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Question 1

Bitcoin: Economics, Technology, and Governance. Important characteristics of Bitcoin?

Answer 1

Bitcoin’s design allows for

• irreversible transactions,
• a prescribed path of money creation over time,
• a public transaction history

Question 2

Bitcoin: Economics, Technology, and Governance.

What are the design principles?

Answer 2

• Scarcity of a money supply;
• Lacks a centralised authority to distribute coins or to track who holds which coins;
• Issues new currency to private parties at a controlled pace in order to provide an incentive to
maintain bookkeeping system, including verifying the validity of transactions.

Question 3

Bitcoin: Economics, Technology, and Governance.
The “block chain”?
Mining?

Answer 3

1) Data structure that verifies all past Bitcoin activity.
2) the Bitcoin system periodically awards newly minted bitcoins to the user who solves a
mathematical puzzle that is based on the pre-existing contents of the block (the solution must be verified by other users, which can cause a delay).

Question 4

Bitcoin: Economics, Technology, and Governance.

Two fundamental technologies?

Answer 4

1. Public-private key cryptography (to store and spend money).
2. Cryptographic validation of transactions (an instruction to transfer money is encrypted using the sender’s private key,
   confirming for everyone that the instruction in fact came from the sender).

Question 5

Bitcoin: Economics, Technology, and Governance.

What are the intermediaries - Centralisation?

Answer 5

1. Currency Exchanges: designated institutions that convert traditional currencies into bitcoins.
   Need online infrastructure capable of withstanding attacks including hacking and denial-of-service attacks.
2. Digital Wallet Services: applications for managing a user’s account in a more convenient way (less space, more mobility, better interface), but prone to hackers.
3. Mixers: to preserve privacy against this tactic, mixers let users pool sets of transactions
   in unpredictable combinations, thus preventing tracking across transactions (however, timing can still yield a clue).
4. Mining Pools: more difficult puzzles and lumpy rewards. In response, mining pools now combine resources from numerous
   miners. Miners work independently, but share earnings with others in the pool. Threaten the decentralisation that underpins Bitcoin’s trustworthiness (manipulation risk).

Question 6

Bitcoin: Economics, Technology, and Governance.

Users of Bitcoin?

Answer 6

Gambling services, retailers (and consumers), buy & hold for price appreciation

Question 7

Bitcoin: Economics, Technology, and Governance.

Risks in Bitcoin

Answer 7

1. Market risk: the value of bitcoins is highly volatile (fluctuations in the exchange rate between bitcoin and other currencies)
2. Shallow market problem (liquidity risk): a person seeking to trade a large amount of bitcoins typically cannot do so quickly without affecting the market price
3. Counterparty risk: currency exchanges may cease operations (45%) without reimbursing their consumers (46%), while digital wallet services are lucrative targets for cybercriminals
4. Transaction risk: (irreversible transactions), possibility to cancel the payment (by the majority/collusion), blacklisting.
5. Operational risk: Threats to security of the private key, Miner “51 percent attack”, Denial-of-service attack
6. Privacy risk
7. Legal and regulatory risk

Question 8

Bitcoin: Economics, Technology, and Governance.

Fighting Crime - types of crime?

Answer 8

1. 1 Bitcoin-specific crime (attacks on currency exchanges and infrastructure, e.g. bitcoin theft, attacks on mining pools, and denial-of-service attacks on exchanges to manipulate exchange rates)
2. 2 Money laundering (through mixers)
3. 3 Bitcoin-facilitated crime: payment for unlawful services delivered (or purportedly delivered) offline, like the illegal goods and services sold on Silk Road and payment of funds in extortion

Question 9

Bitcoin: Economics, Technology, and Governance.

Future concerns?

Answer 9

1. Bitcoin as a Financial Asset —> diversification benefits and arbitrage
2. Incentive-compatibility in Bitcoin Protocols
3. Privacy and Anonymity —> transaction patterns
4. Monetary Policy —> “k-percent rule” – fixing the annual growth rate of the money supply
5. Will it replace other forms of payments completely (low cost, privacy, decentralisation)?
6. Numerous competing virtual currencies that are waiting to achieve confidence in their values and adoption

Question 10

Prone to Fail: The Pre-Crisis Financial System.

The key sources of fragility?

Answer 10

1. Weakly supervised balance sheets of the largest banks and investment banks - “By relying on these sources of funding, dealers were much more vulnerable to runs than was generally appreciated.”
2. The run-prone designs.
3. Weak regulation of the markets for securities financing and over-the-counter derivatives.
4. The undue reliance of regulators on “market discipline” & too-big-to-fail.

Question 11

Prone to Fail: The Pre-Crisis Financial System.

Why did regulators fail to safeguard Financial Stability?

Answer 11

Inappropriate goals - protect the customers of financial firms, no focus on financial stability.
Too difficult for regulators to detect the excessive buildup of risk and flight-prone shortrun debt and derivatives.
The historical US emphasis on a decentralised banking system
Irrationally low probabilities to disaster outcomes.

The SEC had not supervised the investment banks (or their subsidiaries) adequately from the viewpoint of solvency.

Question 12

Prone to Fail: The Pre-Crisis Financial System.

Core Meltdown Risks?

Answer 12

Credit provision dependent on capital markets ->
Largest dealers financed enormous quantities of
inventoried securities with very short-term debt
—> Risks: (1) creditor runs and (2) fire-sale losses

…up to $2.8 trillion in intra-day financing was provided to the dealers every day by the two tri-party
agent banks —> systemic risk (on top of the two agents being large creditors)…

an alternative short-term funding - “commercial paper” (that is, unsecured debt typically issued for up to six or nine months), either directly or indirectly
through off-balance-sheet “structured investment vehicles” (SIVs) created by banks -> liquidity risk

Question 13

Prone to Fail: The Pre-Crisis Financial System.

Regulatory response since the crisis (financial system)?

Answer 13

1. The elimination of intra-day credit provision by tri-party agent banks.
2. The securities inventories themselves are also much smaller —> the need for financing has been reduced
3. Because of the declining presumption by bank
   creditors of “too big to fail,” dealer financing costs have gone up substantially, so the incentive to hold giant inventories is much reduced.
4. The dependence of dealers on flight-prone financing from money market mutual funds has been lowered by a tightening of the regulation of those money funds.
5. Bank capital requirements now apply to all large dealers at the holding company level.
6. The two surviving investment banks became regulated as banks; substantial new bank liquidity
   coverage regulations have been introduced, forcing runnable short-term financing to be covered by a stock of high-quality liquid and unencumbered assets

Question 14

Prone to Fail: The Pre-Crisis Financial System.

Why did the over-the-counter derivatives market contribute to the crisis?

Answer 14

• no regulations of the minimum margin, central clearing, and trade reporting
• unobservable counter-party exposures and the degree of their protection by collateral
• as asset prices related to subprime mortgages fell sharply and concern about counterparty creditworthiness grew,
  margin calls on derivatives acted as a stress amplifier (AIG’s sudden and heavy cash margin calls on
  credit-default-swap protection)

Question 15

Prone to Fail: The Pre-Crisis Financial System.

Regulatory response since the crisis (OTC)?

Answer 15

1. increased use of central clearing
   —> improves the transparency of derivatives positions
   —> enforces uniform collateral practices that are more easily supervised by regulators
   —> all swap transactions must be reported publicly
2. new regulatory capital requirements
   —> all inter-dealer swaps have minimum margin requirements
   —> the largest dealers are now subject to markedly higher capital requirements on their OTC derivatives exposures
3. Compression trading —> fintech approach that helps to eliminate redundant sequences of derivative positions

Question 16

Moore’s Law versus Murphy’s Law.

Explain the two laws.

Answer 16

Moore’s Law in financial markets: from 1929 to 2009 the total market capitalisation of the US stock
market has been doubling every decade
Murphy’s Law: “Whatever can go wrong will go wrong” (faster and with worse consequences when
computers are involved)

Question 17

Moore’s Law versus Murphy’s Law.

3 developments in the financial industry have greatly facilitated the rise of AT?

Answer 17

1. Greater complexity is a consequence of general economic growth and globalisation
2. Quantitative modelling
3. Computer technology

Question 18

Moore’s Law versus Murphy’s Law.

5 major developments that have fuelled growing popularity of AT?

Answer 18

1. Quantitative models in finance
2. The emergence and proliferation of index funds
3. Arbitrage trading activities
4. The push for lower costs of intermediation and execution
5. The proliferation of high-frequency trading

Question 19

Moore’s Law versus Murphy’s Law.

How has the meaning of passive investing changed?

Answer 19

An investment process is “passive” if it does not require any discretionary human intervention— it is based on a welldefined and transparent algorithm. Such a definition decouples active investing from active trading; today, a passive investor may be an active trader to minimise transaction costs, manage risks more adroitly, participate in new investment opportunities or respond more quickly to changing objectives and market conditions.

Question 20

Moore’s Law versus Murphy’s Law.

Execution strategy?

Answer 20

Executing a large order in a single transaction is typically more costly than breaking up the order into a sequence of smaller orders;
The method for determining the timing and sizes of smaller orders is called an “execution strategy,” and optimal execution strategies can be derived by specifying an objective function and a statistical model for stock-price dynamics.

Question 21

Moore’s Law versus Murphy’s Law.

Arbitrage Gone Wild - “Quant Meltdown” - what happened?

Answer 21

The Unwind Hypothesis:
• the initial losses during the second week of August 2007 were due to the forced liquidation of one or
more large equity market-neutral portfolios -> the deadly
feedback loop of coordinated forced liquidations leading to the deterioration of collateral value.
Bottom line: the scaling up and down of portfolios can affect many other portfolios and investors.
AT greatly magnifies the impact of these consequences.

Question 22

Moore’s Law versus Murphy’s Law.

The Perfect Financial Storm - the “Flash Crash” - what happened?

Answer 22

Accenture traded at a penny a share, while Apple traded at $100,000 per share
Reasons:
• An automated execution algorithm on autopilot (a rapid automated sale of 75,000 E-mini S&P 500 June
2010 stock index futures contracts (worth about $4.1 billion))
• a game of “hot potato” among high-frequency traders
• cross-market arbitrage trading

Question 23

Moore’s Law versus Murphy’s Law.

High-Frequency Manipulation types?

Answer 23

• “Spoofing”: intentionally manipulating prices by placing an order to buy or sell a security and then cancelling it shortly thereafter, at which point the spoofer consummates a trade in the opposite direction of
the cancelled order
• “Layering”: placing a sequence of limit orders at successively increasing or decreasing prices to give the
the appearance of a change in demand and artificially increase or decrease the price that unsuspecting
investors are willing to pay; after a trade is consummated at the manipulated price, the layered limit orders are cancelled

Question 24

Moore’s Law versus Murphy’s Law.

Financial Regulation 2.0

Answer 24

1. Systems-Engineered: should approach financial markets as complex systems composed of multiple software applications, hardware devices and human
   personnel
2. Safeguards-Heavy: both human and machine safeguards are necessary to ensure the safe functioning of the system
3. Transparency-rich: should aim to make the design of financial products more transparent and accessible to regular automated audits
4. Platform-neutral: should be designed to encourage innovation in technology and finance and should be neutral with respect to the specifics of how core
   computing technologies work

Question 25

The Economic Consequences of Legal Origins.

What are the economic consequences of legal origins? (French vs English)

Answer 25

Compared to French civil law, common law is associated with:

(a) better investor protection, which in turn is associated with improved financial development, better access to finance, and higher ownership dispersion;
(b) lighter government ownership and regulation, which are in turn associated with less corruption, better functioning labor markets, and smaller unofficial economies;
(c) less formalised and more independent judicial systems, which are in turn associated with more secure property rights and better contract enforcement

Question 26

The Economic Consequences of Legal Origins.

Why does common law lead to better economic outcomes on average?

Answer 26

• Common law is more respective of private property and contracts than civil law
• Common law puts more emphasis on unconditioned private contracting rather than
centrally-directed regulation (“dispute-resolving” vs. “policy-implementing”)
• Common law features a more adaptive framework and evolves over time thanks to
greater judicial independence –> better quality over time

Question 27

The Economic Consequences of Legal Origins.

Toolkits of the two types of law?

Answer 27

The toolkit of civil law:
policies as nationalisation and direct state control
The toolkit of common law:
litigation and market-supporting regulation

Question 28

Towards a Political Theory of the Firm.

Why firms need political power?

Answer 28

The more an economy becomes winner-take-all, the bigger the incentives to corrupt the political system to gain a small, but often decisive, advantage. As a result, industrial titans were at the same time the greatest corruptors
—> In a winner-take-all economy, entrepreneurs lobby and corrupt, not only to seize a crucial first-mover advantage, but also to preserve their power over time as they fear political expropriation

Question 29

Towards a Political Theory of the Firm.

The “Medici vicious circle”?

Answer 29

Most firms are actively engaged in protecting their source of competitive advantage through a mixture of innovation, lobbying, or both
—> when innovation prevails, there is little to worry about
—> when lobbying efforts are dominant, things get problematic: money is used to gain political power and political power is them used to make
more money

Question 30

Towards a Political Theory of the Firm.

Why size of the average publicly listed company in the United States tripled in market capitalisation? Name 2 trends

Answer 30

1. the reduction in the rate of birth of new firms
2. a very high level of merger activity, which for many years in the last two decades exceeded $2 trillion in value per year
   —> increase in profits not caused by capital accumulation

Question 31

Towards a Political Theory of the Firm.

What are the possible explanations of the higher market cap of a firm today?

Answer 31

1. Network externalities: situations in which an increase in usage leads to a direct increase in value for other users
2. Winner-take-all industries: the proliferation of information-intensive goods that have high fixed and low- marginal costs;
3. Reduced antitrust enforcement

Question 32

Towards a Political Theory of the Firm.

Explain a “goldilocks” balance.

Answer 32

The ideal state of affairs is a “goldilocks” balance between the power of the state and the
power of firms.
1. If the state is too weak to enforce property rights, then firms will either resort to enforcing
these rights by themselves (through private violence) or collapse.
2. If a state is too strong, rather than enforcing property rights it will be tempted to expropriate
from firms

Question 33

Towards a Political Theory of the Firm.

Company’s ability to obtain what it wants from the political system is highly dependent upon…

Answer 33

1. its ability to make credible long-term promises = long-term survival probability
2. the grip a company has on the market for specific human capital (for example, how many potential
   employers of nuclear engineers there are)
3. a company’s ability to wrap its self-interest in a bigger, noble, idea
4. the control that a company has through its image in society by way of employment, data ownership,
   media ownership, advertising, research funding, and other methods

Question 34

Towards a Political Theory of the Firm.

The possibility and extent of this Medici vicious circle depend upon several non-market factors…

Answer 34

• the main source of political power,
• the conditions of the media market,
• the independence of the prosecutorial and judiciary power,
• the campaign financing laws,
• the dominant ideology

Question 35

Towards a Political Theory of the Firm.

Several political tools might be put into use:

Answer 35

• increases in transparency of corporate activities;
• improvements in corporate democracy;
• better rules against revolving doors and more attention to the risk of capture of scientists and economists
by corporate interests;
• more aggressive use of the antitrust authority;
• and attention to the functioning and the independence of the media market