Ghost Capital 2021 Q1 Shareholder Letter
When Jamie Mai and Charlie Ledley established Cornwall Capital in 2003, they began with $110K and ran their operation out of a friend’s shed in Berkeley, California. Their strategy? Bet against Wall Street’s understanding of tail probabilities: “Charlie Ledley – curiously uncertain Charlie Ledley – was odd in his belief that the best way to make money on Wall Street was to seek out whatever it was that Wall Street believed was least likely to happen, and bet on its happening.”
As it turns out, Wall Street also was not great at evaluating the likeliest outcomes either. Consider Cornwall’s first gambit: Capital One. When the SEC announced in July 2002 that it was investigating the financial services company for fraud, the share price tanked 60% in two days. That sounds like it makes sense, but it doesn’t.
It doesn’t make sense because it assumes a continuous distribution of appropriate share prices for a company with only two logical valuations. Either Capital One was guilty of fraud and therefore worth close to nothing, or Capital One was not guilty of fraud and therefore significantly oversold.
Coming to the same conclusion, Cornwall deployed $26K (24% of its money) into long-dated, out of the money call options which were systematically underpriced because, again, Wall Street is not great at understanding probabilities let alone “extreme” probabilities. When Capital One was swiftly absolved of wrongdoing, Cornwall’s original position ballooned to $526K. For the suits at home, that’s a 1,923% gain.
And Cornwall’s strategy was no fluke. After Capital One, they turned $500K in call options on a European cable television company into $5M and flipped another $200K in options for $3M on the back of an oxygen tank supplier. By the close of 2005, the “garage band hedge fund” Cornwall Capital held $12M in assets. Three years later, after making the boldest bet of the Financial Crisis and shorting the phony AA tranche of CDOs, Cornwall Capital had amassed $80M.
Upon re-reading Cornwall Capital’s story, Ghost Capital began searching for cross-domain application. How can Cornwall’s simple but profound realization instruct our worldview? What about the future seems tremendously mispriced?
In one sense, the meta-answer is the future itself. The world to come is probably much more utopian or dystopian than forecasted. Great Stagnation thesis aside, the troubling state of affairs coupled with the tools currently at mankind’s disposal (which may grow more powerful if the New Roaring ‘20s techno-optimism proves valid) make the next quarter century’s outcome simultaneously more concave and convex.
But that answer seems too easy because it’s borderline evergreen. If technology is always increasing – no matter its rate of progress – mankind is always one step closer to self-immolation. Paradoxically, every technological step forward enables a much larger, more catastrophic step backward. Eric Weinstein’s quotable, “We are now gods but for the wisdom,” has always been true on a relative basis; it will only become more true on a nominal basis.
And so, if the future itself does not suffice as an acceptable extension of Cornwall’s logical framework, then what might? What will impact the next few decades in a conspicuously involved or uninvolved fashion? Which force represents a starkly bimodal distribution of influence? Ghost Capital humbly submits that designation belongs to the world of gaming.
The transition away from hardware discs ushered in a gaming industry revolution. In 2010, just 20% of gaming monetization flowed from in-game purchases. In 2020, that number was 75%. The importance of this shift cannot be overstated. It lowered barriers to entry by de-emphasizing distribution centric profits and unlocked a strong DIY element where users have more power and increasingly develop games themselves. While this aligns with gaming’s core value proposition of autonomy (something we’ll expound more upon later), it also bolsters the case for rapid adoption as it generates a wellspring of suppliers in the market. This increases competition, demands product excellence, and lowers prices which in turn brings new users aboard, jumpstarts Wright’s Law, and completes a dynamic flywheel. And, this all sits atop a necessary ingredient for any business seeking exponential growth in the 21st century: network effects.
Gaming also benefits from complementary technologies like augmented and virtual reality, which have a chance to actually step into the consumer Overton Window for the first time in the 2020s. With social losing steam, Facebook is increasingly upping the ante on AR/VR (20% of its workforce is dedicated to related efforts) while Apple and Snapchat have also made it a top priority. It is estimated that consumer-grade AR headsets and glasses are in play for 2022 and Ark – who, of course, should be taken with a grain of salt – has gone as far to say that the AR industry could scale from $1B today to $130B in the next decade.
And then there are the technologies like semiconductors and artificial intelligence which provide peripheral tailwinds by improving gaming quality. In semiconductors, Apple’s M1 Chip may have freed the space from Intel’s lackluster innovation pace and tension between China and the United States has forced the latter to initiate the build out of a domestic manufacturing presence that can prevent Taiwan from serving as the industry’s single point of failure. AI has recently flexed its muscles in an eye-opening way whether it be the escalating autonomous vehicle race, GPT-3’s language breakthroughs, or DeepMind’s AlphaFold success. And, if the big AI bulls (think Sam Altman) are right and America’s near to intermediate future involves more job automation and a consequent expansion of the social safety net through universal basic income, it stands to reason that fewer Americans will hold traditional jobs, work 9-to-5s, or commute to an office. That unlocks more free-time which can be funneled into gaming.
But the bull case is more expansive because, despite the merits of gaming’s favorable industrial landscape, the opportunity’s most compelling aspects actually stem from its synergies with today’s dilapidated society. The macro backdrop serves as a colossal tailwind to a secular boom in the gaming industry and it is the reason why the zeitgeist’s bull case is not nearly bullish enough.
It should be painfully obvious, but the West is not well. In the past, similar crises of confidence evoked a collaborative spirit to fix our reality. But in a world where digital universes are a click away, such calls to action are lost because an alternative frequency – gaming – offers an escape from a physical reality that holds little promise to the masses.
Consider the following facts: Life expectancy, even before Corona Virus, stalled out and even declined. Age-adjusted suicides reached 14.2 per 100,000 people (up 36% since 2000!). 42% of United States adults qualify as obese (up nearly 1200bps since 2008!). The share of men between ages 18 and 30 reporting no sexual activity in 2018 was 28% (almost double 1989’s 15%!) and one can only imagine the preference falsification imbued in that figure. Drug overdose deaths now total 21.5 per 100,000 people (in 2000, it was 6.7!). Fertility, a decent bellwether for societal optimism (granted, also inversely correlated with child mortality), is at all-time lows.
Lots of this can be ascribed to America’s economic inequality issue which runs downstream crony capitalism, the lobbying edifice, the Internet, globalization, nature’s non-normal distributions, and the general vacuum of collaborative or competent leadership. And of course, social media serves as an unintended hyper catalyst by reprogramming collective psychology to engage in regular violations of the tenth commandment (“Thou shalt not covet thy neighbor’s land”). Logging on Instagram, Pinterest, Tik Tok, and Twitter… or, dare I say it, Facebook (“ok, BoOmEr”), is today’s equivalent of 1984’s Two Minutes of Hate.
So, what you have heard is true. American Exceptionalism is real. We’re exceptional in a whole host of unsightly ways. In fact, the state of the West sounds eerily reminiscent of Gondor from Lord of the Rings:
“Kings built tombs more splendid than the houses of the living and counted the names of their descent dearer than the names of their sons. Childless lords sat in aged halls musing on heraldry or in high cold towers asking questions of the stars. And so the kingdom of Gondor sank into ruin, the line of kings failed, the white tree withered and the rule of Gondor was given over to lesser men.”
But, there is something else at large. There has been a seismic change in Americans’ attitudes toward the future. This is best encapsulated by Peter Thiel’s 2011 Zero to One matrix which plots optimism and pessimism against definite and indefinite:
Importantly, however, Thiel’s matrix is outdated and must be adjusted to accurately account for America’s psychosomatic condition:
Since the populist/autocratic revolution caught steam in 2015, America has entered a somber reality. We have lots of problems, we do not know how to solve said problems, and, now, we are not sure we can solve said problems. And the people bearing the brunt of those problems, are not the few. It’s not the wealthy, the “well”-educated, or the powerful. It’s the underprivileged masses.
Now, it could be that we’re in the cyclical trough of Will Strauss and Neil Howe’s generational saeculum theory offered in Generations (1991) and The Fourth Turning (1996). They assert that generational cohorts drive four 20-year turnings over an 80-year cycle to shape American history. The current one, the Millennial Saeculum, looks something like the below:
While Strauss has since departed, Howe is alive and well and insistent that our current Fourth Turning could last until 2030. If such is the case, one has to wonder if America still has the competitive spirit to endure until then. And, even worse, it must be pondered if America’s competitive position is under real threat and soon to become the next giant slayed by Thucydides’ Trap where an emergent power displaces the vanguard of the day.
Contrary to what our institutional establishment wants Americans and Westerners to think – that “Build Back Better” or the “Great Reset” is the critical reversal of our fortunes – that does not seem likely. The same cast of characters that put us in this position are the ones assuring us that they have it all figured out. This is not an endorsement of President Trump – far from it. Decadence may be a suitable substitute to disaster, but it’s still not dynamism. The collective psychology of America, our hopes for the future, remain mired in the indeterminately pessimistic quadrant.
In such an environment, the natural response function for people is to disassociate. It is said that children will stop engaging with playmates when they win fewer than 25% of trials and it’s safe to say that the average American is winning far fewer than 25% of their games against reality. Folks are increasingly wising up and declining to play a sucker’s game.
This logic is enshrined in Robert Merton’s Strain Theory matrix which pits acceptance or rejection of a) society’s proposed individual goals against b) the widely accepted means to achieve those goals:
The Conformist is self-explanatory. The Ritualist thinks society’s rules are fair, but the goals are not worth the stress or misguided. Conversely, the Innovator accepts society’s goals, but thinks the rules are unfair and therefore pushes the legal envelope. The Retreatist dismisses society’s goals and means altogether. Over the past half century, America has seen a marked shift in its Mertonian distribution. With the promise of America wobbling, even quaking, droves of people have moved to the Retreatist square.
But the Retreatist square itself has undergone a radical shift. In the past, it represented a cohort of people that had drifted away from society into an alternate reality supplied by the effects of substance abuse. But in today’s digital world, gaming’s virtual realm offers a more attractive route. Relative to a drug-fueled existence, gaming is a safer, more sustainable, less invasive, and more cost effective Retreatist experience.
From the government’s perspective, there are worse outcomes. Truth be told, it may be in the government’s best interest to facilitate the movement because the proliferation of online existence and gaming brings violence reduction. Ross Douthat makes this case in The Decadent Society: “For many men, the fantasy worlds of pornography are a substitute for every kind of real-world in-the-flesh sexual behavior rather than a spur to sexual aggression.” Later on he adds: “There’s been a general substitution of electronic entertainment and virtual communication of real-life behaviors that led past teenagers into peril and temptation.” And finally: “An unemployed young man is a natural troublemaker, a potential radical, tempted by criminality, open to religious appeals, drawn to ideological extremism. Whereas an unemployed young man with a gaming console is more occupied, more entertained, more at peace with his situation.”
We are also obligated to frame this in a more cynical fashion that presupposes more sinister motives on behalf of the government. A population that is more online is physically weaker, more trackable, and more apathetic. It is a population that is easier to control. It is the dream of a government whose ultimate goal is to find ways to incubate and extend its autonomy.
In a separate but important way, this line of thinking can help slice the libertarian-leaning venture capital community into two camps: pessimistic and optimistic investors. Both believe in the private sector’s preeminence to the public sector’s ineffectuality. Both harbor government skepticism and valiantly battle the extension of barnacled and sclerotic institutions. But the former believes that the somber, inevitable, and ultimate result of such a battle is defeat while the latter believes the outcome truly hangs in the balance. And thus, the former believes that a prudent investment cannot be misaligned with the government’s agenda while the latter believes it is indeed imperative to be misaligned. The former somberly resigns and invests in gaming/VR/AR, the latter defiantly funds the cryptocurrency ecosystem. This leaves us with two contrarian insights: First, instead of “do not fight the Fed,” perhaps today’s long-term operative investing maxim is instead “do not fight the Feds.” Second, maybe investment in gaming is an embedded bet on quasi-centralization and the government’s ability to consolidate its control and therefore it represents the most astute hedge to a portfolio long cryptocurrency and decentralization.
As it pertains to gaming’s prospects, we have tried to elucidate the investment merits based on the world view we believe is taking and will be taking shape. However, there’s another vitally important discussion to be had on the ethics and existential consequences of gaming and its virtual worlds which continue to siphon attention and participation from the physical world.
In his early 2000s essay, The Straussian Moment, Peter Thiel demarcates modernity’s birth with 1648’s Peace of Westphalia. It was an agreement by the sovereigns of Europe that centuries of religiously motivated bloodshed had to seize for society to progress. This was the pivotal moment that transitioned the super-philosophy of the day from all-too-controversial first principle questions regarding humanity’s origin to today’s oft celebrated Enlightenment ideals. Scientific rationalism displaced religion. Secular materialism displaced spiritual materialism.
More broadly, empiricism displaced narrative. Early on, that seemed to be a constructive switch because of the easy wins of a science-centered society. But, with the present marred by a half century of declining scientific progress, it could be that we’re discovering the limits of rationalism and rediscovering the value of narrative. Yes, a narrative based world may have been a collection of agreed upon lies. But they were instructive fiction. They were lies that told a deeper truth.
Contrast that with today’s world which is replete with numbers but no insights. We have droves of data but a dearth of agreed upon facts. Religious materialism may have been guilty of reductionism, but it created some semblance of order out of chaos. There is no conclusive verdict on whether that same virtue of governance can be ascribed to secular materialism. And worse yet, modernity increasingly distrusts its own bread and butter – rationality. Consider the following excerpt from a recent interview with Peter Thiel:
“The Medievals believed in the weakness of the will but in the power of the intellect. Moderns tend to believe in the power of the will but the weakness of the intellect. If you have an evangelical Bible study the outward facing thing is that people are moral and that they’re good Christians. The inward facing thing is that you’re sinful… Now if you transpose this to a modern rationalist meetup, the outward facing thing is that you’re more rational, better able to think through things than other people, you’re ‘one of the brights’ as [Richard] Dawkins liked to put it. The inward facing thing is that you’re not capable of thought. Your mind is full of spaghetti code, you can’t believe how bad people are at thinking through things, and that’s the sine qua non of Enlightenment rationality.”
And this loops right back into a Thiel framework mentioned earlier. A society that is positioned in either the indefinite optimism or indefinite pessimism quadrant is a society that fails to take decisive actions because it intrinsically distrusts its ability to make cogent decisions. And this is why, Thiel explains, moderns have an obsession with artificial intelligence:
“The mania we have around artificial intelligence is because it stands for the proposition that humans aren’t supposed to think. We want the machines to do the thinking, but it’s because we’re in a world where individuals are not supposed to have intellectual agency of any sort anymore. We don’t trust rationality. We can maybe believe in the wisdom of crowds or big data or in some sort of mechanistic process but we don’t believe in the mind.”
This brings to the fore a critical question – If we don’t trust modernity’s intellectual bedrock any longer and we increasingly harbor apathy toward the physical reality, have we transcended Rationalist Materialism? Have we passed a new signpost like 1648’s Peace of Westphalia? The answer is yes. Welcome to Post-Modern Virtualism.
In retrospect (like many things), this looks painfully predictable because a non-cornucopian atheist, rationalist materialism is long on wishful thinking and short on anthropological understanding. When you de-emphasize faith in an environment that fails to transcend Malthusian scarcity, you introduce an incentive structure that is unsustainable. On the one hand, you emphasize the importance of the here and now. In any sort of religiously led life, you are engaged in a relatively brief tryout for an infinitely longer chance at the blissful hereafter. In atheism or agnosticism, existence is the main event. You must seize the day because, as the kids say, you only live once.
But when your one life proves disappointing or unfair, and this is the base case for most moderns, hedonism and nihilism become guiding philosophies. Ultimately this creates three extremely counterproductive currents in a society: 1) a people that treat politics with religious fanaticism which inevitably leads to gridlocked partisanship, 2) a people who blame the government for a lackluster existence and choose violence, and 3) a people who blame the government for a lackluster existence and choose divestment from the societal outcome. Do these not sound familiar?
This was predictable because it was, in fact, predicted… just not by Western governments. When the West saw the Berlin Wall fall in 1989, it was not in a mood for introspection. It reveled in the glory of a hard fought victory. China, on the other hand, was watching intently and internalizing a different lesson. It learned that in a rationalist materialist world, the only sustainably successful governance model was one that granted Perestroika (economic liberalism albeit to a particular degree) but did not grant Glasnost (social liberalism). If you loosened your grip on social control a tad too much, the whole experiment could quickly blow up. To be clear, China is not a model society. It has its fair share of problems and they are not small problems. It is far more dystopian than utopian and the success it has experienced from its anti-liberal approach is a big and frightening reason why.
Nonetheless, the West’s problems are broader and more pressing. We must begin by reversing one of the most concerning psycho-social phenomenon wrought by rationalist materialism’s failures – we must stop the leak of attention from the physical to the virtual. We need our people to be interested (and not in political fashion). We need our people to recognize that they have skin in the game. We need our people to understand that they have a responsibility to reality.
Now, if we are foolish enough to appeal to logic, the argument would look something like the one Peter Thiel fashioned back in The Straussian Moment:
“The world of ‘entertainment’ represents the culmination of the shift away from politics. A representation of reality might appear to replace reality: instead of violent wars, there could be violent video games; instead of heroic feats, there could be thrilling amusement park rides; instead of serious thought, there could be ‘intrigues of all sorts,’ as in a soap opera. It is a world where people spend their lives amusing themselves to death… No representation of reality ever is the same as reality. The price of abandoning oneself to such an artificial representation is always too high, because the decisions that are avoided are always too important. By making people forget that they have souls, the Antichrist will succeed in swindling people out of them."
But if we are in the business of persuasion, and we heed Charlie Munger’s wise advice to appeal to interest – not logic – then the approach must be alternatively routed. The inconvenient truth for those that prefer the virtual is that a reliable physical world forms the necessary substrate for the digital world. If people continue to abandon the former for the latter, the former risks an eventual collapse. That unplugs any and all existences ancillary to reality. That’s tantamount to game over.
With that said, the persuasion game is easier said than done. Post-Modern Virtualism’s avant-garde pop-philosophy, Simulation Theory, threatens to make the target population uninterested in negotiation. It’s hard to win the battle for people’s bodies let alone their minds when you have lost the battle for their spirit.
In disbelief with the world presented to them, the prevailing attitudes of Millennials and Gen Z most closely align with that of Westworld’s misanthropic antihero Dr. Robert Ford: “My father told me to be satisfied with my lot in life. That the world owed me nothing. And so, I made my own world.”
This is the rallying cry of America’s two youngest generations. They feel no allegiance to fix a physical world in decay. They didn’t build it. They didn’t break it. They are comfortable in their own virtual worlds. But more important than comfort, they are inspired by their new worlds. Again, Dr. Ford enlightens us: “People don’t come to [Westworld] to find out who they are. They already know who they are. They want a glimpse of what they could be.”
This also sheds light on a subtle but most alarming preference falsification present in the United States. Publicly, we talk our book of democracy. But privately, neither the governing nor the governed actually believe in its functionality. We don’t believe it is any match for an autocracy led by a decisive and savvy authoritarian a la Vladimir Putin or Xi Jinping. Even Hollywood, a historic bastion of liberalism, betrays such anxiety. In the past decade, Americans have binged on a barrage of monarchy, superhero, and celebrity centric cinema. This is indicative of a society that secretly self-loathes its democratic mission statement. In the words of Dr. Ford’s partner, Bernard Lowe: “People like to read about the things that they want the most and experience the least.”
We are seeing this play out more explicitly in politics’ crass machinery. The Democratic Party’s 2016 blockade of Bernie Sanders and 2020 blockade of Andrew Yang demonstrated that real democracy simply is not an acceptable outcome. And, when the Republican Party elected to let democracy run its course in 2016, democracy resulted in the most dangerous man to ever lead the free world. We don’t trust our ability to reason and perhaps, sadly, we cannot be trusted to reason. In 2010, Peter Thiel (tip back your drink once again, loyal readers!) framed this in hysterical fashion:
"By the early '90s, I realized that you could basically measure people's IQ very simply by how optimistic they were about politics. The dumb people tended to think that everyone should vote, the smarter people thought it was probably a bad thing but you still had maintain appearances, and then the really smart people were just despondent. The ones that were conservative engaged in heroic amounts of alcohol consumption. The people that were libertarian did not limit themselves to alcohol."
To top it all off, in the mind of many, democracy is not just ineffective but also stylistically dull. It is boring. It is systematic. It is slow. It is none of the things that we value in contemporary American society - creative vibrancy, titillation, or instant gratification. In these aspects, America’s physical reality has again been outcompeted by virtual reality.
This all culminates in the unsettling but totally unsurprising truth that the foundation of the West is under siege. Our systems are in jeopardy due to a crisis of confidence and our most valuable resource, our talent pool, is in mass emigration. We are in a dogfight for the West’s youth, reality is the underdog, and the stakes are as a high as they possibly could be.
If you believe in the underdog, we envy your optimism. If however, like us, you believe that gaming is the gateway to a scaled emphasis on the virtual over the real and that we’ve walked through a one-way portal, then maybe there is some small semblance of solace to be found through the investment angle: “The characteristic feature of the loser is to bemoan, in general terms, mankind’s flaws, biases, contradictions, and irrationality – without exploiting them for fun or profit.”
