I’ve been thinking about the difference between investing in information assets (computers, information) and investing in real assets (land, oil). There seems to be a fundamental difference between the two, and the effects are starting to manifest themselves in real ways.
The easiest way to understand the difference is to think about two investments. If I invested $2500 in a computer, I could get a really nice machine for that much today. I would have bought the ability to compute and share information. Fast forward 24 months, and that computer, according to Moore’s Law, would be worth half of what I paid for it (i.e., twice as powerful computers would be available). In essence, I bought a deflationary asset—that same $2500 would now buy me twice as much computing power. Compare this to what would happen if I bought $2500 of land, which is about an acre of pasture land in the US. At the end of 24 months, if history is any indicator, I would have modest appreciation (land has appreciated roughly 4% annually in the US). Thus investing in technology (as a store of value) is deflationary, and investing in real assets is inflationary (as a store of value). This is why Buffet won’t buy technology stocks—it’s a bad store of wealth over the long term.
What’s interesting is that the VC industry appears to be breaking along these two lines. Broadly speaking, looking at energy and technology, the venture industry is starting to break into two camps, as Paul Kedrosky recently showed. (Land in some ways is a good proxy for energy—it represents the ability to convert sunlight into calories—i.e., energy). What’s happened on the software side is that the cost of starting a software company has deflated so much that it’s virtually free, and thus the need for large capital investments in software has collapsed. In fact, if you need $10 million to start a software company right now, something is wrong—your scope is too big, or your architecture is bad. When the cost of starting a company is the same as a car, you don’t need venture capital, you need a couple of friends (preferably smart, strategic ones). So what we see is the emergence of “super angels,” or micro-VCs, and incubators that add a lot more value than capital. You take the investment from them because of their focus, their network, and their strategic value. Thus the future of the VC industry seems to be two camps—the Y-Combinators (boot camp and network) or IA Ventures (Big Data sector focus) versus the traditional large ($10-100 million investment) hard science investments.
So why this line between software and energy? And why can’t we take what we’ve learned and apply it to energy (information vs. real assets)? As Bill Gates has said, we’ve been fooled by the rapid success in IT:
But, as Gates put it last week, we’ve been fooled by the rapid success of IT, and “there are things that just don’t move forward.” The pace of chips and IT innovation “is rare,” said Gates. Unfortunately, some of those “things that don’t move forward” are fundamental platforms for the energy industry. For example, as Gates pointed out: batteries. “Batteries have not improved hardly at all. There are deep physical limits,” to this technology, he said.
There seem to be two reasons for this: miniaturization (potentially solvable) and physics (not so much). As Kurzweil outlined in Law of Accelerating Returns, one of the prerequisites for acceleration is the ability to miniaturize the technology. As both Vaclav Smil and Gregor Macdonald have written, all of our energy transitions to date have been one of increasing energy density—wood to coal to oil were all movements to more dense fuels. None of the current transitions and technologies are movements to a denser energy source. Maybe through better nuclear or sparked by open source biology we’ll have thousands of hackers attacking these problems, but anyway you cut it, rapid miniaturization seems unlikely. From Gregor Macdonald:
And here we find the largest hurdle of all. For, in humanity’s last two transitions, from wood to coal and then coal to oil, the trajectory each time was to a higher power density energy source. Energy transition is disruptive enough, but much less so when you are gaining energy density. And how do you suppose transition will be this time, going in the opposite direction, to lower density sources?
The second reason comes from the first law of thermodynamics—energy cannot be created or destroyed, only transformed. We can produce more information, we can only transform energy sources (we do have a nice stream from the sun each day though). From an interview with Vaclav Smil in the FT:
I have named this delusion Moore’s curse because (unlike the crowding of transistors on a microchip) it is fundamentally (that is thermodynamically) impossible for the machines and processes that now constitute the complex infrastructure of global energy extraction, conversion, transportation and transmission to double their capacity or performance, microchip-like, every 18-24 months. It’s a zero sum game… (can not be created or destroyed unlike information) – In other words, you can’t create energy, you simply move it around (fossil fuels, for example, simply release energy that has been stored and concentrated over millions of years); you can’t avoid wasting some energy when you move it around; and you can’t stop using energy altogether.
So let’s look at two technologies that are often talked about: the smart grid and algae. In the case of the smart grid, we’re talking about moving energy around more efficiently—there will be gains in robustness and availability, but it doesn’t create any energy. What’s more applicable is Metcalf’s Law (i.e., the strength of a network is proportional to the number of nodes), so we’ll have a better network and may save energy, but it won’t lead to magnitudes more energy.
Algae gets a bit more interesting because we can apply information technology to the engineering of the cells now through biotech. So we can leverage information technology to sequence, test, and even write the DNA for new cells that can produce fuel. The issue will be one of scale—when you cross the threshold from a cell to scaling it in any size, you are constrained by all the messy real world laws of thermodynamics. It seems cellulosic technologies, algae, and various other technologies all break down when it comes to scale because of this. The challenge for all these technologies seems to be crossing from an informational asset to a real asset.
Investing in real assets—land and energy projects—then is fundamentally different than investing in software. One seems to inflate while the other deflates, one is constrained by physics while the other seems to be unbounded but full of outliers. This isn’t to say one is a better investment than the other, just that they are fundamentally different, and it appears that the venture industry is breaking along these lines. Technology certainly isn’t a bad investment, but when you make such an investment, you better run and run fast because it deflates. The corollary is don’t expect a Google in energy anytime soon—it’s not going to scale like information technology. To put it another way, technology investments have fat tails, but it’s unlikely that energy will.
This isn’t bad at all—as a consequence of the deflation in information technology (or flattening), we’re seeing a shift in focus. On the software side, networks have basically deflated to the physical floor of the speed of light, and each of us has more computation power then we’ll probably ever need just on our desktops, and thus start-ups are attacking the problems of visualizing and processing this massive data set. If the venture industry turns back to more traditional researched-based hard science—biotech and energy—this seems like a good thing. This is where the big challenges and opportunities are, but they are fundamentally different problems.
Maybe a more accurate way then to describe the world is that it is informationally flat and physically lumpy.