Start 1

The startup atmosphere is not what it was six months ago.

Even the flagship successes are going to have to make tough decisions and gamble their existence.

 

It came out last year that Uber is losing a billion dollars on 1.7 billion of revenue. So they are spending $2.7 billion.

 

They raised a total of US$8.8 billion most recently at a valuation above $60 billion. These investors need over 60 billion in profits to break even on an absolute basis.

 

Uber is clearly the best taxi company ever. It’s a relief not to spend hours waiting for a taxi driver in a smelly car who insists on being paid in cash and refuses to drive to Bondi.

 

VCs and other investors dumped cash on Uber’s balance sheet that is now being used to ‘invest’ in growth. But when Uber says invest they don’t mean set up offices in new countries and buy plant and equipment, though there is some of that.

 

What they really mean is they’ll cut prices below profitability to keep Uber cheaper than taxis and anyone else who dares to compete.

 

To make a decent economic return on current revenue they would need to lift their fee by, say, 60%.

 

Soon enough there will be a point where it makes sense for every driver to be on a  congregation app. An app that out-platforms Uber.

 

Anyone looking for an idea?

 

“I prefer building rather than fundraising,” Kalanick added in the interview with Betakit. “But if I don’t participate in the fundraising bonanza, I’ll get squeezed out by others buying market share.”

 

Fintech
 
Fintech is hot right now. No-one has more money than the banks. I mean the banking system literally has all our money. This was always going to attract attention from the startup community.

 

But finance is a poor candidate for start-ups. I do wonder how many of the kids setting up a ‘new kind bank’ would have the stomach to take a home off a family in default.*

 

 A few guys and girls in a room can build a world-changing app – there’s no doubt about it. But picture sharing is very different to lending someone amounts that might take a lifetime to pay back.

 

Some parts of fintech are incredibly promising (and proven): crowdfunding of all shapes and sizes, data analytics, security, wealth management.

 

But some revolutionary start-up thinkers manage to do full circles of logic, such as in P2P lending, where anyone can borrow and anyone can lend. We are all banks now.

 

P2P
 
The idea was that:

 

– the borrowers would be able to find cheaper loans
– the lenders would have access to new markets that were previously closed to individuals.

 

It quickly became too complicated to have individuals lending to people. Too risky and painful to see innocents lending at 8% to someone who won’t pay back. Default rates are still low, but we are at the very end of the credit cycle, precisely when you’d expect financial innovation and new people coming to the market. A bad time to be picking up pennies. So the P2Ps started  dividing the borrowers into tranches according to secret credit rating profiles with uniform default rates and returns.

 

 

The next step most P2P lenders have taken was to gather all the loans together and sell them to institutions.

 

So now we have exactly what we’ve always had – a provider who pools the lending of large amounts of money to different people. This is basically a bank, only without the infrastructure and experience of bankers.

 

The attempt to revolutionise lending ended up at securitised mortgages with all those hazards familiar to Americans who let mortgage brokers in Florida determine credit. Round of applause.

 

Still, the volumes are trivial compared to the trillions of dollars on the lending books of major banks and it’s certainly something new. Good luck to them.

 

Bitcoin
The first time I heard about bitcoin I was fascinated for at least three months.

 

But somehow I – and anyone you hear talking about bitcoin – managed to overlook these incredible flaws:

 

1. It takes 10 minutes to process a transaction

 

2. If one mining pool controls 50% of the computing power, they have total control to reverse transactions and cause mischief. This has happened before.

 

3. There are two groups of chatroom bandits debating how to progress. So instead of having a regulator appointed by politicians, who at least have to win votes every now and then, the bitcoin community is dependent on an indefinite group of anonymous, amorphous, and unelected hackers.

 

4. Immense amounts of electricity is required to process the transactions. The system is literally designed to require increasing amounts of energy, the more energy you put in. So this will get worse rather than better.

 

The economics encourage miners en masse to operate at a loss. There will always be a student with access to a university’s computing power, or punters ready to miscalculate and/or ignore electricity costs.

 

The amount of power used to verify bitcoin transactions is obscene. This is all totally wasted of course – there are no benefits to the broader system of spending huge amounts of energy calculating something that only needed to be calculated because so many other people were trying at the same time.

 

5.The bitcoin merchants are mostly crooks and fools. It turns out that – like normal money –  you have to use providers to store and convert your bitcoin. These people promise to store your bitcoin strings and charge to do so. More than banks ever would. So how, exactly, is this a step forward?

 

But the problem is not just high costs, though it still surprises me to hear intelligent people talk about costless transactions in bitcoin, when the exchange margins would make American Express blush. The issue is these firms are juicy targets for all sorts of crime.

 

Often the owners just spend the bitcoin they were supposed to protect, but usually they just go bust and you lose everything. Trusting your spending power to these kinds of startups is a very poor decision.

 

You’re not just up against backroom hackers but entire states. I wouldn’t bet on a commercial security team against North Korea’s cybercrime unit.
Finally the whole thing is kind of absurd.

 

I mean, we already have electronic, instant money that is extremely secure and backed by all kinds of insurance, as well as implicit and explicit government guarantees, and we can transfer it for free – certainly within countries.

 

Anyway, I’m sure some people made a bundle out of this particular mining boom by selling shovels, however.

 

The good stuff: Data analytics

 

A better example data analytics – there will always be ways to fine-tune and improve credit ratings of individuals and companies.

 

But even this is dodgy territory: most of us would be very uneasy if we knew that the bank was monitoring our purchases and developing comprehensive character profiles of us. Banks could easily delve deep into your purchases and get an extremely good idea of how likely you are to pay a loan.

 

This might be fine if it means extending credit to people who would otherwise be cut off, but it gets a lot muddier if you’re only lending to certain types of people because they are more likely to pay it back.

 

Banks already could already figure out if you’re gay or straight, and have a good idea of your national background. How would you feel about this information being used to adjust your credit score and deny you a home loan? What if Chinese immigrants prove better borrowers than the Greeks? What if a bank used that information?

 

But despite the pitfalls this is definitely an area where the tech genii should be playing.

 

User interface
 
I have bank accounts in the UK and Australia. Using UK banks is like surfing web pages from 1995 – they are ugly, slow and the whole thing looks like it was put together by a child. (Don’t ever sign up with HSBC).

 

Australian banks seem decades ahead. I doubt any startup has the billions to match CBA’s or any of the other banks investment in technology.

 

The major Australian banks each spend about as much on tech as Uber loses in a year. Competition will be stiff, but it’s more likely to happen between these firms than from new outsiders. Could be wrong. But if I wanted to compete with these guys I’d do it be starting a bank, not building an app.

 

Wealth Management
 

 

There are companies like Wealthfront that will do well. They use generic portfolios of stocks and bonds to replicate the asset management of the ultra wealthy – the ones who hold on to their wealth anyway.

 

There are very few ways to make money in the market and this is one of them.

 

Asset allocation works by holding fixed percentages of different assets.

 

A lot of ink has been spilled on this kind of thing – all about volatility and efficient markets. I studied it once, it’s dry, even as far as these things go.

 

But that whole branch of academia kind of misses the point. Turns out efficient horizons are orthogonal to what we actually want our investment portfolios to do: make money and not lose it.

 

It’s actually the fixed percentages that do the magic.

 

Say you have 50% cash and 50% stocks. As the stocks fall, the percentage drops, so you use some of your cash to buy shares. As stocks rise, their percentage increases, so you sell some stock and increase your cash holdings.

 

The total effect is what basically defeats everyone who tries their hand at it: Buying low and selling high.

 

This isn’t just stock and bond portfolios. It’s highly effective in currencies. In my own portfolio I ramp this up by betting against markets, while holding a core portfolio of stocks. It’s the above dynamic on steriods. I wouldn’t recommend trying it unless you want to spend a few painful years losing money learning how to do so.

 

My favourite aspect of the miserable euro crisis was that all the horrible hedge funds who had massive bets against the euro largely lost out, while those with fixed currency ratios (sovereign wealth funds) made fortunes.

 

Similarly, at the peak of the crisis when financiers were collectively losing their minds and their shirts, pretty much every Australian was buying at the lows. Why? Because we all have compulsory investment portfolios that almost all work on fixed percentages. We were all selling bonds and buying stocks right at the bottom.

 

This is perfect for fintech . Managing simple portfolios at low cost is a totally realistic goal for a small number of tech-minded people.

 

Wealthfront, Betterment and their ilk have a rich future – but not for their investors. They will all have to compete on price though, so don’t invest in the companies themselves. But definitely take a look at their products.

 

Interestingly the people running these programs generally misunderstand why they work.
Hedgeable is an example. The CEO claims to have a “proprietary investing technology called the ‘Dynamic Advisor’ “. If you ever find yourself reading something like this, run for the hills! These people always choose almost exactly the same name and never work out.

 

In this case they just move client portfolios to cash when volatility rises. So just when the fixed-percentage portfolios tell investors to load up on stocks and buy low / sell high, Hedgeable will step in and do the reverse, selling low after buying hi.

 

Congratulations Hedgeable ! In a different way you have also done a full circle of logic and are going to do the exact opposite of what you should be doing.

 

A similar sort of mathematical inevitability means you should put all your money in property, but that’s for another blog post.

 

Stock trading: Everyone loves a punt
 

 

Punting shares is a national pastime in most Western countries. You’d be hard pressed to find a red blooded male who hasn’t tried his hand.

 

This is a rich, fat market, desperate for research, desperate for someone to tell them what to do.

 

Have some ideas on this, but this post is already too long, so, you’ll have to read about it next time.

 

ps I haven’t actually seen uber financials so don’t quote me quoting random pages on the internet.

 

Billion Dollar Science

TLDR: Add 10 billion to the annual income available to scientists around the world and see how fast we cure cancer.

Elsevier is one of the more irritating institutions in the world. It has a number of businesses, but the one of interest is its collections of scientific journals, which it on-sells to libraries and universities in incredibly overpriced bundles.

Without wanting to sound communist there is a huge pot of value here. Its market cap is over $15 billion and made over $800 million last year. The entire scientific publishing industry is worth about $10 billion a year.

Of the multiple and varied flavours of immorality in which Elsevier chooses to indulge, the worst is that not a cent of those billions in earnings is paid to scientists who author the papers and review the articles in the journals. And Elsevier is not alone.

It’s as if a broke author submitted a manuscript to a publisher – who then made a fortune, kept the lot, and then strong-armed public libraries into buying it for $14,000 per year, while restricting the hold-outs from accessing any of their books.

There have been a number of responses to this ludicrous state of affairs. Some scientists (or in this case, mathematicians) have organised a boycott. Unfortunately this is unlikely to really achieve anything.

There have been some great attempts to set up journals in the spirit of open-source but I really don’t think that’s the solution.

There are two sides to this problem: Players like Elsevier charging a fortune and blocking government funded research from non-subscribers, and the fact none of the money flows to researchers. Open source is great for access but makes no use of the fact that scientists are actually doing something worth about $10 billion a year, and could easily command a slice of that pie, and use it to bring more scientists into the field.**

People tend to follow the money. If you create demand for mortgage backed securities, then you can be damned sure people are going to build houses no-one wants in the middle of the desert.

Likewise I imagine if you pay researchers a fortune, more and more people will scramble for a piece of that tasty cash pie, and less will be attracted to, say, the zero-sum brawl of finance*, all with the added benefit of progressively better cures for the painful diseases that will kill you and those you love.

How about this for a solution:***

1. We start a (say) monthly journal.

2. Set up a simple, lucrative payment for accepted articles. As a first stab, how about $10 000 paid personally to the researchers responsible. Similarly, each reviewer receives $2,000 for each article reviewed.

I imagine this would be enough to attract some serious submissions. So serious, in fact, that universities and libraries would be obliged to subscribe (at drastically reduced prices). Oh yeah, and you can only submit articles if you or your institution is a subscriber.

So every month hundreds of thousands of dollars would be distributed to scientists, and there would be a monthly prize pool for excellent research. And I bet the journal would be a cracking read (or as cracking as stiff scientific prose ever is, anyway).

But why not take it a step further.

3. Assuming, of course, you executed that first step and attracted some worthwhile research, you could simply distribute all of the profits. So if you attracted 5% of the market… say 50% penetration at half price, you would be able to distribute 250m a year (I know, I know).

I imagine a star researcher would prefer to get paid $200k rather than submit to Nature. And as the quality of the new journal improved, it could even end up becoming more prestigious.

You could actually replicate the current system, with flagship general journals (Nature, Science) and a host of more specific titles. There’s no way of losing money as you’re simply distributing what you earn. And even practitioners of the more esoteric fields would probably prefer something rather than nothing.

Most importantly it would stick one up to operations like Elsevier that screw the struggling authors of their over-priced journals.

Anyone want to help me do it? We could make a schnazzy video and hit the crowd-funding market.

* Not that there’s anything wrong with that

** and buy cars and the like

*** There are other ways to get this done. You could (for example) takeover elsevier. You would need at least $15 billion to do it, and probably a $5 billion equity cheque. You could treat the whole thing as debt, and as you were paid your money back, you could start increasing payments to the authors are reviewers of the articles you are selling.

Also I realise 10 billion is not the amount that could actually be available, but if publishing went down this route – and there are huge economic incentives for it to do so once the ball gets rolling – we are certainly talking billions.

Thriving Hive #2

I don’t think my last post was forceful enough.

It is completely absurd that for 130 million, so much computing power has been put on the task.

For comparison, BP alone has announced plans to spend $100 million on a super computer searching for oil – with a sliver of the computational ability.

This is a hectic example of how a well designed incentive system can trump the combined power of states, in a sphere where you’d expect them to be totally dominant.

Thanks to the hype around bitcoin – and the kicks and coin people get out of participating in the enterprise – the infrastructure developed almost overnight to create most powerful computer the world has ever seen, for a fraction of what it would cost the most powerful governments in the world. Indeed, for a fraction of what they spend on far inferior systems.

And it feels like it appeared out of thin air overnight.

Last year supercomputer sales were $5.6 billion. If these (admittedly not quite apple) comparisons to the bitcoin processing hive are to be believed, the every-ten-minute-bitcoin-releases completely trumps them.

And the bitcoins were conjured out of the aether at no cost by the system itself. Disorientating.

Perhaps politicians, economists, entrepreneurs – actually maybe all of us – should give some thought to how such an outcome has been so freely engineered with such a phenomenal result.