Below is the tenth issue of eVALUATION, Stern’s student-run investment newsletter. For this issue, we elected to focus on Emerging Technologies in Investing.
Inside, you will find detailed insights from industry experts investing in new investment vehicles or using emerging technologies to help them make investment decisions. The newsletter includes interviews with successful investment managers in these sectors as well as a feature with NYU Stern’s very own cryptocurrency expert, Professor David Yermack. In addition, the newsletter features student investment write-ups and a summary of recent SIMR events.
David Yermack is the Albert Fingerhut Professor of Finance and Business Transformation at New York University Stern School of Business. He serves as Chairman of the Finance Department and Director of the NYU Pollack Center for Law and Business. Professor Yermack teaches joint MBA – Law School courses in Restructuring Firms & Industries and Bitcoin & Cryptocurrencies, as well as PhD research courses in corporate governance, executive compensation, and distress and restructuring.
Professor Yermack has been with NYU Stern since 1994. His primary research areas include boards of directors, executive compensation, and corporate finance. Professor Yermack has published more than 25 articles in leading academic journals in Finance, Accounting, Economics, and Law. He is a Faculty Research Associate of the National Bureau of Economic Research and has been a Visiting Scholar at the U.S. Federal Reserve Bank.
Professor Yermack received his Bachelor of Arts in Economics (1985), Master of Business Administration (1991), Juris Doctor (1991), Master of Arts in Business Economics (1993), and Doctor of Philosophy in Business Economics (1994) from Harvard University.
eVALUATION (eV): Can you give me a brief overview of the cryptocurrency space and tell me a little bit about why you are so interested in it?
David Yermack (DY): I got interested in this almost five years ago, around 2013. Originally it was simply from reading about it in the media. I got interested really in the political aspects of the space. I had taken a course in high school on protest literature. There was a novel by Thomas Pynchon called, “The Crying of Lot 49”, about an alternative post office that challenged the monopoly of the postal service and operated on an underground basis. When I read about Bitcoin, it looked like exactly the same idea, but as a banking system instead of as a post office. It was off the grid and beyond political control, with a certain amount of secrecy to it. But, I was amazed that the thing actually worked. That there were a community of users with enough confidence that you could lead a life entirely in Bitcoin by being very strategic about where you shopped and how you travelled. There were enough of an infrastructure of merchants to support this alternative financial identity. Not long after, the U.S. government also got interested in the space for enforcement reasons. There were hearings in Congress and I started paying closer attention to the problems that the government perceived Bitcoin to be causing. The moment that I firmly committed to the area was when I was the keynote speaker at a conference in Puerto Rico in November of 2013. Rather than talk about my prepared topic, corporate governance, I decided almost spontaneously to talk about Bitcoin, and it lit up the audience. People were fascinated. I wrote up my remarks and they went viral on the internet. By the following Spring, within six months, I was being invited to Basel to meet with central bankers at the Bank for International Settlements. I realized that something big was happening because central bankers from around the world were very concerned about it.
eV: Do you think it was interest or fear?
David Yermack: No, it was clearly fear. That they saw a viable alternative of a decentralized financial system with no political control, that in the end could be very threatening to the power of a central bank to fulfill its mission and could really take the tool of monetary policy entirely out of the hands of governments. I realized that there was a real innovation in the technology here that was not going to go away any time soon. I approached a colleague at NYU Law School who had been teaching Banking Law and had been covering a little bit of Bitcoin for a number of years and I proposed launching a course on this topic. That course, if you fast forward today, has 230 students and is the foundation of a whole program of FinTech courses that we have at Stern and the IOMS Department. This has caught the imagination of a lot of students, but also a lot of employers who are hiring many students in the space.
eV: What do you think of the comments from J.P. Morgan CEO, Jamie Dimon, that “Bitcoin is a Fraud”? Do you think that a partnership between traditional and non-traditional currencies in this new space is essential for the new currencies to survive? Or, that the new currencies may eventually take over?
David Yermack: I would first go back to Jamie Dimon’s comments, which were very famous. Whatever this stuff is, it can’t be called a fraud because it is completely transparent. A fraud is something where you mislead or maybe have an omission of a material fact. All of this crypto stuff is open source code. There is absolutely nothing that you can’t observe. You may have concerns about it, but whatever it is, it is not a fraud. It was really a poorly chosen word, and it really shows a degree of misunderstanding on his part and is really characteristic of a lot of executives in the space. I think for the time being the two are going to be competitors. What is ironic is that a lot of the banks and exchanges have looked at the underlying technology and realized that you can co-opt a lot of this and use it within the bank itself. The blockchain technology in itself has become recognized as an innovation for record keeping. It’s really an improvement on the double-entry book keeping system that came about 700 years ago. And it’s entering not only the financial world, but things like shipping, logistics, health care, electric power, and a range of other industries. Even if the Bitcoins and cryptocurrencies disappear, there is going to be a really important legacy of the block chain technology changing the way we account for assets, that in its own way is going to be very revolutionary. But I do think that these decentralized financial platforms are not going to go away easily. Will they replace the sovereign currencies? I am kind of skeptical about that, except maybe in very weak economies, such as Venezuela and Zimbabwe. I do think there will be products that are designed in this way, especially such as smart contracts that are an alternative to many insurance products. You are entering a period where there will be a huge amount of innovation. It’s a very interesting time, that is a great time to be an entrepreneur, and I think many students are interested in precisely that.
eV: I think it really brings back to life the concept of a global currency. What are your thoughts?
David Yermack: It does and I’m not sure if this is a good thing. You can look to the Euro as the closest thing that we have had to that and the Euro has caused a lot of problems. What has happened to the Eurozone is a flow of wealth from the poor countries to the rich. Because wages turn out don’t adjust the way they need to in a system with one currency, you get countries like Germany benefitting at the expense of countries such as Portugal and Greece. It does tend to push you towards one international currency, but with sticky wages in the labor market, I don’t know if this would be a good thing. I think that it is one of these things to be careful what you wish for because the unintended consequences would be severe if it does happen.
eV: What are some other applications for blockchain?
David Yermack: I recently read a story on Bloomberg about applications in the shipping industry. To me, this is probably the killer application for this technology. Tracking freight in transit. The article talks about the containers that are loaded onto big carriers in docks, offloaded half away across the world, put onto rail cars, and eventually pulled by a truck and unloaded at a grocery store. There is a whole worldwide network where you have maybe 30-50 people interacting with a container, each of them keeping their own ledger. All kinds of financial liens and letters of credit are dependent on the precise time of arrival of vehicles in transit. A better accounting system could measure much more precisely the arrival time and the condition of goods at the time they arrive. It could allow you to release liens on goods exactly when you should. Today you have to have further correspondence between the bank and trucking company. Often this is done through the mail, the old mail. If everyone had a shared ledger that was updated in real time that couldn’t be backdated or edited after the fact, not only would it allow for much more efficient behavior, but it would also reduce a lot of moral hazard issues. Shipping and logistics, this article quotes as a trillion-dollar opportunity. Also, in the public sector, things like government ledgers, real estate ownership and building inspector records. All of these kinds of government records are massive databases that can be improved with blockchains to a considerable extent. It’s hard to think of any industry that wouldn’t be impacted if they used data. Think about the advent of data in healthcare and how the security of that data is a really big issue. It seems very natural that blockchain will be a very big part of the future of innovation in the healthcare sector.
eV: When you look at cryptocurrencies, that is something that can be regulated. Blockchain isn’t something that can be driven by regulation. What are your thoughts on regulation in the space?
David Yermack: Well, blockchain is simply a technology. You would regulate its use on an industry by industry basis. An easy thing to look to is the audit industry where you are going to see corporations presenting their auditors with records kept not in a double entry system of accounts, but on a blockchain. So, the accounting regulator will have to deal with this. I think in the long run it will make auditors unnecessary. Blockchains in healthcare for drug trials would be regulated by the FDA. For things like aviation safety, it would be the FAA. Every agency will be receiving data. It’s not that this is one thing in itself that should be regulated, but will force us to rethink the regulations across every industry that enters this stream of commerce.
eV: Focusing on the cryptocurrency space, do you see a natural consolidation occurring?
David Yermack: You are still seeing a lot of innovation. Quite the opposite of consolidation. It is becoming much more fragmented. Even the big currencies like Bitcoins are undergoing these forks. A fork is where a group of users kind of engage in a revolt, and go off on a fork, as they call it, where they change the software and make new rules. With Bitcoin in just the last year, you’ve had forks that are called “Bitcoin Cash”, “Bitcoin Gold”, “Bitcoin Diamond”, among others. These really are the opposite of a consolidation. They are expressions of disagreement, where people act on their disagreement and take some of the value of the network off in their own directions. It’s kind of like anarchy. To me, this a weakness. I’ve always looked at the cryptos as being poorly governed assets. The absence of a good governance mechanism may be the Achilles Heel. If I were an investor, this is probably what would give me the greatest cause for concern.
eV: So, do you mean a lack of regulation is a cause for concern?
David Yermack: Well, lack of governance, as opposed to regulation. Regulation comes from the state, from the government. But, governance is really internal. These things by design are so decentralized that there is no leadership or recourse to an authority. This may be a virtue in some ways, but it makes it difficult to repair problems sometimes as well. I think what you’ve seen are enough of these forks, where people protest the current state of affairs and risk destabilizing these currencies. You have no control over when some angry group of players may take a critical volume of liquidity and go off on their own chain, depriving the system of something valuable. Liquidity.
eV: Do you see any differentiating factors separating one currency or exchange from another?
David Yermack: No, by design many of the currencies are deliberately quite different. They have unique selling points that highlight points of differentiation. One very simple difference with Bitcoin is that there is a limited volume it can handle. The blocks are 1MB and they occur every ten minutes. There are now backlogs of way more people that wish to use the network than there is room for. From the very early days, there has been a competitor, Litecoin. Litecoin looks like Bitcoin, but it accommodates much more transactions at a rate that is four times faster. So, there is a block not every ten minutes, but every two and a half minutes. Ethereum has five blocks per minute. So, it is a twelve second, instead of ten-minute cycle. Ethereum also has a lot of versatility, in that you can make transfers contingently. With Ethereum, I can make it contingent on like the weather, or whether you have made the payment on your automobile loan. Really any type of thing that is uncertain today, but will be known in the future. So, really an insurance contract, like life insurance. I think Ethereum is marketed very clearly at the insurance industry, where Bitcoin is meant as a payments vehicle to challenge the banking industry. So, there is a lot of very interesting differences among the 1500 or so coins that are out there. I would expect further innovation. You are probably at the very early stages of something that is going to change considerably over the next few decades as more and more people figure out better ways to write the software and to capture the relevant information that feeds into the contracts and the chains and so forth.
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