Ransomware and Direct Listings
There is some chance that when you showed up to work this morning your computer was encrypted and demanded a $300 ransom to be decrypted, raising the fundamental question: Would you pay $300 to do your work? I assume that a lot of office workers looked at the ransom screen, chuckled "you win this round computer," and headed right back out the door. But, right, a lot of cyberattacks:
More than 200,000 computers in at least 150 countries have so far been infected, according to Europol, the European Union’s law enforcement agency. The U.K.’s National Cyber Security Centre said new cases of so-called ransomware are possible “at a significant scale.”
Perhaps the best thing to read about ransomware is this post by cryptography professor Matthew Green from February. Green points out the critical problem with ransomware -- with ransom, generally -- which is that, if a criminal locks up your computer and demands $300 in bitcoins to unlock it, you have no reason to trust him to actually unlock the computer if you pay the ransom. He is, after all, a criminal; he has not done a lot to build up trust with you.
But he's getting paid in bitcoins. On the blockchain. The blockchain is of course the place where people go to transact without trusting each other. Once you have started down the blockchain path, the solution for your problem is obvious. What you need is a smart ransomware contract, one that can credibly and verifiably promise -- in software -- to decrypt your information if you follow its requirements (sending the ransom). There are some technical issues -- how can you verify that the software decrypts the files before it does it? -- but the concept is sound. And from there, madness:
Ransomware with the ability to enforce payments would provide a potent funding source for another type of autonomous agent: a Decentralized Autonomous Organization, or (DAO). These systems are “corporations” that consist entirely of code that runs on a consensus network like Ethereum. They’re driven by rules, and are capable of both receiving and transmitting funds without (direct) instruction from human beings.
At least in theory it might be possible to develop a DAO that’s funded entirely by ransomware payments — and in turn mindlessly contracts real human beings to develop better ransomware, deploy it against human targets, and… rinse repeat.
Do you worry at all that the cryptographic-economic focus on building trustless transaction systems will undermine trust? The value of market capitalism is not just that it allocates resources efficiently; it also creates a society in which we all rely on each other for our well-being. I don't grow my own food; I am connected to farmers by a largely invisible web of exchanges, of debits and credits. I rely on the farmers to grow the food I need, and the supermarket to stock it, and the bank to keep track of the money I use to pay for it. Over time, technology has improved all of these processes, but there has always been some residual need for trust that was not entirely susceptible to technological solution, some need for cooperation and belief in the system for that system to function.
The blockchain dream is about solving that problem. Why trust in banks when you can have a decentralized trustless monetary system? Why trust managers to run a business when you can have a decentralized autonomous organization? But this dream of getting rid of the need for trust in human interaction is not entirely benign. Bitcoin's appeal in criminal transactions -- drug deals, ransomware -- is not just that it's "untraceable." (It's pretty traceable!) There's a philosophical appeal, too: A trustless currency is good for people who don't trust each other, and who aren't trustworthy. The rise of bitcoin might make us all a bit more like that.
Spotify AB is rumored to be thinking about going public by "direct listing," where it just plops its stock on an exchange without bothering with the usual apparatus -- roadshow, bookbuilding, pricing -- of an initial public offering. Here is an argument for direct listing from Felix Salmon, who notes that "it helps to marginalize Wall Street investment banks, for one thing, which is generally a good thing." I am somewhat less convinced, though, disclosure, I used to be an equity capital markets banker.
But the start of trading seems hard, for a direct listing. After a regular IPO -- and the opening trade the next day -- the stock is in the hands of a lot of different unaffiliated investors who just want to trade it normally, and the stock will bounce around on a series of small trades that are fairly smoothly connected to each other by the usual mechanisms of the stock market.
With a direct listing ... that might happen? Like, Spotify might announce that its stock will open for trading on a Tuesday, and on Tuesday morning a bunch of investors who want Spotify stock will put in market-on-open or limit-on-open orders to buy it, and a bunch of Spotify insiders who want to sell will put in orders to sell it, and the exchange's opening auction procedure will cross those orders and come to a clearing price for Spotify to start trading, and then a minute after the opening a bunch of regular investors will own the stock and be free to trade it around amongst themselves.
But that is sort of an IPO by other means, and those means are much less well adapted to the goal. All those investors trying to buy will have to do so without any marketing effort from the company, or any analysis from banks. All those insiders thinking about selling will have to do so with no coordinated idea of who else is selling. And everyone on both sides will have to make their decisions without much idea of what the clearing price will be. I mean, they'll have some idea -- the NYSE and Nasdaq opening auctions give traders indications of the clearing price -- but not much. The exchanges start giving indicative opening prices at 9:28 a.m., for a 9:30 opening, giving investors two minutes of price discovery. IPO roadshows -- in which banks and investors and companies figure out the opening price for the company's stock -- can last weeks, and even after that the opening auction can be a mess.
The transition from "not trading" to "trading" is not smooth and automatic; it requires some sort of auction, some sort of coordination of buying and selling interest. Most stocks don't trade (much) between 4 p.m. and 9:30 a.m., and so exchanges run auctions every morning to effect the transition from "not trading for the night" to "trading for the day." The transition from "not trading ever" to "trading from now on" seems like a bigger shift, and one that would require a bigger coordination process. That's why IPOs happen the way they do: to coordinate that sharp transition in an organized way.
Or maybe you wouldn't have a big sharp transition on the first day of listing: Maybe few investors will buy, or few investors will sell. That will make the stock very volatile, perhaps for months: Any insider looking to sell, any institution looking to buy, will swamp the existing supply of stock and move the price dramatically. The stock price won't reflect fundamentals; it will reflect the weird dynamics of doing a weird quasi-IPO.
Still I like the idea of direct listing, even though I am not sure it's a great practical tool for many companies. It is a good conceptual response to a world in which private markets are the new public markets, and in which public companies are largely engaged in the business of returning capital to shareholders. If companies don't need to go public to raise money, it is odd that they more or less always go public by raising money. It seems weird to make such a big deal of IPOs, or to pay banks a lot of money to run them. Why not just check a box saying "we're public now" and be done with it?
You can sort of think of the postmodern corporate life cycle as:
- Raise large amounts of money privately in order to do a thing;
- Succeed at the thing;
- Go public so that early investors can cash out;
- Spend your money as a profitable public company on buying back stock.
In that model, step 3 starts to feel like a vestigial appendage. It is just a matter of timing and convenience. At lots of private companies, early investors can cash out by selling their shares in private transactions to new investors, or to the company itself. And plenty of companies go straight from Step 2 to Step 4: They raise money, build businesses, and return money to shareholders without ever going public. It wouldn't be all that surprising if that one day became the norm for unicorns too. Direct listings -- going public, but not caring very much about it -- are a step in that direction.
Elsewhere in bookbuilding, here's a funny story about bond offerings in China:
One challenge is that investors sometimes place duplicate x-orders with multiple banks to make sure they can get all the bonds they want to buy, which can make demand seem larger than it really is, bankers say.
Last year, China Cinda Asset Management Co. enlisted 23 banks to ensure the smooth launch of a dollar-denominated bond it was using to bolster capital. Cinda initially aimed to raise as much as $4.45 billion. Bankers on the deal say orders, mostly anonymous, at one point were thought to total about $10 billion. By the time pricing was finished and all the orders reconciled, the value had shrunk to $3.2 billion.
That sort of happens everywhere -- capital markets bankers usually assume that investors inflate their demand on hot deals in order to get good allocations -- but it is particularly noteworthy in Chinese deals in which investors place anonymous "x-orders" with one bank in the syndicate, so that that bank gets credit for the order when the company pays underwriting fees:
Fees aren’t distributed evenly among investment banks, as they tend to be in the U.S. or Europe, where orders go in a shared pool and other underwriters can see the names of investors in a bond issue and the amount they are buying.
Stories like this are the result of taking literally financial practices that have become dead metaphors in the West. In theory, underwriters everywhere are paid for going out and finding investors to buy bonds. But in practice, underwriting fees in the U.S. are about relationships and advice and lending and reputation and many other things; the actual process of going out and finding orders is thought to more or less take care of itself. But in the Chinese market, companies say, well, okay, we are paying you to find buyers for our bonds; whoever finds the most buyers will get paid the most.
One widely discussed fact about the rise of indexing is that, as people say, "passive isn't passive." Buying an S&P 500 index fund doesn't relieve you of the need to make decisions: By buying the S&P 500, you've decided to buy large-cap stocks instead of small ones, and U.S. stocks instead of foreign ones, and stocks instead of bonds, and something instead of nothing. Choosing one index (one asset class, geography, etc.) over another could lead to higher or lower returns, as could choosing when to buy the index. Active decision-making is still required. You just avoid the problem of picking which companies to buy.
That problem is now less complicated than the problem of picking which index to buy: "The number of market indexes now exceeds the number of U.S. stocks."
You can sort of decompose investing into two parts:
- Thinking about what will happen in the world; and
- Analyzing companies.
Those two activities are closely connected: Analyzing a company requires thinking about the future of its industry and the economy, while analyzing economic trends requires some understanding of how companies make money. But the top-down work of predicting economic and social trends, and the bottom-up work of analyzing corporate financial statements, are different activities, which will appeal to different personalities and require different skill sets.
Intuitively, the top-down theorizing about economic trends seems like it would be more appealing to hobbyists? I mean, not necessarily -- if you love the careful detailed work of building model trains, you might enjoy reading 10-Ks! -- but it does seem a little easier to have a casual half-informed view about the effect of social media on society than about the price-earnings ratio of Twitter's stock. The profusion of indexes provides new ways to turn ideas into investments, while hiding the mechanics of how those ideas translate into companies. If you think the big economic story is the rise of China, you can go buy a Rise of China Index Fund, without analyzing the operations of hundreds of companies to see which are most exposed to China. The index creators are giving people what they want, but what they want might not be passivity, exactly.
People are worried that people aren't worried enough.
I tell you, after laboring for years in the mines of "people are worried about bond market liquidity" without ever seeing it quite break into the big time, I am continually impressed by how far "people are worried that people aren't worried enough" has come in such a short time. It is everywhere! Here at Bloomberg View, Mohamed El-Erian worries that "Unusually Low Volatility Can Be Dangerous for Markets":
The recent decline in both implied and actual measures of volatility, including a VIX that recently touched levels not seen since 1993, is likely to encourage even greater risk taking both tactically and strategically, including bigger allocations to stocks, high yield bonds and emerging market assets. And both, at least in the short-term, will contribute to damping market volatility further.
Another Bloomberg View colleague, Tyler Cowen, considers other feedback loops:
Perhaps we need a more in-depth study of how non-volatility begets further non-volatility. When prices just aren’t moving by very much, maybe certain kinds of information get drained away, and it becomes harder to conclude that some position other than your status quo default position makes sense.
At CNBC, Michael Santoli has "3 reasons why Trump drama isn't rattling the bull market":
Sure, if this were a skittish market beset by multiple challenges and looking for an excuse to pull back hard, the political headlines could easily serve the purpose. But that's not the current market, which is supported by lots of liquidity and cooperative fundamentals - for now.
And at the Financial Times, Robin Wigglesworth talks to brokers and traders about how worried they are about the lack of worry:
“People aren’t taking lunch breaks because they’re waiting for volatility to come back,” says John Abularrage, president of Tullett Prebon’s operations in the Americas.
They have no time for lunch because there's so little to do!
People are worried about unicorns.
Here's a reason to worry about Uber Technologies Inc.: Alphabet Inc.'s Waymo unit is teaming up with Lyft Inc. to work on self-driving cars.
“Waymo holds today’s best self-driving technology, and collaborating with them will accelerate our shared vision of improving lives with the world’s best transportation,” a Lyft spokeswoman said in a statement.
"Lyft is a ride-hailing company that is not Uber," a Waymo spokesperson said. Wait no that is not what Waymo said -- they said "Lyft’s vision and commitment to improving the way cities move will help Waymo’s self-driving technology reach more people, in more places" -- but it is probably what they meant. Waymo is suing Uber for allegedly stealing its self-driving-car technology, and teaming up with Lyft seems like another way for Alphabet to twist the knife.
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