Have You Ever Seen The Rain?
w.173 | FTX, The Nineties & Chuck Klosterman, Bogle & Vanguard, Rule of 40
Dear Friends,
What a week.
Since Tuesday morning, I’ve been in and out of consistent distraction thanks to the unraveling of FTX. Wow. The information keeps getting bleaker and bleaker. The downstream impacts are likely to be significant but not systematic. While I have no exposure, my sympathies are with all those unwittingly impacted, including many web3 companies that held their balance sheet cash with FTX in USDC.
However, sitting here on Sunday afternoon, I’m optimistic. The political consensus seems to be in favor of moderation. Inflation trended (a bit) lower. Frauds are being exposed. Strange pattern matching is being called out (Hi, Sequoia!).
There was a lot to think about this week and a lot to say this weekend.
Today's Contents:
FTX WTF — What Next?
Good Reads: Sensible Investing & Trends
Book Review: The Nineties by Chuck Klosterman
Song of the Week: Have You Ever Seen The Rain?
FTX WTF — What Next?
OK. Wow. I’m not going to take too long to rehash what’s already been well-reported in so many places across all forms of media. In sum, one of the largest crypto exchanges was using customer funds to shore up their hedge fund, which took on massive losses by originating their own coin. The specifics of what they did and how they did it were quite interesting. If you haven’t followed, you should read Matt Levine here. Here are some primary sources like The Alameda Research 2018 Pitch Deck, FTX Secondary Pitch Deck from Sept, and the memo from Sequoia that they took down but is now archived.
Sequoia: "After my interview with SBF, I was convinced: I was talking to a future trillionaire.”
Cringe. Squared. In retrospect, the signs were all there.
What am I taking away from this week? Stay the course to the tried and true.
I often say that higher education is over-rated and not everyone should go to university. However, it does often feel incongruent with how important and influential my university education has been for me. My career and knowledge as an investor sit on a bedrock of important reading and reflection from my time at Duke, particularly those lessons learned from two professors who I both regularly email with and who subscribe to this newsletter: Ed Tower and Emma Rasiel.
Their teaching about financial markets and investing has proved timeless. I read books as assigned during 2006-2008, and the lessons remain the same today. When I was in Emma’s class, we read When Genius Failed: The Rise and Fall of Long-Term Capital Management, which reminds me to this day how markets can stay irrational longer than we can stay solvent and how leverage can create massive losses.
We also read a book, which, strangely, I don’t seem to be able to find anywhere on the Internet, entirely devoted to how ridiculous and uncredible Jim Cramer from Mad Money is/was, as written by a guy who worked for him. I remember reading this book in 2007 and then being amazed as Jim Cramer continues to be on TV. It’s important to learn the lessons that much of media - particularly financial media - is pure entertainment. It’s critical to learn early so the lessons can only be reinforced and cemented by experience.
With Ed Tower, I read Stocks For the Long Run (a new edition is out, and Ed emailed me to recommend it highly just last week). But more importantly, with Ed, I spent a year writing a senior honors thesis on Time Zone Arbitrage in Vanguard Mutual Funds. I spoke about, thought about, and internalized all the lessons of Vanguard and John Bogle over a year.
What does that have to do with this week and FTX? I have seven takeaways.
1) The power of “Reputation Ponzi Schemes.”
We don’t yet know exactly what went down at FTX/Alameda. It does seem to have elements of a Ponzi scheme. The aspect that I’m most interested in is a term coined by a close investor-friend who I’ve spent years discussing a phenomenon with - the nature of the “reputation Ponzi scheme.” The idea that someone is credible because they are affiliated with someone who seems even more credible, which continues to bolster their story into a furor. SBF was proficient at that.
Every great fraud has the human element of reputation. Maybe it was from his Stanford Law School parents. It’s the same behavior behind the mania in venture capital of outsourcing your due diligence to other “Tier 1” firms like Sequoia or Tiger. Still today, one of the most important slides for investment managers raising capital is the ‘reputation’ of the follow-on capital for being credible investors. There were probably many venture capital rounds raised last year when other investors took that FTX Ventures investing was a credible sign. Those companies probably have significant exposure.
Of all Ponzis to fall, the reputation one is the most difficult. We will see more dominos fall and fall hard in this ecosystem.
I’ve been in countless conversations that go round and round about utility vs. security tokens, how to create money out of the air (it’s a playbook many have been running: invest a token related to a community with some reputation Ponzi scheme elements, swap your token with another token (different reputation Ponzi scheme), mark your token to that valuation, sell as fast as you can). In these conversations, my question always comes back to, “But where is the cash coming from? What stream of cashflows underpin the token?” That’s always problematic.
Also, remember that if Accounting Ponzis get off easy, Reputation Ponzis get punished much less, if not at all.
2) The Ownership Economy and decentralized mission behind web3 remains.
This week doesn’t discredit all of crypto and web3. FTX doesn’t represent the entirety of web3 or crypto. It was a centralized exchange linked with a proprietary investment arm. It did not adhere to any of the values of decentralization and open governance that are core to web3. Eric Lavin and I wrote Web3: It’s all still happening in August, and I stand by everything we wrote.
A decentralized web can be powerful and is likely a big part of the future. Getting the technology to work and the UX/UI to be optimized will take years. Founders that build ownership incentives that are real will drive behavior and be successful.
Digital money is the future. Most money is already digital. Fraud is still fraud.
3) Think independently.
Tom Brady, Matt Damon, Sequoia, Tiger. Always think for yourself. People and institutions always have different and likely non-transparent motivations, so you have to do your best with the information you have. And, if you don’t have good information, don’t play the game.
4) Think long-term in a short-term world.
It always struck me as notable how quickly FTX rose to prominence. They were founded in 2019 and suddenly emerged as a massive market leader. How? Some people on Twitter have theories about how FTX allowed so many traders to be profitable, almost like the game was easy. This should have raised alarm bells about why it was such easy money. But, as the thread points out, everyone wants to believe they are smart, not that something is amiss with the system.
Someone on Twitter shared this short fiction called Slow Tuesday Night about the culture of such accelerated cycles from boom to bust with companies, financial markets, and relationships.
5) Invest in and/or build good businesses.
The only way to grow wealth is to own good businesses with high-integrity people. It’s that simple. That’s what Stocks For The Long Run will tell you. That’s what Warren Buffett and Charlie Munger have practiced.
What’s a good business? Cash-efficient growth. Products that customers love. An enduring moat and competitive advantage. Competent and ethical management. A large and growing market.
Yes, it’s that simple.
6) Align capital with a contribution.
It’s been clear over the past ten years - and definitely in 2020 and 2021 - that you were rewarded for moving fast and growing at all costs. This included and was perhaps fueled by the investment industry. Managers that pumped up their investments and completed investments without diligence or conditions (e.g., pesky governance) were rewarded handsomely.
I was in a group chat with an investor in FTX and Luna. He said he wouldn’t do anything differently. Same message from Sequoia in their public letter to their LPs. My takeaway is this is the attitude that seems to impress. Never admit your mistakes. Our process works, even if this error lost money. It’s better to be invested with people who are insiders to the game than those who didn’t play.
A way to get around this, potentially, is to change the game to align capital with the contributions that are being made to a company. Fewer party rounds. Less YOLO-ing. Get back to the days when people were accountable for the outcome of their capital allocation on the micro-level. It’s impossible to do this at these mega funds.
7) Jack Bogle remains entirely unmatched. Who is the next Jack Bogle?
Who is the greatest philanthropist and most transformative entrepreneur of our time? Someone who re-wrote the rules of the financial system? Jack Bogle, the founder of Vanguard.
Discussing Vanguard and Jack Bogle deserved much more space, but here’s the gist. Jack Bogle has saved the common American investor over $1 Trillion by lowering fees on investment assets. He did that by force of his vision and the way he set up his company. Vanguard is a mutual, which means it is owned by its customers and clients and thus has a reinforcing incentive to keep fees low to non-existent. The rest of the industry has to compete against them.
In my time in and around the crypto industry, I’ve never heard a crypto-venturist discuss Jack Bogle. I found that odd, given he’s the OG of the ownership model in the finance and investment sector. I get that the cryptography and smart contract technical apparatus is interesting and, in a sense, define ‘crypto.’ But, when advancing a technical innovation leap to try to transform the financial sector, it would have been nice to see leaders who walked the walk and paid any attention to those who had come before them.
The culture of ‘wen token moon?’ has always been disgusting and irresponsible. Raising a round of financing of $420, 690,000 isn’t funny. It’s juvenile. There are some things - like managing other people’s money - that deserve to be taken seriously. May our next generation of leaders be the stewards that our system deserves.
What is effective altruism? One of these philosophies popularized by SBF was ‘earn to give’, e.g., you should earn as much money and accumulate as much wealth as possible and then give it away. I can’t think of anything more system-destroying. And that’s before committing massive fraud. Jack Bogle had about $80M net worth at his death a few years back. He didn’t need to give it all away because he had never taken so much from others; instead, he had spent decades giving it all back, bit by bit, to the American retiree.
Finding and helping the next Jack Bogle is one of the greatest opportunities of our time.
Good Reads: Sensible Investing & Trends
Sensible Investing
Lord of the Operating Models: The One Operating Model to Rule-of-40 Them All by Non-GAAP Investing.
An analysis of how to think about the trade-off between growth and profits to get your numbers to add to 40% (growth rate + profit margin).
On The Other Side of Bubble Mountain by Neckar. “The right question is not ‘how much is it down’ but ‘what is it worth in this new world?’”
Trends
Both of these pieces are interesting in the context of the changing winds of culture as we move from the previous decade to the new normal of the 2020s.
The Age of Social Media Is Ending by Ian Bogost for The Atlantic.
Gen Z VCs. The obsession with investing careers has moved from misplaced to unhealthy.
Book Review: The Nineties
Here on Amazon.
I love Chuck Klosterman. His writing style and signature wit have inspired me since I discovered him in college.
Why did I read this book? Firstly, it came highly recommended by my friend and frequent sparing partner in political and cultural trends: Charles Iannuzzi. And I’m on the search for what’s next, and thus, I’m consumed with how the economic cycle is turning but also the cultural one. Klosterman is one of the most insightful minds on culture and our perception of the past and how it manufactures into the culture. If one wants to improve their judgment and independent thinking (as I strive to!), you have always to think about what can be extrapolated from the past and what is noise.
Why the past can be difficult to derive insights from:
“People change, and they tend to view past actions through the prisms of their current self. Memories are replaced by projections. It’s more relevant to examine what people were saying at the time.”
“The compulsion to reconsider the past through the ideals and beliefs of the present is constant and overwhelming. It allows for a sense of moral clarity and feels more enlightened.”
I give this book a nine out of ten. Klosterman's book But What If We're Wrong?: Thinking About the Present As If It Were the Past might have been better. But this may be because it’s the overarching theory he then applies to the 1990s in this book. Klosterman’s writing and understanding of the cultural underpinnings of an era set the stage for the present and what might repeat in the future.
Klosterman delivers these insights so searingly: “what society classifies as ‘credible’ is almost always a product of whichever social demographic happens to be economically dominant at the time of the classification.” e.g., whatever the tech industry thought from 2010-2021.
And truisms like :
“Unlike life, sports make it simple for the ordinary person to deduce who is good and who is bad, who has won and who has lost.”
On Keanu Reeves: “He fell somewhere between a smart person’s interpretation of a meathead and a meathead’s projection of an intellectual.”
When discussing Titanic, the movie, he shows the ways the film bucked the cultural trends at the time by appealing to the universal human instincts that always win: “Titanic tapped into the reservoir of industry realities everyone always claims to concede while continually refusing to fully accept: Some people want entertainment to challenge them, but most people don’t. Some people care about acting, but more people care about actors. Some people see computerized visual spectacle as a distraction from cinematic art, but most people consider visual spectacle to be the art form’s central purpose.”
The book and the nineties foreshadows and explains the origins of current thinking, things like “a growing belief that super-rich private citizens might have better solutions to problems once considered responsibilities of the state” concerning the bio-dome project (one I had forgotten about until I re-read about it here).
Today, I see fragments of the same fashion trends returning from the nineties. As the economic cycle turns, maybe there will be increased disgust with consumerism (second-hand clothing is pretty grunge), and maybe people will dial back from the performative social media games we all have been trained to play and hustle porn people display. “In the nineties, doing nothing on purpose was a valid option, and a specific brand of cool become more important than almost anything else. The key to that coolness was disinterest in conventional success” and “An unvarnished desired to be loved was viewed as desperate and pathetic, so any attempt to alter or soften one’s persona was inauthentic and weak.”
One of the themes throughout the book is how the medium of media consumption - the television - strongly impacted culture and how the Internet evolved out of what was always there in human behavior.
“The sensation that the mediated version of an event will overwrite one’s own personal memory of the same experience, forcing the individual to re-interpret the way that memory skits within their own mind. The internet abbreviated this equation by eliminating the need for a mind. The software does the remembering, relentlessly and inflexibly, for you and for everyone else. The mediated version of the event is the memory, even if the context is false or invisible.”
…
“Television had become the way to understand everything, ruling from a position of one-way control that future generations would never consent to or understand. “
On OJ Simpson and the Bronco chase with people holding makeshift signs proclaiming “The Juice Is Loose”: “Yet this can be understood as the primordial impulse of what would eventually drive the mechanism of social media: the desire of uninformed people to be involved with the news, broadcasting their support for a homicidal maniac not because they liked him, but because it is exhilarating to participate in an experience all of society was experiencing at once.”
And maybe that explains why I was consumed this week participating in the exhilarating experience around the downfall of FTX. Living through history and the story in the making.
What an engaging week.
Selfie & Song of the Week
Have You Ever Seen The Rain?
Music video here.
It’s sort of nice with artists are just upfront with why they wrote the lyrics. And in this case, it’s clear:
Fogerty himself has said in interviews and prior to playing the song in concert that it is about rising tension within CCR. In an interview, Fogerty stated that the song was written about the fact that they were on the top of the charts, and had surpassed all of their wildest expectations of fame and fortune. They were rich and famous, but somehow all of the members of the band at the time were depressed and unhappy; thus the line "Have you ever seen the rain, coming down on a sunny day?"
This made the song of the week because the rain is coming down in the sunny Bahamas this week, and it’s an iconic, fantastic song worth re-listening to and considering many times over.
“Have You Ever Seen The Rain?” by Creedence Clearwater Revival
Someone told me long ago
There’s a calm before the storm
I know, it’s been coming for some time
When it’s over, so they say
It’ll rain a sunny day
I know, shining down like water
Selfie of the week:
My favorite weekend walk in Seattle is along the Puget Sound. Have you ever seen the rain? Well, not today. There’s not a cloud in the sky.
Note: I love writing this newsletter and being part of newsletter writing communities. I’ve got at least three friends who also write insightful weekly newsletters and include selfies. I hope this becomes the new medium of online social connection because it’s much more meaningful, you learn something from your friends’ experience, and it gives you something to build upon for your friendship. I recommend it to all.
Take a spin through these and spin up your own. I’ll be your first subscriber.
Wouldn’t It Be Awesome If by Arvind Nagarajan. Arvind writes this week about JokeDAO, a web3 governance game/startup. I’ll admit to joining his cartel and playing for a while.
Get Over The Hump by Sonny Byrd. It’s a mid-week newsletter. This week, Sonny writes about building a clothing brand from scratch and how that led him to be obsessed with the problems caused by direct-to-consumer ecommerce returns.
Nick Gray Friends by who else? :)
Thanks for reading, friends. Please always be in touch.
As always,
Katelyn