In this issue:

• Stripe and Solid-State Economics

• Hulu's Regulatory Arbitrage

• Post-Archegos

• Patents

• Emissions: a Global Problem

Stripe and Solid-State Economics

Cars, Excel spreadsheets, vacuum tube-based computers, poorly-implemented recursive programs, and attempts to win at real-time strategy games all break for approximately the same reason: they have lots of moving pieces, and the more moving pieces there are, the easier it is for something to stop working. Over the last half-century or more, across a variety of physical products, mechanical products have been replaced by more efficient, more compact, and much more reliable solid-state ones.

This is a literal change in the physical world; the computer I'm using now has an SSD rather than an HDD; reading data off the disk is zippier than it used to be. Tesla talks about how their drivetrain has about a tenth of the moving parts of a typical ICE drivetrain (17 compared to around 200), which means that fewer things break and they're easier to fix (and that managing inventory is easier, too). But this trend is also a useful analogy, and it gets more powerful in software. Solid-state is more of a qualitative trait for software, but it applies when a system is:

1. Useful for some real-world function;

2. Deterministic, or, since that's impossible, graceful at handling the occasional errors that do crop up; and

3. Composable, such that one system can take inputs from another and pass them on to a third.

This is how software eats the world: by taking business functions one at a time, turning them into well-documented API calls with useful error messages (but infrequent errors) that can be chained together with arbitrary complexity and then run with minimal human involvement. The long-term dream is that, when you mouseover the "order now" button on an e-commerce site, a seamless chain of events updates the entire supply chain, and this tiny indication of incremental demand actually affects inventory restocking, hiring, and financial planning all the way down the line. We're not there yet, but we're moving in that direction. And Stripe is supplying the crucial payments layer, and a growing set of adjacent products, to make it happen.

Stripe is part of an interesting category of value-creating companies whose offering is to make some process work the way you'd imagine it worked if you had never actually tried to do it yourself. Early in my career, when I was analyzing data mostly in Excel, I operated on a general assumption that if a business collected data from multiple sources, it would be fairly simple to filter from data source A based on criteria from source B, pipe the output into C, and have this summarized and updated in source D. It's never this easy, but part of the value prop of Snowflake ($) is that it should be. Cloudflare is another example. As their line goes, "The Internet was never actually designed to do what we have asked it to do."

In payments, you might naïvely imagine that if you are located in, say, Texas, and you wish to sell goods or services to someone located in, for example, India or the Netherlands or Japan, that you could throw up a quick payment form on your site and then get some money from them. As it turns out, though, there really isn't "a" global payments system. There are countries, they each have multiple payments systems, some of those systems overlap in some ways, and participating in those systems requires some combination of government approval, banking approval, technical overhead, and ongoing compliance and maintenance costs. Your German customer may prefer to pay through Giropay-enabled bank transfer, while your American customer is optimizing rewards points and plans to use a credit card, and your Japanese customer, naturally, would like to settle their bill at a convenience store. Also, sometimes the rules change. The dream is to transfer value electronically, but it's hard to achieve this in a seamless way. Payments systems long predate electronic communications, and, even worse, they computerized before other industries. In many banks, the core system was written by someone who a) only knew COBOL, and b) has been dead for several decades.

Stripe is an effort to build a seamless layer on top of these systems. This means two kinds of sustained effort:

1. Designing an API that handles a variety of different nuances, expectations, exceptional cases, widely-believed falsehoods, etc. Just about the only constants are that there are units of currency transmitted from (at least) one party to (at least one) other party, at some time, UTC.¹

2. They need to design this API so that, as much as possible, it never changes. The economy is not solid-state when some components get end-of-life announcements, and nobody knows if somewhere deep inside their software stack, or the stack of one of the companies they interface with, is an API that's going to stop functioning. This forces a lot of creativity: what payments systems will arise later? What entities will want to transact in the future? What kinds of transactions might get banned in the future, and should those bans be implemented at the transaction level or somewhere else?

Stripe has long prided itself on quickly approving new users (in one early interview with them, the interviewer notes that it took a lot longer to get approved by their email provider than Stripe). And the actual process of integrating Stripe is also quite straightforward. But that encapsulates a lot of backend effort, edge case analysis, growth-vs-fraud tradeoffs, and integrating across systems that were never designed with integration in mind. As another developer once said of a similarly involved but otherwise very different project: "You know, a lot of effort went into making this effortless."

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Elsewhere

Hulu's Regulatory Arbitrage

Usually, "regulatory arbitrage" means locating something legally in one jurisdiction in order to derive economic benefits somewhere else, or finding a new legal form with the same underlying economics as something that's banned, taxed, or otherwise restricted. It also applies to platforms, many of which perform government-like services (setting basic rules, enforcing contracts) with a government-like revenue model (collecting a 30% income tax). A few years ago, Hulu discovered that an expanded API they had access to allowed them to unsubscribe people through the app store and resubscribe them directly, avoiding the 30% Apple Tax. Apple found out about it, after a tweet, and closed the loophole.

This is very close to how typical aggressive tax strategies get banned. Someone discovers the strategy and quietly uses it to defer or avoid taxes. Eventually, they get good enough at this that their success is conspicuous. Someone writes a news story, and suddenly—the tax strategy is gone.

Post-Archegos

After the collapse of Archegos, banks are reducing how much they lend to hedge funds ($, WSJ). Some of this is prudent; as has been widely reported by now, Credit Suisse, which lost $5.4bn in the Archegos collapse, earned just $17.5m for their trouble ($, FT). I've suspected that there will be two big effects from Archegos:

1. What's happening now, which is that banks reassess their risk and cut back hedge funds' leverage, and

2. What will happen over the next year or two: banks will figure out how to avoid this specific scenario (a fund that is a) highly levered, and b) owns a substantial portion of the economic value of a few companies, through swaps) and will fix those bugs and get back to offering similar leverage. Meanwhile, hedge fund managers who read the story will realize that they could run a lot more leverage personally than they can through managing outside money, and will decide that the ultra-levered family office model is the right one for them.

Raising outside money is, from the manager's perspective, already a form of leverage. Instead of deriving gains from your own net worth, you can also earn fees from gains on somebody else's. But it's not the only source, and it has two important costs: it takes a lot of time to raise and keep outside capital, and for capacity-constrained strategies it caps the ultimate upside.

Patents

The US has endorsed waiving patent protections for Covid-19 vaccines. This is an interesting illustration of the difference between aggregate analysis and more detailed models. There are always obstacles to achieving some level of production for a given good, and in theory every obstacle removed should increase supply. But for these vaccines, IP protection does not seem to be the biggest barrier. This is a brand-new supply chain, built in the last year, and scaled up to unprecedented levels; everything we know about scaling mRNA vaccine production has been learned since the start of 2020. And scaling is hard, often in surprising ways! Moderna's CEO says ($, FT):

There is no idle mRNA manufacturing capacity in the world. This is a new technology, you cannot go hire people who know how to make mRNA — those people don’t exist... If you were to start today, you’re going to have to start by hiring people. Those vaccines don’t fall from the sky... There is no mRNA industry... When we hire people that come from traditional pharma, we have to train them in the art of mRNA.

This doesn't mean that waiving patent protection is completely ineffective. Other manufacturers can start to produce, and perhaps work out the same production bottlenecks at the same pace. So, in a few years—when it's not urgent—we'll have more supply. But the longer-term effect is on incentives. There are lots of dedicated, public-serving people who work in medical research and who will want to tackle pandemics no matter what. But there are also shareholders, boards of directors, and CEOs who are going to run the numbers and decide just how flat-out a company ought to run towards the goal of creating necessary novel drugs.

One of the questions I've thought about a lot in recent months is whether the pandemic made the world more resistant to existential risk. In some ways, the answer is yes; we're all going to pay a lot more attention to news stories about mysterious disease outbreaks! But a big part of solving existential problems is mobilizing resources, and a lot of those resources are currently controlled by companies that think very hard about their earnings per share. The smart thing to do, if we're already spending trillions, is to spend a bit more to ensure that next time, big companies know that the profitable thing to do is also the right thing to do. Alex Tabarrok is right: Patents are not the Problem!

Emissions: a Global Problem

China's greenhouse gas emissions are now higher than aggregate emissions for the OECD. Reducing emissions is partly a financial engineering problem. Rich countries can afford to pursue climate mitigation strategies, whether they're renewable energy sources, more efficient buildings and vehicles, or geoengineering. But the only backtested model for becoming a rich country involves burning lots of fossil fuels along the way. So one model for human civilization is that it has its own "burn rate." Importantly, this pattern has shown up before: escaping Malthusian traps, depleting food supplies or topsoil, avoiding institutional decay—all of these are existential problems that tend to get worse over time but that often get solved. Which is not an argument for passivity. On existential problems, the optimists always turn out to be right because optimists and pessimists only exist in a world where the risk doesn't pan out. In the meantime, there's a complicated negotiation: the rich world doesn't want the consequences of China (and India, and Africa, and South America) getting rich, but those parts of the world are understandably resistant to the argument that they ought to accept an even lower relative standard of living.