas City’s Jackson Hole Economic Symposium, focus on how changes in the income distribution affect saving rates, borrowing, and consumer spending.
The key insight is that the ultra-rich are different from you and me: they have much higher saving rates regardless of their age. No matter how expensive your tastes, there’s a limit to how much you can consume, which means any income above that threshold has to get saved. The ultra-rich therefore spend relatively small shares of their income on goods and services that directly provide jobs and incomes to others, instead accumulating stocks, bonds, art, trophy real estate, and other assets.
The ultra-rich need no encouragement to refrain from buying goods and services, so any increase in income concentration should put downward pressure on interest rates. Another way to look at it is that an increase in income concentration boosts the demand for financial assets, which should push up prices and push down yields.
3. Inside Huarong Bailout That Rocked China’s Financial Elite – John Liu, Rebecca Choong Wilkins, Kevin Kingsbury, and Ye Xie
Huarong was created after the Asian financial crisis of the ’90s to help safeguard Chinese banks. The idea was to have the “bad bank” mop up souring loans that had been made to many state-owned enterprises.
Then its longtime chairman, Lai Xiaomin, began borrowing heavily to expand into all sorts of business. Known as the God of Wealth, Lai was later swept up in a corruption scandal and then executed this past January, just as the problems at Huarong were gaining attention around the financial world.
By June, no one was under any illusions: Huarong needed help. But inside the company’s Beijing headquarters, employees were shocked by the mere suggestion that the once mighty Huarong might become just another subsidiary of some other SOE. Huarong’s decades-long ties to the Ministry of Finance conveyed status and prestige – and suggested a level of government support that, in better times, had meant cheap borrowing costs. Huarong executives were counting on some sort of government help but never dreamed their prized link to the finance ministry might be severed, according to people familiar with the matter.
And yet various regulators, driven by individual interests, couldn’t agree on who should assume responsibility for Huarong – or, more urgently, who would have to pay for it, according to people familiar with the matter. Numbers from offshore subsidiaries and onshore units were tallied again and again. It was clear Huarong had neither the time nor the money to save itself.
Central Huijin Investment Ltd., an arm of China’s sovereign wealth fund, began kicking the tires. But it was hoping the central bank would extend a loan to help finance a deal. The proposal was promptly nixed.
By late June, regulators pulled in Citic. The conglomerate is a ministerial-level financial powerhouse directly overseen by China’s cabinet, with more than $1 trillion of assets.
For nearly two months, a Citic team pored over the books at Huarong’s headquarters. Even at Citic, a Chinese company as connected as they come, the political nature of the task raised eyebrows. Huarong’s finances were so troubled and past dealings so fraught that some members of the Citic team worried they might be blamed for the mess. They wanted assurances that they wouldn’t be held responsible should higher ups take issue with any rescue plan later on, one of the people said.
The numbers, audited by Ernst & Young, were dire. Huarong had lost 102.9 billion yuan ($15.9 billion) in 2020, more than its combined profits since going public in 2015. It wrote off 107.8 billion yuan in bad investments.
For two weeks, officials resisted signing off on the results out of concern for their own careers. But the clock was ticking: Huarong had to disclose the results, overdue for months, by the end of August or it would be deemed in technical default. The deadline was only weeks away.
At last, terms were drawn up and the State Council, long silent about Huarong, gave its blessing to a rescue that combines a government bailout with a more market-driven recapitalization. Huarong will get about 50 billion yuan of fresh capital from a group of investors led by Citic, which will assume the Ministry of Finance’s controlling stake, people familiar have said. Huarong is expected to raise 50 billion yuan more by selling non-core financial assets. On August 18, Huarong went public with its huge losses and quickly followed up with news of its rescue.
4. How Coinbase Ventures Became One Of Crypto’s Busiest VCs—Without Any Full-Time Staff – Alex Konrad
Coinbase Ventures has backed more than 150 companies in its three years in existence, with notable companies in its portfolio from all over the crypto ecosystem like the well-funded but regulation-challenged BlockFi, non-fungible token (NFT) marketplace OpenSea, digital collectibles maker Dapper Labs, blockchain startup StarkWare and TaxBit, which recently raised funding for its crypto tax software at a $1.3 billion valuation.
Unlike some other corporate investors, Coinbase’s venture capital investments don’t come from a dedicated fund, but off its balance sheet. The company writes checks of $50,000 to $250,000 in seed rounds and larger, if necessary later on. And with its volume of deals and lack of dedicated staff, Coinbase Ventures prefers to join rounds led by other VC firms and not take board seats…
…Coinbase Ventures got its start in 2018, after Choi joined in March as head of corporate development after eight years spent in that function at LinkedIn. Meeting with cofounder and CEO Brian Armstrong, Choi says she took the job in part due to Coinbase’s willingness to aggressively consider acquisitions while still a private company. “I’m typically very skeptical of corp dev at late-stage startups,” Choi says. “Everybody says they want to do M&A, and they actually don’t—they just think they do.”
By April 2018, Choi had the idea that Coinbase should launch a program to invest in other crypto startups. Such a move wouldn’t necessarily come as a surprise considering that Armstrong’s cofounder, Fred Ehrsam, had left the previous year to cofound a crypto-focused venture capital firm, Paradigm; Coinbase also maintained close relationships with its own investors such as Union Square Ventures and Andreessen Horowitz. But the company didn’t have any venture professionals on staff; it also might face concerns, as a cryptocurrency exchange, of playing favorites with projects it backed.
Approached by Choi, Armstrong’s response was simple, she says: “Write the blog post.” Within 24 hours, Choi had drafted up a mission statement for Coinbase Ventures in such a public-facing format and published it. The company’s venture arm was now announced.
But that doesn’t mean Choi, later promoted to Coinbase’s COO and president, went on a hiring spree. Coinbase employees, many of them not only in corporate development (more mindful of acquisitions or big partnerships) but also in product and its coverage team, among others, communicate via a dedicated Slack channel. “We were, like, we’re just going to wing it with resources that exist today,” Choi says. “And it’s a labor of love. We just work on it nights and weekends.”
While Coinbase often co-invests alongside the VC firm specialists it knows, many of its potential deals come in from its employees’ activity in the broader crypto ecosystem; others are Coinbase employees striking out on their own.“There is some amazing machinery behind the traditional VC ecosystem. Ours is using Google Docs,” says Choi.
5. What’s in your mutual fund? The collapse of Infinity Q is a warning to investors – Gretchen Morgenson
Marshall Glickman is a careful investor who says he works too hard to take chances with his nest egg.
Back in 2016, his research identified the Infinity Q mutual fund as a holding that could do well even if the stock market didn’t. He slowly built up his stake in the fund, watching its performance, and felt comfortable enough to place 30 percent of his substantial savings into the fund.
“I spoke to management multiple times, including people at the fund who told me they had all their net worth in it,” Glickman said. “These guys had an incredible pedigree. This looked like a total A-team.”
Now, Glickman’s investment in the fund is frozen amid questions about how its manager valued a large swath of its assets. Facing a substantial loss, Glickman, owner of an online bookseller in Vermont, is experiencing that bull market rarity — a mutual fund collapse.
The fall of the almost $2 billion Infinity Q Diversified Alpha Fund is a reminder to investors about the risks that can lurk in their holdings and the heavy costs and frustrations that liquidating funds bring. Glickman, for one, is especially upset that the fund’s trustees have set aside $750 million of investors’ money to cover potential costs associated with lawsuits against the fund and its officials.
At least one expert said he is not surprised that the Infinity Q flop involved a portfolio loaded with exotic and hard-to-value investments. In recent years, some mutual funds have increased their stakes in such instruments, posing significant risks to investors. Infinity Q’s holdings included complex bets on interest rates, commodities, currencies and corporate defaults.
“There are few things as important to investors as knowing the value of what they own, and the [Securities and Exchange Commission] has rules designed to ensure that funds accurately reflect the real values of their financial instruments,” said Tyler Gellasch, executive director of Healthy Markets, a nonprofit organization that promotes best practices in capital markets. “Unfortunately, less than a year ago, the SEC fundamentally weakened those rules.”
The rules were changed in the waning weeks of the Trump administration. One let fund managers increase their exposure to the riskier investments favored by Infinity Q, and the other allowed for relaxed oversight of mutual fund boards when valuing those arcane investments.
There is no evidence that the rule changes triggered Infinity Q’s valuation issues.
The Infinity Q mutual fund began operations in 2014, aiming to generate returns that did not move in tandem with the overall stock and bond markets. It had A-list connections: A major investor in the fund’s manager was the family of David Bonderman, the billionaire co-founder of TPG Capital, a mammoth private-equity firm that may soon sell shares to the public for the first time.
The Bonderman ties were a selling point for Infinity Q; a presentation from last September boasted that its investors would gain access to the same “alternative investment strategies originally created” for the prosperous family.
6. Lauren Taylor Wolfe – The Modern Activist Toolkit – Patrick O’Shaughnessy and Lauren Taylor Wolfe
Patrick: [00:06:25] There’s so much to chew on there and a lot to dive into the nuance of what you’re doing. But I think it would be helpful to frame first the contrast between what Impactive aims to do versus, I’ll call it the stereotype of the activist investor, which I view as very adversarial, trying to take control of the direction of a business because you think it’s going the wrong way and change it very aggressively, sometimes removing management, etc. Could you draw a contrast for us between that style, the sort of stereotype, and what you’ll be doing and are doing at Impactive?
Lauren: [00:06:57] It’s such an important question and we’ve thought so long and hard about that question. We spent a year on gardening leave and neither Christian or I garden much. So we thought about how activism has changed, what we learned, and what were the pitfalls that we want to avoid when pursuing a strategy. And the first I would say is there’s was really a focus on short-termism and low-quality businesses. So what we observed just in our returns and studying the returns of other fellow activists were that the majority of the best returns were in higher quality businesses and when there was investing over the long run whereby those businesses can compound on themselves and be enhanced with the activist levers. The old paradigm of activism had investors pursuing change at very low-quality business or low-quality management teams and they were pursuing sort of that short term quick fix or sugar high. And that can work sometimes. You get involved in a company and quickly force them to put themselves up for sale. But ultimately, in the vast majority of times that does not work. And what the activist is left with is a large illiquid stake in a low-quality business where time is not your friend.
That has the effect of diminishing the overall returns of the portfolio. The first thing that we are evaluating when we look at any new business is we ask ourselves the four key questions. They’re around quality, valuation, time, and activism. The most important thing is that we’re backing a high-quality business where time is our friend. Those are two key distinctive changes that we make. There are a couple of other things that we learned, sort of pitfalls that we felt some activists fall into that we wanted to either avoid or really just sort of flip the approach in its head. And I think the first is having an approach of humility. It is extremely important at Impactive that we lead with the fact and the substance underlying our ideas. We try to make them as indisputable as possible. But when we engage with management teams and boards, we’re doing so with almost a private equity mentality, looking to form a partnership with those teams. And we orient our ideas really around long term sustainable value.
We try to tell CEOs we’re standing shoulder to shoulder alongside you, looking out into the horizon and thinking about how can we make your business worth 2-3x over, call it a three to four or five year period. And that is really important. In the past there were some very hostile activists that would do ton a work but not engage with the management team, write a big whitepaper, show up with a large stake and slap the whitepaper on the internet or across the table to the management team and a board, having had no engagement prior to that. Our view is that if you simply lead with engagement and share the facts and the substance and the data underlying your position, you’ll just come out with better outcomes. And also on this note, there’s been a ton of research done. I think it’s Lucian Bebchuk at Harvard did a study way back that demonstrated that almost all activist situations wind up ending up in a settlement around two years out. So why wouldn’t investors and management frankly want to avoid two years of battling and the expensive cost of proxy fights and not to mention the distraction that management has away from the business?
And then, one last thing that I think is really unique to our culture that we’re building is our approach to compensation. Many other firms or hedge funds what we see is there’s almost a PM and analyst relationship or a relationship where an individual is compensated just on his or her ideas. There’s this sort of jump ball mentality. What that leads to is a lot of politicking, a lot of competition for capital, and it also compromises returns. So at Impactive we’ve designed a compensation structure where the entire team is compensated on the overall profitability of the firm. And we believe that that leads to really a “one firm mentality” of everyone swimming in the same boat…
…Patrick: [00:29:55] I’d love to turn to the E and the S now. These are, again, two tools that have drastically risen in prominence in the last two years or so. And I’d love to hear from someone that does this hands on, not necessarily screening quantitatively for good E and S practices inside of a business, but actually trying to affect change, how you think about these as useful in a way that doesn’t just do good but also does right by the shareholders long term?
Lauren: [00:30:21] When you take a big step back, ESG improvement is about making companies more competitive in the long run. So we talk about the “impact flywheel” of stakeholder primacy ultimately leading back to greater shareholder returns in the long run. And when we come to a board with an idea around environmental, social or governance change, it is always linked to a business case which is linked to profitability. So we ask ourselves two things when we’re trying to propose and advocate ESG change. If you imagine a Venn diagram, in one circle there’s all the ESG change and company can pursue and the other circle is all the NPV positive projects a company can pursue. We only operate where those two circles overlap. And within those two circles there are usually two key questions that are answered. One, is this material to the business? So is this environmental, social, or governance angle very material to what this business actually pursues strategically? And two, will this change drive profitability and value over the long run? And the reason for that is that boards have been skeptical of ESG and they should be skeptical of ESG, and so to encourage boards and management teams to pursue this change in sustainable way, excuse the pun, you have to link it to a business case.
That’s the baseline and the premise from which we’re starting. When you think about ESG and the stakeholder when I talk about the impact flywheel and the key stakeholders, there are really three key stakeholders and constituents that we focus on. Your employees, your customers, and your shareholders. Improved ESG ultimately allows companies to attract and retain stickier customers, stickier employees, and stickier shareholders. Doing this ultimately lowers the customer acquisition costs, it lowers human capital costs, and it lowers the overall financial cost of capital. These are all structural competitive advantages. So by pursuing this ESG flywheel, we’re ultimately urging companies to become more competitive, which will then make them more profitable and make them more valuable over the long run. These are longer term changes in nature. Our view is that when we think about our vision, I’ll take a giant leap up, and over a 10 or 20 year period our vision is that, not only have we changed one company to make it the most sustainable in its industry, but if it is the most competitive and the most profitable and the most valuable, all their other competitors will have to follow suit. So not only have we changed one company, we’ve effectively changed an industry. So that’s the longer-term vision…
…Patrick: [00:32:56] I’d love to hear a bit about how this actually works in an example. I mean, it sounds sort of obvious when you put it that way, but also very hard work that takes time. And so I’d love to hear maybe one of your favorite examples from the portfolio or from a company you’ve observed just to put some real context around what these changes look like inside of a company. So I wonder if there’s an example that you’d be willing to share, whether early or deep into the process.
Lauren: [00:33:22] One of my favorite examples is one of our largest positions is in auto dealer Asbury Automotive. I don’t know if I spoke yet about it, but the three buckets that we look at with companies are companies that are undergoing a business model transition to have more predictable revenue stream, sum of the parts opportunities, and businesses that are just misunderstood. This one falls into the business model has changed and it’s not being appreciated by the public markets. 10 years or 15 years ago auto dealers, very cyclical, new car sales drove a substantial amount of their profitability. Fast forward to today and it’s become more of a razor-razorblade model and the parts and services segment of the business drives two thirds of the profitability of the business.
Now, throughout auto dealers in the US and collision centers in the US, they’re operating at about 50% utilization and it’s because there’s a huge industry-wide labor shortage around mechanics. Curious about that, we engaged with management and we sort of peeled back the onion and what we learned was that there was one key candidate pool that was being completely overlooked in the auto technician field and that was women. Women were only 2% of mechanics but there was a big interest and a growing interest from women who were interested in becoming mechanics. So when you look at the auto services field also women dominate financially. They spend $200 billion annually on parts and services and automobiles. Engaged with the company to think about how can we target your utilization issue in parts and services, which by the way is the most profitable business … It has 26% EBITDA margins, which is much higher than the rest of the business. It has highest return on incremental invested capital. How can we drive more business and utilization by attracting and retaining more women?
So they went through and exercise and they’re the first publicly listed auto dealer to offer paid maternity leave. They’re going to a four-day work week or dual-shift workday so that this important because it allows individuals to offer childcare or eldercare, these two things fall disproportionately on the shoulders of women. They’re likely adding changing rooms for women to change in, for female mechanics to change in. And they’re engaging with other notable professional mechanics who happen to be female who know how to start workshops and attract and retain more women to the space. We know from just the macro perspective is women participate in the labor force in a greater rate, productivity improves, output improves, growth improves. And we’ve seen that for instance in construction and in healthcare. So that’s an example where diversity and inclusion, which is so important, can drive substantial return.
If they can attract and retain more mechanics and more women, and they take their utilization from 50% to 55%, that’s about a 15% uplift for their overall enterprise value. So the way that we convinced this management team to really take this seriously I think was to show them the numbers and the business case around getting their labor force retention improved and getting access to a new labor pool which would take up their utilization rates.
Another area is really thinking about how to make companies more green. So we worked with Wyndham, which is our hotel company to make their offering at their hotels more green and environmentally friendly and have their franchisees really outlay capital which had immediate paybacks for the purposes of pursuing a win-win for both them, their immediate customers, the franchisees, and then the end user guests who prefer to stay at hotels that have green offerings. That is one where Wyndham could flex its muscle representing 9,000 hotels globally to get preferred pricing on things like motion sensor detectors and smart HVAC systems, which have one year paybacks that ultimately drive margin for the franchisees who are generating a higher cash on cash return that will allow Wyndham to attract more franchisees to their overall segment of hotels, their overall brand umbrella, as opposed to their competitors. And it also makes the franchisee better off because they have a higher margin rate and they’re also attracting more customers because consumer tastes and preferences have changed and people care about green programs.
7. The Tim Ferriss Show Transcripts: Vitalik Buterin, Creator of Ethereum, on Understanding Ethereum, ETH vs. BTC, ETH2, Scaling Plans and Timelines, NFTs, Future Considerations, Life Extension, and More (Featuring Naval Ravikant) (#504) – Tim Ferriss, Naval Ravikant, Vitalik Buterin
Naval Ravikant: So once you’re up to speed on that, this one will make a lot more sense, but we’re going to get right into, not what is crypto or what is Bitcoin, we’re going to get into what is Ethereum. So, how do you describe it today, Vitalik?
Vitalik Buterin: Sure. So the one-sentence explanation of Ethereum that I sometimes give is it’s a general-purpose blockchain. So this, of course, makes more sense if you already know what a blockchain is. Right? It’s this decentralized network of many different computers that are together maintaining this kind of ledger or let’s say database together. And different participants have very particular ways of plugging into that. They can sense transactions that do very particular things, but no one can tamper with the system in a way that’s outside of the rules.
And Ethereum expands on the Bitcoin approach, basically saying, well, instead of having rules that are designed around supporting one application, we’re going to make something more general purpose where people can just build their own applications and the rules for whatever applications they built can be executed, implemented on the Ethereum platform.
So one explanation that I heard one person give is that Bitcoin is like a spreadsheet where everyone only controls their own five squares of the spreadsheet, but Ethereum is a spreadsheet with macros. So everyone controls their own accounts, which is their own little piece of this universe, but then these pieces of the universe can have code and they can interact with each other, according to pre-programmed rules. And you can build a lot of things on top of that like Bitcoin builds a monetary system on top, famously Ethereum can build decentralized domain name systems, again, various decentralized financial contraptions, prediction markets, non fungible tokens, and all different schemes that people have been coming up with.
The limit for what you build is basically your own creativity, but the core difference between building an application on Ethereum versus building it on some traditional centralized platform is this core idea that once you build your application, the application does not need to depend on you or any other single person for its continued existence. And the application is guaranteed to continue running according to the rules that were specified and you do not have any ability to irregularly go in and tamper with it.
Naval Ravikant: That’s a great overview. And I liked that Excel analogy of it’s a spreadsheet with macros instead of a spreadsheet where you control your own cells. I’ll also try and articulate in a few ways that I understand it, around the edges, because I think Ethereum is one of those things that’s now quite a bit bigger than you. It probably has evolved in ways that even you didn’t fully anticipate. So in some sense, we’re discovering Ethereum and no longer just building it.
I also like to think of it as an unstoppable application platform. So a platform for building unstoppable applications, like a world computer where let’s say that we want to run very, very important computer programs where we don’t trust the computer itself and we don’t trust the other people to execute code on our behalf. Then we create a single world computer where we check the code on the machines of many, many different people all around the world who are properly incentivized to maintain a single computing state.
So if Bitcoin is a shared ledger, then Ethereum is a shared computer for the entire world to run its most important applications. So some of the applications that people are building on it are among possibly the most important applications of the future. So let’s talk a little bit about those applications, about what this trustless world computer is doing. What are the applications today that are the most common and that you’re most excited about?
Vitalik Buterin: So, first of all, I think ETH, the asset, is a cryptocurrency and in itself is an application and the first application of Ethereum. Going beyond financial things a bit, I mentioned ENS, the Ethereum Name System. So ENS, you can think of it as a decentralized name system. For example, when you go to ethereum.org, there is DNS, Domain Name System which has this big table that maintains this mapping of, well, if a person enters, if you’re on .com the server, they actually have to talk to it, to talk to the website like some particular IP address. And this DNS system that maintains this public relationship is a fairly centralized system with a very small number of servers running it. So ENS is a fully decentralized alternative that is running on the Ethereum blockchain.
And you could use it not just for websites, right? Like you can use it just for accounts. So for example, there was a messaging service called Status. In terms of what it feels like to use it, it’s a messenger, it’s similar to Telegram or Signal or WhatsApp or any of those, but the difference is that it is decentralized. And so there is no dependence on any single server or like there’s still a dependence on Status, the company, which is nice because it makes the whole thing much more censorship-resistant. It makes the whole thing just a much more guaranteed to survive regardless of what forces wish for its existence or wish against its existence in the future. And the like ENS, this is really an important part of it because, well, if you have a chat application, I need to have sub name by which I can refer to — like the users that I want to talk to. Right?
Like I wanted, so I could type in and say, I wanted to talk to the Naval and things like Telegram and Signal and WhatsApp, that mapping is generally like basically authenticated and controlled by a server. But whereas in Status, it’s all just done by the Ethereum blockchain. Right. So, that is one good example. I think of it like not financial, but still very important if you’re in an application. Now going beyond those two cases, there is a lot of more complicated things. So there is the DeFi, decentralized finance space, which is this big category that has all sorts of interesting contraptions in it. So for example, there is a prediction market. So a platform for where you can go in bet on different outcomes like who is going to win some sports game or who is going to win some particular election.
And there have been very successful prediction markets running on the Ethereum blockchain. There’s just the markets for trading between different kinds of assets. There’s what’s called synthetic assets. So, if you want to have access to some mainstream real-world asset like it’s all, or it could be one example, but you don’t have to tell us. There’s lots of other examples as well. There are versions of this that are purely virtual sort of simulated versions that exist purely within the Ethereum environments. So now there’s this entire kind of a very powerful financial tool kit that exists within the Ethereum ecosystem. On the whole, there’s just a lot of these interesting things that happen. I mean, there’s even games that are based on Ethereum. There’s a whole bunch of different things.
Disclaimer: None of the information or analysis presented is intended to form the basis for any offer or recommendation. Of all the companies mentioned, we currently have a vested interest in Alphabet (parent of Google Docs). Holdings are subject to change at any time.
