The total amount of money in the world is a figment of our collective imagination
This post is part of Tailwit Capital, my Substack newsletter which you can subscribe to here.
Just after the FTX unraveling began in November, Bankless' David Hoffman asked the following question on Twitter (don't worry if the names of the companies are unfamiliar to you):
Okay, answer me this:
3AC liquidated...
Alameda liquidated...
FTX insolvent...then who made all the money???
In other words: there were many companies this year that were worth millions or even billions of dollars each, which each within a short interval of time became worth essentially zero dollars. But you don't hear about other companies or individuals that made the equivalent in millions or billions of dollars. So where did all the money go?
The asker of this question is David Hoffman, one of the co-hosts of the Bankless podcast, which is the single resource that has taught me the most about money. David knows a lot about money, yet he seems to be asking honestly, because it's very non-obvious what happened to the money. At the time that he asked, I didn't know the answer either, but it's a question that has given my mind much to chew on in the months since I saw it. It's a question that I think is fundamental to the endeavor of understanding anything about money that goes beyond... well, maybe gold. There will be an answer later in this post, but don't peek ahead! I'm watching you.
Net worth is imaginary
You may be aware by now, from following your favorite household-name billionaires, that it's quite often the case that a billionaire's "net worth" is almost entirely based on the amount of stock they own in various public companies. The bulk of it is not the amount of money they have sitting in any bank account(s), and certainly not the amount of money they have sitting in a massive vault of physical Benjamins. For our purposes, just think of a public company as a company whose total market cap (the amount of money that the market thinks it's worth at any given moment, let's say) is a publicly known number. So you can calculate the corresponding piece of the billionaire's net worth by multiplying the company's market cap by the % of the company that that billionaire owns. If a company is worth $20 billion, and someone owns 50% of it, then that counts as $10 billion toward that person's net worth.
A company's market cap is its number of shares x the stock price (price per share). The number of shares is decided by the company and doesn't change too often, but the stock price can vary wildly from day to day, in extreme cases even minute to minute, and it can be, to an alarmingly high degree, affected by, basically, Feelings. Like whether people who own shares or could buy shares are feeling more hopeful or more despairing, in any given moment, about the future of the company. In less eventful times, the effects from different people's feelings often cancel each other out, or cause very gradual movements in the price over years. But every once in a while, a lot of people feel the same way at once, often due to some news event or some sort of new perception that becomes viral, which can cause a large, sudden spike or drop in the price. A change in stock price is a change in the market cap, and thus a change in the personal net worth of all owners/shareholders. That's how a rich person can suddenly "be worth" $500 million less from one day to the next.
What's most interesting to me about this is how we talk about and judge these things, culturally. Net worth is talked about as if it's a fairly legit and stable metric—essentially the equivalent to how much money someone has, even though equity (owning stocks) is not, strictly speaking, the same as money. But in a hand-wavy sense, net worth is generally treated as if it's money. We have these lists in magazines of the top N highest net worth individuals. These lists are not usually printed with caveats that it's all based on Feelings and the amounts and rankings can change drastically at any time, or that it's not the same as money, etc.
Isn't it funny that someone who keeps their modest life savings in a bank account in USD—which isn't, relatively speaking, super vulnerable to extreme swings in value based on Other People's Feelings—such a person would be considered in our culture kind of quaint, and certainly not a "player" or a "winner," while someone who has a billion dollars in an asset that's completely subject to Other People's Feelings, is considered rational and successful, and their holdings are considered more legitimate? Not to mention the person who keeps in their home a big stash of physical gold or physical USD cash—both even less vulnerable to other people's control than bank deposits are—who we assume must be kind of unhinged at best and possibly some sort of criminal at worst! In fact, it's almost like the more fragile an asset is, the more prestige it carries. A subject for another time, maybe.
So if a famously rich CEO has a big portion of their net worth in a public company and people start to lose faith in the future of the company, this CEO can lose a huge chunk of their net worth in a matter of days. And yet, again, no one else got that money, not even a bunch of individuals added up. In fact, I think it's even theoretically possible in such a scenario that everyone involved with a given stock either loses money or at least doesn't make money. So it seems like, in a big selloff, a big chunk of something that was considered to be money just disappears somewhere. So does that mean that in a buying frenzy, a bunch of money likewise appears out of nowhere? HMMM!
Valuations are imaginary
We just talked about public companies, but let's dive into the even weirder, wonkier world of private companies. There are all kinds of private companies, but I'll focus on startups that haven't "gone public" yet, since that's the kind of private company that I and a lot of my friends are most familiar with.
Private companies also have this concept of "the amount of money that the market thinks the company is worth," but instead of market cap, it's called valuation. They're basically the same idea. But what's really weird about private companies is that the valuation at any given time isn't any known number (except at very specific moments that come maybe once every year or two). I don't mean that the number is secret but known to a special group of people; I mean it's literally unknowable, to anyone.
See, how much money a public OR private company is (reportedly) worth is determined by the aggregate of all the latest individual offers to buy or sell pieces of the company at certain prices. When you don't have any active deals or offers going on, you can't calculate the company's valuation at all. The CEO can claim whatever they want, but as with all things in the market, the ultimate judge is what someone is willing to pay for it. Since shares of public companies can be bought and sold by the general public whenever the markets are open (meaning, during the business day), a public company usually has at least some offers being posted throughout every day, thus it always has a current known price and market cap. But that's why a public company's listed stock price doesn't change over the weekend or at night when the markets are closed. Maybe on Saturday or Sunday everyone in the world changes their mind about it, but you won't see it affect the stock price until the first trades happen on Monday morning.
By contrast, pieces of a private company can't be bought or sold by just anyone at any time. Such offers and deals only happen at very specific points, like when a company is raising more money, which as I said happens closer to once a year or two. At that time, investors will offer to put in a certain amount of money (in cold, hard bank transfers) in exchange for a certain % of the company, which implies a certain valuation. For example, if they put in $1 million for 10% of the company, it means they think the entire company is worth $10 million. Usually you have a group of different investors in each funding round, so the group has to kind of agree on a total valuation and what each investor's share of the company will be.
These things are put in writing of course, which is what forces a private company to have a known, documented valuation at this precise moment. But only at this moment. So in between fundraising rounds (or other events that force a company to have a known valuation), if you ask, "How much is this company worth right now?", literally no one can tell you the answer. The only possible answer is in the form of, "Well, it was last valued at $N dollars a year ago." You may believe it is now more valuable or less valuable than the last official valuation, but it won't be confirmed until the next time someone commits to buy or sell part of it. You know how quantum particles literally don’t have exact measurements until the moment they’re actually measured? It’s like that. Now you can go around telling investors that your startup’s valuation is, in fact, quantum.
...and the more imaginary the valuation, the better??
If you've made it this far, past the idea that it's possible for entities to be worth an inherently unknowable amount of money—this next idea is the real mindfuck. It's best expressed in this 1-minute clip from Silicon Valley, a sitcom that parodies the startup world. In this scene, an idiot (or is he??) billionaire investor explains the idea to the hapless naive founder kid:
If you show revenue, people will ask how much, and it will never be enough. The company that was the 100x-er, the 1000x-er, becomes the 2x dog. But if you have no revenue, you can say you're pre-revenue. You're a potential pure play.
Like the best parodies, it's funny because it's not wrong. You may have heard that this or that huge unicorn startup actually hemorrhages money, yet investors are clambering over each other to buy into it. Why would so many people want to pay money to buy into something that has only ever lost money? Because the way venture capital (VC) investing works is that it's premised on the idea that almost all startups completely fail, but an extremely select few win BIG, and it's not easy to predict which is which. So if you're investing in a bunch of startups that are likely to mostly fail (even in spite of all the research you might do before investing), you can only survive if all of them at least each have a chance of becoming the winner that pays for all the rest. And startups that win BIG can only do so if they prioritize growth at all costs—which often involves losing money in the interim, as they spend a lot of money to gain more users and become the dominant player in their space. They can't win BIG if they have to make sure they're always spending less than they earn. Therefore, companies that lose money but show growth can be more attractive and highly valued than companies that make a moderate, but not earth-shattering, amount of money.
Another way of putting it is that having tons of users but not making money is considered an easier problem to solve than making money but having few users. (Is it true? I have no idea.) That's what investors probably tell themselves and each other, but I'm guessing part of the truth is that high-growth companies are just darn exciting, and we are talking about Feelings, after all. A company that demonstrates a steady, sustainable amount of money coming in is more predictable, and the valuation that it "should" have can be calculated according to traditional formulas that take the revenue into account and do math with it. Boooring. It's easy to write it off as not having much chance of becoming the big winner. But a company that has no revenue but high growth, since its valuation can't be calculated the traditional way, is completely unpredictable, which means if someone were to just figure out how to monetize all those users, it COULD be THE ONE!
It's just like how you've been procrastinating on writing (or whatever your life's work is) all your life so far, because you're afraid that once you actually get started, you might not be amazing at it and everyone will be able to see that.. whereas if you never write anything, then no one can say you're not a genius. The genius of our generation, as a matter of fact. Your potential is infinite.
So where did this idea come from anyway, as far as startups showing no revenue? Did it start with Pinterest, Snapchat, Uber? Or earlier than that, with OGs like Google or Amazon? Think earlier, my friend. It started not in this century but the previous one: it started with Netscape.
In his book The New New Thing, Michael Lewis spends a few pages telling the story of Netscape's (mind-blowingly successful) IPO in 1995. He writes:
In the frenzy that followed [the IPO], a lot of the old rules of capitalism were suspended. For instance, it had long been a rule of thumb with the Silicon Valley venture capitalists that they didn't peddle a new technology company to the investing public until it had had at least four consecutive profitable quarters. Netscape had nothing to show investors but massive losses. But its fabulous stock market success created a precedent. No longer did you need to show profit; you needed to show rapid growth. Having a past actually counted against a company, for a past was a record and a record was a sign of a company's limitations. Never mind that you weren't actually making money—there'd be time for that later, assuming someone eventually figured out how to make money from the Internet. For the moment you needed to plow all of your revenues back into growth. You had to show that you were the company not of the present but of the future. The most appealing companies became those in a state of pure possibility.
So there you have it. This idea that the more imaginary a company's future profits, the more value it can command in the present, has been around at least since the 90s. People invest real dollars into vehicles of "pure possibility," and that's how imaginary things become worth real money.
Perhaps all this begs the question: will such pie-in-the-sky valuations come crashing down on some future day of reckoning? For how many years can a company lose money before investors or shareholders are like, "Okay.. maybe this company is never gonna make money"? I don't think anyone really knows. Some companies flame out in dramatic, streaming-miniseries-worthy fashion, often from having been either fraudulent or highly misleading (Theranos, WeWork, FTX). Some rise and fall quickly from being part of a wave of general mania (the dot-com bubble in the 90s). A few really do start to rake it in after a few (or many) years of losing money (Google, Amazon). But most of them just kind of chug along, to this day, continuing to lose money but have a lot of users, and appearing to not have much of a plan. So the jury's still out, as far as I know.
Here's the kicker, though. The people who invested in a company early (or got equity as compensation for being early employees), while it was private, don't actually need to see the company ever turn a profit, to get a great return on their investment. Because if the company ever IPOs (goes public), then at that point the early investors are free to sell their shares to the general public and cash out. (I'm sure there are caveats here but I'm hand-waving them away.) As long as the IPO is a successful one (commands a high enough stock price), the investors can make their money and walk away. Which means they don't need the company to turn a profit, they just need other people to believe that it someday will. The pure possibility, the imagined potential of the company, which may or may not ever be realized, is just handed over from private investors to the believing public.
Some other stuff is imaginary, too
There are a few more examples I can think of right now of money-like things that are also imaginary, but that I won't get deep into here because this post is already too long.
One broad class of assets with imaginary valuations is around things affected by demand and liquidity. Say you hold 1000 of some identical Pokémon cards, pogs, Chuck E. Cheese tokens, or shares of your friend's latest misadventure. And you've seen somebody sell one of those recently for $20. You could then say that your whole stash is worth $20,000. But there are a number of scenarios that could prevent you from ever being able to actually get $20,000 for it. Maybe, as in the private company fundraising example, you're legally or contractually not allowed to sell anytime you want to, and by the time you can sell, the going price has changed. Maybe nobody wants to buy any more of them, ever, so your stash is effectively worth $0. Maybe you could find buyers for 1000 units at $20 gradually over the next 5 years, but you're in desperate need of cash and need to dump all of them now, so you have to keep lowering the price as you sell more and more of them. The less time you have to sell them, the more you'll have to lower the price. And so on. So being able to sell one unit at a certain price doesn't necessarily mean you'll be able to sell the whole batch at that price. A fact that is sometimes conveniently "forgotten" by the likes of SBF or the Enron folks when they're getting creative with their accounting.
The other class I can think of has to do with leverage, which I really won't get into even a little bit because it's a rabbit hole, but I do hope to explore it in depth with you someday. For now, just trust me that there's a lot of imaginary money to be found in that rabbit hole.
And now that you've made it this far, dear tailwit, I think you're finally more than ready for..
The answer to the question: who made all the money?
Here is the best answer in the replies to David Hoffman's question on Twitter, from one Ben McMillan:
...a neighborhood with 100 houses has one sale for $1M. Everyone thinks there's $100M of "equity". Turns out the other 99 houses only sell for $100k...so only $9.9M of "equity". Noone got the $91.1M. It was always imaginary.*
When you have a batch of things, and you've seen some unit or portion of the batch sell at a certain price, there are still no hard guarantees about the monetary value of the rest of the units in the batch, until they are actually sold. The total value of the batch as a whole is a matter of collective belief.
When those individual units are traded, money is really changing hands; but extrapolating that information to estimate changes in value of the entire batch involves no money changing hands. So rather than say, "This company lost $100 million in market cap the past month," as if something was lost or went missing, it would be more intuitively understandable to say something like, "A month ago the public believed this company was worth $5 billion but now it believes it is worth $100 million less than that."
The reason it's so hard to wrap one's mind around this idea is not only thanks to these misleading nuances of language, but that as I said in the "Net worth" section above, these numerical markers of collective belief are treated with a certain legitimacy and go into official counts of what people colloquially think of as "how much money we have." How big is the US economy? I don't know anything about how that's determined, but one obvious metric that I'm sure gets looked at in some way is the total market cap of all US companies. Which we now know to be largely imaginary! The economy as a whole is a complex organism that "breathes," that expands and contracts, based, to a surprising extent, on Feelings.
Why is this important for us, the little people? What on earth would induce me to write 4000 words on imaginary money, other than to serve as a vehicle for that excellent Silicon Valley clip? I don't think it's possible to understand the money system, and our place in it—collectively or as individuals—without understanding its imaginary elements, and how those can still cause very real suffering OR very real well-being. (Just wait till we get into the Federal Reserve and just how much of its M.O. boils down to, essentially, "mind games.") And understanding how the measures of really big things in the world depend in large part on the aggregate of our tiny individual decisions about the value of things, our individual purchases and debts and trades or lack thereof, and on our opinions and memes and vibes. It's about starting to pull the curtain back on the Wizard and learning how to see more clearly the weird world we find ourselves in.
Refs:
The Question tweet.
The Answer tweet. * Btw, if you noticed that the math is slightly wrong in this tweet, GOOD JOB! Write me back explaining how it's wrong, and I'll send you a STAR. (The value of which is, of course, up to your imagination.)
Reality doesn’t exist until you measure it, quantum parlor trick confirms
Silicon Valley, season 2 episode 3. (Clip)
Michael Lewis, The New New Thing.
Economics of Money and Banking, Perry Mehrling (Coursera). Not actually mentioned in this post, but the idea for this post came to me while watching one of the lecture videos, from which I also got the metaphor of "the economy that breathes." Specifically this video.