Positive and Negative Reciprocity

What We Can Learn From The Gift About Risk: Arms Races, Eastern European Energy, Cyber Insurance Hardening, Cloud Tipping Point, Open Secrets and Tech Debt

A commodity has value and a gift does not. A gift has worth.

― Lewis Hyde, The Gift

Risk Developments this letter:

• Arms Races

• Eastern European Energy

• Cyber Insurance Hardening

• Cloud Tipping Points

• Open Secrets

• Tech Debt

Ernest L. Blumenschein, The Gift, 1922, oil on canvas, Smithsonian American Art Museum.

In The Gift, Lewis Hyde distinguished between commodity and gift saying, “A gift, when it moves across the boundary, either stops being a gift or else abolishes the boundary.” A commodity either leaves the boundary intact or establishes one. The gift, in contrast, has been a way of bringing people closer together. But scale enabled by technology (social or physical) creates risk of negative reciprocation. Negative reciprocation, in moderation, is not bad, but when tit-for-tat reaches a tipping point, small infractions can become arms races.

Before risk models, before consultants and before insurance there was the community. The first risk pools were familial ties. Brother and sister. Father and son. Mother and daughter. A stroke of good luck for one person in a clan was shared without expectation. Symmetrical exchange was rare, and the boundary of trust was delineated by blood, or at most, tribe.

Families grew into peoples, societies developed rules and the invention of writing (credit) facilitated trade. The boundary of trust, once clearly delineated, transformed into a spectrum. Gift giving still exists, of course, but it is confined to the spiritual and artistic, our most intimate relationships, or used symbolically to remove boundaries between people.

To be clear, exchange is not bad. It is merely transactional. Positive exchange allows for complex societies, contracts, trade, markets and healthy interaction with the other. There is something prosaic, however, about the quid pro quo. There is no space left for spirit. No creativity. No romance. No community. No goosebumps.

Hyde’s main theme throughout The Gift, is the tension between gift and exchange, between community and individual:

Every age must find a balance beween the two, and in every age the domination either one will bring with it the call for its opposite. For where, on the one hand, there is no way to assert identity against the mass, and no opportunity for private gain, we lose the well-advertised benefits of a market society—its particular freedoms, its particular kind of innovation, it individual and material variety, and so on. But where, on the other hand, the market alone rules, and particularly where its benefits derive from the conversion of gift property to commodities, the fruits of gift exchange ar lost. At that point commerce becomes correctly associated with the fragmentation of community and the suppression of liveliness, fertility, and social feeling.

One popular observation about business strategy made by Joel Spolsky is that smart companies try to commoditize their compliment. A market compliment is a gift, an enhancement for your product or service, made by somebody else. Taken too far, and you’ll run your compliments out of business. This strategy may not nourish the soul, but it doesn’t make these companies bad actors, like frauds or criminal accomplices.

Inverting Hyde’s work on gift and exchange, can help us explore fraud, crime and risk. Just as there is positive exchange, such as trade, we have negative exchange as well: punishments, consequences, penalties and sanctions. A child misbehaves and they get sent to time-out. A bank fails to perform due diligence, and the Treasury department may levy a fine. Breach a contract and get taken to court. These actions and repercussions maintain order without escalation.

There is, however, negative reciprocation, just as a gift is a positive reciprocation, that do escalate. This get called various names such as a cycle of violence, mimetic crisis, or an arms race. Given two dichotomies, exchange vs gift and positive vs negative, we may create a matrix to illustrate how systems evolve over time:

Take the Internet, for example. It originated as a gift economy. A government funded creation that attracted hacker anarchists who volunteered their time and money to build websites, chat rooms and file transfer systems. Many refer to this as the Golden Age. As the Internet matured, it became a place of commerce, dominated by positive exchange, which erected boundaries. This was the period of the Walled Garden. With walls come penalties, and those who break the rules get thrown out. This is the era of Cancel Culture. This brings us to the era of negative reciprocation. The escalatory nature of the cyber crime economy, Twitter mobs and information warfare, are so dangerous because they reintroduce the spirit of community, but as a dark spirit.

The Old Testament solution to keeping negative reciprocity in check, was to institute the “eye for an eye” law. Rules and punishments are necessary to prevent bad actors, but applied out of proportion or to an innocent victim, and it can quickly spiral into negative feedback loops.

One last word on this topic before getting to current events, there are two types gifts that can discharge the negative escalatory process. The first is to offer up a universally despised third party, as the scapegoat. Say, China, a particular politician, or a tech founder, or perhaps, everybody’s favorite punching bag, social media itself. The second gift is the gift of forgiveness. That is, sacrifice one’s own desire for retribution.

Arms Races

Trading desks have been some of the earliest adopters of new technology to understand prices, place orders and sometimes, place and cancel orders intended to move the price. Now government regulators are using some of the same technology (and same people) to bring cases against market manipulation. Surely the next wave of technology will bring new problems and solutions. In the future traders use quantum technology to place a bid that is both there and not there at the same time, and regulators will both bring and not bring a case at the same time.

Industry, of course, doesn’t only square off against government, but also against competition. Cisco has been ordered to pay a hefty $1.9B to cybersecurity startup, Centripital for stealing intellectual property. The penalty levied in the last story consisted of a fine, restitution for the victims and disgorgement for ill gotten gains. A sort of eye for an eye formula. Here the penalty was 2.5x the damages plus future royalties for “willful and egregious” infringement, a clear escalation. Another reason this story is so fascinating, is the arms race nature of the technology in question.

Centripital patented a capability to perform analytics on encrypted traffic, both increasing the efficiency (decrypting traffic is slow) and efficacy (decrypting traffic isn’t always possible) of traffic analysis. Of course, this poses challenges for privacy advocates, who will have to improve encryption technologies. Perhaps Cisco will develop those improvements in response to the order.

On the topic of cybersecurity, finance and fines, Morgan Stanley was fined $60M for a data breach in 2016 and CitiBank was ordered to pay a $400M civil penalty for enterprise risk and compliance failures. Big banks are finding it hard to stay on top of all of their data especially as their systems age and personnel turn over. More on this below in Tech Debt.

Lastly, the lending arms race has gone stratospheric given the liquidity the fed has pumped into the system, and the promise of bailouts for the foreseeable future. What is a lender to do? One innovative answer is to lend to companies without cash flow or hard assets. Leading insurance brokerage, Aon, has made that possibility a little less scary by insuring intellectual property rights, allowing IP to be used as collateral for borrowing.

Eastern European Energy

In commoditize the compliment news, the Russian market for gas turbines is hot. The world’s second largest producer of natural gas is upgrading its aging power generation infrastructure. Natural gas is a commodity, but it is a funny sort of commodity that can’t be shipped easily. Fracking made natural gas cheap and plentiful, but you don’t need new turbines where the pipelines already go, you need them where there are no pipelines. Unfortunately for turbine producers, renewables stepped where gas would have historically. The big opportunity for natural gas is to replace aging coal and nuclear infrastructure, but whether they’ll be leapfrogged by renwables or beaten by a nuclear renaissance is anybody’s guess.

Ukraine is one of the few countries still betting on nuclear energy, and it’s tricky relationship with Russia makes that even more difficult. Russia is the natural supplier of both gas and nuclear fuel for Ukraine, so signing a fuel deal with Westinghouse is a big deal for their energy independence. Still, this won’t solve the problem of the 15 Soviet era reactors, 12 of which are set for retirement.

The U.S. keenly aware of the geopolitics of energy, if not pressed at home for cheap fuels, has been attempting energy innovation with the ARPA-E program run by the Department of Energy. Now ten years old, the program is fighting for its life by touting its successes. Since energy and military power are compliments, it only makes sense to commoditize energy.

Last note on energy, BP is increasing its security efforts in Azerbaijan. Rumors of an attempted attack on the Baku-Tblisi-Ceyhan pipeline have been denied by the Armenian armed forces. Historically, Russia, Iran and Turkey have controlled the region. In recent years, Turkish, American and European powers have routed oil and gas pipelines to circumvent Russian and Iranian control. With this many parties that have ancient disputes there is real danger of negative reciprocity erupting.

Cyber Insurance Hardening

Another place negative reciprocity is erupting is ransomware insurance. Often payment is no guarantee of getting your data back, and now you may even run afoul of the law. The U.S. Treasury is informing insurers that payment to hackers could violate sanctions. Attribution is difficult, so it’s hard to see how this could be enforced, but the messaging is consistent with the policy not to negotiate with terrorists.

A robust market for ransomware insurance only encourages bad actors to increase activity and prices, as we have seen with the average ransomware payment rising 60% from Q1 to Q2 of 2020 (ibid). It’s not only the prices that have risen, but the number of attacks too. According to one study, ransomware attacks have doubled in the U.S. since the pandemic began.

Insurance can respond to the escalating risks by charging more, controlling losses or selecting better risks. As the market shakes out, some insurers have found a counter intuitive niche. Small businesses, are particularly unsophisticated when it comes to cybersecurity, so you might think that makes them high risk, but a business that doesn’t even know it has been hacked will never file a claim, much less a large aggregated loss.

The trend in cyber insurance over the last few years has been an escalatory price war and race to the bottom in standards. With competition easing for the first time in years, rates are finally creeping up. That is a gift the industry cannot afford to squander.

Cloud Tipping Points

The cloud is not new anymore. In fact, it wasn’t even new when the term came into fashion. But the cloud is new to being the incumbent. For the first time ever, public cloud infrastructure spending is outstripping legacy infrastructure. The early days of computing are littered with stories about “stolen” computer time and radio gifts. Public cloud certainly feels like the commoditization of computing, but maybe it’s just the end of an era and the opening of a new one.

One exciting new space, mentioned in my previous letters is the convergence of space and the cloud. Cloud computing for satellite management makes sense, since they are complimentary. More and cheaper compute/storage makes satellites easier and cheaper to manage, which makes more data cheaper to transmit. It’s unclear which side will manage the complete commoditization of the other first, but some other businesses are getting caught in the crossfire. IBM made a big announcement that it will separate its managed-infrastructure business to focus on cloud services.

Similar to satellites, oil wells require large amounts of data and processing to operate and automate. Also similar to satellites, cloud benefits from cheaper oil. It is no surprise than, that the cloud is a compliment to oil. For all the talk about data being the new oil, it turns out that oil is the new oil, and cloud is just another compliment.

Open Secrets

Spolsky’s main point about commoditizing the compliment is that companies pursue open source projects for their benefit, not out some generous attempt to pay it forward as public relations might spin it. Below are two examples of companies making major investments. Do you think Spolsky is being cynical? Is he wrong?

The first is Microsoft (LinkedIn) open sourcing an AI model for personalization. The article’s author says, the software allows for “swifter training of models with commodity hardware.” Microsoft is one of Spolsky’s examples, and he has an unfair advantage since he worked there. According to him, Microsoft goal was to commoditize the PC market.

Now take a look at Square’s $50M investment in Bitcoin. Square already created an independent group to work on Bitcoin open source called Square Crypto. It’s not clear if Square is Microsoft or Square is Sun in Spolsky’s example. For one thing, they are buying an asset, not investing in open source here (although of course they are with Square Crytpo). How would one even go about commoditizing Bitcoin? Pay employees in Bitcoin? Subsidize the transaction fees? Build crypto development kits? Not sure if any of these will succeed, but it sure looks like they’re trying!

Tech Debt

If open source software is a gift, technical debt is usury. The natural accumulation of issues created by systems designed without perfect foresight is the price paid for moving from gift to commodity. The Department of Defense is swimming in technical debt, a House panel warns. It’s not just government that is struggling to pay down technical issues. Our global financial system is riddled with technical debt across myriad excel spreadsheets (Thank Byrne Hobart at The Diff for the link). One other subject that has been in the news for technical debt is Boeing’s 737 Max. The chief of the FAA personally flew an updated 737 recently. It feels like he gets how to transition back from negative to positive reciprocity. If only our other regulators showed the same level of dedication.

Gratitude

Thank to all of the people who helped make this newsletter better, and my friends at On Deck Writer’s Fellowship. A special thanks to Godiva Golding, Dan Stern, Omar Farha, Alicia Kenworthy, Dan Hightower, Justus Myers and Sasha Levage for reviewing this article! Feeling very blessed to have this many brilliant folks helping me improve my writing. Do check out their Twitter’s and writing for more great content.