Simon Johnson, co-author of the bestseller “13 Bankers,” is the Ronald A. Kurtz (1954) Professor of Entrepreneurship at the MIT Sloan School of Management. He also works closely with Joi Ito, head of MIT’s Media Lab, on the Digital Currency Initiative (DCI).
The following article originally appeared in Consensus Magazine, distributed exclusively to attendees of Consensus 2018.
In 1913, H.G. Wells wrote “The World Set Free,” a chillingly prescient set of predictions about the development of technology.
Published in early 1914, this slim volume called it exactly right on the coming dominance of aircraft in warfare, the ways armies would adapt (or not) and even some of the geopolitical implications. Most astonishingly, Wells also predicted that atomic bombs would soon be dropped from the air on civilian populations – and that this would change everything.
As we grapple with the potential future of crypto-tokens and related developments, Wells’ volume – and particularly the way he thought about the future – bears closer consideration.
The remarkable point about Wells’ reasoning is that he jumped directly from the fairly rudimentary pre-World War I knowledge of radioactivity and atomic structure to the idea that within this science lurked an explosive device of devastating power. In retrospect, this might seem obvious, but it was not until almost exactly 20 years later that a physicist even conceived of exactly how a chain reaction might take place.
Wells was wrong, of course, about all the details. Anyone who imagines the future of technology will necessarily mess up on all the small stuff. The more interesting question is: if we understand the bigger shifts, can we predict at least the direction of future change?
And – much more difficult – if we can see where this new breed of digital, blockchain-based tokens might lead or what they could become, could we glean any insight into when big things might happen?
What we do know is that one feature of this technology is already triggering a societal and economic shift before our eyes: initial coin offerings (ICOs). While it will it take some time, if ever, before this technology’s advocates realize their vision for tokens to forge a new system of economic exchange and governance, ICOs are making waves right now.
There is obviously a lot of debate about the precise nature of ICOs, including whether or not they constitute securities offerings in the eyes of the law – which, in the U.S., the SEC interprets and applies in the first instance (subject to legal appeals and political discourse, of course). I’m not a securities lawyer, and I am not here taking a position on this question.
Instead, let’s focus on what promoters of ICOs say they are trying to do by selling digital tokens to the public – and what appears to have caught the attention of investors. While many will describe their tokens not as investments but as pre-sold, negotiable “products” with a utility function that gives the holder access to the system’s services, so far the most disruptive aspect of this idea lies in how it changes the fundraising dynamic.
And on that score, the idea is relatively straightforward: someone will build a technology that could be useful to you and others, and that person would like to prefund that in a way that the value generated by that technology is shared with early users (and others who are willing to provide risk capital at this development stage).
Access to capital for risky ventures is a key constraint both for the development of individual firms and for our economy-wide process through which new technology reaches the market. ICOs offer a more direct route for both tapping and deploying funds, for matching founders with investors. That turns out to be quite revolutionary.
In the 19th century, before there was a boom in industrial development projects, we built a lot of railroads in Europe and the U.S. The legal form varied somewhat across jurisdictions, but every country that made progress in raising capital did so through some form of Joint Stock Company – liability for investors was limited, and ownership shares could be traded in a relatively efficient forms.
Of course, there was madness and also bad behavior during various railway manias. And we learned the very hard way that unfettered competition can lead to some problematic behavior, either in terms of safety (a lot of people were injured or killed by trains in the early days), the concentration of power (e.g., build railway monopolies and jack up prices), a boom-bust cycle (which can even bring down the financial system and have broader deleterious macroeconomic effects).
We responded over the following century or so with various “soft” or institutional innovations that started in the private sector but ultimately acquired the backing of government.
Dangerous behavior was constrained through the award of legal damages and through the protections demand by trade unions. The predatory pricing behavior of trusts was limited by law and by the executive – Teddy Roosevelt’s first antitrust action was against a regional railroad monopoly.
A central bank was created because, following the panic of 1907, no one was confident that purely private mechanisms could prevent collapses in a severe panic, and securities regulation emerged because the consequences of the Crash of 1929 proved so devastating. David Moss’s compelling book on the rise of the U.S. federal government is aptly titled, When All Else Fails.
Seen in this context, how should we see ICOs – joint stock companies, or railroad ventures, or some combination of both? We don’t know yet for sure, but we can see more clearly the problem that is being addressed – it is relatively hard to raise early stage capital, and under the existing venture capital model it helps to be located in one of a few places (e.g., Silicon Valley broadly defined, Boston and New York).
What about all the people with good ideas who live elsewhere? And what about investors who would like to take some well-considered risk but who are not considered qualified under the existing, rather antiquated rules (which are based entirely on how much “investable” wealth you have). Or what if you have an idea that, for whatever reason, is not on the current wish list for the people who run VC funds?
If there are barriers to entry into venture capital, as seems plausible, it is fairly straightforward to reason that there are very high returns to capital in this sector, at least on average and over a sufficiently long period of time. Who is able to participate in those opportunities, i.e., invest in a VC fund? Not most people who are reading this column.
To be sure, there are many problems to be solved along the way to ICOs – or anything that descends from them – allowing for a more democratic approach to risk-taking. There may be scams or weak governance or just bad ideas – we have seen plenty of each in every previous investment boom. And, to be clear, in any such emerging market situations, you really can lose everything you risk, without recourse or recompense.
Picking up on some of these risks, Mark Carney, governor of the Bank of England, and Agustin Carstens, head of the Bank for International Settlements, weighed in recently against cryptocurrencies, including but not limited to bitcoin. Their speeches are quite different but both are wonderfully erudite and elegantly constructed. They focused primarily on the future of money, at least as they define it. Anyone interested in this space should carry copies with them at all time. As Oscar Wilde suggested, it is important to have something sensational to read on the train.
Or you can read H.G. Wells.
Predicting a limited future for a new way of raising capital today is rather like hearing about the properties of radium in 1898 and remarking, “is that all it can do?”
Now, it’s true that anyone who was concerned about the health implications and other unintended consequences of discovering radioactive elements was exactly right – and should have been listened to more carefully. Carney and Carstens make some good points in this regard.
And – this is a point nailed by Wells – any sufficiently profound development in technology cannot avoid having major effects on the structure of society, including the value of firms and who has (and keeps) a good job. All such effects are inherently hard to predict. To those who wish to hurry change – be careful what you wish for.
Still, it is sudden change that generally proves most difficult to handle, and there are good reasons to think we have some time before the full implications of ICOs (and their institutional grandchildren) are upon us. The SEC will apply existing rules in a judicious manner – investors really do need protection, and there is actually bipartisan support on this point. The Commodity Futures Trading Commission may well weigh in regarding how particular instruments should be traded. The leadership of both organizations seem, at this time, to be paying close and sensible attention to developments.
It should not surprise us if, in our usual empirical and haphazard way, we find a path along which regulation can support more decentralized and lower-cost ways of raising capital. Gate-keepers in the financial world, who do well by controlling various bottlenecks, will come under increasing pressure.
Whatever happens, we should always expect a boom-bust cycle. It is hard to think of an instance of technological change in modern America that has not gone through some phase of exuberance, followed by consolidation and – sometimes – eventual impact.
What we can prepare for
If better access to risk capital lies in our future, what can we say about when this might happen?
This is the hardest question, and it’s likely not a good idea to take (or bet on) a strong view. With regard to the future of power generation, transportation and warfare, H.G. Wells was right on the natural course of science – he picked the 1930s as key decade for applications to emerge from the theory of atoms – but he completely failed to anticipate how much the process could speed up once the resources of a well-run country were applied to a problem with single-minded concentration, i.e., the Manhattan Project.
Wells also thought – and this is interesting for the ICO context – that once one country had acquired destructive nuclear technology, almost all countries in the world would follow suit. He was wrong about that. Similarly, with economic and financial innovations, there are plenty of reasons why some countries will struggle to emulate the leaders – typically because local oligarchs prefer the status quo.
In the end, some relatively prosperous countries – this could include the U.S. or perhaps smaller countries with less of a stake in the existing global financial system – will end up with a better way of raising capital and, most likely, an associated change in how corporate governance operates.
Fundamental issues surrounding the protection of privacy will need to be dealt with along the way. A host of related issues to be addressed include the precise nature of disclosure, what meaningful reporting through financial accounting means, and how markets obtain and respond to information.
We should probably also rethink what kind of investment portfolios are recommended at different stages of life. Who should be regarded as an accredited investor, for example in a technology they know well – and when they are in their early twenties (so there is plenty of time to ride the cycle)? Investors need protection, but against what and through what methods exactly?
None of this means that utopia is around the corner or that productivity growth is about to jump upwards. In “The World Set Free,” H.G. Wells was too optimistic about the future of benevolent government, and we would do well to avoid that mistake.
But the way capital finds and supports opportunities around the world is not just changing – it has already changed. Spend some time thinking through the implications.
Cell membrane via Shutterstock
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