In the 90s, actuaries (and actuarial science) were at a bit of a low ebb as all kinds of public and private institutions had issues with pension liabilities. The actuaries – whose job it was to make detailed predictions of the likely long term demands on these funds and compare these to what the funds actually had in them – had taken a decades long jag of Panglossian assurance that all was for the best in the best possible of all worlds.
One of the odder things they did was to allow fund managers to claim that equities (stocks and shares) were more valuable than any other kind of investment (say government bonds, commodities, derivatives…). This was an accounting convention which allowed “profits” for returns on these equities (dividends or profits from sales, and gains in realisable value during the inflationary years) several years in advance – thus reducing the net liabilities of the pension funds.
By the mid 90s the flaws in this approach were beginning to show – and by the time of the equities crash in the early 00s (that’d be the dot-com bubble bursting) it was clear that something had to be done, and pension funds began de-risking – selling equities (at a loss) and using the proceeds to buy less risky products with smaller, but near-guaranteed returns.
Or so you’d think.
What actually happened in many cases was – having been burned by equities, and egged on by the interests of the defined-benefit pension-holders themselves – pension fund managers sought newer forms of investment that could offer a comparable return but at a lower risk. And a product was there to meet their needs.
David X Li, another actuary, began his financial career investigating ways of quantifying risk. Drawing on the copula function (specifically Gaussian Copulas) he came up with a way of predicting correlation between financial securities. Basically, he could turn the correlation between the likelihood of mortgage holder A defaulting and the likelihood of mortgage holder B defaulting into a single number – simple enough for investment bankers to understand.
Even though Li specifically warned against it, this (comparatively) simple output from a (largely poorly understood) formula became the driving force of the market for collateralised debt obligations – CDOs. (basically a CDO piles a whole bunch of debt into big box, and then slices it into segments rated at different levels of risk. You can buy a low rate of return with little risk of default (the “senior tranche”), or a high rate of return with a much larger rate of default. Li’s formula supported the generation of synthetic CDOs (sometimes CDO-squared), wherein the more-difficult-to-sell lower tranches were put into new boxes and resliced into tranches, thus generating new “senior trances” that could be sold.
And that -it has to be said – ended badly for the pensions of the world.
So where next for your savings and pensions? What about something that combined the the volatility and risk of equity with the anonymity, fungibility and algorithmic obfuscation of the CDO? What if we could combine these features with an entire lack of regulation or state backing, and – just for fun – a huge user base in illegal activity? Ready to fill your boots?
Such a product already exists.
There is significant global debate as to what species of financial instrument a “blockchain-derived currency” really is – a debate that has implications for taxation and licensing by governments.
- Certainly it is tradeable against other currencies, with a widely fluctuating exchange rate – though it is backed neither by commodities nor a government/central bank.
- With no extrinsic value, and no value backed by a known trustworthy party, it is clearly not itself a commodity, although it behaves as such.
- It is issued by what could be considered a decentralised autonomous organisation in return for (computational) work conducted – work that is essential to the continuing viability of the organisation. But unlike equity it offers no voting rights or investor protections.
- There is even some discussion as to whether or not it is a derivative.
What blockchain-derived currencies do offer is a lower administrative cost for transactions, where these transactions are simple. For on-network transactions there are no direct costs – though obviously the conversion to another currency at either end has a cost, and the “hidden” costs of power, connectivity and processing time are not factored in.
In terms of security, blockchains prioritise anonymity and encryption over direct trust. Indeed, “trust” is something of a dirty word – the industries that blockchain is slated to disrupt are generally those based on the need for trust.
Considering say, a bank: it offers some anonymity (it shouldn’t disclose the contents of my account to anyone without my permission), and some transparency (I am able to read about the strategy of the bank at my leisure, and monitor activity via publication and meeting). But the main reason to use a bank is for one of trust – I can (generally) assume that a bank will not do anything to jeapordise the money I have invested in it, and if this trust is misplaced I can (generally) assume that a central bank or nation state will ensure that my losses are mimimised.
By amping up the anonymity (it is impossible for anyone to know the content of my account, or link it to me) and transparency (all transactions are publicly listed), blockchain technology removes the need for trust – for all I (or indeed anyone) knows, Satoshi Nakamoto could be anyone or anything, and the other blockchain participants could be thieves and scoundrels or possibly even libertarians. The Ayn Rand forum accepts bitcoin payments – *shrug*
Bitcoin – to use the most common example, is a deflationary currency. There will only ever be 21m bitcoins – as transactions become more widespread the intention is to stop rewarding “mining” (the generation of the crypographic hash that is used to publicly record a transaction) directly with coins and instead allow miners to receive transaction fees. This change will happen automatically and was designed in to the bitcoin system
So – like CDOs – a smart algorithm has removed the need for me to trust anyone, and – like the old accounting convention around equities – an implication of guaranteed growth and return is undermined by deflationary reality. All of this is governed by the design of the algorithm – requiring (ironically) that we trust only in the wisdom of an anonymous coder that the various variables and correspondences have been set correctly.
Cue myriad screams of “this sounds AWESOME, how can we apply it to edtech?”
When silicon valley sneezes, edtech catches a cold about three-to-five years later. So if you’ve recovered from the “year of the MOOC” (yep, every year since 2012 it seems) then brace yourself for the first of many years of the blockchain! Hurrah!
Blockchain has provided a handily fashionable hook to attach increasingly moribund ideas like micro-credentialing and badges to. Of course we have to actually trust the issuers of the badges in questions, ensure that badges can be rescinded if this trust breaks down on either side, and despite this somehow have a means to incentive miners to keep growing the chain.
It’s fair to say that the blockchain is as poor a fit for micro-credentials as learning itself is – though this has not stopped various initiatives to combine the two. Despite this, there are genuinely interesting uses of blockchain technology which may have educational resonance: Ethereum is one that I see as being worth keeping an eye on more generally, and Mark Johnson is (as usual) thinking rich and stimulating thoughts.
Audrey Watters is researching this area in more detail, and I would highlight her ongoing struggles as a means of staying abreast of the tide of distributed anonymised ledger based nonsense that this year will bring.