Dr. Michael Kollo is joined by Ali Nejadmalayeri, the John A Guthrie Endowed Chair in Banking and Financial Services at University of Wyoming College of Business. They discuss blockchain, his experience in the US, and where the industry is headed.
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Ali Nejadmalayeri
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Hi everybody. This is Michael Kollo from Crypto Cappuccino today. I'm joined by professor Ali Nejadmalayeri to talk all about blockchains, his experiences in the us. And I suppose where all this field is going. I hope you can join us. Welcome everybody. I'm here with Ali. Hello Ali.
Hi. How are you, Mike?
Good. Uh, Ali is a associate professor of finance university of Wyoming.
In fact, sorry. He's the John a goodie and down chair of banking of financial service , which is just an awesome title that we were talking about right before we started here. But, um, so obviously you're coming at the whole world of financial services as a pricing and crypto from a. Uh, interesting perspective, which is all about the academic rigor and, and the background that you hold.
But I'd love to learn a bit about your journey of how you came to be here to start us off with, with the, your PhD, and then how you kind of progressed, uh, through the financial markets and obviously came to be where you are today.
Absolutely. Um, well, first of all, it's, it's a it's it's, it's a great pleasure to be here.
Thank you for the invite. Thank you for talk. Um, I, um, you know, I'm, uh, electrical engineering by training. I got my, uh, uh, BSN electrical engineering, um, 25 to 30 years ago, I started working in oil and gas and one day I'm sitting. Across the client, they're yelling at us, you know, about something that went wrong, had nothing to do with my division, but you know, I have to sit there and take it.
And as I'm listening to you guys, I realize, well, I could get an MBA and sitting right across and yelling at, at the first that I was sitting right, right there. So, uh, so I started, uh, you know, looking around, uh, I ended. Uh, an MBA from Texas a and M and it was my, uh, uh, I kind of started weird. I started, um, uh, not the usual fall.
I started in winter and, uh, my, uh, finance class was in the summer. And, uh, you know, the first semester I took Pecon, uh, accounting, uh, marketing and management, uh, thought management was something I would never want to impress in my life. Marketing was tolerable, accounting clicked, and I loved. And then when I took the finance class, I thought this is it , I don't, I don't need to look at any further, uh, and really the journey in it took its own life.
Um, I, um, I got admission from, uh, ssay Arizona. I remember I was, uh, I was looking for jobs at a time. I was getting close to the end of my MBA. So I'm looking for jobs. I just got back from a, um, sort of. Orientation and, and life insurance company. And I can't remember who it was and I wasn't really excited about it at all.
And all of a sudden, you know, my roommate comes in and says, somebody from Arizona wants you and I wasn't in a mood necessarily. And I thought, maybe it's a telemarketer, something like that. Arizona wants to talk to me. And I realized, oh, wow, this is one of the schools that I applied. So I picked up the phone and lo and behold, this was Mike Wise back now my, my back.
Um, unequivocally and a God of corporate, uh, corporate governance, especially, and is on the phone and says, so when are you gonna come here? You know, we're waiting for you and I'm think I don't even have an admission letter. What are you talking about, man? so, um, so, so said I obviously shortly after I went to Tucson, uh, loved it.
It was, it was a fantastic place to be in. Obviously Mike was there, you know, heavyweight, uh, our other heavy weight was Chris Laroy, who was a, uh, sort of applied as asset pricing person, uh, you know, in per, and then we have Chuck Schitz line who was, uh, one of the young gods of experimental finance. Uh, we had ver Smith who then, you know, won the noble prize for experimental economics downstairs, running.
You know, experiments. Um, I mean everybody around me, you know, now that I look back, I never appreciated how big these people were now that I look back every lot, I was surrounded by giants. I had no idea I was surrounded by giants. And so it was, uh, it was a fascinating, you know, place to be in. It was a fascinating time to be in, uh, learn a lot of stuff.
And, and the great thing about Arizona was. Uh, it, it was a disaster for them. It was a blessing for us. Uh, they, they had a lot of turnover. And so as a result, we were left alone. And so, you know, we took classes, we liked, you know, we experimented this stuff were like, and we had alone a lot of stuff. And, uh, in, in middle of all of this, uh, one of my first ideas, and I think Chris had a lot to do with it, uh, was to study prepayments and, you know, prepayment is when you pay your mortgage.
Now it could be that you're paying faster more, or that you refinance, you know, there are all kinds of different ways it happens. Right. And, uh, the, the mortgage backed security, people hate this. Uh, absolutely hate it cuz you know, they buy the bonds and they fill, you know, for next 30 years I'm gonna earn whatever return you cut 'em off.
And usually when that happens, it's because rates are so low that you're, you're moving to a cheaper mortgage. So obviously they can't reinvest it in something. Um, now the funny thing is that only interest rate explains half of this is stuff. And half of it is never, you can't ever explain it with interest rate movements.
And so they call it irregular, you know, prepayment. And I was very fascinated in, in, uh, first of all, measuring it second, you know, tried to explain. And so at a time there were a lot of, you know, high tech models, you know, uh, trinomial uh, trees, you know, et cetera, et cetera, coming about to just get the interest rate part, you know, correct.
And then, you know, deal with the other nightmare can explain. Uh, and I remember, uh, one day it was funny. I, I printed out this is the time that, you know, Bloomberg didn't have the download capabilities or at least we didn't have it. So I printed a 10,000 pages of, um, Prepayment information for various various mortgage back fools and then, and then read in by scanning him, making 'em electronics.
So then I can make it a database. So I'm in the middle of this process, obviously very arduous, not very pleasant and, um, Uh, ed Kane was great economist at a time. He only taught half a year at Arizona. His son was visit and he was, uh, he was working at the city's mortgage desk at me at a time. So I'm telling him what I'm doing, C cetera.
And he.
Uh, what you mean location? Location locations is good. Good. he? He said, do you know what matters for, uh, for mortgage backed securities? I said, I don't know, location, location, location. She said, no divorce, divorce, divorce. . And I'm trying to understand why he says this. And after he left, you know, I spent quite a bit of time trying to even digest, you know, what, what he meant.
And then I realized it's probably the only. Common factor that can explain untimely liquidation. Uh, there's almost nothing else that, you know, works like that. And so I started running simple regressions on like macro level and low and behold, this thing is beyond significant. Right. Uh, but.
Able to observe that would've, that would've been a tough one to observe. Did you have another data set for that to understand.
Yeah Yeah. Yeah. So, so you, you can get here in us probably most, um, advanced economies have it. It's just hard to get, but here, uh, I was able to call, uh, I think it was part of the department of health services or something like that, that they had, um, basically divorce rates at county.
Okay. And so you could basically match the county of the pool to the county and then run, you know, macro ions. Yeah, sure. Um, so in I'm I'm in the middle of this and Godes all, um, ed deal, uh, was taking his class and he threw a curve ball in class, which had nothing to do with this. He said, I think you had a ton or something weird going on in treasury market.
And he said, um, well, what do you think this is gonna do to corporate finance? Uh, you know, like the choice between data and equity, et cetera, and everybody had an opinion, et cetera. And then I raised my hand and. Is there a paper said there is no paper. And I thought, well, that's, what's basically he saying, it's just saying, you know, go and investigate.
So that became, you know, my, uh, my new passion. And then I went that way. I wrote models to take into account interest rates and then solved for optimal capital structure, et cetera, et cetera. And basically the. Almost 20 years became a variation of that pursuit. Uh, you know, some of the work I've done earlier were all modeling and then I moved onto more empirical stuff.
So to give an example, like when Star's oxyc was passed, uh, the follow up literature was that, you know, this was bad. Uh, and it was bad because it took away, um, mechanisms with, with which information comes about. And so firms start not doing projects as well, not taking risk, et cetera, et cetera. And then I said, well, I mean, if not, not taking risk as much, the corporate bond owners should be happy cuz you know, they hate when they take risk.
Special INAC excessive risk. So we tested it with the, uh, with bonds and law and behold, you could show that, you know, there is a huge drop in the spreads after the law gets passed. Mm. And it's between when it gets passed and it gets implemented and then everything sort of stabilizes, uh, which, you know, tells you need, uh, the fact that it prohibits them or at.
Uh, inhibit their taste for risk taken was a good news for bondholders equity oil might have, might not, might not have liked it. Yeah, sure. But the Bon holes certainly loved it. And so, you know, in that flavor and, um, more recently in the last, uh, few years, a new dataset came about and I got excited, uh, about bond ownership.
You know, one of the things that all along for, you know, almost 30, 40 years or so people studied corporal bonds was that they really didn't know who owns this stuff and what motivates them, you know, why, why do they hold this? But not the other, et cetera, etc. And so there is, uh, there there's a growing body of work that now studies, uh, various things about that.
And one of the things that we sort of come about was that there is quite a bit of network economics in this, uh, for instance, you've, uh, I've, I've got a. Paper that I'm very excited about. You know, one of the things we find is that in, in, in corporate bond ownership, there is no nobody's called leader. I mean, nobody gets that title, right?
It's a little bit different. Like if you go to bankruptcy or you go to syndicated loans, there's usually a lead sort of a lender lead, you know, this and that. Whereas in, in the bond ownership there no lead per se, but it is still within the RO of lending. So you have to think, well, is there anybody leader or not?
And so what we find is that there are. Their effect in price is orders of magnitude more than anyone else. And one of the things that they're, you know, they characterize, characterize, uh, the, the lead lenders that, uh, they, they don't take, you know, huge positions, but they take large positions, but they have large positions elsewhere as well.
And so what they can do, they can really dictate terms. Uh, and, and this is done through very implicit ways, not explicit. So in middle of this, of course, you know, I moved from Oklahoma state. I came to Wyoming and at a time Wyoming was passing a lot of laws that had to do with, uh, blockchain, et cetera. And, uh,
What, what kind of laws were they? Just outta curiosity?
So, uh, so, so Wyoming was one of the, uh, well, it is now. The first estate, not one of the first estate, but, uh, the first estate that basically, uh, created what we call a special purpose depositing institutions. Um, and the way it works, it's basically a custody bank, uh, that this custody bank was chartered by the states, not at the federal level.
And it was allowed to basically do custody of digital assets. Now as you know, you know, here in the us, uh, federally, you're not allowed to, uh, basically use digital assets as it deposits and then lend et cetera. So you can't, you can't do that. Uh, but you know, we were the first one that started this avalanche of.
Uh, we do banking up to lending and then we stop, uh, which is, uh, you know, actually, uh, wrote one of the recommendation letters for, uh, one of our first banks to, to get access, to federal rails, so to speak. So now, you know, they have access, et cetera, et cetera. So while they don't do a lot of lending, they basically have access to us financial system, uh, which basically means they're gateways for internal and external.
You know, if you're outside, you want to get. This is basically the first place you visit and so on and so forth. And then, uh, about a year, a year and a half ago, uh, you know, There, those are the first set of sort of a loss. And then the follow up came, which ended up basically allowing a Dow to become an LLC.
So it is legally a protected sort of entity in the eye of the, of the court. Uh, which again, as you know, in a, not, not all jurisdictions have that. Commission for, for Dows, which basically means, you know, depending on, uh, what happens, you could end up in a court of law. And since that protection is not extended, then everyone who's standing behind that Dow is gonna be personally liable for what's been sued for.
So, uh, you know, the, uh, the guys who were running the show, you our, uh, director of centers for blockchain and traditional innovation, uh, you know, our Dean, et cetera, they came and say, well, um, can you do a course, uh, in blockchain and finance and our CIO, uh, you know, does a fantastic job in sort of. Uh, teaching the investment in a practical way and they do stake in all other stuff with cryptos.
And I said, look, I mean, the guy is doing a fantastic job. If you want another guy to just te you know, teach asset pricing just for, you know, cryptos. And I don't think, you know, I'm, I'm suited for that, but if you wanna do something with banking, that's a different story. Uh, there, I think we can do a lot of damage.
So, uh, so I designed this course, which. Takes a very sort of a step back attitude. You know, we, uh, we start with going back in time and let's talk about payment systems. Cause you know, originally all of this was about payments now as with defi and everything is something else, but originally it was all about payments.
I so well let's understand how payment works to begin with so we can understand, you know, what, uh, what these crypto guys are actually talking about. So, you know, we start with the payment systems. RT GSS, you know, ACH, et cetera, et cetera, swift, what have you. And then, and then we move into, you know, what could be the role of DLTs, uh, which, you know, it's a broad topic.
I mean, depending on type of DLT, you've got, uh, you could have a crypto or you could have something else. Uh, if it's permissionless, well, now we're talking about, you know, Bitcoin, if it's permission, then it's a hybrid. Uh, and there are examples of that as well. And then after that, you know, Then, then we move into, um, the sort of programmable money ideas, um, and what could happen.
There's a beautiful case by Harvard BI school. Uh, um, It's a story of the guys in Deutche bank, uh, who started the first blockchain for corporate bonds. And then they find out how hard it is to actually do, uh, you know, they thought it was a straightforward instrument and then you get into it and you realize how much moving part the bond has and how hard it is to actually create a change for all these, you know, bits and pieces.
Uh, initially. The guy who was running the project now is the CEO of finality, which is the largest, uh, settlement network for all the big banks in, in, in Europe. And actually had a conversation with him, uh, a couple of months ago, but the story, you know, background cetera, et cetera. Uh, and, uh, about a year ago, not coming up to a year, uh, almost.
Uh, you know, the, the director of our center came and said, uh, you know, a couple of guys in, um, card, want talk to you? I said, all right, let let's talk.
Sounds very ominous, Ali. It's guys down the street, Tony wants to talk to you. Never good.
So, uh, at a time they, uh, as part of their cardial, 20, 25, uh, vision, I think they had this project that had to do with, uh, decentralized treasury and, uh, you know, they, most of the work that they, that they've been doing was more from a.
High level, not being a detailed tech, but high level, sort of a computer science attitude of, you know, what to do with it, et cetera, et cetera. And you know, I come in and I was the black sheep that came in with all the nuances that, you know, economics and finance can bring to networks. Right. Cause now you're talking about.
And network that part of it is funding it. And other part of it is project management, uh, conflict resolution, et cetera, et cetera. And it's funny, um, you know, over that, that, you know, topics that I started, I don't think that they really appreciated me, you know, poking holes in, uh, here and there. Uh, over the course of last, uh, year, I've seen a lot of stuff that came in basically, or same, same thing.
In fact, I was listening to a lecturer today. By the guys that are funded by, um, Anderson hos now to, to do basically research on, on blockchain, et cetera. And, uh, you know, there are, uh, theories that are, are coming to forefront that comes from complexity theory, algorithmic, um, Uh, sort of a games, et cetera, et cetera.
And, and it's all about taking our old national equilibrium in economics and, and put it on a steroid. So you can D now work on basically a computer network and, you know, DLTs are not just any computer network. You know, and in a dream scenario, it should be a network that are on its on its own. I mean, that that's a smart contract and no human being should be able to, you know, finagle it.
Um, so, you know, there are a lot of topics that now from a research perspective have become very near and dear to me, uh, couple of them are under, uh, You know, we're putting bits and pieces together, has to do with the stable coins, uh, with when you have a network, whether the network, um, under what conditions would a DLT become decentralized and do DLTs that we observe today are.
Uh, truly democratize or not. And if not, why aren't they democratized? Um, so, you know, 20, some odd years, uh, in a nutshell yeah,
That's that's, I mean, it, it's fantastic. Isn't it? How life always, uh, affords you, um, interesting things to think about. If, if you're open to it, as you say. Pivoted your career a number of times.
And I think what I find fascinating is, uh, you you've touched on so many points there. And I think maybe kind of small subset for me is around the functioning of a network. Right? And so the, the thinking, the network, thinking that this kind of pushes you into and, and the contrast of that with a much more kind of agency.
Information as symmetry certification type perspective that you have a lot of the models in finance working on, which I think are very valuable and, and provide really interesting game theoretical. As you say, models, some of which have, um, equilibrium, some of which have mixed some of which don't, um, have close form solutions, but kind of illustrate.
Various different edge cases and various different kinds of, uh, effects and, and outcomes. Mm-hmm . And I'm guessing that there's a, um, equivalency of this types of thinking within a network structure. Cause when I read the white papers of a lot of the log chains and try to understand what's kind of happening behind it, it's, it's kind of very mechanically written.
So it's a lot more kind of like this happens and this is the, now then this person has to do this. And then so on. Sure. Along with crypto. And it doesn't really explore yet the, um, the kind of systems wide effects, not to mention the cross systems across blockchains and, and various other kinds of effects.
And I suppose one of the things I was gonna ask you about is one of my experiences, um, which I, which I, I'm trying to hard to reconcile at the moment with blockchains. Is that, um, during the global financial crisis, I was working BlackRock and I, it was an amazing experience to work at one of the biggest asset managers at the time, looking across the financial landscape, seeing what's happening.
But one of the observations we had at the time, which was part of the reason that things got so bad is because of the legal rigidity involved with financial contracts. That required, forced liquidation in the, um, even in the event of, of a fire sale. And therefore a lot of these assets were BA basically being sold, forcibly sold, even when there was no prices on the other end, had they had the flexibility to stand back and say, look, why don't we wait for a day or even a week or whatever the prices would've had a very different experience and, and a lot of things that kind of tumbled into, um, because the fire sales wouldn't have.
And so then I kind of wonder now looking at. Or the advents of, um, smart contracts. And as you said, programmable money. And I think about how on the one hand in society, we've learned the hard way about not having rigidity in, in such contracts, right? And also, I suppose, of, of therefore not trusting certain types of algorithmic or kind of fixed, um, functional forms.
And there's a lot of conversations around various different AI adoption and fairness and ethics and whatever reasoning systems, et cetera. On the other side, you've got this new industry coming through going. No, no, no. We can program things. We can write it down. We can just put into a contract and it'll kind of work and it'll be fine.
Is that a naivety or is that genius or something?
So they're not gonna like me, but, but, but I tell 'em, uh, uh, it is a naive, uh, and I think it is because as a former engineer, I, I can perfectly understand where is coming from. You know, it is a second nature for an engineer to think that I can solve all nows in life.
If I just spend little bit more time on the elegance of, of the mechanics, uh, of the. The thing is that as you very well know, economic systems are not like that. We're complex, we're adaptive and we are prone for chaos. Uh, little things can basically create cascades. No one can stop it. And, and you're, you are absolutely right.
That's, that's actually funny cuz uh, one of the things that, uh, uh, am I gonna get into it because I, I might get into trouble with, you know, different people, but one are topics that I'm very much. Working on a putting together proposal has to do with, um, how, uh, bad a fire sale driven algorithm for settling futures can be as opposed to the systems that we have right now, which lags in settlement allows for time to go and things basically wash themselves out.
And, you know, uh, it, it's funny that. Uh, you know, it's a choice, right? It's a choice you make, you want to limit losses. But the way that the current system works is that we aggregate at every level, right. Uh, fr from an institutional level to the exchange level, then to the clearinghouse level. So we aggregate up to make sure that shocks can basically be dampen as they go.
To the system, uh, and the whole reason you want to do that is that it's okay for one account to get into trouble. It is not okay at all for the system to collapse. And so when, when you systemically become very rigid, like you said, that, you know, I cannot tolerate any loss. Then, what you're asking is that the system will be very rigid.
And as a result, very fragile, uh, that, you know, rigidity creates fragility in, in the system. And that's not what you want. Right. You don't want, as it is, a financial system is already levered up to the yield and then you make it a, a fragile one you're just asking for trouble. Um, so one of the things, for instance, And I give the example of, you know, how things cannot be perfectly, uh, programmed, uh, take, for example, a simple mortgage, right?
Uh, this is one of the ideas we're playing around right now. When you have multiple, um, sort of a. Uh, networks that they want to talk to each other, or they refuse to talk to each other. So a mortgage for instance, here in the us. And I think it's, it's customary elsewhere as well. Uh, when you pay the bank, it's not just for your mortgage, you're paying a payment that includes your bank payments.
It includes your taxes, property taxes, and includes the insurance. For the, so now each one of these institutions have a different objective, different perspective, demands, different things for the purpose of mortgage. I can understand that if this was just mortgage, we would pay, it goes on a chain.
Everybody knows what it is, et cetera, et cetera. Okay. If the default happens, hell breaks loose, but let's say, you know, that we can forget that, but there is an element here that you cannot forget. And that's the fact that I do not want the tax man at the end of the year, comes back as well. We never got your taxes.
I'll paid it. and the only reason is one cannot communicate with the other one, because one is rigid in maintaining crypto and, and maintaining everything secret. Whereas the tax man wants to know who's paying the. I wanna know their name. I wanted their identity. I wanna know their, I wanna know everything about it because at the end of the day, that's how they know if I settled my account with them.
Right. And so what you have here is a huge problem. It's it's one sort of a encoding has to be decoded. Reveal tremendous amount of private information to one and only one entity. And then wrap it back up again. And this has to happen in a, in sort of an interactive way now, you tell me how easy it is to do this and , and like I said, you know, the case in, uh, uh, you know, the, the experiment of Doche bank in corporate bond.
Fall apart. And because of that, because they had this bits and pieces that are moving around and the demands are different, different constituencies, demand, different type of information, and you can't be rigid about it. You can't tell, well, this is all I'm gonna do. then you're not programmable, you know, you're you're limited.
Um, so. Uh, I'm not saying that things cannot be programed. What I am saying is as is the case with, you know, the, the real world, right? The, the rules of engagement changes, they evolve, uh, because the laws evolve because the institutional details evolve, et cetera, et cetera, et cetera. Uh, for, for us to think that we can just write a code, leave it alone, and it's all done.
Um, and then lives on, you know, Ethereum or wherever it wants to live forever. That to me, it's, it's a bit, it's a bit more than a naivete, but let's say it is naive.
And, and I think it, it's fascinating cuz obviously. Somebody who's been associated will work with the financial services industry for a long time.
I, I think I also kind of challenge the narrative that there's a them and us. So there's a kind of the banks' elite. Absolutely. Then kind of mess with people and, you know, kind of control people's faiths and therefore we're gonna be taking control out of their hands and put it into this distributed system.
um, I mean, most of my colleagues that people I've worked with, in fact just about all have actually been upstanding citizens with, you know, very high academics who have absolutely four points in time, tried to act with a great deal of integrity and, and honesty and directly. And I, I think there's always bad apples and Asian, but they rarely make it through that heavy sifting now or the financial services of the interviews and the background checks and the whatever.
So I, I feel like. There, there is a kind of a distrust perhaps and in the system, whatever the system might be. And, and that's probably a whole other conversation about Brexit, globalization, equality, and so on. But I just wonder whether this distrust in me in the system is kind of echoed into this element and, and the people have said, okay, we understand that it's not as simple as that, but I'd rather take it back.
In control of it and have a right, you know, a more fragile, more rigid system than have it in someone else's control and be functioning as it is. And, and I think just on this final point, one thing that I will note is I think since Ellen Greenspan days, and certainly through the two thousands, we are living in a managed economy.
And every time that the markets have a significant downturn people immediately turn to the government and the fed for interest rate policy decisions as if there was only one switch, one lever to flick up or down. Sure. You know, go or stop. And everybody kind of stops. I was at a recently as a conference, I was at a chief economist panel talking about economy, and most of the conversation was spent talking about interest rates.
And I find that fascinating given that. Could the economy is, is a group of industries that are engaging in economic activity with inflation and wage pressures and whatever that are affecting them more differently. Right. And really it's, it's, it's kind of like looking at a forest and thinking about, I don't know, precipitation rather than thinking about what are the trees that are actually in that forest.
Sure. So, uh, there, I think there, there are a couple elements there. Uh, so as I'm gonna touch up on all, all that you said, uh, you are absolutely right. There is mistrust and I've read somewhere that, you know, and, and when you look at the age distribution of people who are interested in cryptos and, you know, data space as opposed, uh, you know, elsewhere, Uh, there is a huge dichotomy of, of age groups.
Uh, the, the crypto fans are in sort of a 20 to 40 age bracket. Whereas the financial market fans are all, uh, 45 plus. Uh, so, so clearly there is, there is a separation of that. And part of it, uh, the story is, is that. The 2008 crisis created very bad taste, uh, in people's mouth with respect to, you know, whether it's financial institution hold their end of the bargain or not.
And perhaps, you know, there has been, you know, some, um, malpractice malfeasant, whatever the right word for it is. Uh, there was certainly an excessive risk taking and, and excess. You know, taste for risk, you know, AIG is a pollster child of, you know, taking a simple derivative and basically raising it to power and, you know, just so you can get the fees, not understanding what the unraveling is gonna look like.
So, you know, we can't necessarily say that, you know, there, there are arguments is without merit having said that, uh, you know what I, what I, when I teach my banking classes, you know, I said, look, um, I don't, uh, uh, I'm not trying to stop you from going after the cryptos. That's the future. Whether it would be the way we know it or something else, most likely something else.
I have no doubt about that. What I, what I asked you is that you do not forget the history of your profession. Uh, we don't do a whole lot of innovations, but when we do, we solve fundamental problems and then we move on and that's why we don't need a whole lot of innovation. You only need one fundamental problem.
That's it? I mean, life can go on really well. So, you know, when Madi started the modern banking, what they solved was the network effect. They understood for a bank to stay very strong. They needed two things they needed. Partial ownership. You know, people have a skin in the game, so they don't cheat the banker.
And there has to be a network of banks that irrespective they honor each other the way they created it, they created their own family bank. You know, it was a network that was found, but you know, then, then again, the Racha banking repeated the same thing. So it's been a very successful model and has been repeated over the years because they solve the fundamental problem.
Asymmetric information as you move through financial system. If I want to trust someone else, I think I can trust my own family better than someone else. Most people would are, you know, most people, not everybody , but you know, there is a scale to it, right? I mean, if, if your solution is. Family, you know, owned then, well, you're that the mercy of your family.
And if your, your family grows, then you know, sure. If your family doesn't grow you're squabble, then, then everything falls apart. So the Dutch came, you know, almost hundred, hundred 50 years after that. And they say, forget about this family nonsense, what we're gonna do. We're gonna create exchange. You don't even need to move anything around.
You can just sign a PA you know, sign a book, and we're gonna debit credit. This book all day long. At the end of the day, whoever is short is gonna bring the money back. Whoever is long, you know, they can take money out, but at any stage, we're just gonna balance the book. That's all we're gonna do. Right.
And then the, the, the suites, uh, you know, almost a hundred year after they realize, well, wait a minute, we don't need to ask for gold equivalent amount of trade that they do because only about a 10th of this is actually move in and out every day. So why don't we just ask a system? Right. So, you know, as you can see in the spans of, you know, a hundred year each, we have moved from networks to exchanges, to fractional banking, and then the Brits almost a hundred year after that, they come in and say, you know what, for most part, this exchange stuff that you guys say is basically irrelevant.
Uh, what we need to create as a bear of notes, you bring your bearer note of bank of England. I honor it with the. And I mean, everything that I said are basically the cornerstone of banking, right. We haven't changed that much since their dead days, what they invented, defined the world we're in. And so if it works and it does work okay.
For most part, it does work. I'm not saying that it's not fragile. I'm not saying that we don't have in a crisis, et cetera, et cetera, but it solved a lot of stuff. So what it didn't solve was the fact that. Especially, even in us, you know, as you know, in 18 hundreds, there were tens of thousands of banks because people couldn't, you know, trust a big entity, whether it's a government or, you know, big corporation, et cetera, et cetera.
So what did they find out every 10 years here, Britain elsewhere. You had a depression, not every recess at depression. So how did they solve it? Well, the Brits created a central bank and then the Americans. Copy paste the same thing. And ever since we haven't had a major. We have a lot of recessions, but not a major depression.
So, you know what you said that, you know, we all care about interest rate. I think it comes from that, that we, you know, wanna step at a time. We solve these layers of, you know, onion with just peeling, the layers of onion, and we solving one problem at a time. I remember there was an interview, uh, business week, uh, uh, can't remember his name.
It was before Fisher, uh, governor of. This was when the, the wall came down, there was, you know, 2 million, 3 million, you know, Russian Jews are coming to Israel and he, and Israel, you know, up until then had a anemic sort of in high inflation. They always had a, you know, high inflation, you know, it was a trouble.
So he says, you know, this is after us. You know, Chima ball restless is stole, you know, they raised the race, they crashed the inflation, everything was done. So it was about decade after that. Everybody knew that that recipe does work. There's the pain that you pay upfront, but it does work. So they got together and said, look, This is godsend, not even once century.
I mean, once who knows blue moon, you get two, 3 million highly educated people, all of a sudden walk into, you know, your country. Uh, the only thing we can do is just mess it up. That that's the only thing we can. Cause if you stay out of its way, it's gonna bring marvels. We don't know what, even what they are, what we do know that is that we're at, at, at the, you know, fork of a road, we can either do all the stuff we did and, and it's gonna be same exact trouble.
Or we can decide we're gonna do a Walter, you know, uh, cure, which is gonna be painful. But when we're done, we're gonna bring the cost of capital solo that all of these guys can go do, you know, a miracles and low and behold, I mean, it doesn't take anyone to see that it worked right. They, they, they battled their inflation.
They brought the interest rate below. And the second generation that came out of that is the Israel, the tech, you know, Marvel that, you know, today and left and right. You know, startups here there, you know, So these are, you know, like I said, we find a solution and clearly becomes obvious that we, we solve the fundamental problem that why do I need to change it all the time?
The problem, I think one of the problem, fundamental problems that the engineers who are coming are the software engineers that, you know, they love to do version, you know, 1.0 2.0, et cetera, et cetera, every year. Whereas in our world, It doesn't work that way. We it's not like we don't do innovation, but if I solve a fundamental problem, how many times can I solve a fundamental problem?
How many are there to begin with and how many times can I solve it? So I think that's the...
Yeah, no, I, I completely agree early. And I think may, maybe, maybe the, the other thing I add is I think there's an organic.
So, so, so, so, you know, since people from high speed world of, you know, software come in, you know, clashing to, to the lowest speed of finance and they're blaming us for, you know, being too, too slow, too stodgy, you know, what have you.
And there's a reason why we are slow.
Oh, sure. No, look, look, I think it's the, the, the, the clash of cultures is a fascinating one. I mean, I've often thought about this, that the, the. Breed of people that come into an industry often defines the way that it kind of progresses. Right. And so essentially what you have here is in finance.
We've had, you know, I don't know biological engineers we've come in. We've had chaos theory. We've had statistical machine learning. I spent a lot of time talking about how statistical machine learning is so different to the whole hypothesis testing. Kind of idea. And, and, and, you know, in one case you are using your imagination, the other case you're saying that the answer is in data, if only you could kind of see it.
Right. Right. And, and, and these kind of premises, I think when it comes to financial institutions and money, certainly Bitcoin, I think falls into that camp, maybe Ethereum, but I guess a lot of the other coins and projects, and so on seem to be more built around consumption. Of something consumption of financial services consumption of sure.
Whatever, da, da, da, I think with Bitcoin, there's a kind of a fundamental question. That's why, when people ask you what is Bitcoin and you get these long conversations about what is money, what is exchange? What is trade? Look, I'm perfectly happy to contend that. Um, exchange of, uh, pre-agreed quantities between two parties and transaction, um, for a commonly agreed storage of value could be transactional, could be technologically, you know, improved and sped up and, and solved you.
With all these caveats, I think as soon as you start going into what essentially finance is really good at, which is moving capital around with the promise of future benefits, where that future benefit is uncertain, whether that's an equity bond project, whatever you want to see. Absolutely. You start to move, especially in the uncollateralized space.
Or under collateralized space, you start to move into a space where now you're forecasting the future. You're not solving the same problem anymore. You're no longer talking about, you know, transparency being, or your projects or, or kind of getting rid of the middle one. You're now talking about information as symmetry.
You're talking about, you're talking about uncertainty, decision making under uncertainty and so on. And I think at that point, I, I haven't yet seen anything that addresses that problem in immediately different or better way. And so I think you end up back at a, at a place. A central agency, whether it's a neutral certification agency or a, or a lender, which is a kind of an agent has to make those judgments, those forecast, those assessments, and essentially is still acts as the gateway keeper to the loan or to the, to the conditions of flow of capital in that case.
Right. Um, as well as the deposit take. And I find that. Again, it's very interesting for me cuz in transactional level I throw my hands up and go. Yeah, sure. I mean, I don't think we do that much work in finance to establish more efficient transactional systems except perhaps more in, in the case of provision of liquidity problems where you've got, you know, moving capital, you've got limited amount liquidity, but I, that's not really the problem.
Essentially that I think at the core of Bitcoin, it sort of thought about, I think that they were very much more thinking a peer to peer transaction to people already have a sense of what each other have. And therefore there isn't a liquidity question. That's just an, an exchange question. Absolutely. Um, so it feels like the vast majority of financial services essentially Def.
When you move outside of the fully colorized space, we'll still have this big question on top of it, which is how do you think about the future? How do you predict that? How do you provide that uncertainty? Unless you lock people into very prohibitive contracts where you're getting paid on a blockchain that is automatically deducting payments from you.
To, to move into something and that's a systemized way of guaranteeing payment, but even then obviously you have to keep a, your job and B it doesn't really feel like this in the spirit of the exercise, which is of freedom and, uh, and you know, right. Providing, providing options and such.
You're, you're absolutely, you're absolutely right. Uh, you know, when, uh, the first time I thought the class, you know, one of the things that people were scared of creating C DBCs was dis intermedi. Um, at the time, you know, I thought, you know, this is never gonna happen. The funny thing is now that we've had defi experimentation, et cetera, which you basically have found out is that, uh, there is lending.
The problem is these are flash load and they're done basically to accommodate arbitrary jurors. Now their, their definition of arbitrary jurors is very, very, very large and vague. It's not the way we theoretically think about yours. You know, the, the best way I can describe it is sort of a, like a, a price manipul.
That that's basically what it's, but the problem is that in those instances, as you very well know, you know, the speed of money can be very fast and that's okay. And so any contract, whether it's dead or else can be very short term, but it doesn't solve the real economic problems. Right. When I take mortgage, I don't want to figure out every minute or every day what the going rate is because it, it has that sort of floating rate.
What I want is I wanna lock in for the next 30 years. I don't want to care what that rate is. I'll lock. That's it. And, and the same thing that goes for cars, same things for a student, everything that basically define our lives. We are constantly trying to hedge the risk of dealing with volatility, whether, whether we know how to express it or not, but that's what we do as, as a species.
Whereas defi goes the exact opposite and it says, no, I'm gonna settle this on a second by second, because I don't want to take any. No, you shift that risk to me. It's not like you don't want to take any risk, the risk. I didn't wanna take you pass it back to me now. Why do you think I, I want to participate in the system if I'm not part of that game, right?
If I'm not part of that game, why would I wanna participate in a system that just increase my headache? One more, you know, standard deviation or one level. And then the other thing is, is. Uh, the, I think that's where, you know, like you said, it, it creates a sort of a break from what, what, what the real economy is as opposed to what financial, uh, genius or, or machinery can be.
Uh, you're absolutely right. Uh, You know, ever since the Brits and I, I give this example in my class, uh, the battle Waterloo was fundamental in finance and everything else. It was the day that money went from being the Kings and Queens money to be the people's mind, the Brits, the Brits who didn't have any money.
Right. As opposed to the Spaniards and the France who earned that French who had big silver and gold, they issued bonds. They literally borrowed from themselves. It's it's a time machine. We went through, they went through time, look at themselves and said, look, you, you are the one who citizen of empires son never sets on spot me the, you know, the buck today, and then you can exist.
Otherwise we're done. Nothing will exist. And so they borrowed from themselves, they paid themselves back and they created, I mean, I don't need to tell you enough that they created the largest freaking empire ever existed. So the, the fact the matter is that our money today doesn't come from my wallet. It comes from my future.
That's where it comes from. If I build a greater future, that's how my money on aggregate goes up. Right? If people look at different people, why is it that the, the medical, the school of students can get, you know, bigger loans as opposed to someone who, you know, studied history. Because the income potential is, is dramatically different, right?
It's the future that defines today. And, and the fact the matter is that I don't think very, I think very few people in, in the defi world and the crypto world have that appreciation that the source of our money today is truly credit. And the credit is not something that is created out of thin air it's created out of future that you could potentially create.
Right. So that's, you know how intermediation works. I'll look at you. You're a. High net worth. You could be a high net worth individual. Why shouldn't I lend you a million dollar today?
Well, but the, I think, I think the irony, of course you say that they don't understand, but I think given the ICO issuance and such, I think they're very well understand because that's really cornerstone of that entire philosophy.
I issue a bunch of coins about what I will do at some point when I get this project off the ground and then it will have some benefit to you. And so I sure you know, but, but I think you're right in. The, you know, as usual, these systems are complex. I love the innovation in blockchain. And I think a lot of my questions are really more about trying to find the edges of that innovation, trying to find those areas where you're like, no, um, not yet, but obviously the core part that it solves and how it's able to do that and the eloquence and, and the systems that it's trying to create.
It fits incredibly well. Both with this sense of innovation. Also a little bit of sense of. Globalization. So kinda let's get away from national borders. Let's get away from national monetary systems. Sure. Especially powerful for emerging market economies. Um, and I sort of, I look forward to a lot more of these innovations.
I can imagine that smart contracts in the future will be a lot more dynamic. I can imagine that there'll be a lot, a lot more intricate logic, maybe a bit more AI in built in it to learn, to adapt. And to move. Um, absolutely. But I think, I think, yeah, we, we definitely move into a system where these algorithmic systems are governing the way the capital flows in a slightly more transparent or, or obvious way than they're currently doing, which they are certainly, certainly are currently doing.
Whether we call them risk models or whether we call them something else. I mean, they, they are formal lake and in, in some level of complexity. So I think it's, it's a, it's a really interesting. Spread of innovation. And, and I guess when, when do you think that, uh, finance will start to, um, have, you know, blockchain departments and big research grants?
I mean, obviously you see some of that happening already. You see some great work and, um, uh, you know, various academics doing work on, on, on, on chain, uh, analytics, and, and also trying to think about the structure of these blockchains themselves as, as. You know, potentially as a cause of systematic failures or other kinds of problems as well.
Um, I mean, how, how far do you think we are in, in that, in the mainstream financial, um, academia kind of adopting this stuff?
So, you know, my, in my humble opinion, I, I think, uh, the, the. Technological problems haven't been at risk yet. And that's why majority of the research serious research been done has to do with the tech.
I mean, this announcement by Anderson Horowitz and what they're funding, all the brains that they brought are basically computer science people who've been working on the theoretical aspect and the mechanic aspect of. Uh, you know, the, uh, I read this, uh, that happened either yesterday, today, before yesterday, uh, the, um, uh, the board a, uh, uh, auction that they did, the minting that they did, uh, they were sold, you know, piece, uh, for less than 6,000 bucks.
The gas fee was anywhere from 6,000 to 14,000. I mean, imagine. They blame finance for, for being expensive. Imagine if someone forces you to pay twice or three times as much for the thing you're buying in transaction costs, imagine how mad you're gonna be.
But, but it's, it's, it's gonna go to the moon. I mean, yeah.
Yes, of course.
Well worry about it. It's uh, no, but, but I, I, I think you point out which is we're at the beginning. Of this trend. And I think mechanically, you, you, you see the hype cycles, you see the Ponzi feeling in the air and unfortunately see it at all different levels of the organizations, but amongst it all again, is I think.
Still a very interesting and solid technology that will probably go and move into lots of different use cases, industries a little bit like AI. I, I feel like if AI had managed to launch a coin at the beginning, we would've had a similar type of Ponzi scheme about AI, but AI was similarly touted. If you remember.
As, as, as far back as five or 10 years ago, it was a new electricity and it was going to move into lots of industries and lift up the game in, in lots of different ways.
So, you know, the, the thing of it is I think that the example you gave is a perfect example. You know, AI, even to this day is not part of the curriculum in finance.
Uh, but, but as you said, and as you know, it is part of a practice have been part of a practice for a very long time, right today in the research, you know, we use it for. Just generating either doing the methodological sort of approach better or generating information that you could not have otherwise, uh, you know, have, uh, and so, you know, we are at basically at, at this start of probably next decade becoming part of the curriculums, you know, if that, and, and the, you know, the learning curve is steep.
I mean, you know, you basically are demanding someone who didn't want to code for, for a living. To now, you know, try to understand how a black box of code in works, et cetera, et cetera.
And, and, you know, it's, well, first me is again with AI, the culture behind it is a computer sciences culture, right? So it's not just, you know, like a, a status MATLAB type of thing where you take it off the shelf pops in you're in TRICS 1 0 1.
I wrote one that you have to set up, you know, a, uh, an instance you have to allocate memory, you have to do all these really core level computer science functions where. You're not trained for that. As, as an average researcher, you have to pick up all those skills in addition. But I think, I think your point is well made, which is that generally speaking, it, it is a similar, it feels like a similar beginning, um, promise of, of, of this.
And, and in some cases, it, as we've seen, it's been adopted very quickly. It's been very successful. Lots of other cases been lagging. Blockchain feels like it's, you know, there's 33 billion worth of B capital. That's gone in there for the last year, right. Four courses alone, which is more than any quarter.
This happened before a huge amount of talented people are going into it. It feels like the cement foundations are being kind of worked out. Right. And, and as, as you say, maybe the time, it kind of moves up to the sphere where, um, you and I see it in, in our everyday lives being talked about it, was it a separate industry or as.
A part of, of all these conventional sciences could be, could be a decade away or more maybe.
Right, right. No, absolutely. You know what, what, I'm very excited. Is that, like you said, it's the tech part. Uh, when, when all the, all the wrinkles is gonna iron out, uh, blockchain is going to be the engine that runs the IOT.
Uh, that's the exciting thing to me, uh, where, you know, I give you example, there's a firm called Xometry and what they are, they're basically manufacturing on demand by. And there's another, uh, uh, firm called P and that's, uh, building prototypes, uh, via distance. So, you know, the first one is a manufacturing full.
The other one is CNC machines. You send your designs, they do it for you. They send it back. Now, imagine if these two and all the ecosystem that they serve can sit on a blockchain. So I could simply send my design to Pola. P lab makes the prototype comes back. I'm okay with it. The design is sitting on, on a net.
I mean, I don't have to do. So I just called XRY. I said, here it is, that's a block. I want you to do it. And it goes, and then XRY comes back and says to make this, I need four other members of the network to basically give me this material of this product, et cetera, et cetera, boom, everything done. Um, and, and it's not something that is, you know, um, beyond reach or beyond imagination.
Um, for years and years. FedEx, uh, has been doing and now Amazon do it for, for themselves. But you know, when you ordered a book, it never went to a warehouse that the books were setting. It goes to the central hub. Excuse. Or FedEx or ups work city, they would, they would, they would get your order. They had these industrial printers sitting on the warehouse, they just download the books to the, to the printer.
The printer just prints the book and they send it to you. I mean, it's basically same concept, but you know, it's much wider, you know, more accessible, uh, permission, etcetera. So those are the things that I think, you know, it's are exciting. You know, like people think it's, it's in NSA and Des spies that, you know, they got excited about the crypto and et cetera, et cetera, that's not true.
Money was the first one that needed to solve the problem of making things, you know, safe. That's why you have all the routing numbers, all the designs of the bills, you know, et cetera, et cetera. We have to solve those problems long before any spy got excited about it because our, our, our, you know, our financial health depending.
Whether the instrument itself, a safe instrument. Right? So, so I think a lot of these experimentation that is happening in finance, uh, would not have any application in finance at all. Rather it's actually come and visits the real economy. And I think that's where things get extremely excited.
No, I, I, I absolutely, and I often wonder as, as you said, with these examples as well, the difference between had this technology come to market without the Bitcoin being the lead entrance, right.
Because it was the lead entrance. It came in going, we're gonna replace money. And it became it touch finance, it touched trading, it touched all these different elements of banking, defi, whatever financial services being. One of the primary areas where, you know, the blockchain is being considered. But as you say, there's this kind of a whole wave of application of blockchains, whether that's various different kind of formats and forms and, you know, metaverse, and, and so on that it feels like has nothing to do.
The necessity of having a coin or money. I mean, these are nice things cuz they, as you, as you said, they're the utility tokens or they share the gains or whatever, but it feels like sometimes they're a bit of a side show to the core kind of core element of, of, of, of the improvement that's being offered or, or the kind of the accessibility of data, speed of data access, et cetera, that that's kind of a.
The core value driver of that. So I often kind of think about this industry as a bundled industry of, you know, a pure technology innovation kind of very infrastructure type innovation. Right, right, right, right. And this kind of a gold dust sitting around it, AKA, whatever people get very excited about trading the gold dust or that's crypto or that's what it means.
But in fact, you know, the underlying, uh, element behind it is this kind of very foundational technology. No, it's it's fantastic. Well, listen, thank you so much for your time today, Ali. Um, thank you. I'm sure we could go on for a long time. It feels like if we had a couple of beers in front of us, we, we could have, uh, this conversation going for hours and, and it was a pleasure to have you
It's, it's been my pleasure.
Thank you. Thank you for the invite.
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