Goodharts Law, FANG VC, Custody Milestone

Goodhart’s Law

Last week, one of the data providers for Truflation’s real-time inflation tracker made a small but significant adjustment to their historical data set. That adjustment pushed Truflation’s US inflation reading from just above 2% for 2024 to just below 2%. While I’m sure the adjustments are justified, I can’t help but feel a bit disappointed that the 2% level was broken by a revision and not the trend itself. 2% is significant because it’s the Fed’s inflation target.

The event reminded me of Goodhart’s Law, “When a measure becomes a target, it ceases to be a good measure.” The Fed wants to see inflation target at 2% to cut rates. If this Truflation adjustment is any signal, the closer we get to an official 2% figure, the more we can expect last-minute revisions and exceptions to interfere. The antidote to this is not relying on a single number, fact or figure. The trends are far more valuable. Over the past 18 months, the money supply, Fed balance sheet, inflation rate and commodity prices have all trended down, rates have leveled off and deficit spending and GDP are up. As a result, modest rate cuts are likely in 2024. Over 2024, watch the trends more than each precise data point. The next Fed meeting is on Jan 31, and the next inflation release date is Feb 13.

MANG, FANG, MAG7 Venture Capital

Microsoft, Amazon, Google, Apple and NVidia have been consistent and persistent venture investors for over a decade. A great Washington Post article chronicles this activity titled, “How Big Tech Got So Big.”

Even today, there are reports that big tech venture participation now represents 8% of VC funding. The negative take on this, courtesy of Bill Gurley, is that those investments require startups to use big tech services. This effectively moves cash from the big tech balance sheet to the income statement, which can show a positive but out-of-context impact on earnings.

The optimistic take is that investing in these companies comes with a modest and appropriate ownership stake in a diversified venture capital portfolio. Given that access to venture investing is often limited to family offices and institutional investors, this is a positive factor that benefits a broad set of investors who would otherwise not have access.

Major Custody Milestone – Proof of Reserves

Bitwise is the first major Bitcoin investment manager to publish its public Bitcoin address as proof that the assets held in their fund also exist on the blockchain. Their website is here, and their blockchain address is here.

This concept, Proof of Reserves, has been heavily promoted by Nic Carter of Castle Island Ventures, and it highlights a core benefit of blockchain technology. The public address allows investors to verify that Bitwise has the assets without relying on auditors or self-reporting. If FTX had been required to publish their public addresses, it would have been nearly impossible for them to lie to customers and regulators about the existence of the assets.

You might think that publishing the public address of an account that large would make them a target. Private keys, the ‘password’ to the Bitcoin wallet, are impossible to guess or brute force as they have 2^256 possible combinations. Even if you could force a computer to guess the password at 1 trillion guesses per second, it would take longer than the estimated universe’s total existence to arrive at the correct answer, over 13 billion years. There is a perspective-expanding explainer video on SHA-256 security here. Even if someone managed to hack the Bitwise wallet, all the assets would be traceable to the hacker anyway.

The eradication of fraud is critical to the strength of the economy. Events like FTX, Madoff and Enron rely on producing fake financial statements to perpetuate their schemes. The likelihood of fraud is dramatically reduced when real-time transparency is enforced. Less fraud leads to more economic confidence. That’s what makes this such an important event. Eventually, other assets will sit on publicly available blockchains that can be verified and watched in real time.

Final thought: as much as people equate Bitcoin or crypto with criminal activity, consider that JP Morgan has paid $40 billion in regulatory fines over the past twenty years. Criminals are attracted to all forms of capital, and the majority of fraud is denominated in dollars.