Weekend Reading #33
This is the thirty-third edition of our weekly newsletter, Weekend Reading, sent out on Saturday 7th September 2019.
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The Theory of Nachas.
‘Nachas’ means ‘a feeling of unbridled gratification’. It comes from the Hebrew word ‘Nachat’ and is one of the few words that has successfully crossed over into modern day, secular, Jewish parlance from the rapidly dying Yiddish language.
Yiddish was highly prevalent in Eastern Europe pre World War 2 and was spoken by the sizeable Jewish populations in the region at the time. It originated from German and has Hebrew words mixed into it. Today, it’s still spoken in pockets, but is dying out due to the decimation of the speaking populations in the Holocaust.
Nachas is hard to explain with words – it's more of a feeling when one is bursting with joy or fulfilment at an outcome. Think a kid who has got into medical school (previous generation) or investment banking (current generation) or soon, digital assets (future generation, in our view). A parent gains nachas from their kids’ success.
Imagine the feeling when you’ve trudged through the desert for days in soul-destroying heat and you finally get to drink a bottle of ice-cold water. The utility you get from this is not really measurable – it’s a feeling of unbridled gratification! Or nachas.
This desert scenario is the exact example given in many microeconomics textbooks when trying to convey the concept of utility, or nachas. The question of how to measure utility in the classic microeconomic sense has never been answered with any great degree of comfort.
However, A LOT has changed and we believe it’s now possible that developments in societal needs, technology and law, will soon provide us with the tools we need to do this successfully. Here at Three Body Capital, we think this has the potential to be one of the most significant changes in how businesses operate since Ronald Coase made the case for the ‘firm’ in his seminal 1937 paper, ‘The Nature of the Firm’.
But how exactly does this play out? In order to answer this question, we need to look at some recent trends.
The stakeholder strikes back.
‘Stakeholder’ is becoming an increasingly popular word. It’s a useful one too, as it goes beyond the limitations of ‘shareholders’ to encapsulate the entire ecosystem of parties that benefit (or suffer) through contact with a firm.
For the past few decades, the official stance of Corporate America in particular has been that the interests of shareholders come before those of all other stakeholders – including workers, consumers and the environment in which companies operate. This is, after all, one of Capitalism’s core tenets – that the pursuit of private interest by companies will, by virtue of the Invisible Hand, maximise the overall interests of society.
A couple of weeks back a lobbying group composed of America’s leading CEOs announced that its members ‘share a fundamental commitment to all of our stakeholders’ while pledging ‘to deliver value to all of them, for the future success of our companies, our communities, and our country.’
The media got very excited about this development. Countless blog posts, tweets and TV interviews have been dedicated to this seemingly controversial subject. But here at Three Body Capital, we wonder if everyone’s missing the point.
Top-down changes to the traditional capitalist model are not controversial – they are window dressing. They’re hard to enact, and even harder to empirically monitor (and therefore enforce) on a continual basis. They’re also highly subjective and open to interpretation (and abuse).
Forget the platitudes of CEOs. The only way to reform the way that firms behave is to rethink the economic paradigm in which they operate, forcing them to adapt. Unless incentives change, it’s practically impossible to realign the firm with the broader community over the long term.
This is a big statement, bordering on grandiose, but it’s one we wholeheartedly believe in. So we’ll say it again – if we want corporations to act more equitably towards their stakeholders, we need to rethink and re-engineer the system from the bottom up.
The decentralised era.
As we pointed out in a recent newsletter, for fans of digital assets, the corporate focus on aligning interests with stakeholders is old hat.
Tokenomics prioritises stakeholders, and Binance, the world’s largest digital asset exchange, in particular has a vision of a world where token value supersedes equity value. That’s why it’s ruthlessly optimising for the value of its token, BNB, rather than equity holders. In fact they have been doing so since inception, so much so that they operated for the first 18 months without a bank account. All stakeholders elected to receive payment in BNB rather than traditional currency.
The decentralised era may make it easier for entities to be run by and for stakeholders rather than shareholders, and investors need to be aware of the risks – and massive – opportunities this movement presents. No wonder then, that leading venture capital firms like Andreessen Horowitz are reclassifying as ‘Registered Investment Advisors’ in order to double down on digital assets. Our previously stated view that each decade is roughly defined by a new incarnation of financial product category, leads us to believe that the 20s will be the decade of digital assets. And we think we can bridge the ‘old’ world with the ‘new’.
A coherent philosophy.
In recent months, our minds have been spinning trying to process several powerful and structural forces that are reconfiguring stock markets and the companies that comprise them.
The rise of processing power and its facilitation of decentralised finance; the massive focus on ESG from institutional investors and retail alike; the reformation of the investment industry thanks to passive investing, and concomitant fee compression.
These might be discrete movements, but they are converging rapidly. Our business has been structured to profit from this convergence, but we believe that the vast majority of traditional managers will face immense upheaval in the face of overwhelming disruption.
Three Body Capital has a great team, powerful partners, and a unique market positioning based upon alignment with investors. But until now, we have lacked a fully formed philosophy to articulate how we think and feel about companies, stocks, markets and economies.
We know that alignment is everything to us. And we know that by aggregating demand, we can become a bridge between investors and markets that are currently disconnected. Finally, we know that we believe in the potential of decentralised finance to remove friction from investing and drive huge value creation.
But drawing everything together into a coherent philosophy was another matter. Until now.
The Theory of Nachas.
In recent weeks, the team has been hard at work on an economic treatise articulating our philosophy on maximising stakeholder value.
‘The Theory of Nachas’ is a whitepaper that does just that.
Traditional theories of the firm focus on the supply side of the market, examining the decisions taken through the viewpoint of optimisation for equity value. This approach was, we believe, a function of a lack of technological ability to observe, aggregate and coordinate the demand side of the market, leading to a long-held assumption that demand in the sphere of microeconomics is largely exogenous.
The onset of technologies built on the Internet which allow for individual consumer preferences and demand parameters to not only be identified but measured suggest that a new approach to understanding microeconomic equilibria stemming from the demand, rather than supply, side is now not only possible but necessary.
Our paper proposes the idea of an organised demand entity, a collective, analogous to the firm, with a capital structure governed by tokens which allows not only infinite divisibility and liquidity, but more importantly the ability to capture the value of an aggregated demand collective, both tangible and intangible, including network externalities, into monetary value carried by tokens, which are subsequently conferred upon token holders. In other words, this value capture is in fact the value of UTILITY.
The role of the entrepreneur in this set up, similar to that within the firm, is that of coordinator: making decisions that supersede the default market pricing mechanism to optimise for the total value of the token stock.
By issuing tokens to all stakeholders, internal and external, to the extent that token supply is defined and non inflationary, the collective is incentivised to behave in a manner that maximises stakeholder value (optimising for token value or utility), rather than simply shareholder value (typically in the form of equity), presenting an elegant solution to the adversarial set up of equity holders versus customers that is inherent in the status quo.
A humble request.
Truth be told, our paper is very much still a work in progress. We believe it’s well researched and robustly argued. But it’s definitely not perfect. And we’re not being prescriptive. The paper articulates our vision of what the world could look like going forward - not necessarily what it should look like.
So we’re opening The Theory of Nachas up to you, our community, and asking for your input. We hope you will engage with it and share your thoughts and feelings on its contents with us. It includes a brief case study of Binance, which is leading the charge by pioneering this new type of entity, and it also contains a conceptual study of what Amazon could look like if it embraced this new system and changed from adversarial to aligned with its stakeholders.
Nachas is exactly what you will feel when you realise the opportunities for value creation that a new approach to stakeholder inclusion can bring.
You can download the paper here. We look forward to hearing your thoughts and feedback.
What we're doing.
This week we attended CICC’s annual get together at London’s Corinthia Hotel.
Here at Three Body Capital we spend a lot of time thinking about China, so this was a great opportunity to go beyond the Western media’s depiction of Chinese companies and hear directly from company management.
As you might expect, the conference was extremely well organised, with tonnes of interesting companies present. But the highlight of the day was a conversation with CICC’s chief strategist Hanfeng Wang, who contextualised the US/China ‘Trade War’ within the Chinese economy’s ongoing structural transformation and the cultural imperative of long-term ‘100 year’ thinking. Our meeting was so good, in fact, that we’ve decided to write about it in an upcoming newsletter. So stay tuned.
A massive thank you to CICC for including us, and to the people who shared their stories and their time with us on the day.
What we're reading.
As we prepare to launch an alpha version of our platform for professional investors to trade private assets, this tweet from Andrew Chen really hit home:
'There are high-friction funnels and low-friction ones. Low-friction funnels let you sign up with a phone number to get the magic moment right away. These funnels are about subtracting steps, and removing form fields. Your audience is impulsive -- kids, busy people wasting time.
High-friction funnels live in fintech, real estate, marketplaces, B2B -- where users are smart, do research, and take their time to convert. You need detailed, private info and have many steps that can't be skipped. You need to build trust, not just create immediate gratification.'
Chen is a former Uber employee and now a successful venture capitalist with a16z, and his comments validate our thinking on content marketing and storytelling.
Right now, we’re a startup. Our prospective investors are smart, they need to trust us in order to invest with us, and this means our marketing output is high friction. We like it that way and hopefully the fact that you have made it this far into our newsletter means you like it, too.
What we're watching.
This week we’re not going to talk about a movie, or a podcast, or the fourth Ashes Test.
We’re going to talk about a new app by the name of ZAO, which became China’s top free iOS app in less than 48 hours by allowing users to drop their faces into select TV and movie scenes after uploading a single image. Here’s an example, which will blow you away.
First came the social media victory lap. Then came the backlash.
Turns out the app has a less-than-airtight security policy, which gave the company 'free, irrevocable, permanent, transferable, and relicense-able' rights to all user-generated content – and allows ZAO to leverage users’ images for marketing purposes. After a wave of complaints, the company issued a statement on Weibo to say it had updated its user agreement to address “concerns about privacy and safety issues.”
Regardless of your stance on the privacy issue, you have to agree that ZAO’s capabilities are spectacular. Right now, ‘deepfakes’ powered by AI facial replacement are the preserve of social media laughs – but the time will surely come when they become far more complicated and destructive, with ramifications for our media, entertainment and society at large.