Campbell Harvey on the Future of Finance (Podcast)

And if you are at all crypto curious, if you're wondering why bitcoin is near sixty dollars, why n f t s have gone crazy, and while lots and lots of banks and financial institutions have been embracing crypto, well, then you're going to find this conversation absolutely fascinating. Um. Campbell Harvey is a traditional finance professor, or at least that's how he presents to the outside world, studying behavioral finance, uh, the yield curve and recessions and separating luck and skill

and investment decisions. All this stuff sounds pretty run of

the mill, middle of the road sort of stuff. But then back in he was crypto curious and started doing some research and ended up doing a presentation to one of his classes, and really it had a massive impact on him because you know, at the end of the period, he expects the whole class to get up and leave, and you know, spoiler alert, nobody leaves, and half the class rushes the podium to ask him a bunch of questions about this, and he, you know, really comes to recognize, Oh,

so this is striking a chord with students. There's something here I need to spend some more time and effort going into it. Um That part of that part of the interview was really fascinating. He tells about what he does with crypto, where he was giving bitcoin away to each of his students um so that they had to set up a coin base account and you know, make a promise to return the coin at the end of the term and what ends up happening is pretty pretty

hilarious and fascinating. Anyway, if if you're remotely interested in anything from the world of defy, from crypto, n f T, stable coins. God, I could have spoken to him for another three hours. I kept this fairly um accessible. I had lots and lots of deeper, wonkier questions, but as we were going on through this, it really became clear to me, Oh, this is a great primer for people who really wanna put a toe in the water of crypto.

I found it fascinating and I think you will also so, with no further ado, my conversation with Duke University's few Quass School of Business Professor Campbell Harvey. This is Mesters in Business with Very Results on Bloomberg Radio. My extra special guest this week is cam Harvey. He is a professor at Duke University's Fuquas School of Business. He's best known for his work on yield curve inversion and recessions, as well as the thorny problem of separating luck from

skill in investing. He is a research associate at the National Bureau of Economic Research, as well as a partner and see in your Advisor at Research Affiliates. He is the author of a brand new book titled Defy and the Future of Finance. Campbell Harvey, Welcome to Bloomberg. It's great to be on the show. It's great having you. So you're a pretty traditional finance guy, Duke n b R. How did you get interested in Defy? When did this start and what prompted it. I'm not too sure. I'm

a traditional of finance guy. Uh. Indeed, uh five years ago I announced that half of the empirical research and finance was likely false. So I don't think I'm traditional in any way, but I totally agree that decentralized finance seems far away from inverted deal curves and luck versus skill and back testing and things like that. So let me let me tell you the story about how I got involved in this space. And I've been involved in

this space quite a while. I was on a seven year teaching hiatus because I was editing the Journal of Finance and it was a full time job. When I came back to my asset management course after seven years, I decided to scrap the syllabus and and basically start over. But certain topics I had to include, like four X and I wanted to do the leading edge stuff, and I thought, well, there's this new thing I've heard of

called bitcoin. And this isn't two thousand fourteen, so it was below the radar screen definitely, but I'd heard about it, and I just said, well, if I'm doing the euro, the pound, the dollar again, one not at a cryptocurrency. So that's where I actually started. And I began to research this idea, and the more I researched it, the more I realized that this was something really big, and they spent a lot of time, and it was a single,

like two hour lecture in my course. Uh And I spent more time preparing that lecture than the sum of all of the other lectures in my course. And I was nervous because, and as I management, I've researched this stuff for a long time. I've been very fortunate to have real relationships with some of the leading edge firms. Uh So I kind of what goes on in the practice also, and very comfortable fielding questions from my students.

And of course I can't answer every single question, but I I'm confident I could find somebody very quickly that could help me with the answer. But with this crypto stuff, I'm in the position where I'm giving a lecture and as possible, some of the students know far more than I do. So I sought some help. Um and I practiced the lecture all this stuff, and then I gave this lecture, and again it was probably the most stressful

lecture I've ever given. Uh And and you know the way it is at at college where rate at the end of the lecture everybody gets up and leaves rate on the minute that is supposed to end. Nobody the stays late. They just get out of there. And you know, I've taught for many years that's exactly what happens. But after giving this talk on crypto, people were just sitting there, and I thought, oh, well, maybe I ended the lecture

like a way before I should have. But I looked at the clock and we were exactly at time, people just sitting there, And I said, oh, I must have really bombed this lecture. It was a disaster, I guess. And and and I'm standing there shell shot because it worked so hard and and for it to fail it

was very disappointing. But then students started to come to the front to talk to me, and and they said, but we are shell shocked, like this is a transformational topic that and and I numbered them said this was the most important lecture of their education, and that this cannot be just one lecture. It needs to be a broader learning experience and uh and and so it deserves at least a full course. And that's where I started.

So um I developed the next year into a full course, which was the first blockchain based course taught at a leading school, and then I've just continued it and uh and one thing with the space, uh is changing all the time. So what I was teaching seven years ago was much different than what I teach today. So let's let's go back to that first lecture where where the

students were pretty um enthusiastic and and maybe even dumbfounded. First, did anybody come to the podium and say, Hey, I own a bunch of bitcoin and I don't know what to do with it? And be were you buying bitcoin all the way back in? So no student had any bitcoin? Um, but I actually bought some, and I bought them I think a three a coin. Uh And and this is one of the greatest investment mistakes of my life, um,

I decided. I was on the phone with a reporter from a leading media outlet who was covering crypto also, and I asked him whether he owned any bitcoin, and he said, well, just a small amount, because I'm worried about conflict of interest. And I was thinking, made the same thing. If I'm teaching it, I'll have a small amount. And indeed, um, I was giving it out. So my student, when what do you mean giving it out? Giving it to students. Okay, yeah, so let me tell this story.

Uh an interest. Wait, so you're paying them to go to school. What I did was to give ten dollars words of bitcoin to everybody. Ended deal was the following Uh. They had to set up an account and at that time it was the coin base. I would give ten dollars and then at the end of the course, um, they would send it back to me, and then I would donate it to the university. So that would donation

my annual donation to the university. So it was basically just to get them set up with something in their wallet. So I discovered this one complication and and that is that once you give a crypto to somebody, there's no

way to enforce giving it back. So many of the students didn't give that because it had Yeah you know where I'm going, Like sometimes I get an odd email or oh, um, I remember you gave me, uh whatever, it was like point one of a big coin um back in two thousand and fourteen, I forgot to give it back and yeah, here it is and it's you know,

four thousand dollars so um. So basically what's happened is a lot of students didn't give back, and uh, and we're trying to remind them to do that because it's a couple of hundred thousand dollars and and kind of lost donations to the school. So it's not that they didn't give it back because it had appreciated so much. At the end of the semester, they just like, it's ten dollars and who's who wants to bother and they just got lazies. Is that what I'm hearing? Yeah, that's

what I think. So many of them just forgot about it. But again, that ten dollars is massively appreciated. That's unbelievable. So we're gonna talk in more detail about the book Defy in the Future of Finance, but just of us a broad overview. What's the basic premise And I get the sense you're going to talk about how transformational this

technology is. Yeah, it's kind of interesting to me that the financial system really isn't that much different today than it was a hundred years ago, Like the the exception is digitization, but the basic infrastructure is the same. And I don't think that it's specific to finance. We kind of know that technology will transform a number of businesses. And right now, the way that we interact and finances

with um a brick and mortar intermediary. So you've got a bank in the middle, you've got a broker in the middle, and uh, that middle layer leads to transactions that are more expensive. So so think of putting your money in the savings account, that rate is maybe lower uh than if you didn't have all of that middle layer, um, the back office and all of this stuff. And the same with the lending that the rates are are higher and there's a spread that's effectively taken by the centralized player.

So what the centralized finances about is essentially returning to where we began in market exchange. And that's barber and it's peer one on one and yeah, and that's the key. So you're you're dealing with your peer uh directly or a portfolio peers and through an algorithm, and that's the key. So the algorithm basically takes the place of the functioning of a bank or a broke her And when you do this, when you've just got an algorithm out there,

it makes things much more efficient. So without that middle layer, uh, you're able to get this efficiency gain that's very important, uh for the economy. So as many different aspects of this, but the key idea is, let's deal with the algorithm directly. And when we do that, it's going to reduce costs. It's gonna make transactions uh much more transparent, secure, efficient, all of these things. So so let me push back a little bit. And and by the way, we'll talk

about a c H in a minute. We'll talk about credit cards in a minute. But let me for a moment take the other side of the argument that nothing's changed in finance over a century. Today, I could trade stocks effectively for free. I'm rebuilding a Tyhota FJ in South America. I ship cash down using an app. It costs me three dollars every time I want to send three thousand dollars to South America. That used to be impossible.

I could get cash out of a machine seven. I don't even have to go to the bank to deposit a check. I take a photo with my phone and and that's a deposit. And if we go to dinner and we want to split the tab, I could venmo whoever else is at dinner back and forth. It's like so easy. I think about what technology lets me do today versus I was in college when they first put

an a t M in the student union. It feels to someone like me that the past forty years has seen an endless array of incremental improvements in the financial system, and then the Great Financial Crisis comes along and everybody seems to lose their minds. Aren't we overstating it when we say there's been no improvements in the world of finance. Well, I did make an option with the digitization, but I

think there's been improvements digitization. Yeah. Look, you say, let me go through your list that you can practice the trade for free. So that is it is true that transaction costs have a decreased. It is not true to believe that if you trade on robin Hood you're trading for free. It's just not the case. And then number two, more importantly, for me to take ownership of a share of stock, because the transfer the ownership that takes two days.

So even in this age of the Internet, in the age of digitization, it takes two days to transfer the ownership of let's say a hundred chairs of IBM. It's just completely unsatisfactory, unrealistic and uh yet better in nineties, it was like five days, um, and we've had a change the three days and two days. But that's just to me totally offside. So as for the cash apps, yeah, there's many, uh, many things that have happened to make it a little more efficient to actually do the transactions.

But uh, and I point this out in the book, UM, the current wave of fintech largely uses the banking infrastructure that exists today, the centralized banking infrastructure. And to make the case in the book that look the traditional financial institutions, they are being continuously disrupted and one wave of that disruption is the fintech. So the neon banks, things like that, um, that make it much more friendly for the user. But given that they are using the same centralized infrastructure, in

my opinion, the current wave of fintech is fleeting. I had a speaker in my course, UM, very prominent person in the world of of DeFi who basically at the end of his talk to my course, he said that the current wave of fintech is like putting lipstick on a pig. And if you think about it, what he's saying is, yeah, it's an improvement, um, but you've got

the same constraints of that centralized infrastructure. And what DeFi is doing is not doing an incremental improvement on the current infrastructure, is actually building something that's fresh and new. So I see looking forward that a fintech will definitely disrupt the current financial system, but then eventually the centralized fintech will be disrupted by decentralized algorithms. So so let's talk about what I think is the most expansive part

of centralized finance. Personally, I could care less if a h takes two days to clear stock trade. It doesn't make any difference to me. I could buy and sell that stock a thousand times before the first trade settles and it doesn't cost me anything. But in the book you use the specific example of credit card transactions and that a hundred years ago there was about a three percent cost to send money by wire, and today using credit cards, a century later, it's still a three percent

credit card fig So why does that exist? Why hasn't it been competed down yet? And what will DEFY do about that three big which is the bane of retailers everywhere? Yeah, it's it's remarkable. Uh, the example I use on my book is not one hundred years. It's a hundred and fifty years. And I show this Western Union wire transfer from seventy three and it's for three hundred dollars. And then there's another line for the fees, and the fees

are nine dollars. So it's like and I tell my students that basically nothing has changed in this particular example, nothing has changed. Uh, it's a three percent fee. So the reason that the fees for credit cards are so high, Um, there's many reasons. The leading reasons are the lack of security. So if somebody steals your credit card, then the credit card company is good for it, right, so you're not gonna lose anything that cover um and all the chargebacks.

So uh that that's expensive. The security mechanisms are expensive, and then of course just the brick and mortar back office, all the systems, all of that is expensive. So um, you put that together, it's three percent. We have had, again with fintech, some some competition here. Uh that's driven that three percent lower because credit cards offer cash back and all of these other deals, and we've had innovations like let's say Apple Pay, which is a great deal

for the credit card company. So instead of getting three percent, they get two point five, and Apple gets point five. But it's massively more secure really when you use that. Oh yeah, because to pay with Apple Pay, um, you do the facial recognition. If you're just swiping a credit card, um, there's no pin, right, So in the United States we don't use the pin for the credit cards. In Europe a different story, but it's really much more secure. So we see the fees being bid down a little bit,

but that that's the reason. So so let me let's stay with Apple Pay for a second, because it's such an interesting um example. As a user, I have no insensive really to use Apple Pay over a credit card, but it would It sounds like the credit card companies have a massive incentive to have me use Apple Pay. Why hasn't there or a similar biometric um security system. Why hasn't there been a bigger push in that direction by the credit card companies. So at the beginning, it

wasn't clear that they really understood. So it seems like, well, instead again three we got to take a haircut to two point five. And and maybe there was an expectation that the regular credit card would have better biometrics or or a minimum a pin. But given that we don't have that, uh, it is way more secure to use something like Apple Pay, where you were to use a pin or use the facial recognition. So it's much more difficult to to use like Apple pay, uh if you're

if you've stolen somebody's phone for example. So the security cost um that's attributed to those that use the credit card that Apple pay is way lower. So we have seen a lot of growth. This is not my area of expertise, uh, like credit card uh, you know, mechanics and and the amount of sales that's Apple Pay or uh Android versus just a regular swipe. But but it is much more secure and and that's a major cost. The insecurity is a major issue with not just credit

cards but banking in general. We were discussing what makes decentralization so desirable um and so valuable in so many cases, But the counter argument is centralization allows us to put legal protections into place and security and anti money laundering. How do we manage those around decentralization? What what's the advantage? So it is a tradeoff, and I think that people in decentralized finance understand uh these tradeoffs and there's nothing

that's perfect. There's always going to be some risk. But decentralization is again putting people together, so you deal peer to peer without this thick middle layer, and there's some advantage to doing that. Um, you're correct that centralization does

have some advantages. So one advantage is that you can move very quickly, whereas a decentralized protocol, if there's a change the necessary and that protocol, that's got to go to a vote of of the users or the owners of the governance, so that could take a longer period. At a time, Uh, the throughput in terms of the number of transactions per second much greater if you've just got one centralized clearinghouse. So there there are trade offs here.

But with centralization, uh, these institutions can do what they want. And we were talking in the previous segment about credit cards. Um, well what about like a wire transfer? I did one last week and I had to send um some euros to Europe for uh, you know, for for some repair bill. And UH my bank said, oh, well you're a good customer, We're gonna wave the wire transfer fee. But then they quoted me the rate and I said, well that rate is two point five off the market and it's a sorry,

that's the best we can do. So to send the wire transfer was like swiping a credit card, no difference. And they think, you know, they're convincing the customer that, oh, well, this is a favor that we're doing it. No, so they have got control, they've got market power. So these large financial institutions, it doesn't matter who I go to, it's going to be the same thing where they're going to quote two point five percent off the market rate and and I gotta pay it. So it's very direct

and very large cost. So they've got the power to actually do that. When you go peer to peer, it's nothing like that at all. UM, you're just interacting with your peer. Somebody is buying, somebody is selling, and and we're done. There's no spread. So again, the advantage of UH centralized is that we're familiar with it. UH. It appears to work, it does work to some degree with our system, but it imposes these costs, and these costs lead to, in my opinion, UM, opportunities that are not

pursued that we really need to pursue. And if I could give an example of debt, you're a small entrepreneur. You've got a great idea, you think the return on investment is going to be percent a year, and you go to your bank and basically asked for a loan to get this going, and the bank says, well, you're too small. We prefer larger customers. So we prefer one large customer to a hundred customers like you. Um, so we're not going to do the loan, even though we

like the idea. But oh here, here's a credit card and we've extended the credit limit on it, and you can just borrow on your credit card, and we know what those rates are, so the rate right, the project isn't pursued. And when the project isn't pursued, you've got like a high growth project that isn't pursued. That's exactly what our economy needs. We're stuck in two real GDP growth and given the size of the obligations that the government has taken on UM, there are not many good options.

So you could inflate by increasing the money supply. You could tax, and that's not great for growth, but the best way out is to increase growth. And given the situation that we're facing today where we've got so many people under banked. So under banking is the example I gave where you're not able to get that loan even though you've got a good idea. Uh that that is

a drag on economic growth. So in my opinion, if we take these frictions out or reduce the frictions and allow people to be treated equally and the judgment is basically on the quality of the idea rather than how much you've got, then that opens up the possibility of substantially increased growth in our economy, and we really need that. So so let's stick with unbanked. And it's funny what

you mentioned about doing the wire to Europe. I mentioned the app that I can send money around the world and it costs me nothing, but I'm limited to sending three thousand dollars that's the cap. I think it's every seven days or every five days, or and I think that is a nod to the money launching rules. Let's talk about how much of the world is unbanked and what DEFY can do to give them access. There was a giant story on sixty Minutes a couple of years ago about some person who set up a way to

move money around by phones. In Africa, there's you know, a huge swath of people who are in bank there and and that technology has been making improvements. Tell us a little bit about UM how defy can help people who don't have access to centralized banking. So in the world today, there are one point seven billion people that are unbanked, and there's probably we don't have the exact

number on this, Probably more are underbanked. And my example that I gave you with the entrepreneur, that entrepreneur had a personal bank account, but they they were not able to get alone that and that again is under banking. So it is a very large proportion. Uh. One example I'd like to give UM, and a lot of the action here is happening outside of the US. So think of a country like Venezuela that's in a hyper inflation

a situation. If you're really well off in Venezuela, that hyper inflation really doesn't impact you that much because you've got a US dollar bank account in Miami or somewhere outside of Venezuela. So who is hit the hardest. It's the the average person uh in Venezuela where they don't have the opportunity to set up that bank account outside or the amount of money that they've got isn't that large.

So again the world that decentralized finance comes in very conveniently here where if you've got a mobile phone, a smartphone, then that serves as your bank and you can hold UH token, and you might choose to hold token that is backed by U S dollars and effectively you've done the same thing that you've protected yourself against a hyper inflation in that country. And effectively, what will happen if that country continues on its course is that people will

essentially abandon the native currency. So why do I need it? I can pay with a US dollar token and it doesn't have to be U S dollars. It could be anything. It could be a traditional currency like the dollar or the euro, but it could be a token that's back by gold. So as many possibilities here, and this is just an example of how to effectively bank UH the unbanked and the underbanked. So let's talk a little bit

about the terminology in the space. So much of it is so confusing block chains and forking and protocols and n f t s and d os. For someone who's interested in learning more about this ecosystem, where do they even begin? So it is confusing right now, and this is a one of the reasons that I'm doing what I'm doing, so I teach this. I think it's important for the future. But it's very confusing, And initially it was even more confusing because very little material other than

some computer scientists writing about various protocols. Today there's a huge amount of information on the internet about this, but you need to be very careful because some of the information is basically selling our product. You need to go

somewhere are that's kind of highly rated. I know. I'm working on UM a fourth course sequence UH for corse Era that takes UM takes the viewer or the student through four different stages of understanding decentralized finance from the infrastructure, the primitives, and then a deep dive on some of the key protocols and decentralized finance and go through the mechanics of those, and then the fourth courses about the

risks and opportunities in the space. So it is difficult, and I kind of um come to the realization that well, I might have a couple of hundred students at Duke University. Uh, I want to have a broader impact, so also putting this stuff up um for everybody to learn from. Let's walk professor a little bit about your new book, Defy in the Future of Finance. Give us an overview of the basic premise. What will readers get from this book?

So the book is written for the millions of people that either work in the field of finance or are interested in that field. And they've heard of crypto, maybe they own UH some crypto, maybe they don't, but they want to learn more. And indeed, the motivation for actually reading this book is something that I tell my students at the end of my crypto course, And basically I say to them that I want them to be disrupt ors, not disrupt ese. And this is a highly disruptive technology.

It will change finance as we know it. And and I thought it was important to take that message outside the confines of a single university and put a book together that is accessible to anyone. The language is somewhat different than the language of traditional finance, but but everybody going through the book can figure out the linkages between some of the things that I talked about and UH

and in traditional finance and and see the advantages. And of course it's also crucial with any new technology for the reader to be fully versed on the risks. Uh. This is definitely not a risk free as a situation. This is disruptive, there's going to be many ups and downs. But it's important to go in with your eyes wide open, recognizing the sort of risks that you face. But this is basically my way of trying to explain what's going on. And when you're early in on the technology, it is

difficult to see what's really going on. And people in the media often see bitcoin or doge coin and things like that. It's all about the price of those two tokens. And and decentralized finance has very little to do with bitcoin. So let's focus on decentralized finance. In the book, you talk about the five various flaws of traditional centralized finance. What do you think define most successfully attacks UM in

terms of traditional centralized finance. Well, there are five things that I mentioned in the book UM Centralized control, so basically, you're at the mercy of your bank because they are holding your funds uh. And and there's various other aspects whereas decentralized, you are in total control. You own the bank. Effectively, the bank is in your pocket and you can do what you want. UH. Limited access we've already talked about where this is a technology of financial democracy. Doesn't matter

who you are, you're treated equally as a peer. There's no retail customer, broker, banker, uh sort of relationship. Everybody is the same. It might be a banker, but that bankers appear. It might be a retail customer, you're a peer. Uh. Inefficiency we've talked about also with this two point five or three percent all over the place, a ridiculous uh, you know, lending rates on credit cards. Uh. There's definite

progress that decentralized finance makes. What we haven't talked about is lack of interoperability as a problem in our current system, where for me to transfer some funds to my broker, Uh, that could take two or three days from my bank to my broker. Uh. So and that delay doesn't make any sense in the age of the internet and dig a bit, uh, you know broadband. So Uh. With the

centralized finance, everything is linked together and it's seamless. Uh. In terms of the transfers are are pretty well immediate. And number five issue is uh opacity that you're dealing with the bank. You don't really know UM the health of the bank. You're relying upon the government the f d i C to basically ensure you, but there's limits

to that insurance. And UH, the f d i C and the regulators have a checkered record of detecting problems in advance, whereas in decentralized finance, everything is open, so you can see the balances of the people doing transactions, you can see the code that is the algorithm that you're trading with, you can see the liquidity. It is

completely transparent. So these five problems I think decentralized UH finance deal with, and probably if you're asking me to pick one, I would pick the inefficiency that because of the thick layer of middle people in centralized finance, UH, the probably the primary advantage is to get rid of that, and when you're trading with an algorithm, it's much more efficient. That's really interesting. I'm quite intrigued by the concept of smart contracts. Let's discuss that a bit tell us what

smart contracts are and how they can be used. So this is one of the main differences between Bitcoin and Ethereum. So Bitcoin you can just transfer funds from one person to another, whereas in the Theoryum there's another possibility. Uh, in the theorem you can actually have an algorithm run in the Ethereum blockchain. So the Theorium blockchain is more like a computing platform, whereas the Bitcoin platform is just

purely for transactions. So in the Theoryum, you can actually send funds, not just to another person, which of course you can, but you can send them to an algorithm. And that algorithm might actually uh be what's known as a decentralized exchange or our decks uh the x and that allows me to trade let's say, one token for another token within that algorithm. So I send one token to the algorithm, and the algorithm sends me another token.

It's a beautiful idea, and it's uh and it's remarkable that the algorithm doesn't care who you are, how much you're actually trading, and it doesn't care if you're a buyer or a seller. In in addition, it is running. So this is a very significant idea and uh and and will be definitely disruptive. I'm kind of intrigued by the concept of smart tickets for live events that that really moves a lot of the control over who purchases, who prices it, how much it gets marked up back

to the artist. Can can defy eventually create a world where if Taylor Swift wants to sell tickets first to her registered fans and allow them to resell it but only up to a fixed price, uh, and they get to split the profit between the the fan and the artist. Are those sort of things feasible with with defy or or are some of these really kind of futuristic pipe dreams? No? And actually we talked about ticketing in my course, so

this is a broader application. So think of watchain technology as a technology that will disrupt many areas of business and that uh, the low hanging fruit is finance, but we've also seen a lot of progress and other dimensions like supply chain and things like that. And the supply chain example is that you're shopping at your grocery store because they had to let us with the q R

on it. You scan it. You know where that lettuce was picked, the day it was picked, every whether the farm is organic, every single hop on the supply chain, and how long it's been on the shelf at the grocery store. So that's what blockchain can do. And ticketing is a great example. It's very similar. The dynamics are similar that uh, you know, firms like Ticketmaster and stub Hub they take of the ticket. Yeah, so it's very little leftover for the artist. And there's something else that

happens that is really important to understand. It's not just it's that the customer is dealing with Ticketmaster, they're not dealing with the artist, So there is a separation. There's no relationship between the concertgoer and the artist, just like Amazon does with retail. So you buy something off Amazon, you deal with Amazon, and there's no way for the actual person selling the good to connect with the customer. They only deal with Amazon. So you break that connection

and it's very very costly. Uh, particularly in the arts. You can imagine a different system using blockchain technology. And

there are companies that actually do this. And the company that I like um is called True Tickets, and I believe they're sponsored by IBM right now, but they're offering a solution where, uh, where you actually do have this direct connection between the artist and and the just basically the artist and the concert goer, and the synergies are just remarkable that there could be a song that is done outside of an album that's made available to the

people that are connected to the artist. There could be information about the next tour, all of this stuff. There's a direct connection with the artist, and that's what we really need. Of course, you know that, uh in the music industry, Uh, it's notorious for uh so little goes to the artists. Really the only thing that's profitable is the concert. And even the concert uh, the haircut is is enormous. So there's so many layers of middle people.

And again you're you're onto exactly the right intuition. You take that that that oligop balistic um or market power out of this and connect people directly, then everybody is better off. So yes, um, ticketing is low hanging fruit. We will see some progress on this. But and this is an important butt. The middle people are extremely powerful and they will fight. Just like in the financial system, uh, the banks, the exchanges, they'll try to delay this, whether

it's lobbying government for regulation and things like that. I'm convinced that they realize what's coming. And let me just give you a short story. UM this happened a little before COVID happened. A major stock exchange, UM Global Stock Exchange called me in to talk about crypto. It is pretty vague agenda. I show up. It's their board of directors and their senior management sitting in the room, and they've got a single question for me. How long do

we have? So I think that people realize they can see the trend and and ticketing is a very good example of a system that it doesn't work for the artist, it doesn't work for the concert goer, so we need to fix it, and the technology exists to do that. Let's talk a little bit about what's going on in the crypto sector today. N f t s are on fire, Bitcoin is approaching sixty THO. An investor who wants to speculate with a little money in this area, how should

they put that money to work? So Number one, way too much attention is paid to the price of bitcoin. It goes up and down. And indeed, uh, it was interesting when the price crashed in two thousand eighteen dropped. What was most interesting to me was that the venture capitalists that we're investing in de five there was no impact. So even though the cryptos dropped by they were equally as interested. And what I think are the most interesting

technologies are things that are below the radar screen. The we hear in the news of a big clin and Elon Musk tweeting about doge coin or or whatever. Uh that there's a lot of other stuff that is really interesting that's below the radar. In decentralized finance, it is a very hot area. So for an investor, if you're going to and I do encourage people to get a wallet and to do some experimentation, but you need to be careful that things like investing in bitcoin. The annualized

volatility is about nine so that's huge. So the stock market is fifteen percent. Gold is let's say this is an incredibly volatile asset, and then some people do margin trading. So if you do margin, then the volatilities double. So you need to be really careful Number one, that this is an extremely volatile asset class, and you need to be going into this uh without margin fully knowing that we could have another situation where you lose crypto winters.

Is what what a lot of folks qualities? Yeah, exactly, there's ups and downs and number two, you can't be the so called bandwagon investor where you buy high and and and sell low. So I think of those people that we're buying at the peak in two thousand seventeen at twenty thousand dollars and and then UH in two thousand and eighteen the price crashes to five thousand. Think about the people that bought at twenty and sold at

five thousand. The alternative, you buy at twenty and you take a longer term perspective and look where you are today. So so you need to have a longer term perspective. That's number two. Number three and this is hopefully obvious, that you should have a diversified portfolio. And that means you don't don't put all your money into crypto, and even within the crypto, you need to have a diversified portfolio, so more than one, not just bitcoin UH And and

then number four is maybe the most important. You know what you're investing, Understand what you're investing. You buy a share of Apple, you you might have an iPhone or a Mac, or you use iTunes. You understand the business model and you believe that they're in a good position to UH build profits in the future. You need to do the same thing when you're investing in crypto. You can't just take a tip from somebody, oh, well, this is what I've got. You need to do your homework

and figure out what this token is really representing. Quite interesting you mentioned earlier that you thought, um, a lot of commercial banks are a bit worried about the risk of defy, but we're starting to see some of these giant financial institutions get involved. I think Visas spent dollars on a crypto punk and some other banks have been involved in fintech and and some seed companies as they look to basically do an end run around around centralized

banking and disrupt finance. What do you think is going to happen with these big financial institutions. Are they going to sit on their hands and become disrupted or are they going to try and muscle their way in and keep a finger in the pie, so to speak. So they totally understand this in my opinion, Um, they know this disruption is coming and they will do what they can to delay. So one thing that they can do

in the short term is to become more efficient. So, uh, it's kind of interesting that we all heard a couple of years ago Jamie Diamond saying that, uh that anybody caught trading tript at JP Morgan was gonna be fired, and and the reason for that is that they were basically being stupid. Well, it's a completely different story today where JP Morgan has got a stable coin, which is a type of cryptocurrency, and they fully embraced everything about

this space. It's hard to ignore when the space is capitalized that two trillion dollars, that this is an a novelty anymore. So these banks will do a number of things, so uh, they will use the space to their advantage. And and these stable coins are basically hard back to the era of a free banking where banks for quite a while in the US, we're able to issue their own currency backed by various things. So that's essentially what the banks will do. They tried to do other things.

You mentioned crypto punk, but um Visa actually tried to acquire Plaid for five point three billion dollars. And the reason that they wanted Plaid was this lack of interoperability that was one of the great disadvantages of centralized finance. So it's really hard to move money from your broker to your bank or vice versa. But that was blocked um by the regulators. So so they completely get this that both the combination of fintech and decentralized finance, this

is an existential threat to their business. So they will try to do things. They'll make some investments, they'll work on the politicians will try to do the maximum sort of regulatory push. All of this are our tools um that they will use fully, realizing that it is just a matter of time. Huh, that's interesting. We haven't talked about. The largest company in crypto is probably coin Base. They're publicly traded, but it's kind of ironic. They're also a

centralized company. Tell us a bit about coin bases role in the ecosystem. So coin based very important in terms of the credibility of of crypto and coin Base made it a lot easier for people to get into this space.

So instead of actually having to worry about your private keys and securing them, you could use coin Base, a third party to take care of that, just like we use a broker um so we don't worry about the actual physical ownership of a hundred chair to IBM, the broker handles that for us, so a coin base was

very important in getting people in their fully regulated. There's more than ten thousand exchanges in the world, and probably more than nine of them UM are very questionable, especially in terms of the volume that they report and the sort of deal that you get when you're buying or or selling big spreads. So coin base UM is also ensured, which is interesting UM. And it is centralized. So the way that I described comb base is UM, I call it c defy so C E D E F HI,

so it's centralized centrilcement. So they deal in a lot of decentralized financial protocols and tokens and stuff like that, but they're centralized. And coin Base and Binance, they main competition is what's known as decentralized exchange or decks. So if you look at the amount of trading that's actually happening, there's huge growth and this decks trading and the deck is where you're trading with the algorithm, so there's no

mid person like coin base. The disadvantage of the decks, maybe many were considered an advantage is that you hold your your your private keys. Uh, there's no third party.

That's uh, that's actually UH in the middle UM. So so let's stay with that a second, because there have been all sorts of crazy stories about lost passwords, hundreds of millions of individual dollars lost by some people, and and I've seen estimates of of all um coins have been lost due to either lost passwords or damage hard drives. When you go through a coin base, they take the liability of that off of you. In other words, you don't have to worry about a damage drive or or

a lost password. They'll make sure you have access and I'm assuming it's UM a very secure way to access, as secure as a regular bank exactly. So they deal with the custody. And this has also been a big deal for investment funds. So they've seen the crypto complex gro uh dramatically too, two trillion dollars, and they've been struggling with the cost of the issue. So how how do we secure these private keys? So the solution is

to have a custodian. And that's another thing that coin base actually does very successfully, is that will serve as a custodian for UH, like a hedge fund or a mutual fund UM if they're interested investing in crypto. So corn based. Again very important uh in terms of the evolution. But I do see the trend, and the trend is towards UM trading directly between peers, and then you do need to worry about custody. Custody is a risk that

I go through in a lot of detail. UM. You refer to kind of losing a password, and there's this story in the New York Times where this programmer had UM crypto in a hardware wallet, so that means that the private keys were in the wallet, but then he forgot the password. And the way that this hardware wallet actually operates is that you get ten tries, and if you fail on the tenth try, then the uh, the hardware is physically destroyed, so you can never prepare over

what's in there. So so you basically you just tried eight times, got two more, and over two hundred million dollars a big coin is trapped there. So there are other technologies today, So you can have just a regular custodian. UM, you can have a shared KEYUH. So you split the key into three pieces. You've got maybe one on your smartphone, one on your desktop. UH, and then there's a custodian that's got the other third, and you need two out

of three to reconstitute. So if you lose your mobile phone, your computer crash is no big deal. You just put it together. And this technology will be seamless in the future. So right now it's a little clunky, and that's because we're just so early in this technology, so we're less than per cent in and there will be issues like this.

That's pretty amazing that there was another story, and I think it was the BBC somebody throughout a drive when they were cleaning their as didn't realize that it had their crypto password on it. But the the bigger issue, the longer term issue, is hey, you know, these are really secure cryptography access keys today, but we're not that far away from really quantum computing being more viable. What happens in the future when we see a massive order

of magnitude improvement in computing power. What does that do to these supposedly secure access keys. And I guess it's as true for JP Morrigan and Wells Fargo as it is for bitcoin and ethereum. Sure um, so let me answer this. There's many different dimensions to your question. So the first thing is that quantum computing isn't really a threat to the current security in bitcoin or ethereum. So

the way that blocks are added is pretty well immune. Um, and both bitcoin and ethereum use something that's called proof of work, which is environmentally quite reckless. But Etheroryum has got a strategy to migrate to a different system that would be much more energy efficient. Uh, it would be very energy friendly, frankly, so UM. So that's the first thing. That The second thing is that UM it is true that that with quantum computing in the future, it might

be possible to basically reverse engineer the private key. So given that you've got the public address, that is possible theoretically to go the other way. And you might think, oh, well, that's a disaster, but it isn't. It's not really a big deal because um already we've got quantum proof uh capabilities, and it's really simple. When we get close. All you need to do is to send your crypto to another address that you own and just sign it with a

quantum proof of signature. So I'm not worried about that at all. UM. It is kind of interesting that some of those lost bitcoin you might be able to be recovered with this huh really really intriguing. And I know I only have you for a limited amount of time, and I have to get to some of your previous work before we get to our favorite five questions, and I have to lean into let's talk a little bit about yield curve inversion. What does that tell us about

the likelihood of a future recession? Well, actually was interesting. The last time I was doing a podcast with Bloomberg was two thousand nineteen. Uh, the beginning of July, the eel curban inverted, and I made a recession call. For little did I know that COVID what does strike and and cause such an unusual recession? But this is my dissertation work um at the University of Chicago that I

showed that eel curban versions proceed a recessions. At the time when I'm defending my dissertation, the record was four out of four with no fall signals that, yeah, it could have been lucky. My committee was kind of skeptical, but the theory behind the measure was sound. I passed. And usually what happens after you publish an idea is that if you're lucky, it becomes a weaker effect on the sample and if you're not very lucky, it completely

goes away. But from my particular situation, the youth curban versions predicted accurately the next four recessions, including the Global financial crisis recession for a game advanced warning of a year. So so it's eight for eight right now. I haven't really done research in this area in quite a while, but it's held up, and it's it's something completely unexpected that I'd still be getting questions about my dissertation so many years after I published it. Let's talk about another

area of research that you've you've worked in. Some people have had outstanding investment results and they're lucky, and other people have had an outstanding investment results because they're skillful. How can we tell the difference when all we see is effectively, Hey, that turned out to be a great investment. Yeah, So this is my recent research stream is focused on luck versus skill. And it's really hard to explain, but I think people really want to believe in that upside.

They look at the back test and yeah, this looks really good, and and I think that this is going to repeat, and it often doesn't because the back tests are are overfit. So in my recent research stream, I proposed a number of different ideas UH to kind of adjust back tests and and a protocol UH to really understand the past performance. It comes down to the culture at the asset management firm. Do they just want to gather money in the short term and collect to see

uh it. It also comes down to investors asking the right question. So so, for example, the presentation has been given on a new product, and here's the back test, and and what I do sometimes very uh strategic question. I said, oh, this is pretty super interesting, very impressive work. Uh oh did did you try variable X? And then the response might be, oh, yeah, we tried that, but

it didn't work. So as soon as I hear that answer, I know that there's been extensive data mining, and it is like it's like seeing a cockroach in your house, you know, when there's you see one that there's a dozen behind the wall, and and that sort of small indication is that this product in the back test has been overfit. When it goes to live trading, you're going to be disappointed. So so what do you actually want is in the back test not to choose the best one.

The best one is the one that's most likely to disappoint in in live treating. So you need to do this in a way that minimizes, uh, the overfitting in the back test. And what we what we want is to invest in a product that will repeat it's past performance. We don't want to invest in a product that you know, the advertised sharp ratio is two and and we get

point to in live trading. So is this why you've said half of all the financial research out there is likely false a combination of overfitting and selection bias and all the other fun reasons why back tests are can be somewhat misleading. Yeah, and I said, uh, the half of the empirical research and finance that has published in academic journals. The key is to understand the incentives. So the journal editors compete in terms of um what's known as an impact factor, the number of times that their

articles and their journals are are cited by other journals. Uh. And they know that if they publish a result that is a non result. So you try a trading strategy, for example, and it doesn't work. If they publish that, nobody's going to cite it. So so the authors note that they need to deliver something that's really interesting and is what we call a positive result. So this trading

strategy delivers a very high um sharp ratio. So they know that, and the data mining begins because these academics they need to publish in the top journals to get promoted, so so the data money begins. And then you get a select sort of paper flow that's going in with data mind results, and and you put this together, and you combine that with a mistake that that many people have made in kind of the execution of the statistics.

It might be that you try a hundred things and there's one that works, uh, and and then you even admit that you tried one hundred things, one hundred different versions of the trading strategy, but this one works really well. Well you expect that out of a hundred, five would work just by random chance. So if you're presenting one, it's probably uh, not significant, will not hold up in

live trading. So the incentives defined that really interesting result that you know will be cite it and the journal editor will like it. And you combine that with a mistake of not adjusting for all of the possible things that you tried. Then you get to this fifty percent number.

It is also important to realize that, in my opinion, the problem is is less severe in the practice of management, because in the practice of management, if you really overfit, and if you get people to invest, and if your arrangements are not just a fixed fee but an incentive fee or performance fee um, then if the product doesn't perform, you're not going to get any performance fee and you're

gonna lose a reputation. So in the practice of finance, there's no equivalent to academic tenure, so you don't perform your out. So I think the incentives are better aligned in the practice of asset management and that sort of research, much of which we don't see, so you don't publish the mechanics of a really good training strategy. Renaissance Technologies hasn't released any white papers as to how they're doing

a fees year after year. And and I want to add, this sort of research issue is not just in academic finance, but it seems to be across you know, many many fields. Reproducibility of of results are very very challenging. So it's more than just form fitting. It's even the basic concept of research seems to be um somewhat problematic in in

both academia and in the real world. So you're correct that other fields have actually uh come to this realization well before the field of finance medicine, for example, Uh, they fully realized that half of their research findings are false. And you could argue that that's way more important than finance. So and finance we're talking about like some alpha, and in medicine we're talking about life or death. So again

we need to have a proper perspective on this. I know I only have you for a little while longer, so let's jump to our favorite questions that we ask all of our guests, starting with what have you been doing to stay entertained during the pandemic? Tell us what you're streaming, either Netflix or Amazon or anything you're listening to and enjoying. I'll tell you what I'm streaming on Netflix is a finish UM drama show called border townmmend

it very interesting thing. It's it's dubbed, but it's it's

well done. Um. But in terms of podcasts and things like that, Uh, really, what I'm I'm doing, I'm focusing on one particular podcast which is not for entertainment necessarily, but more in the DEEPI space, and it's called uh fine maddics, that's FI and E matics, and it's really uh nicely done where the presentations are like seventeen to twenty minutes long, animated, but really trying to understand some of these complicated concepts in uh in the crypto space.

Really interesting. Tell us about some of your early mentors who who helped to shape your career. Well, I've just been so lucky, Uh it just my timing. I think I didn't realize that at the time was just so good um and and and UM just purely do to luck that I've had the opportunity, uh to interact with the greats of finance. So my chair um is Eugene Vama uh on my committee Martin Miller and Lars Hanson.

But I also had, uh in half the opportunity to interact with Bill Sharp, my Marin shoals that role, Steve Ross, Bob Martin um and and even Fisher Black. And let me just briefly tell you my introductions of Fisher Black.

I was an assistant professor, junior professor, and I was working late at the office while actually wasn't late for me, was bout nine pm and I get a phone call and Duke had one of the early call I d and I could see the calls coming from Goldman Sachs and I think it's a buddy of mine from Chicago that's working late, just like me. I pick up the phone, just assuming it's him, and and make some disparaging remarks and then there's a long silence and the person says,

is this Campbell Harvey? And I realized, oh, somebody else? And then he said it's Fish or Black. And for a junior person to get a call from Black, who everybody knows it's going to win the Nobel Problems, it was shocking. So so he said, I'm reading your paper here and UM and your table too. I don't believe. I said, well, what do you mean you don't believe? So well, you've you've engaged in data mining to get this particular result and these results are not credible. And

I said, no, there's no data mining. This is all I did, is exactly what I said. There was no uh going variable by variable. It was a predictive regression for the SMP UM that I just basically this is what people have done. And then I just I just presented that and he said, no, uh, it's it's not credible, not credible, and um so it was interesting. We had this conversation and many other conversations. Uh and and we developed a good relationship. Uh and and how did you

convince him it was a legitimate research paper? So I couldn't. So it's just totally convinced. So uh many years later, I decided to basically do the out of sample test and uh so I replicated my Richard results and and I found using the I collected the data again and I found I got almost exactly the result in that table too. But then I did the other sample twenty five years apot a sample and the other sample there

was zero predictability. Really, so Fisher Black was right. And the lesson that I've learned, and the lesson is I didn't do any data mining, so it was clear that I was telling the truth. I didn't. Even a legit

paper can have structural problems in it. But what I did was I relied upon the results of other academics, so so basically they might have been doing the data mining, and then I just took their paper and then implemented it and and and basically it's it's essential delegation, right garage right, Yeah, so this is so he was he was correct and yeah, and obviously that experience was really

important for me and shaping my research agenda. My presidential address to the American Finance Association is exactly on this topic. So he was extremely influential in terms of my development and the idea generation. Meanwhile, that's some murderous row of mentors you had over your career. It's really quite an amazing list. Let's jump to everybody's favorite question. Tell us about some of your favorite books. What are you reading now and what are some of your favorite books to

recommend to students? Well, and probably won't be that interesting. Um. I I began thinking I was going to be an English major, so so I do read um and my tastes or maybe a little unusual. So I'm a James Joyce nut um in terms of reading everything that he's done, which is incredibly challenging to do, but very uh boarding for me. In terms of what I'm reading right now,

I'm reading Danny Kahneman's book on Noise. I do work in behavioral finance also, and I've been struggling with some of the issues that are prominent in his book in terms of some of my recent research. So that, uh, that's something that interests me a lot. UM. And then I'm doing something really geeky UM that I'm trying to make my way through, um the third edition of The Golden Bow, and maybe some of your readers might our listeners will will pick up and take a look at

what that is. It's all online, it's very long, UM, but it's the sort of thing that interests me, and it's essentially how people um come to believe in something. So expectations are something that I've thought about for a very long time. It's very important for our research. Uh. One of my research streams tries to measure those expectations. But this is much deeper analysis of how beliefs are actually form mythology and things like that. More than anticipating

the pleasure of an event or purchase. You're talking about how we start to conceptualize entire frameworks or mythologies exactly, so very important, just the way that is presented, and and some thing's happened that might be random, but others are not. So before I go to the next question, I have to ask, how does the world of stock memes fit into this that that seems to be that sort of investment narrative seems to be dominant over the past five years. Do you do you look at those?

What do you think of those? Sure? So this is extremely interesting to me because we've been on a trend where the retail investor has become a smaller and smaller part of the total amount of investing for many years. However, with the rise of certain fintech, it's been a lot easier for the retail investor to actually get into the market with apps like robin Hood for example. So we've

seen a big turnaround. So the proportion of the retail investor of the total market maybe was ten, is up to fifteen, maybe it will be twenty over the next year. And and what happened there is that the retail investor doesn't have access to the sort of information that an institution well investor has got access to. They have the data, they don't have the computing capability, they're not working on

this full time, but they've got the crowd. So you might have a dedicated team and a hedge fund working out a problem, but the retail investor, even though part time there might be you know, a hundred thousand people that are contributing so effectively, what we're seeing is the possibility of kind of a decentralized hedge fund, if you think about it that way. So I think it's very interesting, like how this space evolves. It is, uh, it has some downsides where a bandwagon has jumped on and it

basically drives a stock well beyond its fundamentals. But usually you would have shorting going on and to bring the stock back down to its fundamental level. But some of these hedge funds, the risk of shorting has gone up dramatically. They've seen what's happened. So when people step out of the shorting, UH, that means that you've got this asymmetry

and it's just more likely that you've got misvaluation. So in my opinion, given what's happened, I think that the market will become less efficient in the short term short term and UH that provides some opportunities, of course, but eventually I think that the information gathering will become cheaper, uh, more efficient, will kind of return to where we were. But in the short term, UH, we get situations like game stop and MC quite fascinating we're down to our

favorite last two questions. What sort of advice would you give to a recent college grad who was interested in the crew year in either UM investment management or finance or crypto and defy. So the key thing to realize, and I give this advice to my students. Uh, the key thing to realize, in my opinion, is that finance will not look like it has in the past in the future. So we are in the midst of a

structural change. So it's really important to have a vision of the future, and just a naive extrapolation from the past is not good enough. So I many of my students take the job at the traditional bank or investment bank, and my advice to them is, after graduating, that doesn't mean that you're finished your learning. You need to know what you don't know. And my course and my book

is maybe a good example. After you read that book, you will know what you don't know, and you will know that there's not a lot more learning that has to happen. So those students that go into the traditional sector, I said, that's fine, you're gonna learn something. You need to continue. Uh, the quest of knowledge in this difficult space and the first day that you arrive, you need to be thinking about the next stop, and hopefully that

stop is somewhere in the DeFi space. Pay down your student loan, and then take some risk to go to a venture. You're gonna learn a lot. The venture probably fail, but it doesn't matter. You're going to learn a lot and you'll be able to go to another venture very quickly. So it's not as risky as you think. But again, and it's way better to be at the vanguard of disruption rather than at an institution that is doing everything possible to hang on to extend that one way, fully

knowing that they will be eventually replaced by algorithms. H really interesting in our final question, what do you know about the world of finance today that you wish you knew thirty years ago or so when you were first starting out. So I guess what I didn't fully appreciate. And it's kind of embarrassing because when you do economics at the University of Chicago, it's it's all about economic

incentives and and how that shape's behavior. And we've talked about this a little bit that I've really realized that the research in my field is is shaped by Economic Guy and say atoms. So at most schools in the world, well maybe ninety percent or more schools, just a single publication in a very top journal is a job for life. You've done it right. So the Journal of Finance publishes seventy seven zero articles a year, so it's very difficult

to get in to a journal like that. So to get promoted, UM, you've got to hit this top journal. And that causes UM data mining, UM and and and some of it might even be unconscious where you're you're trying to to look at various different techniques of estimation and you just happened to pick the one that works the best. So these incentives are really think of influenced research and has led to a problem with our research, and that when you take that research into live trading,

it doesn't do as well as what was published. And I think it's purely the result of these incentives. I was naive UM graduating and thought that well, this is just about the pursuit of truth. Well that's part of it, but for many people it's about the pursuit of a job for life. That's quite quite fascinating. Professor cam Harvey, thank you for being so generous with your time. You can pick up his new book, Defy in the Future

of Finance wherever you get your usual book purchases. If you enjoy this conversation, we'll be sure to check you out any of our previous three and seventy six podcasts we've done over the past seven years. You can find that iTunes, Spotify, wherever finer podcasts are sold. We love your comments, feedback and suggestions right to us at m IB podcast at Bloomberg dot net. Sign up for my daily reads at Riholts dot com. Check out my weekly column at Bloomberg dot com slash Opinion. Follow me on

Twitter at Riolts. I would be remiss if I did not thank the Cracks staff who helps put these conversations together each week. Nick Falco is my audio engineer. Michael Batnick is my head of research. Paris Wald is my producer slash booker. Latico val Bron is our project manager. I'm Barry Riholtz, upens and two master's in business on Bloomberg Radio