Money Stuff: Everyone Wants a Wounded Lion

The central fact of financial industry compensation is that agents get a call option on their principals’ returns. If you give me a billion dollars to manage, and I turn it into $2 billion (a 100% return), I’m going to charge you at least $200 million for that service, and you will be thrilled to pay it. That level of investing skill is rare and valuable, and the going rate for it is at least 20% of gains. If, however, you give me a billion dollars to manage, and I turn it into $0 (a negative 100% return), I am not generally going to refund you $200 million, or anything. If I lose 100% of your money, I probably don’t have $200 million of my own money lying around, so I couldn’t give you a refund even if I wanted to.

So my exposure to your returns has the shape of a call option: I get nothing if you get nothing, I get some linear share of your profit if you make money, and I lose nothing if you lose money. I get the upside of your returns, but not the downside.

A few points here. First, is this … good? Bad? Depends what you want. The value of a call option increases with volatility, so paying people in call options gives them incentives to increase volatility: If I get the upside of my trades but not the downside, then I will want to take big risky bets to maximize my upside. You might dislike this. (Bank regulators, notably, dislike it; the “heads-I-win-tails-you-lose” nature of financial compensation might make banks riskier than they should be.) Or you might like it; you might want to incentivize me to take big swings rather than just playing it safe and hugging the index. (Stock options are the standard way to pay public-company chief executive officers in corporate finance, because shareholders want them to take risks. [1] ) In general, investing involves risk, and if you think I am a skilled investor you might want to give me incentives to take risks.

Second, this is not always true as a contractual matter — Warren Buffett doesn’t have a call option on Berkshire Hathaway’s returns — but it is generally true as a practical matter. If I am good at making money for you, I will be able to charge you a large percentage of the money I make for you, but if I lose all your money, I will just quit and find a new job. If you don’t like this system, you can try to find ways to contract around it — you can pay me a flat fee rather than a performance fee; you can write clawbacks into my contract so that I have to pay you back some money if I have losses — but it is a competitive market and there’s only so much you can do. The people who have investing skill will charge for it, and in the way that is best for them.

This does create weird problems of timing. I probably get my cut of your profits for some time period, say a calendar year. [2]  If it is October and I am up 80% for the year, that’s pretty good and I should stop: That 80% return will get me a big bonus, so I don’t want to keep taking risks that might get me back to zero and lose me my bonus. I should just put it all in cash and go on vacation. If it is October and I am down 3% for the year, that’s terrible — no bonus — and I should dial up the risk: A negative 100% return is not materially worse for my bonus than a negative 3% return, but a positive 10% return is much better, so I should take even negative-expected-value risks to increase my volatility and my chances of getting into the black. At big hedge funds, risk managers will try to prevent both of these scenarios: They’ll stop me from taking excessive risks if I’m down, but they’ll also yell at me for taking no risks if I’m up.

If it is October and I am down 20%, though, the situation is different. I’m not getting back in the black. This year is shot. Depending on the terms of my contract, next year is probably shot too: I probably have to get back to even (earn back my 20% losses) before I get paid for any upside. My option is very out-of-the-money, so it’s not worth much.

But it’s an option. I can just walk away. I can hand you back (80% of) your money, say “sorry it didn’t work out,” and go find someone else’s money to manage. I get my cut of the first dollar I make for them, whereas I’m already in the hole with you. Better to start over from zero than to continue from 20% down. The whole point of my option is that, if I lose money for you, that’s not my problem.

“Ah,” you might say, “but won’t you have a hard time finding someone else to give you their money, when you lost 20% of my money and shut down your fund?” That’s a reasonable question! But, no. Investing skill is rare and valuable, and if I convinced you that I have it I probably do, so I can probably convince someone else that (1) I have investing skill, (2) I just had some bad luck and (3) that can’t continue forever, so they might as well give me their money now when I’m available.

One thing that I like to say around here is that it is good, for your financial career, to lose a billion dollars. This is more or less why. If you lost a billion dollars it’s not your money; it’s someone else’s. If you lost a billion dollars that means you got someone to trust you to take risks with a billion dollars (probably several billion dollars), which means you convinced smart clients that you have investing skill, which means that you probably do. If you lost a billion dollars it means that you took risks with the money, and clients want people to take risks (that’s why they pay them in call options). If you lost a billion dollars it probably means that you learned from your mistakes and won’t make those particular mistakes again. [3]  And if you lost a billion dollars it probably means that you had a run of bad luck, and that feels like it might be mean-reverting. So if you lost a billion dollars, that is good evidence — not absolutely conclusive evidence, but surprisingly persuasive evidence — that someone else should give you another billion dollars.

Bloomberg’s Nishant Kumar has a very fun story about how the most desirable hedge fund portfolio managers are the ones who just lost a ton of money:

Rather than being damaged goods, veteran portfolio managers making heavy losses are now some of the hottest recruits around.

Fallen stars are being viewed as battle-tested hunters temporarily off their game. That moment of weakness is when they’re most poachable, driven and available at a discount, people with knowledge of the matter say. Instead of the slog of recouping a pile of losses at their previous employer, traders can wipe the slate clean and start making money for themselves again.

Yes: call options.

Say a trader has a $100 million shortfall they have to make back for their fund, and a one-year non-compete clause. If they don’t think they can recoup that money within 12 months, it makes financial sense to jump ship so you don’t start the following year in the red again.

Far better to transfer to a rival, who’ll offer you a juicy signing up fee, and a fat purse of client money to make a fresh start with.

This is not great for the clients of the hedge funds, who pay for everyone’s upside from zero but don’t recoup much on the downside:

Hedge fund investors, who tend to place their money across different firms … often have poor visibility on when these moves are happening and why, according to someone who works for one of most influential backers. With no say, they’re having to swallow the losses at the first fund, and pay for the same trader’s comeback elsewhere.

But that really is the central fact of hedge-fund compensation. Also here’s a great quote:

“Even a wounded lion is still a lion,” says Jason Kennedy, whose eponymous firm helps hedge funds recruit. “And the lion isn’t mortally wounded. He will heal. And when he’s fully back, that lion is worth a lot more money.”

If I lost a billion dollars, shut down my hedge fund, and then started a new one to reset my high-water mark, I would definitely call the new one Wounded Lion Capital Management LP. That’s the precise balance of arrogance and humility that investors want in a hedge fund.

By the way. You don’t have to believe any of this. You don’t have to believe that a portfolio manager who lost a lot of money is a wounded lion; you can think she’s a dead zebra. You can believe that markets are basically efficient, investing skill is fleeting, and highly paid hedge-fund portfolio managers had a bunch of lucky coin flips; you can be skeptical that their previous wins were due to “persistent skill” and their recent losses were due to “bad luck.” Empirically, though, this is not what the managers of the big multistrategy hedge funds, or their clients, believe. The basic theory here is that investing skill exists, that it is persistent and valuable, and that the big hedge funds can reliably identify it even in managers who lost a lot of money. So they should give those managers some more money.

Though if you lose the money twice that’s it:

Hedge fund history shows that second chances have been available a while for the small band of traders who’ve managed giant pots of client cash. But another failure will probably be fatal to a top-level career, the head of a medium-sized multistrategy firm says.

If you keep losing money for clients, that does suggest that they should stop giving you money.

I have always thought that issuing stablecoins is a great business. The way it works is:

1. People give you dollars in exchange for cryptographic tokens that you make up.
2. You invest their dollars in safe short-term assets, like a government money market fund yielding about 4%.
3. You promise to exchange their tokens back into dollars back whenever they want.
4. Without interest.

It’s like banking, but without interest or branches or credit risk: Instead of taking people’s money and using it to make loans, you take their money and park it in Treasury bills and keep the interest for yourself. Your costs are low and your revenue is high.

This is such an obviously good business that everyone should do it, but not everybody can. Network effects are very important for stablecoins: People want stablecoins — they want to give you dollars for your tokens — because they want to be able to transact with them, so they only want widely used popular stablecoins (like Tether or USDC) that can be used for transactions. If you have a new startup stablecoin, it is hard to convince people to adopt it.

What can you do about this? Well, one obvious answer is: pay people interest! If you earn 4% interest on your investments, and pay out 2% to your token holders, you still make a lot of money, and they get 2%, which is better than the 0% they get from Tether or USDC. This seems like a promising avenue, except that it’s illegal in the US. The GENIUS Act, the US law passed this year to regulate stablecoins, says that “no permitted payment  stablecoin issuer or foreign payment stablecoin issuer shall pay the holder of any payment stablecoin any form of interest or yield (whether in cash, tokens, or other consideration) solely in connection with the holding, use, or retention of such payment stablecoin.” So paying interest is out. [4]

What else can you do? Well, you want your stablecoin to be widely used for transactions. What sorts of transactions do people do with stablecoins? “Every sort of transaction that might be done with dollars can be done with stablecoins, simply and more efficiently,” is the crypto maximalist answer, but the actual main answer so far is “speculating on crypto exchanges.” Stablecoins are dollars in crypto form, and they are used mostly to buy other crypto things. One day perhaps people will spend stablecoins easily at the grocery store, but for now they spend them on crypto exchanges.

And so an obvious path to adoption is paying crypto exchanges to use and promote your token. If you earn 4% interest on your investments, you go to a crypto exchange and say “hey if you make our stablecoin the default form of dollars on your platform, we’ll split the interest with you 50/50.” You get to keep 2%, but the exchange gets a cut of the money for promoting your stablecoin. And in fact this is a common approach. For instance, it is what Circle Internet Group Inc., the issuer of USDC, does: USDC is the preferred stablecoin of Coinbase, and Circle and Coinbase split its revenue. [5]

What does the exchange do with the money? Again the ideal answer would be “Scrooge McDuck swimming pool,” but it’s not that simple. The exchange is in a competitive network-effects business too, and it wants to attract customers. If a stablecoin issuer is paying half, or all, of its interest income to a crypto exchange, the exchange might pass some or all of that money on to its users. There are various ways to do that: cutting trading fees to zero, or giving customers bonuses for trading a lot, or just paying the customers interest on their stablecoin deposits held on the exchange. The GENIUS Act says that stablecoin issuers are not allowed to pay interest on stablecoins, but it doesn’t say that crypto exchanges aren’t allowed to pay interest on stablecoin balances.

That is controversial. The Financial Times reported last month that “banking lobbies including the American Bankers Association, the Bank Policy Institute and the Consumer Bankers Association last week warned lawmakers of a ‘loophole’ in regulation that will let some crypto exchanges indirectly pay interest to stablecoin holders,” which might “spark mass deposit outflows ... if customers choose to earn yield by holding stablecoins at crypto exchanges rather than coins or cash dollars at banks.”

But it also means that issuing stablecoins is not as great a business as I once thought. It was, when there were only a few stablecoins and the stablecoins acquired their network effects naturally. But in the long run, to be a competitive stablecoin, you might have to pay most or all of your interest income to crypto exchanges, and the exchanges might have to pass most or all of it back to the customers. “You hold people’s dollars for them, you collect interest, and you don’t give them any of it” really is a good business model, but it’s too good to last.

At the Information, Yueqi Yang reports on the erosion of that business model:

Just two months after Congress passed a cryptocurrency law that gave a big boost to stablecoins, a price war has broken out, potentially wiping away the lucrative profits these tokens could generate.

The battle is taking place among users of Hyperliquid, a fast-growing decentralized crypto exchange. They are considering reducing their use of Circle’s USDC, the main stablecoin on Hyperliquid. Competitors are rushing in, offering far better deals to Hyperliquid’s customers. …

The stablecoin legislation that passed Congress banned stablecoin issuers from directly paying interest to end users. It does allow stablecoin issuers to share their revenue with exchanges, which then reward investors who hold the stablecoins.

Now, Hyperliquid has started a price war. Stablecoin issuers hoping to steal Circle’s business are offering to share an increasing portion of their revenue, in some cases all of it, with Hyperliquid. The fight could quickly turn stablecoins into a commodity business where profits are under constant pressure. …

Hyperliquid would reduce its use of USDC by finding a partner to issue a new stablecoin, USDH. Stablecoin providers Paxos, Agora and Ethena are among those vying to be the issuer of that stablecoin.

All have proposed to pass along the majority of their revenue back to Hyperliquid users. Agora said it will share all of its revenue, effectively wiping out any profit it could earn on a stablecoin. “We made the race to the bottom. Now no one should make money off this,” said Nick van Eck, co-founder of Agora.

I mean, yes, nobody should make much money off of issuing stablecoins, but historically people absolutely did and they will be sad to give that up.

Stock brokerages traditionally combine two somewhat distinct services, (1) executing stock trades for you and (2) helping you figure out which stocks to buy. Traditional full-service brokers have research analysts who publish reports for the brokers’ customers, telling them what stocks to buy. Online brokers show various charts, ratios, news stories, etc., so that customers who are looking at a stock can find out some relevant information about it.

In the olden days, the way you figured out which stocks to buy was by asking questions like “what do expert securities analysts think I should buy” or “what is this stock’s P/E ratio” or “is there a head and shoulders pattern in the stock chart” or whatever. In 2025, the way to figure out which stocks to buy is by asking questions like “what are my friends saying about these stocks on social media,” so here you go:

Soon, Robinhood Markets Inc.’s retail traders won’t have to leave the platform to brag about their positions or post taunting memes celebrating their investment victories. The online brokerage is breaking into social media. …

The company will invite a small group of customers to join Robinhood Social early next year, then broaden the availability later, the company said in a statement Tuesday. Initially, all posts by traders will be required to include a trade of equities, options or other assets. Those positions will continue to update in real time after they’re shared, and comments on posts will be allowed.

“We always thought it was something that we wanted to get into more of, especially with social and investing becoming more and more tied together,” Abhishek Fatehpuria, vice president of product management at Robinhood, said in an interview.

Investors also will be able to follow the moves and statistics of other users who join Robinhood Social, including their one-year and daily profit and loss statements and profit rates. Profiles for public figures, such as former US House Speaker Nancy Pelosi and billionaire hedge-fund manager Bill Ackman, for example, will also be on the platform, with their trades populated via public disclosures required by law.

Honestly an investing social media site that discloses everyone’s investing performance is an amazing idea? Like there are a lot of people giving investing advice on X, and they are good at making themselves sound smart, but do their trades make any money? I don’t know. But if instead of a little blue checkmark Robinhood gave them a little green “+23.5% YTD” or a little red “-17.1% YTD,” then you’d know.

Also, though, see the first section above. If you lose too much money on Robinhood Social, you have to shut down your account and open a new one. What credibility would you have with that little red “-17.1% YTD” next to your name?

Or is it the opposite? I gather that a lot of social clout on Reddit comes from posting “loss porn,” not from successes. Will a little red “-99.9% YTD” be the best possible badge to have on Robinhood Social? Will people compete to lose money for clout?

I, uh, write a newsletter and have a podcast, so I think a lot about the economics of parasocial online content creation, and I have followed with some interest (though no direct participation) the trend of charging consumers directly for that content. [6] There are two main ways to do that:

1. Paywall some or all of your content, and charge people money to access the content.
2. Don’t do that — make everything free — but ask people to pay you money because they like you and want to encourage you to keep making more content.

The first approach is the obvious one: People mostly pay for stuff that costs money, and tend not to pay for stuff that is available for free. But — from my secondhand, anecdotal, but quite interested view of things — the second approach works. Not in general, I mean, but in the specific case of parasocial online content creation. If you make a newsletter or a podcast that people love, some of them will be happy to give you money, to encourage you, even if they can get the content for free. Most people will free-ride, but you don’t need everyone to pay; you just need enough people to pay.

My impression is that, most of the time, the first approach works better. You can make more money by charging people for stuff than you can by asking them to pay for stuff that you give away. But it is a closer question than you’d think. (Getting stuff free is a better user experience and might create a closer parasocial relationship than charging directly, which might lead some people to voluntarily pay a lot more than they would pay to subscribe.) It’s not like charging money would bring in $100 and giving it away for free would bring in $0. It’s, like, $100 vs. $70 or something.

And then there are taxes. Bloomberg’s Caitlin Reilly reports that “Podcasters and OnlyFans Creators,” like me, [7] “Stand to Win Big Under Trump’s Tax Law”:

Katherine Green, a dominatrix who creates online adult videos, wasn’t expecting a windfall from President Donald Trump’s signature push to make tips tax-free.

The Houston-based OnlyFans Ltd. creator, who goes by the title Mistress professionally, is not a waitress, a rideshare driver or a golf caddy — professions typically associated with tipping. But new Treasury Department guidelines on Trump’s tax law include digital content creators like Green on the break. ...

More than a quarter of large US-based influencers — those with at least 100,000 followers — reported earning tips, according to a 2024 study by the Creative Class Group. The new tax law could restructure compensation in an emerging industry to draw even more heavily on gratuities. …

Defining a tip in the digital creative space could be complicated, said Alex Muresianu, a senior policy analyst at the Tax Foundation. 

Currently, a tip is a voluntary and optional payment a customer makes in addition to the cost of the goods or services provided. If creators provide any additional content or benefits to subscribers, that subscription cost would not fit the current definition of a tip. Some influencers may be tempted to categorize payments as tips that in reality don’t fit the bill or restructure their pay to take advantage of the tax break, Muresianu said.

If you charge for your, um, podcast, the IRS will take a portion of your income. If you give it away and ask for tips, you keep whatever you get. [8]

Ellison Tops Musk as World’s Richest Man After $101 Billion Gain. Oracle Shares Surge Most Since 1992 on Cloud Contract Wins. OpenAI Executives Rattled by Campaigns to Derail For-Profit Restructuring. Italy’s Monte Dei Paschi Secures Control of Mediobanca in Deal Valued at $19 Billion. Labor Inspector General Initiates Review of BLS ‘Challenges.’ Winklevosses Lean on MAGA Clout as Gemini’s Losses Mount Ahead of IPO. Quantum computing company raises a record $1bn. Cracker Barrel Cancels Restaurant-Revamp Plans After Backlash. That Crypto Treasury Frenzy Is Already Running Out of Steam. 

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