I’ve been doing a lot of coffee meetings recently and often, I need to find venues—mostly cafes—that are convenient for both parties. Using Google maps for this can be cumbersome, and so I thought, why not ask ChatGPT-4 to write a simple program that could solve this problem? The app could take two locations and automatically identify a list of coffee shops located roughly halfway between the two addresses.
To my surprise, and in less than 30 minutes of working with GPT and the Python programming language, I had working code. Here’s the output of that initial process.
Wrote this scrappy little app in < 30 mins after dinner thanks to GPT4 help . Now if I have a coffee plans with a friend and want to meet somewhere that's about equally distant for both parties, I punch in the post codes and it maps out the options for me. pic.twitter.com/gzAl91GP8V
While this code was enough for me, it wasn’t user-friendly for non-technical people. So I went back and forth with ChatGPT-4 through a bunch of queries until I cobbled together a web app that anyone could use. You can see how that turned out in this demo video.
Feel free to try out the app here, but only for a short while before my Google Maps API budget is depleted.
What did I learn from this?
Going through this process of iteration and collaboration with AI was fun, but it also drove home a point that most tech-savvy people are already familiar with: AI can write code that works, but it’s not a full-on substitute for a good software developer. (This means now is still a good time to learn to code!)
Deploying even the simplest of apps involves a maze of tools and systems. It’s not just about the code. In my case, I had to set up a Google developers’ account to be able to use their maps technology. (This involved going through their documentation when the GPT-written code turned out to be out of date!) I also had to research and debate the merits of various hosting providers for the app before deciding which one to use. Additionally, I had to buy a domain name and link it to my servers. And then of course, I couldn’t forget the basics, like setting up analytics and regularly backing up the app code on Github, among other steps.
Of course people who do this work daily find it trivial in a technical sense. However, even seasoned software developers grumble about how time-consuming it is to get all these tools and platforms working together for a public-facing app.
Simply put, you can’t fully automate the process of building things that will be used in the real world by real people. We’re not there yet. But what tools like GPT can do is speed up your prototyping process. Furthermore, if you have a touch of technical know-how, you can quickly automate a variety of personal tasks that don’t need to be public or require a full-fledged app. To me, that’s enough reason to be optimistic about how generative AI will meaningfully impact global productivity in the years to come.
Personal branding — assuming brand can even be applied to a complex human being in the same way it can to a commodity — is mostly a by-product of something else: making valuable and meaningful contributions in your areas of interest.
People who tirelessly and directly work on personal brand often do so at the expense of other activities that matter. And at the extreme end, there are some who go as far as fraud just to build a name for themselves. (See this list of fraudulent Forbes 30 under 30 candidates for example).
Paradoxically, and as this paper about the ‘Best-New-Artist Grammy Nomination Curse’ puts it, if you seek recognition directly, you probably won’t do your best work. That’s because people-pleasing antics and unrealistic versions of success are a distraction from what really matters. In contrast, if you care less about public opinion and awards, you may find yourself producing better and more original work.
For these reasons I’m not sold on the idea of spending lots of time on a “personal brand”, especially if it precedes any meaningful contributions from an individual. Attempts to establish a personal brand without genuine achievement are, at best, fruitless busy work and, at worst, delusional.
Only a select few can pull off a personal brand. It emerges in its strongest form after incredible achievement. Beyonce, Michael Jordan, Steve Jobs: each of these individuals has a great personal brand. But in all cases their mastery of craft preceded mastery of image.
Chances are, you won’t tread the same path as Bey, Mike, or Steve. That’s okay. It means you can skip the personal branding frenzy. Instead, focus on doing exceptional work and contribute meaningfully in your areas of interest. Your reputation will naturally grow and you won’t have to rely on a contrived personal image to open doors. Let the superstars have their personal branding. For the rest of us, there are more impactful ways to invest our time.
I’ve been reading Fred Wilson’s blog for almost a decade and his writing inspired my move into venture capital some years back. He’s a seasoned early-stage investor and a co-founder of Union Square Ventures, one of the best venture capital firms of all time. (They invested in the likes of Stripe, Twitter, and Coinbase).
I’m still reading through each and every one of Fred’s blog posts because there’s a ton of early-stage investing knowledge in it, and his writing is such a delight to read. But as a fan of his blog I also wanted to create an interactive way of traversing his knowledge base.
ChatVC: An AI bot that uses avc.com blog posts.
Enter GPT, Langchain, and Chromadb. These tools helped me quickly build a prototype chatbot that I could ask questions about early-stage investing. Below are some gif examples of the answers I can get from the bot. I also tweeted about it here. How did I build it?
How did I build it?
There were broadly three steps. First I used an open source Python library called BeautifulSoup to extract all the text from https://avc.com/. Second, I created an AI-native database of that text using Chroma. This part is really cool because Chroma stores the text in a highly multi-dimensional space where related concepts can be found easily. Finally, I used Langchain to connect to OpenAI’s GPT model for chat and language capabilities. (The user interface is powered by Gradio.)
All this sounds super technical for non-coders, but I’m not a software engineer by the way. I’ve completed online coding classes before and I know a few basic programming principles, but it’s not my area of expertise. I built this VC AI by using open source tools and asking ChatGPT for a lot of help!
Implications for Entrepreneurs
If I can build something like this over a few evenings, and the technology that enables people to do it is getting simpler and more accessible, we’re going to see a massive rise in the number of people who can create software tools and apps. And one of the things I’m excited about here is that entrepreneurs who previously weren’t technical enough to start a tech company can do so without the hurdle of having to find a technical co-founder. That partner could be an AI.
Implications for Investors
I’ve built a prototype investor chatbot for personal use and learning but I don’t believe it can displace any seasoned investors, yet. Coincidentally, just as I was finishing the prototype, Fred Wilson wrote about this same topic yesterday and he makes a number of points that I agree with.
The thing is, there are facts, there’s knowledge, and then there’s wisdom. Everyone has cheap access to facts. Wikipedia does a wonderful job of that. Many people also accumulate knowledge with time and some expense – i.e. the know-how and nuance of applying different facts and ideas in a specialist area. AI is now getting really good at this.
The final element is wisdom, and that’s hard-won. It’s very human. It involves living through an experience and internalising the whys and counterfactuals of what happened and what could have happened. I can’t just read a blog post from Fred Wilson or ask an AI about how to deal with a situation and all of a sudden become a wise person. That takes significant time, reflection, and tangible practical experience.
AI might become wise some day, but from what I’ve built and learnt about large language models so far, it will be exceptionally difficult to replicate that. I remain open to the idea that this could change quickly if some new innovation in AI emerges. For now though, I don’t think investor jobs are going to be displaced by bots. Investing will, however, be augmented by AI.
The excitement that surrounded the personal computer revolution in the 1980s and the advent of the world wide web in the 1990s has surely been eclipsed by what’s going on in artificial intelligence today.
Bill Gates – who was around for both eras – believes that the “development of AI is as fundamental as the creation of the microprocessor, the personal computer, the Internet, and the mobile phone.”
The Economist and others go further. They liken what’s coming with AI to the impact the printing press ignited 600 years ago, when a new general purpose technology led to an explosion of knowledge and productivity, as well as widespread upheavals and disruptive social change.
ChatGPT – the fastest-growing internet app ever – and the large language model that powers it are the fuel behind the excitement. The app is unlike anything we’ve ever seen. It’s so good at answering a wide variety of questions that it feels as if you’re chatting to the collective knowledge of humanity (or at least the publicly available text the AI was trained on.)
Note: ChatGPT is the fastest growing app of all time.
I’ve worked in tech as a “non-techy” person on the investment and operational side of things for several years now, and I get to meet technologists often. I also often seek out and synthesize non-mainstream content about technology from a diverse group of friends, Twitter accounts, forums, and niche blogs. Never in this time have I felt a greater sense of technology acceleration than now.
From AI researchers highlighting that “2023 has already seen more advances in AI than any other year,” to hearing from software developers about how thrilled they are to build on this new technology, and how some are terrified of it (the potential near term challenges and long run risks should not be ignored), the path ahead is going to be full of surprises.
Note: Computers that train AI models are doubling in power every 6 months. This means a 1000x increase in power every 5 years if the trajectory continues. [Chart by Sevilla et. al 2022 and adapted by Korinek 2023.]
How should we prepare? I’m not entirely sure since I’m also just coming to terms with what’s happening. However, I’ve adopted the technology early (I first spoke about GPT on a BBC show back in 2020); I’m exploring how I can invest in entrepreneurs who are building AI tools that will get us to the future more safely; and I want to learn and do more of what makes us positively and uniquely human.
My hope is that we end up in a future where AI helps us solve some of the world’s biggest problems, rather than make them worse. But for that to happen, a lot more of the public will need to engage the topic today.
University has never been more expensive, so is it still worth it if it will cost new students £100,000 in graduate debt and take 40 years to repay?
Recently we’ve seen the cost of everyday items skyrocket. From pasta prices to fuel and energy bills hitting record highs. But while the cost-of-living crisis is making headlines, a lesser-told story is the fact that the average graduate today ends up with almost three times as much student debt as they did 10 years ago.
In addition, this cost-of-education crisis is expected to balloon further. The upcoming changes to the student loan system could see graduates pay back £100,000 of debt and interest over their working lives.
With such a huge price tag, you would expect university to still be the superior option. However, the research I conducted for my book, Is Going to Uni Worth it?, showed that there are many cases where an alternative, such as an apprenticeship, could be a better option.
How can you determine what’s likely to work for you? There are five key areas detailed in the book, but answering the three questions below can act as a starting guide.
1. What do you want to do in the future?
If you know what you’d like to do in the future and that path requires a degree, university is an obvious choice. For example an aspiring astronomer or biologist must complete a degree. In contrast, you don’t need a degree to work as a journalist, accountant, or banker. These careers can be pursued via an apprenticeship.
2. What’s your learning preference?
University emphasises academics (i.e. lectures, reading assignments) while an apprenticeship focusses on the practical applications of knowledge. Practical learners are therefore better served by an apprenticeship, while conventional academia is better pursued at university.
3. What’s your affordability consideration?
Some university courses can be expensive. For example, just 4% of doctors come from a working-class background, and part of the reason for this is that many graduates of medicine accumulate £80,000 or more of student debt and often require additional financial support from their family to complete their training.
Thankfully, from 2023 it will be possible to train and qualify as a doctor by taking a degree apprenticeship, which doesn’t come with the student debt of a traditional path. So if you wished to be a doctor and the cost was out of reach, a degree apprenticeship would be a no-brainer.
These three questions are just the start when it comes to figuring out whether university is for you or not. But — as is the case with all interesting decisions — there’s no perfect answer, just one that’s good enough and hopefully worth it for you.
The world emits about 50 billion tonnes of greenhouse gases annually. In contrast, the average UK citizen contributes roughly 10 tonnes each year to the grand total. This represents one part in every five billion parts of global emissions. It’s one fifty-millionth of a percent (0.00000002%). In other words, it’s a rounding error and practically negligible, according to some people.
Given how tiny our personal carbon footprints are, it’s easy to dismiss individual efforts. It’s also common to feel despair about how much influence you can really have on climate change – after all, what meaningful difference can a ‘one fifty-millionth percenter’ make in the grand scheme of things?
In recent months I’ve come to appreciate that our personal action matters more than we realise. In fact if you combine a lower personal carbon footprint with climate activism, the impact you can have is hugely meaningful. Here’s how I see it.
Every tonne of CO2 matters
First, let’s bring to life what 1 tonne of CO2 really looks like. This is roughly the amount someone in the UK emits every 5 weeks. Below you’ll see how much volume you can fill up with just 1 tonne of CO2.
Now imagine dumping one of these cubes or balls outside your home every five weeks for 60+ years. Would it be something you’d ignore? Is it really that negligible? Or, does this volume of CO2 actually count and would you be compelled to do something about?
What you do is magnified negatively or positively
Our collective impact on the planet is unquestionable. We already haveirreversible climate damage and events such as the recent 1-in-a-1,000-year heatwave in Canada – which was 150 times less likely to happen without human influence – are a testament to this. But surely our individual action is so tiny that there’s no point trying, right? This statement is wrong on two accounts.
1.Negative Knock-on Effects
Although the world’s climate is a complex system and it’s impossible to know what specific bit of pollution could lead to catastrophe, all excessive emissions play a part in destabilising the system.
Consider a game of Jenga as a rough example. At first, you can remove several blocks without affecting the overall structure that much. But as you remove one block after the other, you eventually get to a point where a small change is followed by the entire system collapsing.
In the Jenga example, small changes appear harmless until they aren’t. This is also the case with climate. Someone’s pollution seems harmless but in the background, it’s linked to a collective instability that each one of us—to varying degrees of course—is responsible for. So although one person’s footprint will always appear negligible in isolation, its systematic influence – which accumulates as time goes on – isn’t. Tiny changes can drive harmful butterfly effects.
2. Positive Knock-on Effects
The things you do about climate can also have wider positive knock-on effects. For example if you decide to live an eco-friendly life, your friends will take notice and ask about it. This won’t necessarily turn them into climate activists, but in learning about your choices, your friends (and their friends, too) might consider doing something good for the planet.
You can also multiply your impact through activism. And when I say activism, I don’t just mean just going out on the streets and campaigning – although this is certainly a proven means of enacting change. You can be a climate activist in other ways.
For instance, you can amplify your impact when you vote for and support politicians who are serious about climate change; you can influence sustainable investments with your wallet when you spend money with climate-positive businesses; and finally, you may also choose to put your talents and time to work at an employer that’s aligned with a greener future, just like I did when I joined tickr.
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The challenges of climate change are undeniably epic. Governments and corporations will have to work hard together at a global level to avert disaster. However, what’s clear to me now is that there’s no reason to feel despair about how much you can do on personal level.
All our carbon footprints count. Who we vote for and where we spend our money and time all matters. And although our individual actions might not count for much in isolation, the reality is that they often go further than we realise – certainly much further than our ‘one fifty-millionth of a percent’ would suggest.
‘How to Avoid a Climate Disaster’ is a fantastic read for people who are new to climate change. To my surprise, Bill Gates is also relatively new to the space (although he’s ahead by over a decade compared to most people!) He changed his mind on the topic in 2006 and I believe his newness to the topic led to a more accessible climate book. In the introduction he writes:
“Things changed for me in late 2006 when I met with two former Microsoft colleagues who were starting nonprofits focused on energy and climate. They brought along two climate scientists who were well versed in the issues, and the four of them showed me the data connecting greenhouse gas emissions to climate change.
I knew that greenhouse gases were making the temperature rise, but I had assumed that there were cyclical variations or other factors that would naturally prevent a true climate disaster. And it was hard to accept that as long as humans kept emitting any amount of greenhouse gases, temperatures would keep going up.
I went back to the group several times with follow-up questions. Eventually it sank in. The world needs to provide more energy so the poorest can thrive, but we need to provide that energy without releasing any more greenhouse gases.”
How to Avoid a Climate Disaster (Hardback version, Page 7)
Bill Gates does well to avoid technical jargon in the book, and balances pessimistic realism with reasons to be optimistic. This makes the book an easy and encouraging read.
Below are some of the highlights I made in the book but the full title is worth reading if you’d like to learn more about climate change and what we can do about it.
We add 51 billion tonnes of greenhouse gases to the atmosphere annually. That’s about 1 billion a week. The warming impact is equivalent to detonating 1 Hiroshima-sized nuke every second of every day, all year round.
Greenhouse gases are roughly composed of CO2 (76%), methane (16%) and nitrous oxide (6%). But even though methane and nitrous oxide are a smaller portion of the total, their warming impact is significantly larger. Methane causes 28 times more warming per molecule in 100 years compared to CO2. Meanwhile nitrous oxide causes 265 times more warming per molecule over a century. (See Box 3.2, Table 1 here.)
The fossil fuel energy industry is huge and will be resistant to change. It generates $2-3 trillion of revenues a year. That’s like the GDP of a rich country. For example it’s more than the GDP of Canada or Italy, and close to that of the UK.
The energy sector needs to urgently invest in the research and development of clean energy technologies given the climate emergency we face. However, it only invests around 0.3% to 0.4% of its revenue in R&D. The electronics and pharmaceutical industries do over 30 times that amount, with 10% or more of revenues invested.
A small rise in global warming seems harmless but it isn’t. The Paris Agreement aims to keep it below 2.0°C relative to pre-industrial levels and ideally below 1.5°C. But if we go from 1.5 to 2.0 it won’t just be 33% worse. The damage could be 100% worse or more since climate is a non-linear system. (On a related note, researchers estimate that based “on current trends, the probability of staying below 2°C of warming is only 5%.” The temperature scale below from a book called ‘The Madhouse Effect’ shows what the impact of this could be.)
Oil is so cheap that it’s cheaper than a soft drink. In 2020 a barrel of oil cost around $40—that’s just 25 cents per litre. In pound sterling today that’s 18 pence, while a litre of coke at Tesco costs £1.45. (Notice that even though oil is cheap today, the price doesn’t reflect the potentially irreversible costs of climate change.)
Around 50% of global CO2 emissions come from just 15% of the world’s countries. These are China (27%), USA (15%), EU and the UK (10%). (Bill Gates framed this slightly differently in his book, noting that “nearly 40% of the world’s emissions are produced by the richest 16% of the population.”)
The major sources of greenhouse gases are listed below (from page 55 of the hardback version of the book).
Cement is especially worth highlighting. The following statistic isn’t from Bill Gates’ book but it’s telling nonetheless: “If the cement industry were a country, it would be the third largest emitter in the word,” according to Carbon Brief.
If we transition to clean energy for all our electricity, we’d have to pay a bit more in the short term. For Americans this would be around 15% (a Green Premium of $18/month for the average home) and around 20% for Europeans.
Transmission and distribution make up a considerable portion of the cost of electricity. Bill Gates cites that this is more than a third of the final cost. The number I found for the UK is around a fifth.
Although solar cells are almost 10 times cheaper since 2010 (which is fantastic progress), they are starting to reach their efficiency limits. The best solar panels convert less than 25% of sunlight into electricity and the theoretical limit for current technology is around 33%.
Lithium-ion batteries might also be reaching their peak in terms of how long they can last and the number of charge-discharge-cycles they can go through. Bill Gates believes that we can probably make batteries 3 times better but we’re unlikely to get a 50x improvement.
Nuclear energy sounds scary. People often cite accidents like Fukushima (2011) and Chernobyl (1986) as reasons for why we shouldn’t use it for electricity. However deaths per terawatt hour (“TWh”) are far less for nuclear (0.07 people) compared to coal (25 people) or oil (18 people). (Ps. The UK uses around 1 TWh in a day.)
The UK is currently the biggest user of offshore wind energy but China will likely take that position within a decade. (Ps. Offshore wind powers around 10% of the UK’s electricity and could be cheaper than gas by 2023.)
Carbon capture is an exciting new technology that can remove CO2 from the air directly. However, it’s technically challenging and expensive. This is because CO2 makes up just 1 molecule for every 2,500 molecules in the atmosphere (or 3.8 per 10,000).
Americans waste 30-40% of their food while in the UK it’s about 16-18%. (For Europe it’s 20%.)
Since 1990 the world has lost an area of forest that’s almost 4 times the size of Germany. That’s around 1.3 million square kilometres of forest cover.
The poorest countries will suffer the most from climate change yet they are the least responsible. For example, Africa accounts for just 2-3% of global emissions but it will be the hardest hit by climate change. This BBC article covers why this is the case.
Most people believe that only the Bank of England can create money. Many people also believe that high street banks can only lend money if they have enough savers’ deposits to lend from. But as I’ll explain shortly, both views are mistaken.
It’s true that once upon a time that’s how things worked. A central bank like the Bank of England had a monopoly on money creation and prior to 1931, this money was pegged to gold reserves.
Meanwhile, high street banks could only hold bank deposits in the form of savings from customers. And since savers rarely need all their money at once, banks would profit by lending out a portion (or multiple) of customer deposits at a higher interest rate than that offered to savers.
A sketch of how money used to work.
This isn’t how money works in the UK economy today. The reality is stranger than intuition would suggest. I certainly wouldn’t have believed the mechanics either had I not read a full account of the process in a 2014 bulletin published by the Bank of England itself.
It turns out, the Bank of England hasn’t got a monopoly on money creation. Commercial banks such as HSBC, Barclays, and Lloyds all create new money every time they issue a loan. They create this money as a digital entry that represents a new bank deposit for the borrower. So if I take out a loan of £1,000 from a bank, here’s what roughly happens:
The bank creates a new digital bank balance of +£1,000 in my account. It doesn’t need to draw from customer savings to create this balance. It just makes a digital entry.
The bank recognises a new ‘asset’ in its accounts because it now expects a future repayment from me that’s worth £1,000.
The bank also recognises a new matching obligation (or liability) of £1,000. This is because it has made me a promise—an I owe you (“IOU”)—that I can go to a cash machine and withdraw £1,000 in hard cash if I wanted. I can also send some or all of this digital IOU to others as payment for goods or services. This would transfer the IOU made by the bank to me, to an IOU the bank makes to another individual or business.
When I repay the loan, the new money that was created by the bank is cancelled out and destroyed. Any extra bits I repay as interest are kept by the bank as profit. Such earnings are usually held by the bank as ‘capital’—amounts which ultimately benefit the shareholders and other funders of the bank.
When I learnt about this process I expected these digital bank deposits to be a small fraction of money in the UK. But this expectation is wrong. Digital bank deposits make up the majority of money in the economy.
According to the Bank of England, around 80% of all money in circulation is created digitally by commercial banks. The remainder takes the form of currency (banknotes and coins) and central bank reserves (electronic money that commercial banks hold with the Bank of England). These make up around 3% and 18% of money in the UK economy respectively and only the Bank of England can create them.
If we focus on just the money that people and businesses use (so if we exclude central bank reserves), digital bank deposits make up 96% of money while just 4% is physical currency.
The curious among you will now have more questions about how all this works.
Do banks create money from thin air?
Is your personal income in the bank ‘real money’?
What stops high street banks from creating too much money if issuing loans isn’t restricted by lending from customer deposits?
Where does the Bank of England fit in? Does it also create money from nothing given it doesn’t hold gold reserves for every pound sterling?
How do banks fail?
These are all good questions. I got sucked into a rabbit hole of inquiry trying to answer them and the next 3,000 words reveal what I found.
The following section will condense a lot of complexity but if you can get through it, you’ll know more about how money works than 85% of politicians in the UK and probably over 90% of the general public.
We start with some key definitions before moving onto the questions of how money works in practice.
Key Definitions
Money
Money is just an “I owe you” (IOU) that’s easy to move around. It’s a recorded promise to deliver value in the future but critically, if everyone trusts the issuer of that promise, you can exchange that IOU directly with other people for other goods and services.
Early versions of this system can be traced back to English goldsmiths in the 1600s. You could store gold or silver with them and they would issue a “promissory note”. This piece of paper promised that you could withdraw your precious metals from a secure vault at some point in the future. Since other people also trusted goldsmiths, you could trade your promissory note with other people directly for other goods, rather than go back to the goldsmith to fetch your gold or silver for trade. Promissory notes were IOUs that were easy to move around, just like today’s money.
The best IOU object—whether it’s digital or in paper form—does three things well. First, it reliably stores value over the long term. Second, it’s accepted by everyone as medium of exchange. And finally, it’s used everywhere as a unit to measure the value of goods and services.
Modern money achieves all these functions wonderfully. It’s a trusted store of value (so I trust that the Bank of England will protect it from losing its worth); it’s accepted as a medium of exchange by everyone (and more importantly, it will always be accepted by the UK government when I pay my taxes); and finally, everything I buy or sell is valued and denominated in pound sterling, not some other unit of account.
Bank Deposits
A bank deposit is a digital form of money. It’s an electronic IOU that you hold in your bank account. It’s created by high street banks every time they issue a loan and it’s distinct from currency (which we’ll cover shortly.) As I shared earlier, bank deposits make up over 90% of all the money that people and companies hold in the UK.
‘But if this money is created when banks issue a loan, what are my savings then?’ you might ask. We’ll answer that in the questions section later. For now, just know that bank deposits are digital IOUs created by the likes of HSBC, Barclays, and other banks.
When you take out a loan, a bank just makes a digital entry that represents an IOU to you. It’s a promise of value from a bank that you can cash in (literally) when you decide to withdraw that loan as physical money.
These digital IOUs are easier to move around than physical money. So instead of withdrawing cash and paying for goods, you can just wire a portion of your digital IOU to someone else’s bank account. In that instance, what the bank owed you becomes something the bank owes to the recipient of your payment. And since everyone trusts that these digital IOUs can be converted to cash, they are widely accepted as money. The Bank of England also provides further security: If a bank fails, up to £85,000 of your bank deposits are guaranteed by the government.
Currency
This is basically cash. It’s a physical record of an IOU from a central bank. It comes in the form of banknotes and coins that are manufactured and backed by the Bank of England. Only central banks can create this type of money and it represents just 4% of all the money that households and businesses have.
High street banks always have some currency to meet daily customer cash withdrawals. They buy it from the Bank of England using central reserves, which I’ll define next.
However, banks don’t need large holdings of currency because it’s unlikely that all customers would ever want to withdraw their full bank deposits at the same time. In addition, most people and businesses prefer the convenience of digital bank deposits. Currency is falling out of favour as you can see from the BBC chart below.
Central bank reserves
This is digital money created by the Bank of England for use by commercial banks only. Since a Barclays can’t create money to pay a Halifax or vice versa, central bank reserves are used as the ultimate settlement medium between banks. These reserves can also be exchanged for currency so that banks can meet customer cash demand.
How is central bank money created? Here’s a quote from a Bank of England handbook that explains the process:
“Unlike banknotes there is no physical cost to producing reserves, the central bank can create reserves simply by pressing a key on a keyboard to credit a commercial bank account.”
In other words, central bank reserves are created digitally, just like the money you have in your bank account. The main difference is that only banks can use this money. We’ll look at an example of this use later on.
Central bank
Each country has a “central” bank that manages its currency. In the UK we have the Bank of England (sometimes known as “the Bank”—with a capital “B”).
One of the Bank’s primary objectives is to help keep the value of money stable and to make sure there isn’t too much or too little of it. Without this stability, few people in the UK would adopt the pound as a medium of exchange or as a store of value.
The Bank can influence the stability of money by adjusting interest rates or creating more money (some people refer to this as “printing money” but the Bank does it digitally). You can read about how interest rates impact the economy here and how creating more money can stimulate spending in the economy here.
Although the Bank of England is owned by the UK government—and it returns most of its profits (around £400m per year) to HM Treasury—it’s independent from it. What does that mean in practice? Here’s a quote from the Bank’s website:
“Independence means that we can promote the good of the people of the UK by maintaining monetary and financial stability, free from political influence.”
Commercial (or high street) banks
This is all the banks you know, such as Monzo, RBS, Lloyds, Barclays and others. They are formally designated as ‘credit institutions’ and have permission from regulators to take deposits, make loans, and create new money.
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Now that we know the different types of money and the distinction between central banks and high street banks, we can look more closely at how money works in practice. We’ll do that by addressing six key questions on the process.
FAQ on How Money Works in the UK
Do banks really create money from thin air?
No. This is because money is always linked to an IOU—a promise to deliver value at some point in the future. A brief historical detour on money makes this point clear.
Hunter gatherers didn’t need money (or IOUs) because they provided everything for themselves. But as life got more sophisticated, barter trade emerged. People would now trade various commodities for items they couldn’t get themselves, such as salt in exchange for clothes or spices for weapons.
This method of exchange only worked up to a certain point though. For example, if I needed to trade my ripe tomatoes today but I wasn’t sure what else I needed and when I needed it, my produce would go bad or I’d have to get spices or salt that I didn’t need.
This is where money as an IOU comes in. Rather than barter trade my tomatoes for a random commodity I didn’t need, I could go to a trusted party and get an IOU in exchange for my tomatoes. The issuer of the IOU would then promise to deliver some equivalent value to me in the future. Meanwhile, I could hold onto the IOU or trade it for other goods as long as other people trusted the IOU issuer as well.
This is what modern money enables. It transforms value into an easily exchangeable object that can move across time and space.
So when a bank issues a loan and creates a bank deposit, it isn’t really creating money from thin air. Instead, it’s transforming a borrower’s future ability to repay into an object that can be used today. Repayment is crucial and it’s why banks run credit checks to make sure borrowers can pay back their loans. Banks also charge a high enough interest on loans so that profits from lending can cover losses on the few debts that go bad.
Put in simpler terms, money used to be created by linking it to gold or some other precious object. Today, it can also be linked to someone’s ability to generate value in the future. Therefore money isn’t made from nothing. It’s always linked to value somewhere.
What stops banks from creating as much money as they want?
Commercial banks can’t issue loans and make new money without limit because doing so would put them out of business. There’s a variety of ways this can happen but let’s look at three factors that protect against this.
Regulation (by the Prudential Regulation Authority) – Commercial banks are highly regulated and there are rules on how financially sound they need to be. More specifically, if a bank lends too much money, it exposes itself to more risk of losses from loans that go bad. Such a bank would therefore need larger buffers of its own funding (i.e. ‘capital’) that could absorb potential losses. If the bank failed to secure enough of a buffer—as is required by regulators—it could lose its permission to operate. Here’s a recent example where regulators asked Monzo to increase its ‘capital’ to guard against potential losses.
Market forces (from other banks, businesses, and households) – A bank can only lend money if it has borrowers to lend to. And not just that, but the pool of credit-worthy borrowers is limited. So even if a bank finds enough good borrowers, it has to compete for them against other banks. One way it can do this is to offer loans at low interest rates. Yet, if the rates are too low the bank would risk making losses that could put it out of business. Lending (and money creation) is therefore limited by the opportunities a bank can find to lend money at a profit.
Interest rates (set by the Bank of England) – Another factor that influences the amount of money creation is the interest rate the Bank of England pays on central reserves held by commercial banks (i.e. the “Bank Rate”). You can read more about this here but the basic principle of this factor is this: If there’s too much money and lending in the economy, the Bank of England can raise the Bank Rate. This change usually flows through to the wider economy such that banks now have to pay more interest on savings and in turn, they have to charge a higher interest rate on loans. If loans are more expensive, less people will borrow money and that ultimately limits the creation of new bank deposits.
Are the savings and wages in my bank account real money?
Yes. They are real money to the extent that whatever deposit you have in your bank account, other people and businesses can accept it as payment.
You might now wonder: “My employer pays a salary into my bank account without taking out a loan. They have accumulated their own deposits by selling products or services. So if my salary isn’t linked to a loan, where do the bank deposits from my employer come from?”
I couldn’t find a definitive answer to this in my research but here’s what I believe is happening. If it were possible to go back in time and fully trace the family tree of where a bank deposit in your account came from, you’d probably find that a loan sparked its creation.
Consider the following facts. At the time of writing this blog, the private sector (excluding banks) in the UK held around £3 trillion of money. Guess how much debt the private sector has? Put another way, how much money do people and businesses owe to banks? When I wrote this it was around £3 trillion also. The chart below shows what these figures looked like historically.
Remember, money is an IOU and the majority of bank deposits in the UK are naturally linked to debt. That debt is then transformed into digital deposits that spread throughout the economy. This includes the money sitting in your account today.
How do payments between banks work?
Since each bank creates money when it issues loans, there has to be a way to use the sums created at one bank as payment to another bank account. This happens in two ways.
First, banks can offset payments against each other. For example if I send £100 from my Monzo account to a Barclays customer, there will also be payments flowing in the other direction that can offset what’s owed.
In our example, let’s assume a different Barclays customer has sent £150 from their account to another Monzo user. We now have a situation where the IOU Monzo had with me (it owed me my £100 of savings) has been transferred to an IOU it has with Barclays.
Conversely, the IOU Barclays had to its customer of £150 has now been transferred to an IOU Barclays has to Monzo. Still with me? Here’s a visual representation of this.
Given these exchanges, the two banks can just net off the two amounts to arrive at a net obligation. In this case, Barclays has a net IOU of £50 to Monzo (and in turn, Monzo has that IOU to the customer who was sent the £150).
Notice that Barclays can’t just create new money to settle the obligation it has to Monzo. It has to use another resource. This is where the second settlement method between banks comes in.
All commercial banks have an account with the Bank of England that holds their respective central bank reserves. Remember we defined central bank reserves as money that the Bank of England creates specifically for other banks to pay each other. We’ll come to how this money is created shortly, but for now, just know that all commercial banks have a portion of their ‘worth and savings’ (in other words assets) in the form of central bank reserves. They can draw from this balance to settle obligations with other banks when the offsetting method isn’t sufficient.
In our example, all Barclays would now have to do is ask the Bank of England to send £50 worth of central reserves from its account to Monzo in order to settle its obligation.
I wanted to write more about this process because there’s more to it. But given the 4,000 word limit I set myself we’ll have to stop here. For those who are super curious though, here are some quick facts about bank settlement systems in the UK and the relevant links where you can learn more.
High value transactions (on average £1m+ or for things like buying a house) don’t happen with the offsetting system I described earlier. Instead, they go directly through a Bank of England accounting system called ‘real-time gross settlement’. These payments are dealt with one-by-one but through a ‘clearing house automated payment system’ called CHAPS, which draws from central bank reserves.
In 2019 CHAPS payments were just 0.5% of the volume of payments in the UK (around 192,000 transactions a day) but they represented 92% of all the sterling value (£83 trillion for the year or £330bn every working day.)
You might have heard of payment technologies like Faster Payments or Bacs. These systems are not operated by the Bank of England and deal with smaller value transactions. They allow banks to offset amounts with each other first, and then the final net obligation is sent to the Bank of England for settlement with central bank reserves through its real-time gross settlement system.
How do commercial banks get central bank reserves?
High street banks accumulate central bank reserves in three ways.
First, they can receive payment from other banks in the form of reserves—we covered this in the previous section.
Second, and more commonly, banks can borrow reserves from the Bank of England for a six-month period. This lending doesn’t come for free though. Commercial banks must offer the Bank of England a high-quality asset that it will hold until the loan is fully repaid. This ‘collateral’ is typically a high quality financial asset such as a gilt (i.e. a government bond – this is an IOU of future payments from a government to the bond holder). The diagram below from the Bank of England visualises this process.
Note: The Bank creates new central bank reserves when it lends money to commercial banks.
Finally, commercial banks can get more central bank reserves by selling high quality financial assets to the Bank of England. Again, these are usually government bonds or other low-risk assets.
How do banks fail?
There are two main ways a bank can fail.
First, if we all decide to go to a bank and withdraw all our deposits as cash today, the bank would face a ‘liquidity crisis’ and go under. This is because no bank actually keeps everything it owns in the form of central bank reserves or currency. The majority of bank assets are in a less liquid form (e.g. its loan book and other investments) but so long as people have confidence that the bank’s finances are sound, this liquidity crisis—or ‘a run on the bank’, as it’s better known—is unlikely to happen.
The second way a bank can fail is if it ends up in a situation where the value of everything it owns (its assets) falls below the value of everything it owes (its liabilities.) This can happen if a bank issues loans recklessly to lots of borrowers who fail to pay back what they owe. In that instance, the following would happen:
The bank would have more liabilities than assets.
It would be considered ‘insolvent’.
Investors who originally funded the bank (by buying its shares or lending it money) could force it to shut down and sell everything it owns so that they could recover their capital.
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That’s all for now on how money works in the UK. I left out a lot of detail to keep the blog readable but I look forward to discussing this with readers and friends.
Bonus question 1: Why isn’t currency linked to gold anymore?
The ‘the gold standard’ was abandoned because it was too rigid. Fiat currency—so currency that isn’t pegged to an underlying asset—gave governments more flexibility in managing their money supply and ultimately, their economies.
In fact someeconomistsargue that the gold standard made the great depression in the 1930s worse. Meanwhile the UK fared better because it was able to control its money supply without being tied to how much gold was available.
All told, pegging currency to gold risks more economic volatility and many governments prefer to have more control of their money supply than what’s possible with a commodity-linked currency.
Bonus question 2: If currency isn’t linked to gold, how can it be worth anything?
It all comes down to trust. And currency and central bank reserves are currently the most trusted IOUs you can get. They are a promise of value from the central bank and ultimately the government.
Moreover if I have £10 today, I trust that the Bank of England will always honour that value in whatever type of money they create in the future. I also know that the government will do what it can to help maintain its value over time and that it will always accept currency as payment for tax.
This—along with wide public acceptance of its worth—is what makes fiat currency valuable, even if it isn’t linked to gold or some other commodity.
Ps. Other interesting things I discovered during my research.
How does one interview for the job of Governor of the Bank England? Here are the answers Mark Carney had to give to a selection panel when he applied for and the job.
What’s the most common banknote in the UK? The £20 note accounts for almost half of all banknotes in circulation in the UK economy both by volume and value.
Will the Bank of England ever make central reserves available to the public and non-bank private sector? Possibly. Here’s a discussion paper from the Bank that considers the opportunities and challenges of a widely used central bank digital currency.
Do more, we’re told. You’ll be happier when you do more. This is because when you achieve more, you’ll be more. ‘More of what?’ you say. ‘More worthy,’ they say.
People who achieve lots are admired by society. People who do little, well, we forget about them, mostly.
We equate doing more with being more worthy. Do well at school so you can be more. Do well at your job so you can be more. Achieve mastery and you’ll be more. Help lots of people and you can be even more. Of course, you can also make more money so you can buy more things and then you’ll be really more—more worthy than everyone else.
But there’s something deeply wrong with this kind of more because how much more is enough? How much more must you do to be more enough to be enough. How much money makes you enough? How much achievement makes you enough? How much of helping others and the world makes you enough? Is enough even possible? Not with the kind of ‘do more to be more worthy’ we’ve grown accustomed to. That kind of kind of more is a social construct with a reliably moving goalpost.
Want to know a secret that will set you free from this trap of more? It’s simple. Recognise that you are already more than more could ever be. You are the universe manifesting itself. Think about it. All your atoms—and the rest of the universe—came from a single point of infinite density 13.8 billion years ago. This singularity turned into an explosion of atoms, some of which organised into complex, sentient, thinking, feeling beings. That alone makes your life—and all lives for that matter—both infinitesimally rare and infinitely worthy. You are already more than any more can ever be.
But maybe you still think doing more makes you more worthy and that when you achieve no more you are worth—less. Well how about this: think about your best friend (or partner or kids). Do you love them more when they achieve more success? And when they do less do you love them no more? In the best relationships none of this matters. The person is infinitely worthy regardless of their achievements. Now if you can have that kind relationship with others why not have it with yourself too?
If you were your best friend you’d be worthy whether you did more or less. Of course you’d want your best friend to be happy, and some of that comes with doing more to be enough materially. But doing more to be more worthy doesn’t get you to happiness. Recognising you are already enough is what gets you there.
So do less, I say. Try it, even if for a short while, and see how it feels. The worse it feels the more trapped you are in doing more—in which case reading this couldn’t have come at a better time.
Afterword
This was a note I drafted to myself in 3 bullet points initially. Then I played with it some more by turning it into stylistic prose without the confines of formality or tightness of argument. Doing this more freely meant the first draft came out effortlessly, with the second and final drafts needing just a few minor tweaks.
The note is inspired by themes I’ve long thought about on the need for overachievement, and the works of Michael Singer (see “The Premise” chapter in the book “The Surrender Experiment“) and David Burns (see “Your work is not your worth” chapter in the book “Feeling Good“).
Venture capital is a power law business: most of the underlying investments fail¹ while a tiny fraction generate the bulk of returns. This is in contrast to normal distributions where most outcomes cluster around some central value.²
The chart below — which roughly follows a power law distribution — shows that most investments (65% of companies) don’t work out but a few (4% of companies) can generate 10 to 50 times your money or more.
Moreover when you look at fund-level performance, you find that it’s that very small number of investments that drive aggregate fund returns. This can be seen in data from Horsley Bridge — a limited partner in A16Z and other funds — which found that 6% of investments generated 60% of fund returns.
But why exactly do venture capital fund returns (and the underlying entrepreneurial ventures) follow a power law distribution? What leads a tiny minority to significantly outperform the overwhelming majority? And when you understand power law drivers, can you tilt the odds in your favour?
To answer these questions I spent a few evenings and weekends scouring academic literature on power laws. Admittedly some of the maths involved is beyond me, but I did pick up on 3 possible power law drivers that are worth internalising when starting a business or investing in startups.
Power Law Drivers in Entrepreneurship and Venture Capital
(1) Preferential Attachment
This power law mechanism is commonly expressed in the maxim ‘the rich get richer’. Or if you’re religiously inclined, the Bible says ‘for whoever has, more will be given to them.’
Academics call this phenomenon preferential attachment (or cumulative advantage). It’s when an initial endowment makes subsequent gains more likely. This leads to a privileged position where early wins lead to further benefits that cumulatively add up to an outsized advantage.
I’ve seen this privilege play out in my life in a small way. Getting my first book deal was a low probability event but once that door was open, getting the second, third, and fourth book contracts became more likely.
Preferential attachment isn’t always fair and it contributes to inequalities in the world that I won’t go into here. However, understanding it in the context of entrepreneurship and venture capital can inform strategy.
(Preferential attachment in action. Notice how the larger blobs more easily scoop up the smaller ones. Original video here.)
We see preferential attachment in entrepreneurship when an ex-Google engineer finds it easier to raise money and recruit talent for their startup because of their pedigree. We also see it in network effects, where each user added to a platform increases the likelihood that other users will flock to it.
Meanwhile in venture capital the best startups preferentially attach to funds which already have success in their portfolio. In other words, success begets more success and as Samir Kaji puts it: “One massive hit is often all it takes to “mint” an investor, regardless of how serendipitous the investment was.”
To benefit from preferential attachment, identify positive feedback loops in your field then look for ways to engineer them to your advantage.
(2) Self-organized Criticality
Despite the unusual name this power law driver is something you’re already familiar with. We see it in ‘overnight success’, which is actually an inaccurate description of something that’s so common in nature that theoretical physicists gave it a technical label 30+ years ago: ‘self-organized criticality’.
A useful analogy here is a pile of rice. If you build one by adding a few grains at a time, most of the grains don’t have much impact. But after a while, adding just one grain of rice can lead to an avalanche.
This is similar to overnight success. Except that even though the description suggests instant success from nowhere, most successful people make it only after years of metaphorically adding small grains of rice to a pile of effort.
(You can read Sarah’s story here and from this tweet.)
In startups, getting to product-market-fit is a similar affair. Companies have to iterate continuously until something clicks so that the business can start to scale. Even in later years, those same businesses have to persevere before they can benefit from a step-change in growth.
One example I really like here is that of Microsoft when it was still a startup. In 1980 it secured a landmark contract to supply IBM with an operating system — an event that arguably changed the course of tech history.
However, this event didn’t pop into existence on its own. Lots of prior events had already placed Microsoft at a point of “criticality”. To name but a few:
Bill Gates and Paul Allen had been writing and selling software for almost 10 years already and were well-suited to getting the job done.
Among other reasons IBM had attracted decades of anti-trust investigations against it and to avoid further regulatory scrutiny, it accepted a non-exclusive contract with Microsoft.
The latter point meant that Microsoft was free to sell its software to other computer manufacturers and as PC hardware become commoditised, the business grew without restriction and saw its revenues balloon almost 10x, from $16m in 1981 to $140m in 1985.
Uneventful steps taken frequently can also lead to outsized outcomes in venture capital. Fred Wilson was writing and thinking about bitcoin for years before he met and invested in Coinbase. In fact he met the company because he was willing to persevere through a lengthy office hours session at Y Combinator with 16 startups across 4 hours of back-to-back pitches.
To benefit from self-organized criticality, play the long game and take heed of Seneca’s observation that “luck is what happens when preparation meets opportunity”. Or putting things more poetically:
“Chance can be on our side if we but stir it up with our energies, stay receptive to the glint of opportunity on even a single hair above the underbrush, and continually provoke it by individuality in our attitudes and approach to life.” — James H. Austin in Chase, Chance, and Creativity.
(3) Multiplicative Processes
Power laws also emerge when events are multiplicative instead of additive. One example is word-of-mouth. If you have a fantastic restaurant experience you don’t just tell one other person about it (which would be an additive process). You tell lots of friends who then go on to tell many others too.
Other examples of this process include population growth, the spread of viruses, and rapid wealth accumulation (getting rich through investing is a multiplicative process while building wealth through a salary is additive.)
Multiplicative processes are perhaps the simplest power law generator: a value is multiplied by some variable and the result is further multiplied by another variable. Repeat this process and you get exponential growth.
In startups, hiring a ‘10x employee’ is a multiplicative process. An elite performer can substantially change the trajectory of a business while most hires tend to be additive.⁴ For VCs, blogging is multiplicative networking. Ideas can spread faster online compared to offline 1–2–1 conversations.
To benefit from multiplicative processes, you have to identify and seek out multiplicative factors — much like preferential attachment — then look for ways to engineer them to your advantage.5
Engineering a Power Law Mindset
Outsized success is rare and takes just as much (if not more) in luck as it does effort to hit a home run. However, if we internalise how power laws work, we become better placed to tilt the odds in our favour by working not just harder, but also smarter.
(3 Power Law Drivers and Examples in Entrepreneurial Ventures)
Notes
[1] Businesses fail for a variety of reasons (e.g. team issues, lack of funding, creating products that people don’t need, competition and market timing.) But while building for the future is inherently unpredictable and hard, it’s worth remembering that..
“In any natural system, failure is the engine that causes growth, that causes new birth, that causes anything to happen. One of the truly big differences between growing economies and economies that stagnate is the acceptance of failure. If you don’t let forests burn, if you don’t let the old trees die out and the new trees grow, you don’t get a healthy forest. The ability to manage failure so that enterprises fail but people can still succeed becomes one of the tricks of how you build a society that can reinvent itself as the world changes.” — Shikhar Ghosh in the Harvard Business Review.
[2] In normal distributions most outcomes cluster around a central value. Human height is one example of this. Over two thirds of the population are close to average height while a minority are really short or really tall.
A height normal distribution example (chart by Michael Minn)
[3] A ‘critical state’ is typically a hypersensitive state between order and disorder (or vice-versa).
[4] Data from 5 studies covering 600,000+ professionals shows that performance in many domains isn’t normally distributed. A small portion of talent outperforms the majority by a significant margin. See examples below from this paper.
[5] eBay leveraged the Beanie Baby collectibles mania that run from 1996 to 1999 in order to grow faster. Brian McCullough provides a good historical account of this in his book.
