Speaker 1: M. This is Mesters in Business with Very Renaults on
Speaker 1: Bluebird Radio this weekend. On the podcast, I have a
Speaker 1: special guest. His name is Campbell Harvey and he is
Speaker 1: a professor at Duke University School of Business. He's also
Speaker 1: the author of a fascinating book co author really of
Speaker 1: a fascinating book called Defy and the Future of Finance.
Speaker 1: And if you are at all crypto curious, if you're
Speaker 1: wondering why bitcoin is near sixty dollars, why n f
Speaker 1: t s have gone crazy, and while lots and lots
Speaker 1: of banks and financial institutions have been embracing crypto, well,
Speaker 1: then you're going to find this conversation absolutely fascinating. Um.
Speaker 1: Campbell Harvey is a traditional finance professor, or at least
Speaker 1: that's how he presents to the outside world, studying behavioral finance, uh,
Speaker 1: the yield curve and recessions and separating luck and skill
Speaker 1: and investment decisions. All this stuff sounds pretty run of
Speaker 1: the mill, middle of the road sort of stuff. But
Speaker 1: then back in he was crypto curious and started doing
Speaker 1: some research and ended up doing a presentation to one
Speaker 1: of his classes, and really it had a massive impact
Speaker 1: on him because you know, at the end of the period,
Speaker 1: he expects the whole class to get up and leave,
Speaker 1: and you know, spoiler alert, nobody leaves, and half the
Speaker 1: class rushes the podium to ask him a bunch of
Speaker 1: questions about this, and he, you know, really comes to recognize, Oh,
Speaker 1: so this is striking a chord with students. There's something
Speaker 1: here I need to spend some more time and effort
Speaker 1: going into it. Um That part of that part of
Speaker 1: the interview was really fascinating. He tells about what he
Speaker 1: does with crypto, where he was giving bitcoin away to
Speaker 1: each of his students um so that they had to
Speaker 1: set up a coin base account and you know, make
Speaker 1: a promise to return the coin at the end of
Speaker 1: the term and what ends up happening is pretty pretty
Speaker 1: hilarious and fascinating. Anyway, if if you're remotely interested in
Speaker 1: anything from the world of defy, from crypto, n f T,
Speaker 1: stable coins. God, I could have spoken to him for
Speaker 1: another three hours. I kept this fairly um accessible. I
Speaker 1: had lots and lots of deeper, wonkier questions, but as
Speaker 1: we were going on through this, it really became clear
Speaker 1: to me, Oh, this is a great primer for people
Speaker 1: who really wanna put a toe in the water of crypto.
Speaker 1: I found it fascinating and I think you will also so,
Speaker 1: with no further ado, my conversation with Duke University's few
Speaker 1: Quass School of Business Professor Campbell Harvey. This is Mesters
Speaker 1: in Business with Very Results on Bloomberg Radio. My extra
Speaker 1: special guest this week is cam Harvey. He is a
Speaker 1: professor at Duke University's Fuquas School of Business. He's best
Speaker 1: known for his work on yield curve inversion and recessions,
Speaker 1: as well as the thorny problem of separating luck from
Speaker 1: skill in investing. He is a research associate at the
Speaker 1: National Bureau of Economic Research, as well as a partner
Speaker 1: and see in your Advisor at Research Affiliates. He is
Speaker 1: the author of a brand new book titled Defy and
Speaker 1: the Future of Finance. Campbell Harvey, Welcome to Bloomberg. It's
Speaker 1: great to be on the show. It's great having you.
Speaker 1: So you're a pretty traditional finance guy, Duke n b R.
Speaker 1: How did you get interested in Defy? When did this
Speaker 1: start and what prompted it. I'm not too sure. I'm
Speaker 1: a traditional of finance guy. Uh. Indeed, uh five years
Speaker 1: ago I announced that half of the empirical research and
Speaker 1: finance was likely false. So I don't think I'm traditional
Speaker 1: in any way, but I totally agree that decentralized finance
Speaker 1: seems far away from inverted deal curves and luck versus
Speaker 1: skill and back testing and things like that. So let
Speaker 1: me let me tell you the story about how I
Speaker 1: got involved in this space. And I've been involved in
Speaker 1: this space quite a while. I was on a seven
Speaker 1: year teaching hiatus because I was editing the Journal of
Speaker 1: Finance and it was a full time job. When I
Speaker 1: came back to my asset management course after seven years,
Speaker 1: I decided to scrap the syllabus and and basically start over.
Speaker 1: But certain topics I had to include, like four X
Speaker 1: and I wanted to do the leading edge stuff, and
Speaker 1: I thought, well, there's this new thing I've heard of
Speaker 1: called bitcoin. And this isn't two thousand fourteen, so it
Speaker 1: was below the radar screen definitely, but I'd heard about it,
Speaker 1: and I just said, well, if I'm doing the euro,
Speaker 1: the pound, the dollar again, one not at a cryptocurrency.
Speaker 1: So that's where I actually started. And I began to
Speaker 1: research this idea, and the more I researched it, the
Speaker 1: more I realized that this was something really big, and
Speaker 1: they spent a lot of time, and it was a single,
Speaker 1: like two hour lecture in my course. Uh And I
Speaker 1: spent more time preparing that lecture than the sum of
Speaker 1: all of the other lectures in my course. And I
Speaker 1: was nervous because, and as I management, I've researched this
Speaker 1: stuff for a long time. I've been very fortunate to
Speaker 1: have real relationships with some of the leading edge firms.
Speaker 1: Uh So I kind of what goes on in the
Speaker 1: practice also, and very comfortable fielding questions from my students.
Speaker 1: And of course I can't answer every single question, but
Speaker 1: I I'm confident I could find somebody very quickly that
Speaker 1: could help me with the answer. But with this crypto stuff,
Speaker 1: I'm in the position where I'm giving a lecture and
Speaker 1: as possible, some of the students know far more than
Speaker 1: I do. So I sought some help. Um and I
Speaker 1: practiced the lecture all this stuff, and then I gave
Speaker 1: this lecture, and again it was probably the most stressful
Speaker 1: lecture I've ever given. Uh And and you know the
Speaker 1: way it is at at college where rate at the
Speaker 1: end of the lecture everybody gets up and leaves rate
Speaker 1: on the minute that is supposed to end. Nobody the
Speaker 1: stays late. They just get out of there. And you know,
Speaker 1: I've taught for many years that's exactly what happens. But
Speaker 1: after giving this talk on crypto, people were just sitting there,
Speaker 1: and I thought, oh, well, maybe I ended the lecture
Speaker 1: like a way before I should have. But I looked
Speaker 1: at the clock and we were exactly at time, people
Speaker 1: just sitting there, And I said, oh, I must have
Speaker 1: really bombed this lecture. It was a disaster, I guess.
Speaker 1: And and and I'm standing there shell shot because it
Speaker 1: worked so hard and and for it to fail it
Speaker 1: was very disappointing. But then students started to come to
Speaker 1: the front to talk to me, and and they said,
Speaker 1: but we are shell shocked, like this is a transformational
Speaker 1: topic that and and I numbered them said this was
Speaker 1: the most important lecture of their education, and that this
Speaker 1: cannot be just one lecture. It needs to be a
Speaker 1: broader learning experience and uh and and so it deserves
Speaker 1: at least a full course. And that's where I started.
Speaker 1: So um I developed the next year into a full course,
Speaker 1: which was the first blockchain based course taught at a
Speaker 1: leading school, and then I've just continued it and uh
Speaker 1: and one thing with the space, uh is changing all
Speaker 1: the time. So what I was teaching seven years ago
Speaker 1: was much different than what I teach today. So let's
Speaker 1: let's go back to that first lecture where where the
Speaker 1: students were pretty um enthusiastic and and maybe even dumbfounded. First,
Speaker 1: did anybody come to the podium and say, Hey, I
Speaker 1: own a bunch of bitcoin and I don't know what
Speaker 1: to do with it? And be were you buying bitcoin
Speaker 1: all the way back in? So no student had any bitcoin? Um,
Speaker 1: but I actually bought some, and I bought them I
Speaker 1: think a three a coin. Uh And and this is
Speaker 1: one of the greatest investment mistakes of my life, um,
Speaker 1: I decided. I was on the phone with a reporter
Speaker 1: from a leading media outlet who was covering crypto also,
Speaker 1: and I asked him whether he owned any bitcoin, and
Speaker 1: he said, well, just a small amount, because I'm worried
Speaker 1: about conflict of interest. And I was thinking, made the
Speaker 1: same thing. If I'm teaching it, I'll have a small amount.
Speaker 1: And indeed, um, I was giving it out. So my student,
Speaker 1: when what do you mean giving it out? Giving it
Speaker 1: to students. Okay, yeah, so let me tell this story.
Speaker 1: Uh an interest. Wait, so you're paying them to go
Speaker 1: to school. What I did was to give ten dollars
Speaker 1: words of bitcoin to everybody. Ended deal was the following Uh.
Speaker 1: They had to set up an account and at that
Speaker 1: time it was the coin base. I would give ten
Speaker 1: dollars and then at the end of the course, um,
Speaker 1: they would send it back to me, and then I
Speaker 1: would donate it to the university. So that would donation
Speaker 1: my annual donation to the university. So it was basically
Speaker 1: just to get them set up with something in their wallet.
Speaker 1: So I discovered this one complication and and that is
Speaker 1: that once you give a crypto to somebody, there's no
Speaker 1: way to enforce giving it back. So many of the
Speaker 1: students didn't give that because it had Yeah you know
Speaker 1: where I'm going, Like sometimes I get an odd email
Speaker 1: or oh, um, I remember you gave me, uh whatever,
Speaker 1: it was like point one of a big coin um
Speaker 1: back in two thousand and fourteen, I forgot to give
Speaker 1: it back and yeah, here it is and it's you know,
Speaker 1: four thousand dollars so um. So basically what's happened is
Speaker 1: a lot of students didn't give back, and uh, and
Speaker 1: we're trying to remind them to do that because it's
Speaker 1: a couple of hundred thousand dollars and and kind of
Speaker 1: lost donations to the school. So it's not that they
Speaker 1: didn't give it back because it had appreciated so much.
Speaker 1: At the end of the semester, they just like, it's
Speaker 1: ten dollars and who's who wants to bother and they
Speaker 1: just got lazies. Is that what I'm hearing? Yeah, that's
Speaker 1: what I think. So many of them just forgot about it.
Speaker 1: But again, that ten dollars is massively appreciated. That's unbelievable.
Speaker 1: So we're gonna talk in more detail about the book
Speaker 1: Defy in the Future of Finance, but just of us
Speaker 1: a broad overview. What's the basic premise And I get
Speaker 1: the sense you're going to talk about how transformational this
Speaker 1: technology is. Yeah, it's kind of interesting to me that
Speaker 1: the financial system really isn't that much different today than
Speaker 1: it was a hundred years ago, Like the the exception
Speaker 1: is digitization, but the basic infrastructure is the same. And
Speaker 1: I don't think that it's specific to finance. We kind
Speaker 1: of know that technology will transform a number of businesses.
Speaker 1: And right now, the way that we interact and finances
Speaker 1: with um a brick and mortar intermediary. So you've got
Speaker 1: a bank in the middle, you've got a broker in
Speaker 1: the middle, and uh, that middle layer leads to transactions
Speaker 1: that are more expensive. So so think of putting your
Speaker 1: money in the savings account, that rate is maybe lower
Speaker 1: uh than if you didn't have all of that middle layer, um,
Speaker 1: the back office and all of this stuff. And the
Speaker 1: same with the lending that the rates are are higher
Speaker 1: and there's a spread that's effectively taken by the centralized player.
Speaker 1: So what the centralized finances about is essentially returning to
Speaker 1: where we began in market exchange. And that's barber and
Speaker 1: it's peer one on one and yeah, and that's the key.
Speaker 1: So you're you're dealing with your peer uh directly or
Speaker 1: a portfolio peers and through an algorithm, and that's the key.
Speaker 1: So the algorithm basically takes the place of the functioning
Speaker 1: of a bank or a broke her And when you
Speaker 1: do this, when you've just got an algorithm out there,
Speaker 1: it makes things much more efficient. So without that middle layer, uh,
Speaker 1: you're able to get this efficiency gain that's very important,
Speaker 1: uh for the economy. So as many different aspects of this,
Speaker 1: but the key idea is, let's deal with the algorithm directly.
Speaker 1: And when we do that, it's going to reduce costs.
Speaker 1: It's gonna make transactions uh much more transparent, secure, efficient,
Speaker 1: all of these things. So so let me push back
Speaker 1: a little bit. And and by the way, we'll talk
Speaker 1: about a c H in a minute. We'll talk about
Speaker 1: credit cards in a minute. But let me for a
Speaker 1: moment take the other side of the argument that nothing's
Speaker 1: changed in finance over a century. Today, I could trade
Speaker 1: stocks effectively for free. I'm rebuilding a Tyhota FJ in
Speaker 1: South America. I ship cash down using an app. It
Speaker 1: costs me three dollars every time I want to send
Speaker 1: three thousand dollars to South America. That used to be impossible.
Speaker 1: I could get cash out of a machine seven. I
Speaker 1: don't even have to go to the bank to deposit
Speaker 1: a check. I take a photo with my phone and
Speaker 1: and that's a deposit. And if we go to dinner
Speaker 1: and we want to split the tab, I could venmo
Speaker 1: whoever else is at dinner back and forth. It's like
Speaker 1: so easy. I think about what technology lets me do
Speaker 1: today versus I was in college when they first put
Speaker 1: an a t M in the student union. It feels
Speaker 1: to someone like me that the past forty years has
Speaker 1: seen an endless array of incremental improvements in the financial system,
Speaker 1: and then the Great Financial Crisis comes along and everybody
Speaker 1: seems to lose their minds. Aren't we overstating it when
Speaker 1: we say there's been no improvements in the world of finance. Well,
Speaker 1: I did make an option with the digitization, but I
Speaker 1: think there's been improvements digitization. Yeah. Look, you say, let
Speaker 1: me go through your list that you can practice the
Speaker 1: trade for free. So that is it is true that
Speaker 1: transaction costs have a decreased. It is not true to
Speaker 1: believe that if you trade on robin Hood you're trading
Speaker 1: for free. It's just not the case. And then number two,
Speaker 1: more importantly, for me to take ownership of a share
Speaker 1: of stock, because the transfer the ownership that takes two days.
Speaker 1: So even in this age of the Internet, in the
Speaker 1: age of digitization, it takes two days to transfer the
Speaker 1: ownership of let's say a hundred chairs of IBM. It's
Speaker 1: just completely unsatisfactory, unrealistic and uh yet better in nineties,
Speaker 1: it was like five days, um, and we've had a
Speaker 1: change the three days and two days. But that's just
Speaker 1: to me totally offside. So as for the cash apps, yeah,
Speaker 1: there's many, uh, many things that have happened to make
Speaker 1: it a little more efficient to actually do the transactions.
Speaker 1: But uh, and I point this out in the book, UM,
Speaker 1: the current wave of fintech largely uses the banking infrastructure
Speaker 1: that exists today, the centralized banking infrastructure. And to make
Speaker 1: the case in the book that look the traditional financial institutions,
Speaker 1: they are being continuously disrupted and one wave of that
Speaker 1: disruption is the fintech. So the neon banks, things like that, um,
Speaker 1: that make it much more friendly for the user. But
Speaker 1: given that they are using the same centralized infrastructure, in
Speaker 1: my opinion, the current wave of fintech is fleeting. I
Speaker 1: had a speaker in my course, UM, very prominent person
Speaker 1: in the world of of DeFi who basically at the
Speaker 1: end of his talk to my course, he said that
Speaker 1: the current wave of fintech is like putting lipstick on
Speaker 1: a pig. And if you think about it, what he's
Speaker 1: saying is, yeah, it's an improvement, um, but you've got
Speaker 1: the same constraints of that centralized infrastructure. And what DeFi
Speaker 1: is doing is not doing an incremental improvement on the
Speaker 1: current infrastructure, is actually building something that's fresh and new.
Speaker 1: So I see looking forward that a fintech will definitely
Speaker 1: disrupt the current financial system, but then eventually the centralized
Speaker 1: fintech will be disrupted by decentralized algorithms. So so let's
Speaker 1: talk about what I think is the most expansive part
Speaker 1: of centralized finance. Personally, I could care less if a
Speaker 1: h takes two days to clear stock trade. It doesn't
Speaker 1: make any difference to me. I could buy and sell
Speaker 1: that stock a thousand times before the first trade settles
Speaker 1: and it doesn't cost me anything. But in the book
Speaker 1: you use the specific example of credit card transactions and
Speaker 1: that a hundred years ago there was about a three
Speaker 1: percent cost to send money by wire, and today using
Speaker 1: credit cards, a century later, it's still a three percent
Speaker 1: credit card fig So why does that exist? Why hasn't
Speaker 1: it been competed down yet? And what will DEFY do
Speaker 1: about that three big which is the bane of retailers everywhere? Yeah,
Speaker 1: it's it's remarkable. Uh, the example I use on my
Speaker 1: book is not one hundred years. It's a hundred and
Speaker 1: fifty years. And I show this Western Union wire transfer
Speaker 1: from seventy three and it's for three hundred dollars. And
Speaker 1: then there's another line for the fees, and the fees
Speaker 1: are nine dollars. So it's like and I tell my
Speaker 1: students that basically nothing has changed in this particular example,
Speaker 1: nothing has changed. Uh, it's a three percent fee. So
Speaker 1: the reason that the fees for credit cards are so high, Um,
Speaker 1: there's many reasons. The leading reasons are the lack of security.
Speaker 1: So if somebody steals your credit card, then the credit
Speaker 1: card company is good for it, right, so you're not
Speaker 1: gonna lose anything that cover um and all the chargebacks.
Speaker 1: So uh that that's expensive. The security mechanisms are expensive,
Speaker 1: and then of course just the brick and mortar back office,
Speaker 1: all the systems, all of that is expensive. So um,
Speaker 1: you put that together, it's three percent. We have had,
Speaker 1: again with fintech, some some competition here. Uh that's driven
Speaker 1: that three percent lower because credit cards offer cash back
Speaker 1: and all of these other deals, and we've had innovations
Speaker 1: like let's say Apple Pay, which is a great deal
Speaker 1: for the credit card company. So instead of getting three percent,
Speaker 1: they get two point five, and Apple gets point five.
Speaker 1: But it's massively more secure really when you use that.
Speaker 1: Oh yeah, because to pay with Apple Pay, um, you
Speaker 1: do the facial recognition. If you're just swiping a credit card, um,
Speaker 1: there's no pin, right, So in the United States we
Speaker 1: don't use the pin for the credit cards. In Europe
Speaker 1: a different story, but it's really much more secure. So
Speaker 1: we see the fees being bid down a little bit,
Speaker 1: but that that's the reason. So so let me let's
Speaker 1: stay with Apple Pay for a second, because it's such
Speaker 1: an interesting um example. As a user, I have no
Speaker 1: insensive really to use Apple Pay over a credit card,
Speaker 1: but it would It sounds like the credit card companies
Speaker 1: have a massive incentive to have me use Apple Pay.
Speaker 1: Why hasn't there or a similar biometric um security system.
Speaker 1: Why hasn't there been a bigger push in that direction
Speaker 1: by the credit card companies. So at the beginning, it
Speaker 1: wasn't clear that they really understood. So it seems like, well,
Speaker 1: instead again three we got to take a haircut to
Speaker 1: two point five. And and maybe there was an expectation
Speaker 1: that the regular credit card would have better biometrics or
Speaker 1: or a minimum a pin. But given that we don't
Speaker 1: have that, uh, it is way more secure to use
Speaker 1: something like Apple Pay, where you were to use a
Speaker 1: pin or use the facial recognition. So it's much more
Speaker 1: difficult to to use like Apple pay, uh if you're
Speaker 1: if you've stolen somebody's phone for example. So the security
Speaker 1: cost um that's attributed to those that use the credit
Speaker 1: card that Apple pay is way lower. So we have
Speaker 1: seen a lot of growth. This is not my area
Speaker 1: of expertise, uh, like credit card uh, you know, mechanics
Speaker 1: and and the amount of sales that's Apple Pay or
Speaker 1: uh Android versus just a regular swipe. But but it
Speaker 1: is much more secure and and that's a major cost.
Speaker 1: The insecurity is a major issue with not just credit
Speaker 1: cards but banking in general. We were discussing what makes
Speaker 1: decentralization so desirable um and so valuable in so many cases,
Speaker 1: But the counter argument is centralization allows us to put
Speaker 1: legal protections into place and security and anti money laundering.
Speaker 1: How do we manage those around decentralization? What what's the advantage?
Speaker 1: So it is a tradeoff, and I think that people
Speaker 1: in decentralized finance understand uh these tradeoffs and there's nothing
Speaker 1: that's perfect. There's always going to be some risk. But
Speaker 1: decentralization is again putting people together, so you deal peer
Speaker 1: to peer without this thick middle layer, and there's some
Speaker 1: advantage to doing that. Um, you're correct that centralization does
Speaker 1: have some advantages. So one advantage is that you can
Speaker 1: move very quickly, whereas a decentralized protocol, if there's a
Speaker 1: change the necessary and that protocol, that's got to go
Speaker 1: to a vote of of the users or the owners
Speaker 1: of the governance, so that could take a longer period.
Speaker 1: At a time, Uh, the throughput in terms of the
Speaker 1: number of transactions per second much greater if you've just
Speaker 1: got one centralized clearinghouse. So there there are trade offs here.
Speaker 1: But with centralization, uh, these institutions can do what they want.
Speaker 1: And we were talking in the previous segment about credit cards. Um,
Speaker 1: well what about like a wire transfer? I did one
Speaker 1: last week and I had to send um some euros
Speaker 1: to Europe for uh, you know, for for some repair bill.
Speaker 1: And UH my bank said, oh, well you're a good customer,
Speaker 1: We're gonna wave the wire transfer fee. But then they
Speaker 1: quoted me the rate and I said, well that rate
Speaker 1: is two point five off the market and it's a sorry,
Speaker 1: that's the best we can do. So to send the
Speaker 1: wire transfer was like swiping a credit card, no difference.
Speaker 1: And they think, you know, they're convincing the customer that, oh, well,
Speaker 1: this is a favor that we're doing it. No, so
Speaker 1: they have got control, they've got market power. So these
Speaker 1: large financial institutions, it doesn't matter who I go to,
Speaker 1: it's going to be the same thing where they're going
Speaker 1: to quote two point five percent off the market rate
Speaker 1: and and I gotta pay it. So it's very direct
Speaker 1: and very large cost. So they've got the power to
Speaker 1: actually do that. When you go peer to peer, it's
Speaker 1: nothing like that at all. UM, you're just interacting with
Speaker 1: your peer. Somebody is buying, somebody is selling, and and
Speaker 1: we're done. There's no spread. So again, the advantage of
Speaker 1: UH centralized is that we're familiar with it. UH. It
Speaker 1: appears to work, it does work to some degree with
Speaker 1: our system, but it imposes these costs, and these costs
Speaker 1: lead to, in my opinion, UM, opportunities that are not
Speaker 1: pursued that we really need to pursue. And if I
Speaker 1: could give an example of debt, you're a small entrepreneur.
Speaker 1: You've got a great idea, you think the return on
Speaker 1: investment is going to be percent a year, and you
Speaker 1: go to your bank and basically asked for a loan
Speaker 1: to get this going, and the bank says, well, you're
Speaker 1: too small. We prefer larger customers. So we prefer one
Speaker 1: large customer to a hundred customers like you. Um, so
Speaker 1: we're not going to do the loan, even though we
Speaker 1: like the idea. But oh here, here's a credit card
Speaker 1: and we've extended the credit limit on it, and you
Speaker 1: can just borrow on your credit card, and we know
Speaker 1: what those rates are, so the rate right, the project
Speaker 1: isn't pursued. And when the project isn't pursued, you've got
Speaker 1: like a high growth project that isn't pursued. That's exactly
Speaker 1: what our economy needs. We're stuck in two real GDP
Speaker 1: growth and given the size of the obligations that the
Speaker 1: government has taken on UM, there are not many good options.
Speaker 1: So you could inflate by increasing the money supply. You
Speaker 1: could tax, and that's not great for growth, but the
Speaker 1: best way out is to increase growth. And given the
Speaker 1: situation that we're facing today where we've got so many
Speaker 1: people under banked. So under banking is the example I
Speaker 1: gave where you're not able to get that loan even
Speaker 1: though you've got a good idea. Uh that that is
Speaker 1: a drag on economic growth. So in my opinion, if
Speaker 1: we take these frictions out or reduce the frictions and
Speaker 1: allow people to be treated equally and the judgment is
Speaker 1: basically on the quality of the idea rather than how
Speaker 1: much you've got, then that opens up the possibility of
Speaker 1: substantially increased growth in our economy, and we really need that.
Speaker 1: So so let's stick with unbanked. And it's funny what
Speaker 1: you mentioned about doing the wire to Europe. I mentioned
Speaker 1: the app that I can send money around the world
Speaker 1: and it costs me nothing, but I'm limited to sending
Speaker 1: three thousand dollars that's the cap. I think it's every
Speaker 1: seven days or every five days, or and I think
Speaker 1: that is a nod to the money launching rules. Let's
Speaker 1: talk about how much of the world is unbanked and
Speaker 1: what DEFY can do to give them access. There was
Speaker 1: a giant story on sixty Minutes a couple of years
Speaker 1: ago about some person who set up a way to
Speaker 1: move money around by phones. In Africa, there's you know,
Speaker 1: a huge swath of people who are in bank there
Speaker 1: and and that technology has been making improvements. Tell us
Speaker 1: a little bit about UM how defy can help people
Speaker 1: who don't have access to centralized banking. So in the
Speaker 1: world today, there are one point seven billion people that
Speaker 1: are unbanked, and there's probably we don't have the exact
Speaker 1: number on this, Probably more are underbanked. And my example
Speaker 1: that I gave you with the entrepreneur, that entrepreneur had
Speaker 1: a personal bank account, but they they were not able
Speaker 1: to get alone that and that again is under banking.
Speaker 1: So it is a very large proportion. Uh. One example
Speaker 1: I'd like to give UM, and a lot of the
Speaker 1: action here is happening outside of the US. So think
Speaker 1: of a country like Venezuela that's in a hyper inflation
Speaker 1: a situation. If you're really well off in Venezuela, that
Speaker 1: hyper inflation really doesn't impact you that much because you've
Speaker 1: got a US dollar bank account in Miami or somewhere
Speaker 1: outside of Venezuela. So who is hit the hardest. It's
Speaker 1: the the average person uh in Venezuela where they don't
Speaker 1: have the opportunity to set up that bank account outside
Speaker 1: or the amount of money that they've got isn't that large.
Speaker 1: So again the world that decentralized finance comes in very
Speaker 1: conveniently here where if you've got a mobile phone, a smartphone,
Speaker 1: then that serves as your bank and you can hold
Speaker 1: UH token, and you might choose to hold token that
Speaker 1: is backed by U S dollars and effectively you've done
Speaker 1: the same thing that you've protected yourself against a hyper
Speaker 1: inflation in that country. And effectively, what will happen if
Speaker 1: that country continues on its course is that people will
Speaker 1: essentially abandon the native currency. So why do I need it?
Speaker 1: I can pay with a US dollar token and it
Speaker 1: doesn't have to be U S dollars. It could be anything.
Speaker 1: It could be a traditional currency like the dollar or
Speaker 1: the euro, but it could be a token that's back
Speaker 1: by gold. So as many possibilities here, and this is
Speaker 1: just an example of how to effectively bank UH the
Speaker 1: unbanked and the underbanked. So let's talk a little bit
Speaker 1: about the terminology in the space. So much of it
Speaker 1: is so confusing block chains and forking and protocols and
Speaker 1: n f t s and d os. For someone who's
Speaker 1: interested in learning more about this ecosystem, where do they
Speaker 1: even begin? So it is confusing right now, and this
Speaker 1: is a one of the reasons that I'm doing what
Speaker 1: I'm doing, so I teach this. I think it's important
Speaker 1: for the future. But it's very confusing, And initially it
Speaker 1: was even more confusing because very little material other than
Speaker 1: some computer scientists writing about various protocols. Today there's a
Speaker 1: huge amount of information on the internet about this, but
Speaker 1: you need to be very careful because some of the
Speaker 1: information is basically selling our product. You need to go
Speaker 1: somewhere are that's kind of highly rated. I know. I'm
Speaker 1: working on UM a fourth course sequence UH for corse
Speaker 1: Era that takes UM takes the viewer or the student
Speaker 1: through four different stages of understanding decentralized finance from the infrastructure,
Speaker 1: the primitives, and then a deep dive on some of
Speaker 1: the key protocols and decentralized finance and go through the
Speaker 1: mechanics of those, and then the fourth courses about the
Speaker 1: risks and opportunities in the space. So it is difficult,
Speaker 1: and I kind of um come to the realization that well,
Speaker 1: I might have a couple of hundred students at Duke University. Uh,
Speaker 1: I want to have a broader impact, so also putting
Speaker 1: this stuff up um for everybody to learn from. Let's
Speaker 1: walk professor a little bit about your new book, Defy
Speaker 1: in the Future of Finance. Give us an overview of
Speaker 1: the basic premise. What will readers get from this book?
Speaker 1: So the book is written for the millions of people
Speaker 1: that either work in the field of finance or are
Speaker 1: interested in that field. And they've heard of crypto, maybe
Speaker 1: they own UH some crypto, maybe they don't, but they
Speaker 1: want to learn more. And indeed, the motivation for actually
Speaker 1: reading this book is something that I tell my students
Speaker 1: at the end of my crypto course, And basically I
Speaker 1: say to them that I want them to be disrupt ors,
Speaker 1: not disrupt ese. And this is a highly disruptive technology.
Speaker 1: It will change finance as we know it. And and
Speaker 1: I thought it was important to take that message outside
Speaker 1: the confines of a single university and put a book
Speaker 1: together that is accessible to anyone. The language is somewhat
Speaker 1: different than the language of traditional finance, but but everybody
Speaker 1: going through the book can figure out the linkages between
Speaker 1: some of the things that I talked about and UH
Speaker 1: and in traditional finance and and see the advantages. And
Speaker 1: of course it's also crucial with any new technology for
Speaker 1: the reader to be fully versed on the risks. Uh.
Speaker 1: This is definitely not a risk free as a situation.
Speaker 1: This is disruptive, there's going to be many ups and downs.
Speaker 1: But it's important to go in with your eyes wide open,
Speaker 1: recognizing the sort of risks that you face. But this
Speaker 1: is basically my way of trying to explain what's going on.
Speaker 1: And when you're early in on the technology, it is
Speaker 1: difficult to see what's really going on. And people in
Speaker 1: the media often see bitcoin or doge coin and things
Speaker 1: like that. It's all about the price of those two tokens.
Speaker 1: And and decentralized finance has very little to do with bitcoin.
Speaker 1: So let's focus on decentralized finance. In the book, you
Speaker 1: talk about the five various flaws of traditional centralized finance.
Speaker 1: What do you think define most successfully attacks UM in
Speaker 1: terms of traditional centralized finance. Well, there are five things
Speaker 1: that I mentioned in the book UM Centralized control, so basically,
Speaker 1: you're at the mercy of your bank because they are
Speaker 1: holding your funds uh. And and there's various other aspects
Speaker 1: whereas decentralized, you are in total control. You own the bank. Effectively,
Speaker 1: the bank is in your pocket and you can do
Speaker 1: what you want. UH. Limited access we've already talked about
Speaker 1: where this is a technology of financial democracy. Doesn't matter
Speaker 1: who you are, you're treated equally as a peer. There's
Speaker 1: no retail customer, broker, banker, uh sort of relationship. Everybody
Speaker 1: is the same. It might be a banker, but that
Speaker 1: bankers appear. It might be a retail customer, you're a peer. Uh.
Speaker 1: Inefficiency we've talked about also with this two point five
Speaker 1: or three percent all over the place, a ridiculous uh,
Speaker 1: you know, lending rates on credit cards. Uh. There's definite
Speaker 1: progress that decentralized finance makes. What we haven't talked about
Speaker 1: is lack of interoperability as a problem in our current system,
Speaker 1: where for me to transfer some funds to my broker, Uh,
Speaker 1: that could take two or three days from my bank
Speaker 1: to my broker. Uh. So and that delay doesn't make
Speaker 1: any sense in the age of the internet and dig
Speaker 1: a bit, uh, you know broadband. So Uh. With the
Speaker 1: centralized finance, everything is linked together and it's seamless. Uh.
Speaker 1: In terms of the transfers are are pretty well immediate.
Speaker 1: And number five issue is uh opacity that you're dealing
Speaker 1: with the bank. You don't really know UM the health
Speaker 1: of the bank. You're relying upon the government the f
Speaker 1: d i C to basically ensure you, but there's limits
Speaker 1: to that insurance. And UH, the f d i C
Speaker 1: and the regulators have a checkered record of detecting problems
Speaker 1: in advance, whereas in decentralized finance, everything is open, so
Speaker 1: you can see the balances of the people doing transactions,
Speaker 1: you can see the code that is the algorithm that
Speaker 1: you're trading with, you can see the liquidity. It is
Speaker 1: completely transparent. So these five problems I think decentralized UH
Speaker 1: finance deal with, and probably if you're asking me to
Speaker 1: pick one, I would pick the inefficiency that because of
Speaker 1: the thick layer of middle people in centralized finance, UH,
Speaker 1: the probably the primary advantage is to get rid of that,
Speaker 1: and when you're trading with an algorithm, it's much more efficient.
Speaker 1: That's really interesting. I'm quite intrigued by the concept of
Speaker 1: smart contracts. Let's discuss that a bit tell us what
Speaker 1: smart contracts are and how they can be used. So
Speaker 1: this is one of the main differences between Bitcoin and Ethereum.
Speaker 1: So Bitcoin you can just transfer funds from one person
Speaker 1: to another, whereas in the Theoryum there's another possibility. Uh,
Speaker 1: in the theorem you can actually have an algorithm run
Speaker 1: in the Ethereum blockchain. So the Theorium blockchain is more
Speaker 1: like a computing platform, whereas the Bitcoin platform is just
Speaker 1: purely for transactions. So in the Theoryum, you can actually
Speaker 1: send funds, not just to another person, which of course
Speaker 1: you can, but you can send them to an algorithm.
Speaker 1: And that algorithm might actually uh be what's known as
Speaker 1: a decentralized exchange or our decks uh the x and
Speaker 1: that allows me to trade let's say, one token for
Speaker 1: another token within that algorithm. So I send one token
Speaker 1: to the algorithm, and the algorithm sends me another token.
Speaker 1: It's a beautiful idea, and it's uh and it's remarkable
Speaker 1: that the algorithm doesn't care who you are, how much
Speaker 1: you're actually trading, and it doesn't care if you're a
Speaker 1: buyer or a seller. In in addition, it is running.
Speaker 1: So this is a very significant idea and uh and
Speaker 1: and will be definitely disruptive. I'm kind of intrigued by
Speaker 1: the concept of smart tickets for live events that that
Speaker 1: really moves a lot of the control over who purchases,
Speaker 1: who prices it, how much it gets marked up back
Speaker 1: to the artist. Can can defy eventually create a world
Speaker 1: where if Taylor Swift wants to sell tickets first to
Speaker 1: her registered fans and allow them to resell it but
Speaker 1: only up to a fixed price, uh, and they get
Speaker 1: to split the profit between the the fan and the artist.
Speaker 1: Are those sort of things feasible with with defy or
Speaker 1: or are some of these really kind of futuristic pipe dreams? No?
Speaker 1: And actually we talked about ticketing in my course, so
Speaker 1: this is a broader application. So think of watchain technology
Speaker 1: as a technology that will disrupt many areas of business
Speaker 1: and that uh, the low hanging fruit is finance, but
Speaker 1: we've also seen a lot of progress and other dimensions
Speaker 1: like supply chain and things like that. And the supply
Speaker 1: chain example is that you're shopping at your grocery store
Speaker 1: because they had to let us with the q R
Speaker 1: on it. You scan it. You know where that lettuce
Speaker 1: was picked, the day it was picked, every whether the
Speaker 1: farm is organic, every single hop on the supply chain,
Speaker 1: and how long it's been on the shelf at the
Speaker 1: grocery store. So that's what blockchain can do. And ticketing
Speaker 1: is a great example. It's very similar. The dynamics are
Speaker 1: similar that uh, you know, firms like Ticketmaster and stub
Speaker 1: Hub they take of the ticket. Yeah, so it's very
Speaker 1: little leftover for the artist. And there's something else that
Speaker 1: happens that is really important to understand. It's not just
Speaker 1: it's that the customer is dealing with Ticketmaster, they're not
Speaker 1: dealing with the artist, So there is a separation. There's
Speaker 1: no relationship between the concertgoer and the artist, just like
Speaker 1: Amazon does with retail. So you buy something off Amazon,
Speaker 1: you deal with Amazon, and there's no way for the
Speaker 1: actual person selling the good to connect with the customer.
Speaker 1: They only deal with Amazon. So you break that connection
Speaker 1: and it's very very costly. Uh, particularly in the arts.
Speaker 1: You can imagine a different system using blockchain technology. And
Speaker 1: there are companies that actually do this. And the company
Speaker 1: that I like um is called True Tickets, and I
Speaker 1: believe they're sponsored by IBM right now, but they're offering
Speaker 1: a solution where, uh, where you actually do have this
Speaker 1: direct connection between the artist and and the just basically
Speaker 1: the artist and the concert goer, and the synergies are
Speaker 1: just remarkable that there could be a song that is
Speaker 1: done outside of an album that's made available to the
Speaker 1: people that are connected to the artist. There could be
Speaker 1: information about the next tour, all of this stuff. There's
Speaker 1: a direct connection with the artist, and that's what we
Speaker 1: really need. Of course, you know that, uh in the
Speaker 1: music industry, Uh, it's notorious for uh so little goes
Speaker 1: to the artists. Really the only thing that's profitable is
Speaker 1: the concert. And even the concert uh, the haircut is
Speaker 1: is enormous. So there's so many layers of middle people.
Speaker 1: And again you're you're onto exactly the right intuition. You
Speaker 1: take that that that oligop balistic um or market power
Speaker 1: out of this and connect people directly, then everybody is
Speaker 1: better off. So yes, um, ticketing is low hanging fruit.
Speaker 1: We will see some progress on this. But and this
Speaker 1: is an important butt. The middle people are extremely powerful
Speaker 1: and they will fight. Just like in the financial system, uh,
Speaker 1: the banks, the exchanges, they'll try to delay this, whether
Speaker 1: it's lobbying government for regulation and things like that. I'm
Speaker 1: convinced that they realize what's coming. And let me just
Speaker 1: give you a short story. UM this happened a little
Speaker 1: before COVID happened. A major stock exchange, UM Global Stock
Speaker 1: Exchange called me in to talk about crypto. It is
Speaker 1: pretty vague agenda. I show up. It's their board of
Speaker 1: directors and their senior management sitting in the room, and
Speaker 1: they've got a single question for me. How long do
Speaker 1: we have? So I think that people realize they can
Speaker 1: see the trend and and ticketing is a very good
Speaker 1: example of a system that it doesn't work for the artist,
Speaker 1: it doesn't work for the concert goer, so we need
Speaker 1: to fix it, and the technology exists to do that.
Speaker 1: Let's talk a little bit about what's going on in
Speaker 1: the crypto sector today. N f t s are on fire,
Speaker 1: Bitcoin is approaching sixty THO. An investor who wants to
Speaker 1: speculate with a little money in this area, how should
Speaker 1: they put that money to work? So Number one, way
Speaker 1: too much attention is paid to the price of bitcoin.
Speaker 1: It goes up and down. And indeed, uh, it was
Speaker 1: interesting when the price crashed in two thousand eighteen dropped.
Speaker 1: What was most interesting to me was that the venture
Speaker 1: capitalists that we're investing in de five there was no impact.
Speaker 1: So even though the cryptos dropped by they were equally
Speaker 1: as interested. And what I think are the most interesting
Speaker 1: technologies are things that are below the radar screen. The
Speaker 1: we hear in the news of a big clin and
Speaker 1: Elon Musk tweeting about doge coin or or whatever. Uh
Speaker 1: that there's a lot of other stuff that is really
Speaker 1: interesting that's below the radar. In decentralized finance, it is
Speaker 1: a very hot area. So for an investor, if you're
Speaker 1: going to and I do encourage people to get a
Speaker 1: wallet and to do some experimentation, but you need to
Speaker 1: be careful that things like investing in bitcoin. The annualized
Speaker 1: volatility is about nine so that's huge. So the stock
Speaker 1: market is fifteen percent. Gold is let's say this is
Speaker 1: an incredibly volatile asset, and then some people do margin trading.
Speaker 1: So if you do margin, then the volatilities double. So
Speaker 1: you need to be really careful Number one, that this
Speaker 1: is an extremely volatile asset class, and you need to
Speaker 1: be going into this uh without margin fully knowing that
Speaker 1: we could have another situation where you lose crypto winters.
Speaker 1: Is what what a lot of folks qualities? Yeah, exactly,
Speaker 1: there's ups and downs and number two, you can't be
Speaker 1: the so called bandwagon investor where you buy high and
Speaker 1: and and sell low. So I think of those people
Speaker 1: that we're buying at the peak in two thousand seventeen
Speaker 1: at twenty thousand dollars and and then UH in two
Speaker 1: thousand and eighteen the price crashes to five thousand. Think
Speaker 1: about the people that bought at twenty and sold at
Speaker 1: five thousand. The alternative, you buy at twenty and you
Speaker 1: take a longer term perspective and look where you are today.
Speaker 1: So so you need to have a longer term perspective.
Speaker 1: That's number two. Number three and this is hopefully obvious,
Speaker 1: that you should have a diversified portfolio. And that means
Speaker 1: you don't don't put all your money into crypto, and
Speaker 1: even within the crypto, you need to have a diversified portfolio,
Speaker 1: so more than one, not just bitcoin UH And and
Speaker 1: then number four is maybe the most important. You know
Speaker 1: what you're investing, Understand what you're investing. You buy a
Speaker 1: share of Apple, you you might have an iPhone or
Speaker 1: a Mac, or you use iTunes. You understand the business
Speaker 1: model and you believe that they're in a good position
Speaker 1: to UH build profits in the future. You need to
Speaker 1: do the same thing when you're investing in crypto. You
Speaker 1: can't just take a tip from somebody, oh, well, this
Speaker 1: is what I've got. You need to do your homework
Speaker 1: and figure out what this token is really representing. Quite
Speaker 1: interesting you mentioned earlier that you thought, um, a lot
Speaker 1: of commercial banks are a bit worried about the risk
Speaker 1: of defy, but we're starting to see some of these
Speaker 1: giant financial institutions get involved. I think Visas spent dollars
Speaker 1: on a crypto punk and some other banks have been
Speaker 1: involved in fintech and and some seed companies as they
Speaker 1: look to basically do an end run around around centralized
Speaker 1: banking and disrupt finance. What do you think is going
Speaker 1: to happen with these big financial institutions. Are they going
Speaker 1: to sit on their hands and become disrupted or are
Speaker 1: they going to try and muscle their way in and
Speaker 1: keep a finger in the pie, so to speak. So
Speaker 1: they totally understand this in my opinion, Um, they know
Speaker 1: this disruption is coming and they will do what they
Speaker 1: can to delay. So one thing that they can do
Speaker 1: in the short term is to become more efficient. So, uh,
Speaker 1: it's kind of interesting that we all heard a couple
Speaker 1: of years ago Jamie Diamond saying that, uh that anybody
Speaker 1: caught trading tript at JP Morgan was gonna be fired,
Speaker 1: and and the reason for that is that they were
Speaker 1: basically being stupid. Well, it's a completely different story today
Speaker 1: where JP Morgan has got a stable coin, which is
Speaker 1: a type of cryptocurrency, and they fully embraced everything about
Speaker 1: this space. It's hard to ignore when the space is
Speaker 1: capitalized that two trillion dollars, that this is an a
Speaker 1: novelty anymore. So these banks will do a number of things,
Speaker 1: so uh, they will use the space to their advantage.
Speaker 1: And and these stable coins are basically hard back to
Speaker 1: the era of a free banking where banks for quite
Speaker 1: a while in the US, we're able to issue their
Speaker 1: own currency backed by various things. So that's essentially what
Speaker 1: the banks will do. They tried to do other things.
Speaker 1: You mentioned crypto punk, but um Visa actually tried to
Speaker 1: acquire Plaid for five point three billion dollars. And the
Speaker 1: reason that they wanted Plaid was this lack of interoperability
Speaker 1: that was one of the great disadvantages of centralized finance.
Speaker 1: So it's really hard to move money from your broker
Speaker 1: to your bank or vice versa. But that was blocked
Speaker 1: um by the regulators. So so they completely get this
Speaker 1: that both the combination of fintech and decentralized finance, this
Speaker 1: is an existential threat to their business. So they will
Speaker 1: try to do things. They'll make some investments, they'll work
Speaker 1: on the politicians will try to do the maximum sort
Speaker 1: of regulatory push. All of this are our tools um
Speaker 1: that they will use fully, realizing that it is just
Speaker 1: a matter of time. Huh, that's interesting. We haven't talked about.
Speaker 1: The largest company in crypto is probably coin Base. They're
Speaker 1: publicly traded, but it's kind of ironic. They're also a
Speaker 1: centralized company. Tell us a bit about coin bases role
Speaker 1: in the ecosystem. So coin based very important in terms
Speaker 1: of the credibility of of crypto and coin Base made
Speaker 1: it a lot easier for people to get into this space.
Speaker 1: So instead of actually having to worry about your private
Speaker 1: keys and securing them, you could use coin Base, a
Speaker 1: third party to take care of that, just like we
Speaker 1: use a broker um so we don't worry about the
Speaker 1: actual physical ownership of a hundred chair to IBM, the
Speaker 1: broker handles that for us, so a coin base was
Speaker 1: very important in getting people in their fully regulated. There's
Speaker 1: more than ten thousand exchanges in the world, and probably
Speaker 1: more than nine of them UM are very questionable, especially
Speaker 1: in terms of the volume that they report and the
Speaker 1: sort of deal that you get when you're buying or
Speaker 1: or selling big spreads. So coin base UM is also ensured,
Speaker 1: which is interesting UM. And it is centralized. So the
Speaker 1: way that I described comb base is UM, I call
Speaker 1: it c defy so C E D E F HI,
Speaker 1: so it's centralized centrilcement. So they deal in a lot
Speaker 1: of decentralized financial protocols and tokens and stuff like that,
Speaker 1: but they're centralized. And coin Base and Binance, they main
Speaker 1: competition is what's known as decentralized exchange or decks. So
Speaker 1: if you look at the amount of trading that's actually happening,
Speaker 1: there's huge growth and this decks trading and the deck
Speaker 1: is where you're trading with the algorithm, so there's no
Speaker 1: mid person like coin base. The disadvantage of the decks,
Speaker 1: maybe many were considered an advantage is that you hold
Speaker 1: your your your private keys. Uh, there's no third party.
Speaker 1: That's uh, that's actually UH in the middle UM. So
Speaker 1: so let's stay with that a second, because there have
Speaker 1: been all sorts of crazy stories about lost passwords, hundreds
Speaker 1: of millions of individual dollars lost by some people, and
Speaker 1: and I've seen estimates of of all um coins have
Speaker 1: been lost due to either lost passwords or damage hard drives.
Speaker 1: When you go through a coin base, they take the
Speaker 1: liability of that off of you. In other words, you
Speaker 1: don't have to worry about a damage drive or or
Speaker 1: a lost password. They'll make sure you have access and
Speaker 1: I'm assuming it's UM a very secure way to access,
Speaker 1: as secure as a regular bank exactly. So they deal
Speaker 1: with the custody. And this has also been a big
Speaker 1: deal for investment funds. So they've seen the crypto complex
Speaker 1: gro uh dramatically too, two trillion dollars, and they've been
Speaker 1: struggling with the cost of the issue. So how how
Speaker 1: do we secure these private keys? So the solution is
Speaker 1: to have a custodian. And that's another thing that coin
Speaker 1: base actually does very successfully, is that will serve as
Speaker 1: a custodian for UH, like a hedge fund or a
Speaker 1: mutual fund UM if they're interested investing in crypto. So
Speaker 1: corn based. Again very important uh in terms of the evolution.
Speaker 1: But I do see the trend, and the trend is
Speaker 1: towards UM trading directly between peers, and then you do
Speaker 1: need to worry about custody. Custody is a risk that
Speaker 1: I go through in a lot of detail. UM. You
Speaker 1: refer to kind of losing a password, and there's this
Speaker 1: story in the New York Times where this programmer had
Speaker 1: UM crypto in a hardware wallet, so that means that
Speaker 1: the private keys were in the wallet, but then he
Speaker 1: forgot the password. And the way that this hardware wallet
Speaker 1: actually operates is that you get ten tries, and if
Speaker 1: you fail on the tenth try, then the uh, the
Speaker 1: hardware is physically destroyed, so you can never prepare over
Speaker 1: what's in there. So so you basically you just tried
Speaker 1: eight times, got two more, and over two hundred million
Speaker 1: dollars a big coin is trapped there. So there are
Speaker 1: other technologies today, So you can have just a regular custodian. UM,
Speaker 1: you can have a shared KEYUH. So you split the
Speaker 1: key into three pieces. You've got maybe one on your smartphone,
Speaker 1: one on your desktop. UH, and then there's a custodian
Speaker 1: that's got the other third, and you need two out
Speaker 1: of three to reconstitute. So if you lose your mobile phone,
Speaker 1: your computer crash is no big deal. You just put
Speaker 1: it together. And this technology will be seamless in the future.
Speaker 1: So right now it's a little clunky, and that's because
Speaker 1: we're just so early in this technology, so we're less
Speaker 1: than per cent in and there will be issues like this.
Speaker 1: That's pretty amazing that there was another story, and I
Speaker 1: think it was the BBC somebody throughout a drive when
Speaker 1: they were cleaning their as didn't realize that it had
Speaker 1: their crypto password on it. But the the bigger issue,
Speaker 1: the longer term issue, is hey, you know, these are
Speaker 1: really secure cryptography access keys today, but we're not that
Speaker 1: far away from really quantum computing being more viable. What
Speaker 1: happens in the future when we see a massive order
Speaker 1: of magnitude improvement in computing power. What does that do
Speaker 1: to these supposedly secure access keys. And I guess it's
Speaker 1: as true for JP Morrigan and Wells Fargo as it
Speaker 1: is for bitcoin and ethereum. Sure um, so let me
Speaker 1: answer this. There's many different dimensions to your question. So
Speaker 1: the first thing is that quantum computing isn't really a
Speaker 1: threat to the current security in bitcoin or ethereum. So
Speaker 1: the way that blocks are added is pretty well immune. Um,
Speaker 1: and both bitcoin and ethereum use something that's called proof
Speaker 1: of work, which is environmentally quite reckless. But Etheroryum has
Speaker 1: got a strategy to migrate to a different system that
Speaker 1: would be much more energy efficient. Uh, it would be
Speaker 1: very energy friendly, frankly, so UM. So that's the first thing.
Speaker 1: That The second thing is that UM it is true
Speaker 1: that that with quantum computing in the future, it might
Speaker 1: be possible to basically reverse engineer the private key. So
Speaker 1: given that you've got the public address, that is possible
Speaker 1: theoretically to go the other way. And you might think, oh, well,
Speaker 1: that's a disaster, but it isn't. It's not really a
Speaker 1: big deal because um already we've got quantum proof uh capabilities,
Speaker 1: and it's really simple. When we get close. All you
Speaker 1: need to do is to send your crypto to another
Speaker 1: address that you own and just sign it with a
Speaker 1: quantum proof of signature. So I'm not worried about that
Speaker 1: at all. UM. It is kind of interesting that some
Speaker 1: of those lost bitcoin you might be able to be
Speaker 1: recovered with this huh really really intriguing. And I know
Speaker 1: I only have you for a limited amount of time,
Speaker 1: and I have to get to some of your previous
Speaker 1: work before we get to our favorite five questions, and
Speaker 1: I have to lean into let's talk a little bit
Speaker 1: about yield curve inversion. What does that tell us about
Speaker 1: the likelihood of a future recession? Well, actually was interesting.
Speaker 1: The last time I was doing a podcast with Bloomberg
Speaker 1: was two thousand nineteen. Uh, the beginning of July, the
Speaker 1: eel curban inverted, and I made a recession call. For
Speaker 1: little did I know that COVID what does strike and
Speaker 1: and cause such an unusual recession? But this is my
Speaker 1: dissertation work um at the University of Chicago that I
Speaker 1: showed that eel curban versions proceed a recessions. At the
Speaker 1: time when I'm defending my dissertation, the record was four
Speaker 1: out of four with no fall signals that, yeah, it
Speaker 1: could have been lucky. My committee was kind of skeptical,
Speaker 1: but the theory behind the measure was sound. I passed.
Speaker 1: And usually what happens after you publish an idea is
Speaker 1: that if you're lucky, it becomes a weaker effect on
Speaker 1: the sample and if you're not very lucky, it completely
Speaker 1: goes away. But from my particular situation, the youth curban
Speaker 1: versions predicted accurately the next four recessions, including the Global
Speaker 1: financial crisis recession for a game advanced warning of a year.
Speaker 1: So so it's eight for eight right now. I haven't
Speaker 1: really done research in this area in quite a while,
Speaker 1: but it's held up, and it's it's something completely unexpected
Speaker 1: that I'd still be getting questions about my dissertation so
Speaker 1: many years after I published it. Let's talk about another
Speaker 1: area of research that you've you've worked in. Some people
Speaker 1: have had outstanding investment results and they're lucky, and other
Speaker 1: people have had an outstanding investment results because they're skillful.
Speaker 1: How can we tell the difference when all we see
Speaker 1: is effectively, Hey, that turned out to be a great investment. Yeah,
Speaker 1: So this is my recent research stream is focused on
Speaker 1: luck versus skill. And it's really hard to explain, but
Speaker 1: I think people really want to believe in that upside.
Speaker 1: They look at the back test and yeah, this looks
Speaker 1: really good, and and I think that this is going
Speaker 1: to repeat, and it often doesn't because the back tests
Speaker 1: are are overfit. So in my recent research stream, I
Speaker 1: proposed a number of different ideas UH to kind of
Speaker 1: adjust back tests and and a protocol UH to really
Speaker 1: understand the past performance. It comes down to the culture
Speaker 1: at the asset management firm. Do they just want to
Speaker 1: gather money in the short term and collect to see
Speaker 1: uh it. It also comes down to investors asking the
Speaker 1: right question. So so, for example, the presentation has been
Speaker 1: given on a new product, and here's the back test,
Speaker 1: and and what I do sometimes very uh strategic question.
Speaker 1: I said, oh, this is pretty super interesting, very impressive work.
Speaker 1: Uh oh did did you try variable X? And then
Speaker 1: the response might be, oh, yeah, we tried that, but
Speaker 1: it didn't work. So as soon as I hear that answer,
Speaker 1: I know that there's been extensive data mining, and it
Speaker 1: is like it's like seeing a cockroach in your house,
Speaker 1: you know, when there's you see one that there's a
Speaker 1: dozen behind the wall, and and that sort of small
Speaker 1: indication is that this product in the back test has
Speaker 1: been overfit. When it goes to live trading, you're going
Speaker 1: to be disappointed. So so what do you actually want
Speaker 1: is in the back test not to choose the best one.
Speaker 1: The best one is the one that's most likely to
Speaker 1: disappoint in in live treating. So you need to do
Speaker 1: this in a way that minimizes, uh, the overfitting in
Speaker 1: the back test. And what we what we want is
Speaker 1: to invest in a product that will repeat it's past performance.
Speaker 1: We don't want to invest in a product that you know,
Speaker 1: the advertised sharp ratio is two and and we get
Speaker 1: point to in live trading. So is this why you've
Speaker 1: said half of all the financial research out there is
Speaker 1: likely false a combination of overfitting and selection bias and
Speaker 1: all the other fun reasons why back tests are can
Speaker 1: be somewhat misleading. Yeah, and I said, uh, the half
Speaker 1: of the empirical research and finance that has published in
Speaker 1: academic journals. The key is to understand the incentives. So
Speaker 1: the journal editors compete in terms of um what's known
Speaker 1: as an impact factor, the number of times that their
Speaker 1: articles and their journals are are cited by other journals. Uh.
Speaker 1: And they know that if they publish a result that
Speaker 1: is a non result. So you try a trading strategy,
Speaker 1: for example, and it doesn't work. If they publish that,
Speaker 1: nobody's going to cite it. So so the authors note
Speaker 1: that they need to deliver something that's really interesting and
Speaker 1: is what we call a positive result. So this trading
Speaker 1: strategy delivers a very high um sharp ratio. So they
Speaker 1: know that, and the data mining begins because these academics
Speaker 1: they need to publish in the top journals to get promoted,
Speaker 1: so so the data money begins. And then you get
Speaker 1: a select sort of paper flow that's going in with
Speaker 1: data mind results, and and you put this together, and
Speaker 1: you combine that with a mistake that that many people
Speaker 1: have made in kind of the execution of the statistics.
Speaker 1: It might be that you try a hundred things and
Speaker 1: there's one that works, uh, and and then you even
Speaker 1: admit that you tried one hundred things, one hundred different
Speaker 1: versions of the trading strategy, but this one works really well.
Speaker 1: Well you expect that out of a hundred, five would
Speaker 1: work just by random chance. So if you're presenting one,
Speaker 1: it's probably uh, not significant, will not hold up in
Speaker 1: live trading. So the incentives defined that really interesting result
Speaker 1: that you know will be cite it and the journal
Speaker 1: editor will like it. And you combine that with a
Speaker 1: mistake of not adjusting for all of the possible things
Speaker 1: that you tried. Then you get to this fifty percent number.
Speaker 1: It is also important to realize that, in my opinion,
Speaker 1: the problem is is less severe in the practice of management,
Speaker 1: because in the practice of management, if you really overfit,
Speaker 1: and if you get people to invest, and if your
Speaker 1: arrangements are not just a fixed fee but an incentive
Speaker 1: fee or performance fee um, then if the product doesn't perform,
Speaker 1: you're not going to get any performance fee and you're
Speaker 1: gonna lose a reputation. So in the practice of finance,
Speaker 1: there's no equivalent to academic tenure, so you don't perform
Speaker 1: your out. So I think the incentives are better aligned
Speaker 1: in the practice of asset management and that sort of research,
Speaker 1: much of which we don't see, so you don't publish
Speaker 1: the mechanics of a really good training strategy. Renaissance Technologies
Speaker 1: hasn't released any white papers as to how they're doing
Speaker 1: a fees year after year. And and I want to add,
Speaker 1: this sort of research issue is not just in academic finance,
Speaker 1: but it seems to be across you know, many many fields.
Speaker 1: Reproducibility of of results are very very challenging. So it's
Speaker 1: more than just form fitting. It's even the basic concept
Speaker 1: of research seems to be um somewhat problematic in in
Speaker 1: both academia and in the real world. So you're correct
Speaker 1: that other fields have actually uh come to this realization
Speaker 1: well before the field of finance medicine, for example, Uh,
Speaker 1: they fully realized that half of their research findings are false.
Speaker 1: And you could argue that that's way more important than finance.
Speaker 1: So and finance we're talking about like some alpha, and
Speaker 1: in medicine we're talking about life or death. So again
Speaker 1: we need to have a proper perspective on this. I
Speaker 1: know I only have you for a little while longer,
Speaker 1: so let's jump to our favorite questions that we ask
Speaker 1: all of our guests, starting with what have you been
Speaker 1: doing to stay entertained during the pandemic? Tell us what
Speaker 1: you're streaming, either Netflix or Amazon or anything you're listening
Speaker 1: to and enjoying. I'll tell you what I'm streaming on
Speaker 1: Netflix is a finish UM drama show called border townmmend
Speaker 1: it very interesting thing. It's it's dubbed, but it's it's
Speaker 1: well done. Um. But in terms of podcasts and things
Speaker 1: like that, Uh, really, what I'm I'm doing, I'm focusing
Speaker 1: on one particular podcast which is not for entertainment necessarily,
Speaker 1: but more in the DEEPI space, and it's called uh
Speaker 1: fine maddics, that's FI and E matics, and it's really
Speaker 1: uh nicely done where the presentations are like seventeen to
Speaker 1: twenty minutes long, animated, but really trying to understand some
Speaker 1: of these complicated concepts in uh in the crypto space.
Speaker 1: Really interesting. Tell us about some of your early mentors
Speaker 1: who who helped to shape your career. Well, I've just
Speaker 1: been so lucky, Uh it just my timing. I think
Speaker 1: I didn't realize that at the time was just so
Speaker 1: good um and and and UM just purely do to
Speaker 1: luck that I've had the opportunity, uh to interact with
Speaker 1: the greats of finance. So my chair um is Eugene
Speaker 1: Vama uh on my committee Martin Miller and Lars Hanson.
Speaker 1: But I also had, uh in half the opportunity to
Speaker 1: interact with Bill Sharp, my Marin shoals that role, Steve Ross,
Speaker 1: Bob Martin um and and even Fisher Black. And let
Speaker 1: me just briefly tell you my introductions of Fisher Black.
Speaker 1: I was an assistant professor, junior professor, and I was
Speaker 1: working late at the office while actually wasn't late for me,
Speaker 1: was bout nine pm and I get a phone call
Speaker 1: and Duke had one of the early call I d
Speaker 1: and I could see the calls coming from Goldman Sachs
Speaker 1: and I think it's a buddy of mine from Chicago
Speaker 1: that's working late, just like me. I pick up the phone,
Speaker 1: just assuming it's him, and and make some disparaging remarks
Speaker 1: and then there's a long silence and the person says,
Speaker 1: is this Campbell Harvey? And I realized, oh, somebody else?
Speaker 1: And then he said it's Fish or Black. And for
Speaker 1: a junior person to get a call from Black, who
Speaker 1: everybody knows it's going to win the Nobel Problems, it
Speaker 1: was shocking. So so he said, I'm reading your paper
Speaker 1: here and UM and your table too. I don't believe.
Speaker 1: I said, well, what do you mean you don't believe?
Speaker 1: So well, you've you've engaged in data mining to get
Speaker 1: this particular result and these results are not credible. And
Speaker 1: I said, no, there's no data mining. This is all
Speaker 1: I did, is exactly what I said. There was no
Speaker 1: uh going variable by variable. It was a predictive regression
Speaker 1: for the SMP UM that I just basically this is
Speaker 1: what people have done. And then I just I just
Speaker 1: presented that and he said, no, uh, it's it's not credible,
Speaker 1: not credible, and um so it was interesting. We had
Speaker 1: this conversation and many other conversations. Uh and and we
Speaker 1: developed a good relationship. Uh and and how did you
Speaker 1: convince him it was a legitimate research paper? So I couldn't.
Speaker 1: So it's just totally convinced. So uh many years later,
Speaker 1: I decided to basically do the out of sample test
Speaker 1: and uh so I replicated my Richard results and and
Speaker 1: I found using the I collected the data again and
Speaker 1: I found I got almost exactly the result in that
Speaker 1: table too. But then I did the other sample twenty
Speaker 1: five years apot a sample and the other sample there
Speaker 1: was zero predictability. Really, so Fisher Black was right. And
Speaker 1: the lesson that I've learned, and the lesson is I
Speaker 1: didn't do any data mining, so it was clear that
Speaker 1: I was telling the truth. I didn't. Even a legit
Speaker 1: paper can have structural problems in it. But what I
Speaker 1: did was I relied upon the results of other academics,
Speaker 1: so so basically they might have been doing the data mining,
Speaker 1: and then I just took their paper and then implemented
Speaker 1: it and and and basically it's it's essential delegation, right
Speaker 1: garage right, Yeah, so this is so he was he
Speaker 1: was correct and yeah, and obviously that experience was really
Speaker 1: important for me and shaping my research agenda. My presidential
Speaker 1: address to the American Finance Association is exactly on this topic.
Speaker 1: So he was extremely influential in terms of my development
Speaker 1: and the idea generation. Meanwhile, that's some murderous row of
Speaker 1: mentors you had over your career. It's really quite an
Speaker 1: amazing list. Let's jump to everybody's favorite question. Tell us
Speaker 1: about some of your favorite books. What are you reading
Speaker 1: now and what are some of your favorite books to
Speaker 1: recommend to students? Well, and probably won't be that interesting. Um.
Speaker 1: I I began thinking I was going to be an
Speaker 1: English major, so so I do read um and my
Speaker 1: tastes or maybe a little unusual. So I'm a James
Speaker 1: Joyce nut um in terms of reading everything that he's done,
Speaker 1: which is incredibly challenging to do, but very uh boarding
Speaker 1: for me. In terms of what I'm reading right now,
Speaker 1: I'm reading Danny Kahneman's book on Noise. I do work
Speaker 1: in behavioral finance also, and I've been struggling with some
Speaker 1: of the issues that are prominent in his book in
Speaker 1: terms of some of my recent research. So that, uh,
Speaker 1: that's something that interests me a lot. UM. And then
Speaker 1: I'm doing something really geeky UM that I'm trying to
Speaker 1: make my way through, um the third edition of The
Speaker 1: Golden Bow, and maybe some of your readers might our
Speaker 1: listeners will will pick up and take a look at
Speaker 1: what that is. It's all online, it's very long, UM,
Speaker 1: but it's the sort of thing that interests me, and
Speaker 1: it's essentially how people um come to believe in something.
Speaker 1: So expectations are something that I've thought about for a
Speaker 1: very long time. It's very important for our research. Uh.
Speaker 1: One of my research streams tries to measure those expectations.
Speaker 1: But this is much deeper analysis of how beliefs are
Speaker 1: actually form mythology and things like that. More than anticipating
Speaker 1: the pleasure of an event or purchase. You're talking about
Speaker 1: how we start to conceptualize entire frameworks or mythologies exactly,
Speaker 1: so very important, just the way that is presented, and
Speaker 1: and some thing's happened that might be random, but others
Speaker 1: are not. So before I go to the next question,
Speaker 1: I have to ask, how does the world of stock
Speaker 1: memes fit into this that that seems to be that
Speaker 1: sort of investment narrative seems to be dominant over the
Speaker 1: past five years. Do you do you look at those?
Speaker 1: What do you think of those? Sure? So this is
Speaker 1: extremely interesting to me because we've been on a trend
Speaker 1: where the retail investor has become a smaller and smaller
Speaker 1: part of the total amount of investing for many years. However,
Speaker 1: with the rise of certain fintech, it's been a lot
Speaker 1: easier for the retail investor to actually get into the
Speaker 1: market with apps like robin Hood for example. So we've
Speaker 1: seen a big turnaround. So the proportion of the retail
Speaker 1: investor of the total market maybe was ten, is up
Speaker 1: to fifteen, maybe it will be twenty over the next year.
Speaker 1: And and what happened there is that the retail investor
Speaker 1: doesn't have access to the sort of information that an
Speaker 1: institution well investor has got access to. They have the data,
Speaker 1: they don't have the computing capability, they're not working on
Speaker 1: this full time, but they've got the crowd. So you
Speaker 1: might have a dedicated team and a hedge fund working
Speaker 1: out a problem, but the retail investor, even though part
Speaker 1: time there might be you know, a hundred thousand people
Speaker 1: that are contributing so effectively, what we're seeing is the
Speaker 1: possibility of kind of a decentralized hedge fund, if you
Speaker 1: think about it that way. So I think it's very interesting,
Speaker 1: like how this space evolves. It is, uh, it has
Speaker 1: some downsides where a bandwagon has jumped on and it
Speaker 1: basically drives a stock well beyond its fundamentals. But usually
Speaker 1: you would have shorting going on and to bring the
Speaker 1: stock back down to its fundamental level. But some of
Speaker 1: these hedge funds, the risk of shorting has gone up dramatically.
Speaker 1: They've seen what's happened. So when people step out of
Speaker 1: the shorting, UH, that means that you've got this asymmetry
Speaker 1: and it's just more likely that you've got misvaluation. So
Speaker 1: in my opinion, given what's happened, I think that the
Speaker 1: market will become less efficient in the short term short
Speaker 1: term and UH that provides some opportunities, of course, but
Speaker 1: eventually I think that the information gathering will become cheaper, uh,
Speaker 1: more efficient, will kind of return to where we were.
Speaker 1: But in the short term, UH, we get situations like
Speaker 1: game stop and MC quite fascinating we're down to our
Speaker 1: favorite last two questions. What sort of advice would you
Speaker 1: give to a recent college grad who was interested in
Speaker 1: the crew year in either UM investment management or finance
Speaker 1: or crypto and defy. So the key thing to realize,
Speaker 1: and I give this advice to my students. Uh, the
Speaker 1: key thing to realize, in my opinion, is that finance
Speaker 1: will not look like it has in the past in
Speaker 1: the future. So we are in the midst of a
Speaker 1: structural change. So it's really important to have a vision
Speaker 1: of the future, and just a naive extrapolation from the
Speaker 1: past is not good enough. So I many of my
Speaker 1: students take the job at the traditional bank or investment bank,
Speaker 1: and my advice to them is, after graduating, that doesn't
Speaker 1: mean that you're finished your learning. You need to know
Speaker 1: what you don't know. And my course and my book
Speaker 1: is maybe a good example. After you read that book,
Speaker 1: you will know what you don't know, and you will
Speaker 1: know that there's not a lot more learning that has
Speaker 1: to happen. So those students that go into the traditional sector,
Speaker 1: I said, that's fine, you're gonna learn something. You need
Speaker 1: to continue. Uh, the quest of knowledge in this difficult
Speaker 1: space and the first day that you arrive, you need
Speaker 1: to be thinking about the next stop, and hopefully that
Speaker 1: stop is somewhere in the DeFi space. Pay down your
Speaker 1: student loan, and then take some risk to go to
Speaker 1: a venture. You're gonna learn a lot. The venture probably fail,
Speaker 1: but it doesn't matter. You're going to learn a lot
Speaker 1: and you'll be able to go to another venture very quickly.
Speaker 1: So it's not as risky as you think. But again,
Speaker 1: and it's way better to be at the vanguard of
Speaker 1: disruption rather than at an institution that is doing everything
Speaker 1: possible to hang on to extend that one way, fully
Speaker 1: knowing that they will be eventually replaced by algorithms. H
Speaker 1: really interesting in our final question, what do you know
Speaker 1: about the world of finance today that you wish you
Speaker 1: knew thirty years ago or so when you were first
Speaker 1: starting out. So I guess what I didn't fully appreciate.
Speaker 1: And it's kind of embarrassing because when you do economics
Speaker 1: at the University of Chicago, it's it's all about economic
Speaker 1: incentives and and how that shape's behavior. And we've talked
Speaker 1: about this a little bit that I've really realized that
Speaker 1: the research in my field is is shaped by Economic
Speaker 1: Guy and say atoms. So at most schools in the world,
Speaker 1: well maybe ninety percent or more schools, just a single
Speaker 1: publication in a very top journal is a job for life.
Speaker 1: You've done it right. So the Journal of Finance publishes
Speaker 1: seventy seven zero articles a year, so it's very difficult
Speaker 1: to get in to a journal like that. So to
Speaker 1: get promoted, UM, you've got to hit this top journal.
Speaker 1: And that causes UM data mining, UM and and and
Speaker 1: some of it might even be unconscious where you're you're
Speaker 1: trying to to look at various different techniques of estimation
Speaker 1: and you just happened to pick the one that works
Speaker 1: the best. So these incentives are really think of influenced
Speaker 1: research and has led to a problem with our research,
Speaker 1: and that when you take that research into live trading,
Speaker 1: it doesn't do as well as what was published. And
Speaker 1: I think it's purely the result of these incentives. I
Speaker 1: was naive UM graduating and thought that well, this is
Speaker 1: just about the pursuit of truth. Well that's part of it,
Speaker 1: but for many people it's about the pursuit of a
Speaker 1: job for life. That's quite quite fascinating. Professor cam Harvey,
Speaker 1: thank you for being so generous with your time. You
Speaker 1: can pick up his new book, Defy in the Future
Speaker 1: of Finance wherever you get your usual book purchases. If
Speaker 1: you enjoy this conversation, we'll be sure to check you
Speaker 1: out any of our previous three and seventy six podcasts
Speaker 1: we've done over the past seven years. You can find
Speaker 1: that iTunes, Spotify, wherever finer podcasts are sold. We love
Speaker 1: your comments, feedback and suggestions right to us at m
Speaker 1: IB podcast at Bloomberg dot net. Sign up for my
Speaker 1: daily reads at Riholts dot com. Check out my weekly
Speaker 1: column at Bloomberg dot com slash Opinion. Follow me on
Speaker 1: Twitter at Riolts. I would be remiss if I did
Speaker 1: not thank the Cracks staff who helps put these conversations
Speaker 1: together each week. Nick Falco is my audio engineer. Michael
Speaker 1: Batnick is my head of research. Paris Wald is my
Speaker 1: producer slash booker. Latico val Bron is our project manager.
Speaker 1: I'm Barry Riholtz, upens and two master's in business on
Speaker 1: Bloomberg Radio