What We’re Reading (Week Ending 19 December 2021) - 19 Dec 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 19 December 2021):
1. Want to be a Disruptor? – Marc Randolph
Stories of disruption almost always start this way.
I recently consulted for a large manufacturer who sold their product using a classic distribution model; they sold their product to distributors; the distributors sold to retailers; the retailers sold to the end users. Everyone was happy. Of course, to support so many tiers of distribution, the price to the end-user had to be high, but so what? They had a monopoly. Where else was a customer going to go?
But then the inevitable happened. A start-up launched a similar product, but rather than take the leader on directly, they bypassed the usual channels and sold directly to end users. The product wasn’t as good, but by cutting out distributors and high-priced salespeople, their prices were about half.
The CEO of the larger company saw this happening and knew exactly how to respond. They would launch their own direct-to-consumer division and use their more powerful brand name and dramatically larger marketing budget to nip this threat in the bud. All good.
All good, that is, until their VP of sales heard about it. “We’re going to compete with our own distributors? You’re going to make my job harder? I’m out of here!”
The next call came from their biggest distributor. “You’re going to compete with me? Find yourself another distributor!”
Soon the entire retail network was up in arms. The direct-to-consumer division idea was shut down before it even started.
And the start-up? They got three good years of market share gains before the larger company finally decided to launch the D2C division they should have launched at the beginning. But by then it was too late.
2. The Volatility is the Point – Joshua Brown
You don’t grasp that returns only come to those who are willing to bear that volatility when others won’t.
The volatility is the point.
It is the growling guard dog that keeps others away and safeguards the opportunity for you, if you dare.
It’s the reminder that the road to wealth isn’t freshly paved blacktop. As Logan Roy explained to his son this weekend, “It’s a fight for a knife in the mud.”
Its the governor that forces us – me, you, everyone – to be thoughtful about the size and nature of risk we’re about to take.
If not for the volatility, the fluctuation and drawdown, the pain of seeing dollars on a screen disappear, then premium returns over the interest rate on a checking account would not exist. That’s where the term ‘risk premium’ comes from. No risk, no premium. Showing off your ignorance of this concept lets everyone know how immature, inexperienced, uninformed and short-sighted you are.
Real players of the game know this. That’s why you never see them cackling at others over losses, be they temporary or permanent. Anyone who’s ever accomplished anything in the investment markets has lost. Many times. Lost big. Will lose again.
You cannot win if you are unwilling to lose.
It cannot be any other way.
3. Aaron Wright – A Primer on DAOs – Eric Golden and Bill Aaron Wright
[00:05:08] Eric: From that germ, that whitepaper, that first let’s call it DAO, it was about a year later, they were attempting to raise $500,000. They raised something like 150 million. There was a famous hack, which people can go read about, and then an SEC letter that said, “These are securities.” And so the first DAO didn’t go well. And I think what I’m really curious about is someone like you, who’s starting to take a very successful career and dedicate it to this space, what made you stay with DAOs in the midst of all this, I’m assuming, very negative emotion?
[00:05:37] Aaron: Why did I get involved with this? Many ways, lawyers are architects. They structure transactions, they help people manage risk, and they also help structure the flow of value. And so it’s a core thing that lawyers think about all the time or these top level issues related to how value flows, how to create different structures to accommodate the different risks, and also governance. That’s a big thing of what lawyers think about, particularly if they’re counseling in a more traditional setting, like a board of directors, or working with clients that may have these difficult questions that emerge when different groups of people work together. And so for me, I was fortunate enough to fall down the Bitcoin rabbit hole pretty early, fascinated by concepts around Bitcoin. And I think many folks in the ecosystem recognized that the DAO itself was an experiment. And even though it didn’t wind up in a place that everybody was hoping, this core idea of having a different and disparate group of people work together to pull capital to begin to support projects was something that I’ve always found really fascinating.
I think the notion that we can build more effective organizations, more efficient organizations is something that is probably one of the most important sets of questions that we, as a society, have to grapple with. I think for folks that have grown up during the time when I’ve grown up, we’ve seen failures on the part of different corporations, different governmental bodies, different organizations, to be responsive to the needs of people. And to me, DAOs, at their broadest level, are hopefully going to be able to present new ways to do things or improve ways to do things so that we can begin to tackle these problems. But at its core, why have I been so focused on blockchain technology and Ethereum? I think it’s because this idea that’s embedded in blockchains is exceptionally powerful. How can we work together, even though we may live in different countries, even though we may live in different time zones, to build something that we can all reasonably rely upon in order to order our affairs, whether that’s a store value like Bitcoin or the broader use cases that we’re seeing on Ethereum?
I just think that that’s one of the most important technical tasks that we can spend time with. And that’s why I’ve been so focused on it. And I do think that its core, Ethereum is a super fascinating system, not just because it’s a more generalized version of Bitcoin and not just because it has this global virtual machine that you can execute smart contract code in, but fundamentally, it’s a rules engine and it’s a protocol for rules and law. And that’s something that I’ve spent a lot of time thinking about, both as a practicing lawyer and as an academic. So not surprisingly, it tickles me in all the right places…
…[00:13:26] Eric: So I’m super excited to go into Flamingo. But before we do that, I just want to go back to something you said about Silicon Valley missing some of the biggest moves here. What do you think it is about Silicon Valley that led to this blind spot?
[00:14:34] Aaron: Crypto is one of the first major technology categories that didn’t come out of traditional academia. Obviously, lots of academic innovations have fed into crypto, but Bitcoin started with a synonymous whitepaper, a, or a group of developers that released into the wild on a message board… Mailing list, not even a message board. So I think it’s always been a little non-traditional, and I think a lot of the entrepreneurs and innovators that work in the crypto space don’t necessarily fit the classic archetype of a Silicon Valley entrepreneur. They may not have gone to the best schools. They may be located outside of the Valley. They may be working on remote teams, at least pre-COVID, was not the norm. They may not have gone to the most illustrious schools.
So, that combination, I think, has always made it a little bit of an oddity to some Silicon Valley-type investors. It’s not that they haven’t backed amazing teams, they have. I just think there’s been some that have slipped through the filter, which I’m sure always happens, but it seems to happen at a higher rate when it comes to crypto.
I think the other thing is, for the projects that they did back, in many ways, they seemed obvious to plenty of folks in the space that they needed capital and support. It didn’t make much sense that that capital shouldn’t come from the community that they were interacting with. The folks that were actually going to use the platforms or projects or DAP or whatever they’re developing and/or continue to provide longer-term support. I think that was another thing that fed in into our thinking…
…[00:18:05] Eric: We’re going to jump into the legal side, obviously, and understand the difference between this and an LLC. But before we get there, I think the secret sauce of DAOs, in particular, from my watching of Flamingo from the outside, it’s this idea of a hive mind as you call it. First, can you just define for the audience, what is a hive mind because I really think this is the secret sauce that people don’t focus on as much of what makes a DAO or specifically Flamingo special?
[00:18:30] Aaron: I think it’s a unique characteristic of our DAOs and other DAOs that are following a similar model. We have 70 plus members, many of whom put their own capital at risk. And they’re passionate about a particular topic. So this is what they’re geeking out on. They’re spending countless hours per day, even if they have other jobs, completely obsessing over NFTs, opportunities, different communities, artists, ecosystems that are creating NFTS by blending together the voices of not just a handful of people, let’s say like one or two people, or maybe possibly more, which would be the normal setup inside of like a hedge fund or a venture capital fund. It’s a broader group.
That broader group creates a filter about potential opportunities. So we’ve seen in the NFT ecosystem plenty of projects that launch and then their price goes up and then it rapidly comes down. Those types of projects don’t tend to gain traction inside of Flamingo. Even though if you’re an avid reader of CryptoTwitter, or even paying attention in the popular press, some of these projects would’ve hit your radar. This broader base of active participants, I think just creates a better noise to signal ratio. And people are interested in different parts of the ecosystem.
We have some folks that are really focused on early NFTs and collectibles. We have other members that are really focused on generative art. And we’ve done a lot to support generative art, both by supporting Art Blocks and also by collecting a whole bunch of generative artworks. We have other folks that are focused more on this transition of digital artists into NFTs or emerging artists that are using NFTs to develop their platform. We have folks that have been diving deep into the metaverse, and that’s why we set up Neon because we realized that that was a bigger opportunity. And we’re geeking out on different land or parcels or other items that can be acquired in the metaverse.
We had folks that were focused on gaming and other subcategories inside that broader NFT ecosystem. So because this broad range of coverage, it’s like a brain. Different people are focused on different areas, but everybody could have an opinion on it. And you kind of get a sense of whether or not you’re making a good or bad decision, palpably feel opportunities and whether people are excited about it. And now that have a network of DAOs, you can see these different hive minds coming to decisions. And sometimes you get some interesting signal across all the DAOs.
[00:20:51] Eric: How does this brain work? I’d really like to talk about the investment process. How do you source a deal? How do you think about what people would in normal investing think about is due diligence? How do you make a decision and then monitor that investment?
[00:21:06] Aaron: In terms of deals, that would be more kind of in the bucket of the LAO. So supporting a project or a company or some other more venture capital like, venture capital styled investment, there the deals come from all angles. All of our members have different networks that they’re a part of. They know different founders. And if they hear that a project that they’re interested in is raising, they’ll flag it. We congregate on Discord. So they’ll flag it in a new opportunities channel. And they’ll circulate a little bit of information. That catches one or more person’s eye. Then either that member will schedule a time to talk to the team to get more detail, and then report that back. My company, Tribute Labs, will fill in the gaps. So if no member’s able to do that, we’ll schedule a call and collect that information and report it back.
Either based in the conversation in Discord. We also have some calls that people can voluntarily join, which are pretty well attended. We’ll get a flavor of whether or not people want to move forward. If there’s like a sentiment that people want to move forward, there’ll be some soft polling on Discord, just to get a sense and confirm it. And assuming that they want to move forward, it goes up for a formal vote.
Somebody will draft up a proposal or the team will apply and describe why they need the capital. And then it goes up for a formal on-chain vote at that point in time. If more people want to support the project than not support the project during a voting window, it’s seven days in LAO. It’s shorter in some of the other DAOs. Then the capital’s committed. And then we take steps to kind of make sure that all the legal docs and other things are in order and are authorized to settle the transaction on behalf of the members.
[00:22:47] Eric: So in the LAO, I guess thinking about that, that sounds a lot like a venture capital model. How do you think in the way of speed that what you just described, going into a Discord, saying, “I have an idea. I was just talking to this founder. I like it. Let’s get together.” How does that compare in speed to a traditional several partners at a venture capital firm having a meeting to say, “We should do this deal”?
[00:23:07] Aaron: Before crypto, and I think a lot of VC funds that operate in crypto are moving faster, but we can come to a decision in a matter of hours if needed. People are online. They can weigh in on polling. If we need to move quick, then we can move quick. If things are slower, we can move slower and collect some more information. So just the cadence. If you look at the number of deals that the LAO’s done, it’s over a hundred. That’s a lot for most VC funds.
They’re really looking, at least a lot of them are looking to kind of maximize their exposure into a smaller number of bets. We take a slightly different approach where we’re looking to build connections to great projects and teams. We’re happy to participate in a number of different rounds and work with as many teams as we think are worthy of working with.
Inside Flamingo, when it comes to a particular project in different capacities or NFT opportunity, well, it’s a similar process in the sense that people flag either an artist or they’ll flag a set of NFTs that they’re interested in, and there’ll be a conversation related to it. And people will get excited and will decide what the allocation should be. And then either members will acquire them or we’ll acquire them on behalf of the members.
[00:24:18] Eric: One of the beautiful things about blockchain is I can look into your portfolio and see things that you’ve purchased. And now I’m talking about Flamingo. When I look at it, you have 242 CryptoPunks, which I think makes you one of the top holders. You have 22 Bored Apes. I’m curious, just how did you arrive at those allocations? What was it like? Someone said, “Hey, these Bored Apes are launching. This is a good idea. Let’s just throw some money at it.” Or were you saying, “No, we really want to meet with the founders first.” Like, how do we go from, I just saw something on Twitter or my friend told me something we should get involved to sending capital from the Flamingo DAO?
[00:24:51] Aaron: CryptoPunks have been around for a while. We developed inside Flamingo just some core buckets that we were interested in collecting. One of those buckets inside Flamingo was early NFTs. So that included things like CryptoPunks, Autoglyphs, and there’s a handful of other projects.
We began to look at the market and tried to get a sense of what we thought the opportunity would be. When it came to Punks, we bought a handful off the bat. And then there was increasing numbers of proposals to just expand that exposure until we got to a point where we became one of the largest holders in that project. The thesis there, at least distilling it down for members, was really that if there’s going to be trends of NFTs, at some point, people would look back to see what the really first original ones were. And there was some one-off ones, but CryptoPunks stood out as being one of those early iconic sets. And we wanted to have a pretty heavy exposure into that.
For Bored Apes, Bored Apes, it’s an amazing project and I think it’s completely fascinating. And I think they’ve developed an amazing community and have an incredible roadmap. That one, I think members were a little less sure about, just because of the way it was kind of released. And the fact that at that point in time there was more sets of NFTs that were getting created every day. But one member in particular was very, very interested in Bored Apes and thought that we should at least have some exposure there. So we just decided to acquire a handful. And then, I think we acquired a couple more after that, as we began to learn a little bit more about what Bored Apes was thinking about as a community and the plan for developing those sets of characters.
4. Integrating Around The Consumer: A path forward for the global apparel manufacturing supply chain – Jon George and Peter Ting
A widely used but erroneous framework that has guided the supply chain’s business model evolution (and those of other industries) is based on the notion of core competence. If a process fits a company’s core competence, it’s done internally, and if another company can perform the process better or for lower cost, it’s outsourced. The problem with this approach is that what may not be a value-added activity today, may be crucial tomorrow and vice versa. Additionally, core competencies can actually become core rigidities, limiting a company’s ability to adapt to a changing landscape. So, “core competence” is not the most reliable framework for managers in deciding which activities their companies should perform in order to maintain attractive profits over time.
In contrast, the Theory of Interdependence and Modularity is based on the fact that products, services, and even entire industries have architectures that dictate which components or steps are required to make something work and how they should fit together. Products and services have multiple constituent components, and they go through several value-added processes before reaching consumers. The place where any two components fit together is called an interface. Interfaces exist not just within products but also between stages in the value-added chain. For example, there is an interface between manufacturing and distribution, and another between distribution and retailing.
An architecture is interdependent if one process component cannot be completed independently of another. This happens if the way one component is designed and made depends on the way other components are designed and made. When there are unpredictable interdependencies across an interface, the same organization needs to perform both steps in that value chain in order to adequately do either step.
Businesses commonly adopt an interdependent architecture during early phases of an industry when products and services aren’t quite good enough for consumers. An interdependent architecture optimizes on performance, and businesses need to integrate multiple components and value-added processes to be competitive. For example, early computer manufacturers like IBM designed and produced nearly all the required components—including microprocessors, drives, memory, operating systems, etc.—to deliver computers with enough performance to satisfy customer expectations.
In contrast, in a modular architecture, components and processes fit and work together in well understood and highly defined ways. This happens when there is no unpredictability across interfaces. In this architecture, each step of the value-added process is specifiable, verifiable, and predictable. Therefore, it doesn’t matter who makes a given component or performs a service in a certain part of the value chain. Today’s personal computer industry is highly modular. Nearly any component from any manufacturer can fit into any motherboard due to industry-wide standards that specify exactly how interfaces pass data from one component to another (SCSI, USB, etc).
A modular architecture optimizes on flexibility, but this comes at the cost of performance. Modular architectures must be highly specified. As a result, engineers have less latitude in designing a product for bleeding edge performance. Thus, modular architectures tend to be prevalent in products or industries that have matured to a point where some aspects of performance can be sacrificed in favor of choice and customization.
The primary difference between the two architectures and the main implication to businesses is the basis of competition, or the way in which companies must optimize their offerings in order to compete effectively. Initially, when there is a performance gap—when functionality and reliability are not yet good enough for consumers—companies win by taking the interdependent architecture and controlling every critical component of their offerings. However, as products and services improve over time, the basis of competition changes. Performance gaps that once necessitated integration become performance surpluses, and consumers at some point stop paying a premium for ever more functionality. When this overshooting happens, what becomes “not good enough” is that consumers cannot get exactly what they want, when they need it, as conveniently as possible. As a result, the industry migrates to a modular architecture to meet customer demand along new dimensions: speed to market, convenience, and customization.
5. Could cosmic rays unlock the secret tomb of China’s Qin Shi Huang guarded by terracotta warriors? – Stephen Chen
The Mausoleum of the First Qin Emperor in Xian, Shaanxi province, was built by hundreds of thousands of labourers over nearly four decades and finished around 208BC, according to Han dynasty historian Sima Qian, who lived soon after that period.
With a total area more than 70 times the size of the Forbidden City, it is the biggest tomb ever built for an individual in the world.
The tomb’s surface buildings are no longer standing, but its underground structures are mostly still intact. Some archaeologists believe the central chamber that housed the emperor’s coffin and most valuable treasures remain undisturbed after they combed the entire field and found no holes indicating thieves had been at work.
The study, funded by the central government to evaluate the feasibility of the cosmic ray project, found at least two cosmic ray detectors would be needed, to be planted in different locations less than 100 metres (328 feet) under the surface of the tomb.
These devices, each about the size of a washing machine, could detect subatomic particles of cosmic origin piercing the ground.
The data would allow scientists to identify hidden structures unseen using other detection methods in high detail, said Professor Liu Yuanyuan and her colleagues at Beijing Normal University in a paper published in Acta Physica Sinica, the official journal of the Chinese Physical Society, on Monday…
…After decades of surveying, archaeologists have confirmed the existence of an underground palace more than 30 metres tall. They also found trace evidence supporting descriptions by Sima that had been disregarded as fairy tale, such as pools and waterways filled with mercury to mimic China’s major rivers and the sea.
But the palace’s detailed structure and the exact location of the emperor’s chamber remained uncertain. Sima’s other descriptions – such as traps armed with arrows and crossbows to shoot anyone who enters the tomb – were not verified.
Using cosmic rays in archaeology is a concept that dates as far back as the 1960s. Astrophysicists discovered that cosmic rays could hit air molecules and produce a particle known as a muon that could penetrate almost anything.
Muons have a higher chance of being absorbed when going through denser materials. By comparing the number of muons a detector received from various angles, archaeologists could discover hollow structures, such as hidden chambers or passages in a building.
6. How To Be Successful – Sam Altman
Most people are primarily externally driven; they do what they do because they want to impress other people. This is bad for many reasons, but here are two important ones.
First, you will work on consensus ideas and on consensus career tracks. You will care a lot—much more than you realize—if other people think you’re doing the right thing. This will probably prevent you from doing truly interesting work, and even if you do, someone else would have done it anyway.
Second, you will usually get risk calculations wrong. You’ll be very focused on keeping up with other people and not falling behind in competitive games, even in the short term.
Smart people seem to be especially at risk of such externally-driven behavior. Being aware of it helps, but only a little—you will likely have to work super-hard to not fall in the mimetic trap.
The most successful people I know are primarily internally driven; they do what they do to impress themselves and because they feel compelled to make something happen in the world. After you’ve made enough money to buy whatever you want and gotten enough social status that it stops being fun to get more, this is the only force I know of that will continue to drive you to higher levels of performance.
This is why the question of a person’s motivation is so important. It’s the first thing I try to understand about someone. The right motivations are hard to define a set of rules for, but you know it when you see it.
Jessica Livingston and Paul Graham are my benchmarks for this. YC was widely mocked for the first few years, and almost no one thought it would be a big success when they first started. But they thought it would be great for the world if it worked, and they love helping people, and they were convinced their new model was better than the existing model.
Eventually, you will define your success by performing excellent work in areas that are important to you. The sooner you can start off in that direction, the further you will be able to go. It is hard to be wildly successful at anything you aren’t obsessed with.
7. Investing: Is it skill or luck? – Eugene Ng
“There’s a quick and easy way to test whether an activity involves skill: ask whether you can lose on purpose. In games of skill, it’s clear that you can lose intentionally, but when playing roulette or the lottery, you can’t lose on purpose.
— Michael Mauboussin”
With activities of skill, like chess, swimming, basketball, one can lose on purpose (as long as you have some basic mastery of the activity). Whereas with activities of luck, like roulette, coin toss, lottery, one cannot lose on purpose. If one cannot lose on purpose, one cannot win on purpose. Following which, if one can lose on purpose, one too can win on purpose, it is likely to be an activity of skill. This has significant implications to us as investors, who are buyers of individual stocks for the long-term. Can this similarly be applied to investing? Which begs the question, can one lose intentionally and pick losing stocks for the long-term?…\
…That is also, why we are of the following view that:
1. Investing, especially over relatively short periods of time, is much more a matter of luck than of skill. 2. Investing, especially over relatively long periods of time, is much more a matter of skill than of luck.
Investing is often viewed by many and the financial media as more luck than skill, because in the short-term, feedback loops are often unclear and inconsistent and can be very volatile. In addition, very few investors keep playing the game very well for decades and beyond, thus investing is rarely viewed as a skilled game by most. But as we think one can possibly win intentionally (read our book to find out how), we do believe one can also lose intentionally as well. To us, investing is both a game of both luck and skill, and where it is on the continuum, depends on the strategy deployed, how it is being played, and the time perspective.
We do believe that gradually with time, in years and decades, that investing as an activity in the luck-skill continuum, can shift more to the right over time (i.e. more skill than luck), as skill becomes more evident for the ones who do have the skill, with luck still playing a crucial role.
Disclaimer: None of the information or analysis presented is intended to form the basis for any offer or recommendation. We currently do not have a vested interest in any company mentioned. Holdings are subject to change at any time.
