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OVER THE JULY FOURTH weekend, a friend asked me what I thought about the new financial instrument known as a “stock token.” Developed by the online broker Robinhood, a stock token is designed for investors to buy stakes in private companies such as OpenAI, creator of ChatGPT. It’s a novel concept because private company investments are typically inaccessible to individual investors.
Despite the appeal, I urged caution. Why? These tokens may not perform as expected because they aren’t the same as actual equity in a company. In fact, we still don’t know exactly what they are.
With respect to the token linked to its stock, OpenAI issued this statement: “These ‘OpenAI tokens’ are not OpenAI equity. We did not partner with Robinhood, were not involved in this, and do not endorse it…. Please be careful.”
In an interview, Robinhood’s CEO, Vlad Tenev, didn’t dispute that the tokens “are not technically equity.” But, he argued, “it’s not entirely relevant that it’s not technically an equity instrument.”
To better understand tokens, you could consult Robinhood’s website. It explains that tokens are “derivatives tracked on the blockchain that follow traditional stock and ETF prices, giving you exposure to the U.S. market.” In other words, when you buy one of these tokens, what you’re buying isn’t actual company stock. It may be similar to a stock option, but it isn’t clear.
This complexity of definition is the first reason I’m wary of investments like this. Fortunately, these tokens aren’t currently available in the U.S. Regulations prohibit them. In Europe, where they are available, Robinhood’s regulator, the Bank of Lithuania, has opened an investigation, which may provide more clarity.
In the meantime, though, there’s a more fundamental reason to be wary of investments like this, and it stems from an idea known as Lindy’s law.
Before it closed in the 1960s, Lindy’s delicatessen in New York was a popular gathering spot for professional comedians, and a frequent topic of conversation was the relative success and career longevity of their peers. Over time, a rule of thumb developed: Comedians who had been around for a long time were more likely to have many more years in front of them. Newer performers, on the other hand, might or might not last. They hadn’t yet stood the test of time.
In a 1964 article in The New Republic, Albert Goldman dubbed this phenomenon “Lindy’s law,” though he was quick to acknowledge that it wasn’t necessarily a blinding insight. He simply observed that new things need time to prove themselves. But “despite its awesome air of common sense,” Goldman wrote, Lindy’s law may nonetheless be useful as a guide.
Over time, Lindy’s law has been applied to other fields, and I believe it’s especially applicable in finance because new financial innovations need to be tested through a variety of economic environments. This takes time. Consider the hedge fund Long-Term Capital Management, which was founded by a group of well-known economists, including more than one Nobel Prize winner. It got off to a fast start. In its first year, it returned 21%. In its second year, it gained 43%, and in its third year it delivered 41%. But in its fourth year, an unexpected event in the bond market caused the fund to suffer catastrophic failure and shut down. It turned out the fund’s quantitative strategy was flawed. But the flaw was one that an investor, when looking at the fund’s pedigree and strong early returns, couldn’t have predicted.
That’s an extreme example. But in financial markets, it illustrates the importance of giving new innovations time to be stress tested. That’s the primary reason I’d be cautious with Robinhood’s new tokens. And it’s for that same reason I’d tread carefully when it comes to other new inventions, such as Robinhood’s event contracts, which allow people to bet on elections and other events. I’d be similarly cautious with other financial creations, such as non-fungible tokens (NFTs), leveraged and inverse ETFs, special purpose acquisition companies (SPACs) and cryptocurrencies. These are all still very new, but they have gained in popularity since the pandemic. A recent writeup in The Wall Street Journal carried the headline “Meme Stocks and YOLO Bets Are Back.”
As Albert Goldman noted, Lindy’s law is largely common sense, but I believe it’s useful in making investment decisions. When we choose to be cautious with newly created financial instruments, it’s not because we can accurately predict how they’ll work out. And it’s not because we’re Luddites, reflexively opposed to anything new. Lindy’s law tells us it’s rational to stick with tried-and-true investments because they have proven themselves through multiple market cycles.
It’s important to emphasize, though, that Lindy’s law is a guideline, not a rule, meaning there can be false positives. For example, products such as whole life insurance have been around for decades, but I believe they’re still not great investments. Therefore, longevity alone is not sufficient to vet an investment.
Lindy’s law may also produce false negatives. It can cause investors to be overly cautious, rejecting anything that’s new just because it’s new. That would be a mistake too. Lindy’s law encourages us to move slowly, but it doesn’t mean we should never invest in anything new or do anything different. As Goldman wrote, “the factors that determine success or failure are a good deal more complicated than the rule suggests.”
Lindy’s law can, though, help us think about risk management. It tells us that when something is new—no matter how logical, safe or secure it may seem—we should be more careful. In situations involving new financial instruments, investing small amounts, or investing incrementally, may make more sense.
In his book Antifragile, Nassim Taleb talks about the value of Lindy’s law but notes that “it’s a noisy indicator.” It should be expected to work “on average, not in every case,” he says, and I think that’s the right way to think about it. Indeed, it’s possible that investments that look speculative today may, in time, prove themselves. In the case of Robinhood’s new tokens, I’m still skeptical. But only time will tell.
Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam’s Daily Ideas email, follow him on X @AdamMGrossman and check out his earlier articles.
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stock tokens are just another crypto con.. avoid.
see, https://www.citationneeded.news/issue-88/
Hmmm, I’m thinking these ‘tokens’ are somewhat akin to the wares that companies such as Start Engine, and NetCapital offer. Buying into companies before they are publicly traded. What are some thoughts?
For years, many warned people to stay away from Bitcoin—yet it ended up making a lot of money.
That doesn’t mean you had to invest 10+% of your portfolio in it.
But dismissing it entirely was a missed opportunity.
Not all tech investments are fads. Some turn into game-changers.
I just read the Robinhood stock token page. https://robinhood.com/eu/en/support/articles/about-stock-tokens/
It is too vague.
If it said something like this, then at least there would be a clear definition. “Individuals don’t have access to private equity. To make private equity available to you, we have taken stakes in companies which have not gone public and we are making portions of these ownerships available to you via tokens managed as smart contracts on Ethereum.” And then continued to explain how the stakes were apportioned as tokens.
I still wouldn’t trust it, but at least it would be a clear definition.
These people are masters at getting some of us to part with our hard-earned dollars. If the cartels sold stock in their enterprises, I’m sure there would be a long line to buy shares.
When thinking about any new investment opportunity, Charlie Munger used to say “always invert”.
He meant: Before you figure out how this thing will make you gobs of money, first figure out how it will fail. That’s usually the hard work of investing and it’s the smart path because it focuses on risk first and then return.
Even with sound, tried-and-true investments, like a humble stock fund tracking a broad index with ample history, there are many ways to fail. With entirely new things which most people have never seen before — Adam’s focus here — you don’t know what you don’t know, and likely won’t know until it risks out.
A company named after a thief tells you all you need to know about their product and service offerings…….
So is bitcoin old enough?
Given the political chaos we have now, especially with politicians trying to take of the Fed, the answer is no. The dollar isn’t old enough too.
I’d ask for what?
As an investment? As soon as it starts to throw off reliable cash flows…
As a store of value? IMO not yet. I also don’t hold gold or Euro’s….
The Dutch Tulip Bubble lasted 3 to 4 years. I don’t know how long you wait until something is “mature.”
Certainly, for speculation.
Thanks for another really interesting read. I always look forward to your thoughts and investment insights. My thoughts are much, much simpler: If I don’t understand, I don’t invest.
I’ll add to Mark’s thoughts. If an investment can’t be clearly explained in two sentences (three max) then I’m not interested. I’m sure I miss out on some good but complex investments but I can live with that.