Crypto-nite and Meta Crash: 5 Lessons on Innovation
I published this post first on JuST THINK. To stay up to date, come to https://justthink.substack.com/ and subscribe for free!
The second largest crypto exchange, FTX, blew up and went bankrupt. Meta (the company formerly known as Facebook) has seen its market value collapse. The giants that drove the latest tech boom are laying off thousands of employees. Elon Musk is seeking a different business model for Twitter.
Was this last wave of innovation just hype, as skeptics claimed all along?
I’ve come to the world of innovation from an unlikely angle — I was GE’s Chief Economist when the company embraced the digital revolution and I had joined GE after a decade and a half in policy and finance. So I am especially attentive to the hardware/software nexus, the marriage of bits and atoms. I see the power and the limits of pure digital innovation, but also the enormous value digital can bring to the world of manufacturing — constrained by the laws of physics.
From this perspective, here are my five innovation lessons from this latest tech crash:
1. The pyramids are still standing
They said “crypto” would reshape finance. A bottom-up revolution would replace banks, insurance companies and even central banks with a more efficient democratized setup. The hype brushed aside all obstacles and complications: technology, incentives, regulations, and more. But the hype on the new technology hid some very old-fashioned bad behavior.
Blockchain is a revolutionary technology with a wide range of applications. Cryptocurrencies will remain embedded in our financial system in some form. But the explosive growth of the crypto universe had little to do with innovative technology. It was a good old pyramid scheme.
(Calling these schemes “pyramids” is both accurate and misleading. Yes, you need a large base of participants at the bottom so that a few at the top can extract value. But the actual pyramids last forever — go see them — they are extremely stable structures. Financial pyramids always collapse. They are reverse pyramids — upside down. Maybe they will be stable in the metaverse.)
There will aways be manias and bubbles. This time central banks set the stage by providing ample liquidity and making it impossible to generate any returns without taking outsized risks. Then a technology that sounds way too complex to understand but translates into a simple idea acted as the perfect bait. A clever con-man — FTX founder Sam Bankman-Fried — dressed it up in the feel-good disguise of effective altruism. In a recent response to a reporter, Bankman-Fried candidly admitted the cynical hypocrisy behind this: it is a “dumb game we woke westerners play where we say all the right shibboleths and so everyone likes us.” And so a con-man gets the open endorsement of politicians, sports stars and entertainers, from Bill Clinton and Tony Blair to Tom Brady and Katy Perry.
Hopefully the crypto crash will just burn off some excess liquidity with limited impact on the financial system. Hopefully.
First lesson: in the new world, look out for the same old traps.
2. Value-add vs. Risk-add
The first question we should always ask when evaluating a new technology is: what does it add? The “old economy” measures every step in the economic chain in terms of value added. I buy cloth and sell you a jacket: the value added lies in my craftsmanship, and gets embodied in better functionality and style. That’s what you pay for (and in countries with a value added tax, that’s what the government taxes.)
Many of the innovations in crypto operate on a risk-added rather than value-added basis. FTX helped you swap dollars for volatile tokens, and might have used your dollars to place risky financial bets of its own, through its affiliate Alameda Capital. This added a lot of risk and no value — except for the value we assign to gambling. That’s what you paid for: the additional risk intrinsic in a gamble. The way you pay for a lottery ticket. The innovation, it turns out, served mostly to blindside regulators and avoid the traditional safeguards of the “old” financial system.
Second lesson: make sure the new technology adds value, not (just) risk
3. Mad Men
Speaking of value, what are you selling, really? Innovation is not everything — it matters what you can offer, how you make money. Some of the new tech giants grew so fast because they gave us services for free. That of course meant we were not the customer — we were the product. They lured us with clickbait and harvested our data, which they sold to advertisers. Advertising accounts for nearly all of Facebook’s revenue (98%); about 90% of Twitter’s and over 80% of Google’s. These are not tech companies, they are media and advertising companies. It should have been obvious all along.
The joke was on us, but also on those shelling out big bucks to bombard us with ads for the same pair of running shoes we have already bought: there is zero evidence that internet ads increase sales — try this Freakonomics podcast for an entertaining and informative take on the topic.
Now, as the tide of generous central bank liquidity goes out, financial markets might finally be repricing these companies for what they really are: media companies whose growth will be ultimately be capped by the hours we can spend on our screens and by their sponsors’ naïveté.
Third lesson: check how the new technology makes money, and compare the new company to “old” companies that make money in exactly the same way.
4. Value is in the eye of the beholder
“We wanted flying cars, instead we got 140 characters.” In 2013 venture capital investor Peter Thiel captured pithily how digital innovation had skewed towards social media and entertainment. Northwestern economist Robert Gordon has been similarly dismissive of digital innovation, arguing that its economic potential does not even get close to that of the industrial revolution.
Digital innovation holds enormous transformative potential. But so far, that potential has been realized mostly in entertainment. Yes, we all claim we need Twitter to keep up to date on news and research, but let’s be honest, what we seek is entertainment. Facebook, Instagram, TikTok, Netflix,…shall I go on? The Federal Reserve Board’s research department has 15,000 followers on Twitter; Justin Bieber has over 100 million. Say no more.
The future looks much the same. If you are wondering what the metaverse is all about, read Neal Stephenson’s Snow Crash and Ready Player One. It’s entertainment. Yes, one day we’ll be able to have realistic virtual work meetings in the metaverse — but it’s not like meetings are the best way to increase work productivity.
Value, however, is in the eye of the beholder. The metaverse might turn out to be nothing but one giant black hole of a video game where we get sucked in to spend our entire lives, while in the real world the robots do all the work. It might cripple our cognitive abilities in a more fundamental way than even social media have done so far (my friend Mickey McManus and I dubbed this The Great Cognitive Depression). But if people want entertainment and can pay for entertainment, they will pay for entertainment. And the metaverse will make money. Potentially a lot of it. In two traditional ways, however (remember the third lesson): through advertising, or by having people pay for access.
Fourth lesson: never underestimate people’s willingness to spend real money on silly things (an NFT pet rock, anyone?)
5. Does anyone remember Owen?
In 2016 GE was striving to make the Industrial Internet vision a profitable reality, with software that would improve the efficiency and performance of gas and wind turbines, jet engines, locomotives, medical devices. Finding the right talent was one of the biggest challenges: how could we compete with the likes of Google and Facebook, not to mention a vast universe of start-ups? Our marketing team launched a brilliant series of ads: “What’s the matter with Owen?”. The ads self-deprecatingly recognized GE was an unlikely competitor in the job market for software developers. But at the same time pointed out that digital work in manufacturing would create real, tangible value.
GE’s industrial internet strategy failed, but the industrial internet succeeded. Industry 4.0 has become a buzzword, and companies across a wide range of industries now invest heavily in digital technologies. The proof points are building up. It will take longer for this revolution to scale, but the value added it creates is undeniable. And it builds on the same technological breakthroughs that have given us crypto currencies and Pokemon Go. The fact that some applications look silly and useless does not mean the technology is. It’s just that realizing digital value in the world of atoms is hard and takes time.
Fifth lesson: don’t judge a new technology by its silliest applications; be skeptical of the hype, but don’t discount the long term value where serious people are working hard on serious applications.
The tech reset we are witnessing is a healthy one. It will puncture bubbles, expose old-style scams decked in high-tech clothing. It will force us to take a hard look at where and how companies make money, so we don’t mistake a media and advertising conglomerate for a true technology pathbreaker. But a lot of digital innovation has already made its way into the world of atoms and will continue to deliver true value in energy, manufacturing, health care and more. This wave of digital-industrial innovation will continue, and will boost productivity. It will provide job opportunities for some of the software wizards laid off by the likes of Twitter — they might want to call Owen for some career advice. Some pure digital technologies like blockchain also have solid value to deliver.
All this I believe will provide a bottom to this tech market crash. It was not all hype. Now we need to be more discriminating and patient. Yes, I know, until the next bubble inevitably comes along and we get swept away again…