Navigating the currents and eddies of finance was never easy, but the complexities of today’s markets have increased the challenge — and potentially the reward. There’s a lot to know, a lot of new tools to use and avenues to explore. Let’s take a look.
This is how crazy things are. In mid-April a new cryptocurrency platform came into being — BitClout. It’s been described as a way to invest in celebrity fame by buying “creator coins” that increase in value as the celebrity gains in popularity. Put another way, celebrities and influencers can monetize their following. It sounds nutty, but it’s very real and works more or less the same way any market does.
The price of a coin is related to the demand for the coin. Right now, Elon Musk has the most valuable coin on the platform at $70K. And like the stock market, the way to make money is to buy into an asset whose value is on the rise — in this case the coin of someone whose social influence is growing. With a growth in influence comes a rise in the price of an individual’s coin. Yes, it sounds crazy, but the market value of BitClout has recently been estimated at $1 billion. How does this happen?
In an attempt to understand that Alice-in-Wonderland situation, let’s start with the basics and take a run at it.
All markets, all economies, large and small, begin with one thing: a transaction. Before we had currencies — money — I swapped you a chicken for a bag of flour. After we figured out money, be it shells or beads, gold or silver or pieces of paper that we all agreed had a certain value, we exchanged money for goods or services or financial assets. That’s a transaction.
A market is a place where all the buyers and sellers come together to make transactions for the same thing. So, there are markets for wheat and poultry and gold and silver and stocks and bonds. If a bunch of someones want to buy whatever and a bunch of someones want to sell whatever, there’s a market for, well, whatever.
And the price of whatever is determined by supply and demand. A lot has changed about how we think about markets and how we think they move, but the law of supply and demand remains pretty constant. And to state the obvious, if you have no demand for a thing, then its price goes down; if you have a lot of demand for it, the price goes up.
Note that the inherent value of the thing has no impact on price. You can’t eat a share of stock or heat your home with it, but the price of a share of stock may well be more than the price of your dinner or your power bill.
At the risk of distorting a lot of economic theory…
For a long time, we thought that markets reacted more or less rationally. That, given a free, transparent flow of information, the price of a thing would adjust to incorporate all we know about the thing. It’s the Efficient Market
Hypothesis that markets fully, accurately and instantaneously incorporate all relevant information into price.
If, for example, we know that a company may soon be purchased, the price of that company in the market will rise in response to that information. Or more to the point, if we know that there’s going to be a big unmet demand for toilet paper or gasoline, it’s likely that the price of toilet paper or gasoline will rise. And if you’ve got that information before anyone else does, you stand to make some bank.
It’s not just what you know, but when you know it. It’s how fast the information moves. That’s why Venetian merchants paid a lot of money for Galileo’s telescopes. They could look out to the horizon and see what ships and goods were coming to market. And why, 400 years later, a couple of guys built a $300 million fiber optic connection between Chicago and New Jersey to reduce the round trip time for information from 13.1 to 12.98 milliseconds. A few hundredths of milliseconds is just the edge you need to make a lot of money on futures contracts.
Markets do move on information. That said, research has shown that markets react to more than just information. In his recent book “Narrative Economics,” Nobel laureate Robert Shiller talks about how “contagious popular stories that spread through word of mouth, the news media, and social media create a narrative [that] is often more emotionally compelling and resonant than an argument about valuation.” In other words, while data is valuable, it’s not the only thing.
This conclusion should come as no real surprise. Every successful salesperson, every successful entrepreneur, creates a compelling argument about the value of a product or an idea. If we, as consumers, buy that argument, that narrative, we buy the product or the idea. We purchase or invest. So, it might be the story that creates the perception of value that creates the demand that drives the price … and the investment.
Silicon Valley has long been critical of the traditional path to an initial public offering — too long, too many regulations, too many limitations on what a company can and cannot say on the way to filing with the Securities and Exchange Commission. The rules are in place to protect investors, but there are those who say that the regulations block much of the public from participating.
Thus SPACs, special purpose acquisition companies. A “sponsor” creates a shell company, sells that company to the public and then looks for a real private business with which to merge. The merger is a publicly traded real company. It’s been called a “back door listing.” In 2020, nearly 250 SPACs went public; so far this year, it’s more than 300. SPACs have emerged as the preferred listing mode for new enterprises seeking to go public.
Investment companies — brokerage houses, hedge funds, private equity funds — are prohibited from selling “unregistered securities” to the man on the street and can only solicit funds from qualified or “accredited investors” — high-net-worth individuals who are deemed sophisticated investors. The everyday investor can’t get in on the game.
Those investment companies and the firms they take public are prohibited by SEC regs from openly forecasting revenues until a host of documents have been filed. Moreover, the regs stipulate a sometimes lengthy “quiet period,” a mandated embargo on promotional publicity which prevents company executives from speaking about the company’s future profit potential.
At the end of the day, it could be said that a SPAC is about who’s allowed to tell the financial story and who’s allowed to benefit.
In today’s world, where we get our information and our stories online, what is a primary driver of our perceptions?
Social media, perhaps?
And in today’s world, where we’re bombarded with tales of unicorn companies and instant millionaires, maybe “get rich quick” is not an unreasonable path to a stable life. So, if you’re not an accredited investor, if you’re young, relatively tolerant of risk, want a shot at the opportunities afforded the old money, you might be willing to take a chance on a speculative venture. And how do you know where to put that investment? Social media, perhaps?
So, you search the message boards and listen to your “influencers” and act on their advice. Or their Twitter feeds. And that’s why Elon Musk can make, or destroy, millions with a couple of words. On Jan. 7 this year, Musk tweeted, “Use Signal.” He was referring to an encrypted messaging app. On Jan. 11, the Signal app logged 1.3 million downloads. Inadvertently, the stock of biotech company Signal Advance benefited from reflected glory. Its stock rocketed from 37 cents to $6.36, an increase of 1,719%.
It’s in this social media world that SPACs, meme stocks and NFTs live. Billionaire entrepreneur/investor Chamath Palihapitiaya has been called the king of SPACs. His latest SPAC, IPO.F (he started with IPO.A) is valued in excess of $2.25 billion. He champions SPACs as a way to increase the efficiency of capital markets.
“We don’t have capital markets that can support young, high-growing, fast companies in a way that really builds for the future of America,” he said. But the chief advantage of a SPAC — relatively unencumbered by SEC rules — is that “you’re allowed to talk about the future. I’m using … my accumulated quote-unquote ‘social capital’ and credibility to say, ‘Let me explain to you why you want to own this thing.’”
In other words, Palihapitiaya controls the narrative. And he’s touting that narrative as part of what makes an efficient capital market.
Recently, we’ve seen that those who control the narrative prosper. GameStop and AMC are examples of stocks whose runup has been driven primarily by upvotes on a message board. Yes, information drives markets, but what’s different is the pervasive nature of social media and the speed at which it moves. These two elements — quantum leaps in both the volume and velocity of information — are incredibly powerful, particularly in the hands of a broadly followed influencer. Can we, should we, look at social media memes as a form of valuation, as a market driver?
If you consider influence as a commodity, a thing that has an inherent value and can be actively traded, BitClout is not at all far-fetched. Maybe when looking at the value of a commodity in the marketplace we need to “price in” its social media narrative.
BitClout is new and certainly offbeat, if not downright odd, but at the outset so were mutual funds, credit cards and junk bonds. At one time these financial instruments were considered outlandish, if not legally suspect. Financial entrepreneurs spun stories around wealth and convenience and doubtless some investors lost money. That loss, by the way, is how we pay for new financial marketplaces, products and infrastructures. Over time, some of these new financial instruments fall away and some become accepted, if not commonplace.
Markets continually ebb and flow, responding to the world around them. Investors, if they are to be successful, must adjust to this constantly changing environment. On the one hand, Efficient Market Theory says that markets move in a rational relationship to information; on the other hand, behavioral economics says that humans — irrational, inconsistent and unpredictable — force markets to flow in similarly unpredictable ways. Pragmatically, we know both frameworks to be true, but how do they co-exist?
Recently, a theory has emerged: the Adaptive Market Hypothesis. Borrowing from Charles Darwin, the hypothesis suggests that the market flows with changes in information. Those movements, however, are shaped by the sometimes erratic behavior of investors and the cleverness of financiers and are rarely smooth and efficient. Thus bubbles, run-ups, crashes, SPACs, cryptocurrencies and non-fungible tokens. Those who successfully navigate the eddies and rapids, or build the vessels that do, learn from the market response and adapt. It’s a Darwinian concept.
Participants in the marketplace come to the competition for wealth with a variety of perceptions and biases. These biases, rational and not, traditional and radical, get sorted out by market dynamics. Those that prove successful survive and prosper, others drown and die — an evolving, adaptive system.
Traditionally, companies are valued by their future earnings potential. Capital markets create liquidity for businesses and entrepreneurs and regulations preserve stability and prevent the so-called hucksters from exploiting the so-called stooges.
A wide, deep river moves steadily forward. It doesn’t speed so much as make progress. Off this river are streams and creeks that tumble, swirl and crash through rapids. Here are the memes and the SPACs, the GameStops, AMCs and BitClouts. Some of these will carry you quickly forward, others will dump you on the rocks. Value investment still works, but there are new modes of information and new financial instruments — new forces that shape the flow of the market and new vessels to take advantage of those new currents.
Warren Buffett once said, “Never invest in a business you can’t understand.” While that maxim has clearly served him well, by his own admission he missed Google and Amazon. It’s always been true that one benefits from an understanding of financial instruments and the flows of information that determine their value, but with the volume and pace of social media and the dizzying array of possible investments, the more thorough the understanding, the better one can navigate and prosper from the ebbs and flows of the changing marketplace.
Understand What Really Determines Value
Where there’s a will, there’s a way. Smart and creative individuals apply physics, rocket science and technology to finance and economics to quantify what was previously unquantifiable or better predict an unknown future outcome. Finance has a history of finding solutions and creating markets, such as monetizing celebrity in the case of BitClout.
But with all the expertise and knowledge we have accumulated, uncertainty still exists. It all comes back to the fundamental principle of supply and demand, of which information is an important factor. Information moves markets. Today, social media allows information to move quickly and broadly and be consumed by both experienced and inexperienced investors.
We can estimate value, but ultimately value is the price someone else is willing to pay for an asset. One can estimate the value of a home from similar recent home sales or a multivariate predictive model. That reduces uncertainty about value – whether it should be listed closer to $200,000 or $2 million. But one cannot say with certainty what the value is until the transaction is complete. Demand, and therefore price, may be impacted by social media posts about neighborhood crime or local schools.
The same is true when valuing companies. Investment bankers estimate value based on discounted cash flows, precedent transactions and comparable companies, but it is simply an estimate. Ultimate value depends on the demand for the stock, which may be tarnished by negative social media posts about products or work conditions or enhanced by seemingly unwavering apologists.
Further, when supply is lower than demand, the value of the prestige of owning a scarce asset may increase. Think of Ferrari.
As long as there is supply and demand, there is value. While I may not recognize the value of watching nine-year-old Ryan Kaji unbox items or MrBeast giving away money and cars on YouTube, they each made well over $20 million last year as the two highest earners on the platform.
Synovus Fellow and Associate Professor
Department of Finance
Social Media Has Helped Open Financial Markets
Financial market performance and asset pricing in these markets are functions of available information. Social media platforms such as Facebook, LinkedIn, Reddit, Twitter, etc., have now provided a warehouse in which users have a one-stop shop to not only access information, but also other users’ opinions, perspectives and directives. The speed with which information on these platforms is accessed and absorbed by its users has caused many enlightenments and otherwise created an avenue for financial inclusion for retail investors. Social media has redirected financial markets from being only Wall Street-accessible and Wall Street-smart and has become an everyday component even for users who would not consider themselves financially savvy.
Department of Finance