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Stablecoins, a new type of financial institution, are unique in two ways. First, they use decentralized databases like Ethereum and Tron to run their platforms. Secondly, and more important for the purposes of this article, they grant access to almost anyone, no questions asked. I'm going to illustrate this openness by showing how Garantex, a sanctioned Russian exchange that laundered ransomware and darknet payments, has enjoyed almost continual access to financial services offered by stablecoin platforms like Tether and USDC throughout its six year existence, despite a well-known reputation as a bad actor. Last month, law enforcement seizures combined with an indictment and arrest of Garantex's operators appear to have finally severed Garantex's stablecoin connection... or not. Evidence shows that Garantex simply rebranded and slipped right back onto stablecoin platforms. Stablecoins' no-vetting model is a stark departure from the finance industry's default due diligence model, adhered to by banks (such as Wells Fargo) and fintechs (such as PayPal). We all know the drill—provide two pieces of ID to open a payments account. Requirements for businesses will probably be more onerous. Anyone on a sanctions list will be left at the door. Banks and fintechs must identify who they let on their platforms because the law requires it. By contrast, to access the Tether or USDC platforms, the two leading U.S. dollar stablecoins, no ID is required. Anyone can start using stablecoin payments services without having to pass through a due diligence process. Sanctioned customers won't get kicked off, as Garantex's long-uninterrupted access shows. Regulators seem to tolerate this arrangement—so far, no stablecoin operators have faced penalties for money laundering or sanctions evasion. A quick history of the Tether-Garantex nexus Garantex became notorious early on for its role in laundering ransomware payments. Russian ransomware gangs hacked Western firms, extorted them for bitcoin ransoms, and cashed out at Moscow-based exchanges like Garantex. Garantex also became a popular venue for laundering darknet-related proceeds, particularly Hydra, once the largest darknet market. Reports allege that the exchange's shareholders have Kremlin links and that terror groups Hezbollah and Quds Force have used it. Founded in 2019, Garantex was connected to Tether's platform by August 2020. We know this because an archived version of Garantex's website from that month show trading and payment services being offered using Tether's token, USDT. Archived Garantex.org trading page from March 2024 with USDT-to-ruble, Dai-ruble, and USDC-ruble markets [link] This connection to Tether allowed Garantex's customers to transfer their Tether balances to Garantex's Tether wallet, in the same way that a shopper might use their U.S. dollar account at PayPal to make payments to a business with a PayPal account. This allowed Garantex's users to trade U.S. dollars (in the form of Tether) on its platform for bitcoins or ether, two volatile cryptocurrencies, and vice versa. The Tether linkage also meant that Garantex could offer a market for trading ruble-USD. By April 2022, Garantex's bad behaviour had caught up to it: the exchange was sanctioned by the U.S. Treasury's Office of Foreign Asset Control (OFAC). U.S. individual and entities were now prohibited from doing business with Garantex. Out of fear of being penalized, most non-Russian financial institutions would have quickly severed ties with it. Yet Tether, based in the British Virgin Islands at the time, permitted its relationship with Garantex to continue without interruption. Archived copies of Garantex's trading page from mid-2022 and 2023 show that Tether-denominated services were still being offered. The Wall Street Journal reported in 2023 that around 80% of the exchange’s trading involved Tether, despite sanctions being in place. The net amounts were not small. According to Bloomberg, an alleged $20 billion worth of Tether had been transacted via Garantex post-sanctions. A 2024 Wall Street Journal report revealed that sanctions-evading middlemen used Tether to "break up the connection" between buyers like Kalashnikov and sellers in Hong Kong, with Garantex serving as their venue for acquiring Tether balances. Finally, analysis from Elliptic, a blockchain analytics firm, alleges that Garantex offered USDT trading services to North Korean hacking group Lazarus in June 2023. This transaction flow is illustrated below: The Garantex/Tether nexus in 2023: Elliptic alleges that North Korean hackers stole ether from Atomic Wallet, converted it to Tether using a decentralized exchange 1inch, and then sent Tether to Garantex to trade for bitcoin. (Click to enlarge.) Source: Twitter, Elliptic Tether's excuse for not off-boarding sanctioned entities such as Garantex? A supposed lack of government clarity. When Tornado Cash was sanctioned in 2022, for instance, the company said that it would "hold firm" and not comply because the U.S. Treasury had "not indicated" whether stablecoin issuers were required to ban sanctioned entities from using what Tether refers to as "secondary market addresses." Translating, Tether was saying that if bad actors wanted to use Tether's platform to transact with other Tether users (i.e. in the "secondary market"), it would let them do so. Tether's only obligation, the company believed, was to stop sanctioned users from asking Tether itself to directly cash them out of the platform into U.S. dollars (i.e. the "primary market"). This is quite the statement. Imagine if PayPal allowed everyone—including sanctioned actors—to open an account without ID and send funds freely within its system, only intervening when bad actors asked PayPal to cash them out into regular dollars. That was Tether's stance. Or if Wells Fargo let sanctioned actors make payments with other Wells Fargo customers, but only stopped them from withdrawing at ATM. Banks and fintechs can't get away with such a bare bones compliance strategy; they must do due diligence on all their users. But Tether seemed to believe that a different set of rules applied to it. In December 2023, Tether reversed course. It would now initiate a new "voluntary" policy of freezing out all OFAC-listed actors using its platform, not just "primary market" sanctioned users seeking direct cash-outs. This brought Tether into what it described as "alignment" with the U.S. Treasury. Soon after, Tether froze three wallets linked by OFAC in 2022 to Garantex. However, this action was largely symbolic. By the time Tether froze those wallets, Garantex had already abandoned them and opened new ones, thus allowing the exchange to maintain access to Tether's platform. Tether's no-vetting model permitted this pivot. Archived versions of Garantex's trading page show that it continued offering Tether services throughout 2024 and early 2025. The U.S. Department of Justice recently confirmed Garantex's tactic of replacing wallets in its March 2025 indictment of the exchange's operators. It alleges that Garantex frequently cycled through new Tether wallet addresses—sometimes on a daily basis—to evade detection by U.S.-based crypto exchanges like Coinbase and Kraken, which are legally required to block customer payments made to sanctioned entities. That the relationship between Tether and Garantex continued even after Tether's supposed 180 degree turn to "align" itself with the U.S. government is backed up by several reports from blockchain analytics firm Chainalysis. The first, published in August 2024, found that a large purchaser of Russian drones used Garantex to process more than $100 million in Tether transactions. The second describes how Russian disinformation campaigners received $200,000 worth of Tether balances in 2023 and 2024, much of it directly from Garantex. In a March 2024 podcast, Chainalysis executives allege that "a majority" of activity on Garantex continued to be in stablecoins. After years of regular access to Tether's stablecoin platform, a rupture finally occurred earlier this month when Tether froze $23 million worth of Garantex's USDT balances at the request of law enforcement authorities. The move came in conjunction with a seizure by law enforcement of Garantex's website and servers. Garantex's website was seized in March 2025 by a collection of law enforcement agencies. In a press release, Tether claimed that its actions against Garantex illustrated its ability to "track transactions and freeze USDt." But if Tether was so good at tracking its users, why did it connect a sanctioned party like Garantex in the first place, and continue to service it for over four years? Something doesn't add up. Not just Tether: other stablecoins offered Garantex access, too Tether doesn't appear to have been the only stablecoin platform to provide Garantex with access to its platform. MakerDAO (recently rebranded as Sky) and Circle Internet may have done so, too. Circle, based in Boston, manages the second-largest stablecoin, USDC. When OFAC put Garantex on its sanctions list in April 2022, Circle was quick to freeze one of the designated addresses. It did no hold any USDC balances. However, like Tether, Circle's no-vetting policy means that it doesn't do due diligence on users (sanctioned or not) who open new wallets, hold USDC in those wallets, and use them to make payments within the USDC system. Circle only checks the ID of users who ask it to cash them out. Thus, it would have been a cinch for Garantex to dodge Circle's initial freeze: just open up a new access point to the USDC platform. Which is exactly what appears to have happened. On March 30, 2022, Garantex used its Twitter/X account to announce that it was offering USDC-denominated services. Beginning at some point in the first half of 2022, close to the time that the U.S. Treasury's sanctions were announced, Garantex began to list USDC on its trading page (see screenshot at top). The exchange's trading page continued to advertise USDC-denominated financial services through 2023, 2024, and 2025 until its website was seized last month. Tether, Circle's competitor, proceeded to freeze $23 million worth of USDT on behalf of law enforcement authorities, as already outlined. However, respected blockchain sleuth ZachXBT says that Circle did not itself interdict Garantex's access to the USDC payments platform, alleging that "a few Garantex addresses" holding USDC had not been blacklisted. MakerDAO is a geography-free financial institution that maintains and governs the Dai stablecoin, pegged to the U.S. dollar. Archived screenshots show that Garantex added Dai to its trading list by September 2020, not long after the exchange had enabled Tether connectivity. According to blockchain analytics firm Elliptic, Russian ransomware group Conti has used Garantex to get Dai-denominated financial services. Garantex is able to access the Dai platform because MakerDAO uses the same no-vetting model as Tether. In fact, MakerDAO takes an even more hands-off approach than the other stablecoin platforms: it didn't seize any of the original 2022 addresses emphasized by OFAC. That's because Dai was designed without freezing functionality. Not vetting users is lucrative Providing financial services to a sanctioned Garantex would have been profitable for Tether and competing stablecoin platforms managed by Circle and MakerDAO. All stablecoins hold assets—typically treasury bills and other short term assets—to "back" the U.S. dollar tokens they have issued. They get to keep all the interest these assets generate for themselves rather than paying it to customers like Garantex. If we assume an average interest rate of 5% and that Garantex maintained a consistent $23 million in Tether balances over the 34 months from April 2022 (when it was sanctioned) to March 2025 (when it was finally frozen out), Tether could have earned approximately $3.2 million in interest courtesy of its relationship. Not only does their no-vetting model mean that stablecoin platforms get to earn ongoing income from bad actors like Garantex, this model also seems... not illegal? Stablecoin legal teams have signed off on the setup, both those in the U.S. and overseas. Government licensing bodies like the New York Department of Financial Services don't seem to care that licensed stablecoins don't ask for ID, or at least they turn a blind eye. (Perhaps these government agencies are simply unaware?) Nor has the U.S. Department of Justice indicted a single stablecoin platform for money laundering, sanctions violations, or failing to have a compliance program, despite it being eleven years now since Tether's no-vetting model first appeared. The model seem to have legal chops. Or not? Banks and fintechs are no doubt looking on jealously at the no-vetting model. Had either PayPal or Wells Fargo allowed Garantex to get access to their payments services, the punishment would have been a large fine or even criminal charges. Sanctions violations are a strict liability offence, meaning that U.S. financial institutions can be held liable even if they only accidentally engage in sanctioned transactions. But more than a decade without punishment suggests stablecoins may be exempt. This hands-off approach benefits stablecoins not only on the revenue side (i.e they can earn ongoing revenues from sanctioned actors). It also reduces their costs: they can hire far fewer sanctions and anti-money laundering compliance staff than an equivalent bank or fintech platform. Tether earned $13 billion in last year with just 100 or so employees. That's more profits than Citigroup, the U.S.'s fourth largest bank with 229,000 employees, a gap due in no small part to Tether's no-vetting access model. The coming financial migration? Zooming out from Garantex's stablecoin experience, what is the bigger picture? I suspect that a great financial migration is likely upon us. Financial institutions can now seemingly provide services to the Garantex's of the world as long as the deliver them on a new type of substrate: decentralized databases. If so, banks and fintechs will very quickly shift their existing services over from centralized databases to decentralized ones in order to take advantage of their superior revenue opportunities and drastically lower compliance costs. This impending shift isn't from an inferior technology to a superior one, but from an older rule-bound technology to a rule-free one. PayPal recently launching its own stablecoin is evidence that this migration is afoot. The argument many stablecoins advocates make to justify the replacement of full due diligence with a no-vetting access model is one based on financial inclusion. Consumers and legal businesses in places such as Turkey or Latin America, which suffer from high inflation, may want to hold digital dollars but don't necessarily have access to U.S. dollar accounts provided by local banks, perhaps because they don't qualify or lack trust in the domestic banking system. An open access model without vetting solves their problem. What about the American voting public? Do they agree with this migration? The last few decades have been characterized by a policy whereby the government requires financial institutions to screen out dangerous actors like Garantex in order to protect the public. Forced to the fringes of the financial system, criminals encounter extra operating dangers and costs. The effort to sneak back in serves as an additional choke point to catch them. To boot, the additional complexity created by bank due diligence serves to dissuade many would-be criminals from engaging in crime. Is the public ready to let the Garantexes back in by default? I'm not so sure it is. Tether is available at Grinex, a Garantex reboot. [link] Garantex's stablecoin story didn't end with last month's seizures and indictment. According to blockchain analytics firm Global Ledger, the exchange has been renamed Grinex and continues to operate. Tether services are already available on this new look-alike exchange, as the screenshot above reveals. Global Ledger says that $29.6 million worth of Tether have already been moved to Grinex as of March 14, 2025. This is the reality of an open-access, no-vetting financial system: bad actors slip in, eventually get cut off, and re-enter minutes later—an endless game of whack-a-mole that seems, for now at least, to be tolerated. It will only get larger as more financial institutions, eager to cut costs, gravitate to it.
We're all busy doing our best to boycott U.S. products. I can't buy Special K cereal anymore, because it's made in the U.S. by Kellogg's. But I'm still buying Shreddies, which is made in Niagara Falls, Ontario. Even that's a grey area, since Shreddies is owned by Post, a big American company. Should I be boycotting it? Probably. However, the disturbing thing is that I'm paying for my carefully-curated basket of Canadian groceries with my MasterCard. If we really want to avoid U.S. products, we can't just vet the things we are buying. We also need to be careful about how we are doing our buying. Our Canadian credit cards are basically made-in-U.S. goods. They rely on the U.S-based Visa or MasterCard networks for processing. Each credit card transaction you make generates a few cents in revenue for these two American mega-corporations. It doesn't sound like much, but when multiplied by millions of Canadians using their cards every day, it adds up. Vigilant Canadians shouldn't be using them. Canadians who want to boycott American card networks have two options. Go back to paying with cash, which is 100% Canadian. Or transact with your debit card. Debit card transactions are routed via the made-in-Canada Interac debit network.* We're lucky to have a domestic debit card option. Our European friends are in a worse position, since many European countries (Poland, Sweden, the Netherlands, Finland, and Austria) are entirely reliant on MasterCard and Visa for both debit and credit card transactions. Unfortunately, going back to debit cards means doing without all of the consumer protection that credit cards offer in an online environment. Worse, you're giving up your credit card rewards or cash back. If you don't pay with your 2% cash back credit card, for instance, and use your debit card instead, which doesn't offer a reward, you're effectively losing out on $2 for every $100 you spend. This should illustrate to you, I hope, the golden shackles imposed on us by our U.S.-based credit cards. It's fairly easy to replace your American-grown tomatoes with Mexican ones or your U.S.-made car with a Japanese car. But networks, which tend towards monopolization, are not so easy to bypass. Which gets us into the meatier issue of national sovereignty. The difficulty we all face boycotting the MasterCard and Visa networks reveals how Canada has let itself become over-reliant on these critical pieces of U.S financial infrastructure. My fear is that our neighbour's political leadership is only going to fall further into authoritarianism and belligerence, eventually making a play to slowly annex Canada—not by invasion, but by "Canshluss". If so, this will involve using our dependencies on U.S. systems, including the card networks, to extract concessions from us. "Canada, if you don't do x for me," says Trump in 2026, "we're TURNING OFF all your credit cards!" In anticipation, we need to remove this particular financial dependency, quick. We're already safe when it comes to debit cards; we've got Interac. But we need the same independence for our credit cards. More specifically, we need to pursue an end-goal in which all Canadian credit cards are "co-badged". That means our credit cards would be able to use both the Visa/Mastercard card networks and Interac (or, if Interac can't be repurposed for credit cards, some other yet-to-be-built domestic credit card network). With co-badging, if your credit card payment can't be executed by Visa because of a Trump freeze order, at least the Canadian network will still process it. This is how the French card system works. While much of Europe suffers from a massive dependency on MasterCard and Visa, France is unique in having built a 100% French card solution. The local Carte Bancaire (CB) network can process both French debit card transactions, like Interac can, but goes one step further by also handling French credit card purchases. Before paying for their groceries with a card, French card holders get to choose which network to use, the local one or the international one. THIS IS WHAT CANADA NEEDS: This French credit card, issued by Credite Agricole, is co-badged with the domestic Carte Bancaire (CB) network and the international MasterCard network. When incidents occur on one route (CB, for instance), traffic is automatically routed to the back-up route, MasterCard, and vice versa. I think that a Canadian solution to the Trump problem would look something like this French CB card. The incoming Carney government should move to co-sponsor a CB-style domestic credit card network along with the big banks (perhaps a simple upgrade to Interac will do?). All Canadian financial institutions that issue credit cards would be required to co-badge them so that Canadians can connect to this new network as well as Visa or MasterCard. Even if annexation never actually occurs, at least we've got a more robust card system in place to deal with outages arising from hacking or natural disasters. Along with France, we can take inspiration from India, which introduced their Visa/MasterCard alternative, Rupay, in 2012. Thirteen years later, RuPay is now a genuine competitor with the American card networks. I can't believe I'm saying this, but we can also use Russia as a model, which was entirely dependent on Visa and MasterCard for card payments until it deployed its Mir card network in 2016—in the nick of time before Visa and MasterCard cut ties in 2022. Europe will have to push harder, too. The EU has been trying to rid itself of its Visa and MasterCard addiction for over a decade now, without much luck. Its first attempt, the Euro Alliance of Payment Schemes, was abandoned in 2013. (In fact, one of the reasons the European Central Bank is exploring its own digital currency is to provide an alternative to the American card networks.) As Canada builds out its own domestic credit card workaround, we can learn from the European mistakes. The U.S. is no longer a clear friend. Boycotting U.S. products is one thing. But if we truly want to reduce the external threat, we need to build our own card infrastructure—before it's too late. * In-person debit payments are processed by the Interac network. However, online debit card transactions default to the Visa or MasterCard networks. While Interac does allow for online purchases, many retailers don't offer the option, and when they do, the checkout process requires the user to log into their online banking, which is more of a hassle than using a card.
In what seems to be an effort to extort Canada for additional benefits, Donald Trump complained yesterday on social media that CANADA DOESN'T EVEN ALLOW U.S. BANKS TO OPEN OR DO BUSINESS THERE. And so according to Trump, Canada doubly deserves to be disciplined with tariffs. Well, if it's true that U.S banks aren't allowed to do business in Canada, then why in god's name is one of the U.S.'s largest banks doing business in downtown Toronto? Citigroup Place, 123 Front St. West, Toronto, Ontario, Canada Citi has been operating in Canada since 1919 and currently has 1,700 Canadian employees. According to OSFI, Canada's bank regulator, the bank earned C$35 million in Canada in the first three quarters of 2024 and has C$5.49 billion in Canadian assets as of September 30, 2024. In short, Trump was either lying, misinformed, crazy, or some combination of those three. Canada allows foreign banks to enter our banking industry by requiring them to set up a domestic subsidiary and applying for a Schedule II banking charter. Schedule II banks can operate in all of the same lines of business as mainstay Canadian banks (i.e. Schedule I banks) like Royal Bank or Bank of Montreal. There are 16 Schedule II banks in Canada, three of which are American. (In addition to Citi, the other two are Amex Bank and JP Morgan.) Some folks on social media tried to reinterpret Trump's complaint: "But JP, what Trump really meant to say is that Canada doesn't allow U.S. banks to serve retail customers." As proof they cited the fact that if you walk into a Citi office in Canada, Citi won't allow you to open a personal chequing account. The reason that Citi won't give you a personal chequing account isn't because the rules prevent them from doing so. Rather, Citi (along with Amex and JP Morgan) have chosen not to enter the Canadian retail banking market, preferring to focus instead on other types of Canadian banking, like commercial and investment banking. If Citi, for instance, wanted to set up a retail branch network, it could. In fact, Citi once had a small five-branch retail banking network in Vancouver and Toronto, offering personal chequing and savings account, term deposits, loans, mortgages, mutual funds and RRSPs. But it sold out in 1999 to Canada Trust, which was ultimately bought by TD Bank. Other foreign banks have also set up Schedule II banks with a retail presence, only to sell out to domestic banks. HSBC Canada, owned by its British parent, became Canada's seventh largest bank—one that was notably successful in offering mortgages to retail customers—but was recently offloaded by its parent to Royal Bank, a Schedule I bank. ING Canada, owned by Dutch-based ING Bank, created one of Canada's most popular discount retail banks, ING Direct, but sold it to Scotia Bank in 2012, which rechristened the discount bank Tangerine Bank. The lone Schedule II foreign bank I'm aware of that still serves retail customers is ICICI Bank, which is owned by its Indian parent. Why are U.S. and foreign banks reticent to compete in Canada's retail banking market? Contrary to perceptions that Canadian banking is slow and lazy, it's actually quite difficult to make much headway in Canada. The Big-5 banks, plus National Bank, which counts as half a big bank, have built strong retail branch networks that span the entire country. They compete rigorously for consumer deposits, offering higher interest rates than U.S. banks offer to Americans, suggesting a more cut-throat market than south of the border. In short, U.S. banks don't have the cojones to cross the border and compete head-to-head against Canada's more competitive behemoths. Citi already tried. It gave up. By contrast, the U.S. is an easier market for a foreign bank to enter because its banking industry is more fragmented. And many Canadian banks have entered, with TD Bank and Bank of Montreal occupying 10th and 13th spot respectively on the list of largest U.S. banks. This fragmentation is the residue of the U.S.'s refusal (until recently) to allow banks to set up branches across state lines. By contrast, Canada has always had fairly permissive rules about establishing cross-country banking networks. The irony here is that Trump's complaints about lack of openness best apply to the U.S., historically the culprit when it comes to tamping down the spread of banking. Canadian banks' U.S. and international exposure has increased over time. A recent Bank of Canada study finds that our banks now have more foreign liabilities (i.e. deposits) than domestic liabilities. (See chart below). More precisely, 57% of all Canadian banks' liabilities are now foreign. As for our banks' asset mix, foreign assets are poised to surpass domestic assets in the next year or two, if trends continue. Rising Canadian bank exposure to the rest of the world. Source: Bank of Canada The reason for this outward migration is clear. Canada's saturated retail banking market offers few opportunities for growth, but other parts of the world are less saturated, and so these jurisdictions offer Canadian banks ideal avenues for acquisitions and growth. This gives us an additional vantage point for viewing Trump's absurd comments about Canadian banking. He may not be saying that Canada's banking system is closed, but that the U.S. banking system is now effectively shut off to additional acquisitions by Canadian banks, as part of some sort of America First banking policy. This implicit threat of a foreign banking blockade may explain, in part, why the price of Canadian bank stocks fell so much more than the broader Canadian market yesterday. Their avenues for growth may have just narrowed.
On Twitter/X, I recently suggested that the network effects of the stablecoin market are massive. Tether, which has four times more wallets than all other stablecoins, is locked-in as the stablecoin lingua franca, just like English has been locked-in as the global language of business. In case you've missed the trend, stablecoins are fiat money (primarily U.S. dollars) that are issued on a new type of database called a blockchain. The total value of stablecoins in circulation has grown from $0 to over $200 billion in a decade, with Tether dominating at $138 billion. When I said at the outset that the stablecoin market is governed by network effects, what I meant is that a positive feedback loop exists whereby the value that a network (i.e. languages or stablecoins) provides to users increases as more users join the network. Once a given stablecoin has entered into this virtuous loop, other issuers cannot join in, and will have troubles competing. It's a winner take all market that Tether and its stablecoin USDt (and perhaps smaller competitor USDC, issued by Circle) have already won. Larry White, a monetary economist who I've mentioned a few times on my blog, asked me why I think network effects are present in the stablecoin market. We don’t see network effects with other U.S. dollar payment media like checkable deposits, Larry points out (and I agree), so it's not clear why we should see this with stablecoins. Here's my logic. Stablecoins aren't fungible, bank deposits are The key is that while U.S. dollar stablecoins—Tether's USDt, Circle's USDC, PayPal USD, etc—are pegged to the dollar, and thus seem to be alike, they are not actually completely alike. That is, they are not fungible with each other. Fungibility is one of my favorite words, and I write about it quite often on this blog. It means that members of a population are interchangeable, or perfectly replaceable with each other. All grams of pure raw gold are interchangeable. Not all grams of pizza are alike—pizza is non-fungible. U.S. dollar bank deposits (say Well Fargo dollars and Chase dollars) are fungible with each other. Rather than being independent, they are fused together as homogeneous and singular U.S. dollars. A Chase dollar is just as good as a Wells Fargo dollar for the purposes of making payments. That's not the case with stablecoins, which are like pizza. Or better yet, in the same way that Chinese yuan and UAE dirham are pegged to the dollar but remain independent currencies, each U.S. dollar stablecoin is pegged to the dollar but functions as its own distinct non-fungible currency. For the purposes of making payments, one stablecoin is not as good as another one, just like how dirham balances aren't perfect replacements for yuan. The reason behind this difference is that U.S. banks cooperate with each other by accepting competitor's money at par on behalf of their customers. For instance, I can take a Wells Fargo check to my Chase branch and Chase will accept it 1:1 even though it represents a competing bank's dollar. Or I can send an ACH payment directly from Wells Fargo to Chase, and Chase will accept that Wells Fargo dollar at par and convert it into a Chase dollar for me. The effect of this reciprocal acceptance is that all U.S. banking dollars are tightly knit together, or interchangeable. A fungible standard has been created. I can't perform these same actions with stablecoins. I can't send 100 USDC to Tether to be converted into 100 USDt, nor send 100 USDt to Circle, which issues USDC, to be converted into 100 USDC. Stablecoins issuers are loners. They've chosen to avoid banding together to weave a unified U.S dollar stablecoin standard. This lack of standardization explains some weird things in the stablecoin market, like why there are so many markets to trade USDt for USDC (see below). Notice that the clearing price in these stablecoin-to-stablecoin markets is never an even $1, but always some inconvenient price like 0.991 or 1.018. Some of the multiple markets for trading USDt for USDC, all at varying prices Source: Coingecko There is no equivalent trading market for Chase-to-Wells Fargo balances or TD-to-Bank of America dollars. These banks' dollars are perfectly compatible and don't require such markets. The advantages of a single dollar standard Harmonization is useful. Anyone can walk into a McDonald's and purchase a Big Mac for $5.69 with whatever brand of bank dollar they want. Money held at small banks is just as useful as money at massive ones: the Bank of Little Rock may only have five branches, but its dollars are accepted at McDonald's all across the world, on par with those of Chase, America's largest bank. McDonald doesn't accept stablecoins, but if it did, it would have to offer multiple prices for a Big Mac: i.e. 5.73 USDt and 5.68 USDC. Each stablecoin serving as its own particular unit of account is inconvenient, both for McDonald's and its customers. PayPal USD probably wouldn't even be accepted at McDonald's: it's too small. The lack of standardized stablecoin market becomes even more awkward in asset markets. If you want to buy $1 million bitcoins on, say, Binance, there's a whole array of different U.S. dollar stablecoin markets available, including bitcoin-to-USDt, bitcoin-to-USDC, and bitcoin-to-FDUSD. (FDUSD refers to First Digital USD, a medium sized stablecoin.) The table above shows the prices of bitcoin and ether on Binance, the world's largest crypto exchanges. Notice that liquidity in both Binance's bitcoin and ether trading market is compartmentalized into different stablecoins rather than being fused into a single homogeneous US dollar-to-bitcoin market. Source: Coingecko You can forget about easily buying bitcoins with PayPal USD stablecoins. No crypto exchange offers that trading pair; PayPal USD is too small to be worth the hassle. This has the effect of fragmenting the liquidity of the stablecoin market into different buckets. Instead of stablecoins-in-general having a certain level of marketability, each individual stablecoin has its own distinct liquidity profile in asset markets. In contrast, the liquidity that a Wells Fargo dollar, a Bank of Little Rock, or a Chase dollar provides to their owner in the context of asset markets has been unified into a collective whole. If you want to buy shares of Blackrock's iShares Bitcoin ETF, there isn't a separate market for Wells Fargo-to-bitcoin or Chase-to-bitcoin. As for Bank of Little Rock dollars, they are just as fit for bitcoin purchases as its much largest competitors. A winner-takes-all market Now we can understand why network effects dominate the stablecoin market. If you want to start using stablecoins to trade crypto or buy stuff, you will always be arm-twisted by market logic into choosing the largest most liquid stablecoin. And your decision to go with the largest one makes that stablecoin a little more liquid, thus solidifying its pole position. Selecting a smaller stablecoin like PayPal USD makes little sense. McDonald's will never accept it, and there are many crypto assets that you won't be able to buy with it. Even when certain PayPal USD trading pairs are available, the bid-ask spreads will be wide, imposing much larger costs on you than if you simply went with a larger stablecoin. Thus network effects, working in reverse, repel uptake of PayPal USD. The unsafe stablecoin is the largest Tether remains the largest stablecoin, despite being one of the most unsafe stablecoins. (USDC does not get top marks for safety, either.) Network effects explain this. Stablecoin rating agency Bluechip awards Tether a D rating, noting that it is "less transparent and has inferior reserves... USDT is not a safe stablecoin". Under normal conditions (i.e. those not characterized by network effects) the safest stablecoins would have long-since displaced Tether from its leading spot. But in stablecoin markets, the safest stablecoins—Gemini USD, PayPal USD, and USDP, all rated A or A- by Bluechip—remain insignificant players. The virtuous circle in which Tether is locked dominates all other factors. These are the best-ranked fiat stablecoins according to Bluechip. But they are also tiny, with market capitalization below $1 billion. There appears to be no point trying to be a safe stablecoin, since the network effects arising from liquidity completely dominate any safety concerns that users might have. Eyeing Tether's profits, new competitors are entering the stablecoin market. But this is a game they probably shouldn't bother playing. PayPal arrived last year with PayPal USD, but to date it remains mostly irrelevant, despite huge growth in the overall stablecoin market over the same period. Ripple and Revolut are also slated to bring out their own products. They're also destined to mediocrity, because they're too late to make the jump into the virtuous loop that Tether and (to a lesser extent) Circle occupy. (There is one caveat. Should one of the two leaders eventually be shutdown for money laundering offenses or sanctions evasion, one of these also-rans could be vaulted into their spot.) Might the stablecoin sector eventually migrate over to the unified fungible standard that characterizes banking deposits? No, that's probably not going to happen. For a fusion to occur, Tether and runner-up Circle, which issues USDC, would have to start accepting their competitors' stablecoins at par. But they won't go down this path, since that would kill off the network effect that gives them their unrivaled dominance over the rest of the pack. No, it's in the interests of the leaders for chaotic non-fungibility to continue. Alas, this lack of standardization may limit the stablecoin sector's broader potential to serve as a cohesive global payment alternative to the better-organized banking standard. Sometimes a bit of cooperation trumps competition.
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I knew that my post on Anthropic would draw strong reactions, when I made it public last week. I did mention in the course of the post that I have no interest in selling my estimate of value to the rest of the world, both because I don't own the high ground here and because it is meant to guide my decisions, not yours. That is why I made my model open to changes that you can make to my story and inputs, and while you have to trust my mechanics, I tried to carry your inputs into value. Much of the pushback I have received has been thoughtful and productive, some of it has been emotional (either from people who love Anthropic or from those who would not touch it with a ten-foot pole) and some of it, especially on the cost of capital, reflects a fundamental disconnect with market history, current market pricing and just basic business sense. I plan to play devil's advocate with my own valuation, looking at my story inputs, and ranking them in order of fragility, partly to stress-test my value estimate and partly to reinforce some corporate finance first principles, and then move on to your feedback and what I take away from it. Playing Devil's Advocate: A self-critique of my Anthropic valuation Since I posted my valuation only a week ago, rather than rehash how I approached the valuation and my end results, you can read the gory details in the post that accompanied it. I will start with a summary of the valuation, though, and then list the parts of my story that I believe are most directly driving my value estimate on both magnitude (how much it is affecting value) and fragility (how uncertain I feel about the part). The IPO Valuation I did summarize my valuation of Anthropic in a figure in my original post, but since there was that much to compress into that picture, I will try a different format for the same here: Download updated spreadsheet If you check against my estimates from my earlier post, you will notice that the equity value at $1.45 trillion is slightly lower than my prior estimate of $1.475 trillion, as I adjusted the trailing 12-month revenue and operating income numbers to include the just-leaked third quarter numbers. Note that replacing the third quarter revenues from 2025 with the third quarter revenues of 2026 raises the base revenues, and since I still believe that the revenues for the coming twelve months will stay at my original estimate of about $100 billion, the growth rate in revenues in year 1 has been adjusted down to deliver that result. This reframing allows me to add a few details that I might have glossed over in my last post, as well as correct errors (none of which thankfully changed by value estimate: Value per share: Though I have a share count, created by adding the shares reported as outstanding in the balance sheet to the restricted shares granted to employees, that share count will change before the public offering, as bankers adjust it to deliver on a per share value that they believe will make the company more "sellable". I will revisit this number, and update it when the company does (and it has to, before setting an offering price), but it should not change the aggregate value of equity. Cost of capital choices: I used a 9.74% cost of capital which incorporates risky technology cost of equity and a cost of debt based on a BB+ rating for the company, putting the company at close to the 90th percentile of US companies in 2026. I know that some of you felt this was too low, and I will come back to address what a cost of capital can and cannot do for you in valuation, later in this post, and why I don't think that this is the input that most moves the valuation. Compute commitments: I wish that Anthropic had created a table in their prospectus, where they specifically listed total commitments, both contractual and total, by year, similar to the table that they have for purchase commitments. Instead, they have sprayed content commitment numbers in the text, with little detail on timing and contractual standing, which results in differences of opinion in what those commitments are., with estimates ranging from $400 billion to $800 billion, with no clarity on timing or contractual terms. In my valuation, my estimate of contractual commitments results in an aggregated value of just over $450 billion and a present value of about $373 billion. It is possible that these numbers will need revisiting as details emerge of these commitments, but this will remain a long term issue for anyone valuing or pricing the company. To offer an imperfect analogy, I struggle with dealing with content commitments at Netflix, whenever I value the company, and especially so in the early years, when the entire Netflix library was leased or rented from content providers. Dilution Risk: Anthropic, like many young companies, has used its equity as currency, paying employees with restricted stock and options, and used it as an add-on to borrow money in the form of convertible bonds. In addition, if the company needs to raise capital in future years, it will have to issue additional shares for that purpose, and the larger its ambitions, the greater these issuances will be. When valuing Anthropic, there is no escaping this dilution overhang, and here is how it is incorporated into the value per share. With stock-based compensation, I valued the equity options (at their option value, rather than exercise value) and netted that number ($472 million) from my estimated equity value to get to value of equity in common stock; I also included the restricted shares as part of my share count to compute value per share. With the convertible debt, I have assumed that the marked-to-market number (it was the marking to market that created the $72 billion hit to earnings in 2026) is close to fair value, and subtracting it out will remove the conversion option from the equity. The future share issuances are to fund negative free cashflows, and since those negative cashflows are already weighing down my present value, there is no need to add the shares issued to the share count; adding it will be double counting. If you are surprised that adding the third quarter numbers did not move my value by much, it is because it was an open secret that Anthropic's third quarter revenue growth had slowed and I had already incorporated that into my valuation story. Value Drivers The equity value that I obtain for Anthropic is close to the lower end of the offering price estimates, but as I noted at the time that I posted it, and will reinforce again now, it is a function of not just my upbeat story about the company, but also one about how the AI products and services market will evolve over time. To the question that some posed about whether I was concerned that I could be wrong, of course I am, but as I will argue in the next section, I cannot let that concern paralyze me. I would, of course, rather be right than wrong, but I am trying to forecast the future, and it is a guarantee that I will be wrong. That said, I am more uncertain and exposed on some parts of my story line than others, and here is how I would rank them for Anthropic, from most critical to less so: Target Revenues: If I were forced to pick one variable around which my valuation revolves the most, it is my estimate of the target revenues for Anthropic, which I estimate to reach a trillion dollars in ten years. Not only would this put them at or close to the top of all companies, in terms of total annual revenues, but they will also be sharing that grouping with companies like Amazon and Walmart that deliver on scale, but at the expense of margins. The revenue assumption is also inextricably linked to not only what you think AI agents and products can do, but also how demand for these will be monetized. In addition, there is a company-specific component to this story, where Anthropic emerges as a winner in the premium portion of the AI market. capturing a dominant market share, with pricing power. The fragility of the target revenue assumption comes from it being susceptible to any of the parts failing, and if a part fails, revenues will end up below a trillion, and perhaps significantly so. That, in turn, will have ripple effects on the other parts of your story and inputs, with lower revenue growth pushing down margins, creating idle compute power and increasing the risk of failure. Governance: I did use harsh words to describe the governance structure at Anthropic in my last post, describing the combination of its structure as a public benefit corporation and a voting share concoction that leaves founders in control, no matter how much capital the company raises in equity markets, as a red flag. I did get some pushback from some arguing that this is a good feature, not a bad one, since these are smart people who understand AI better than anyone else in the world. Even if you accept these views I would still argue, perhaps even more forcefully, that concentrating power in the hands of founders is a bad idea, and here is why. Anthropic has a plausible or even probable pathways to business riches, but those pathways come with setbacks (technological, regulatory, competitive), and you need management that can respond quickly and decisively, sometimes abandoning existing policies. For the latter to happen, you often need outsiders, not as immersed or even as informed on the technology front, but with different backgrounds and experiences, to call attention to management missteps and push for change. I don't know any of the founders of Anthropic, and this may be unfair, but they seem to share a common worldview and operate in an echo chamber. My concern, as an investor, would be that they will not see changes occurring in business economics, and even if they do, be unable to or unwilling to adapt to a changing environment, and for Anthropic, that may be fatal. Profitability: My story for Anthropic is that it will not only be able to deliver operating profits soon, but do so on a sustained basis, with a target operating margin of 32.5% (before taking the regulatory risk haircut). Implicit in my profit story are assumptions about pricing power, the unit economics of the AI business and economies of scale and each is breakable: One of the most frequent critiques I received in responses to my Anthropic valuation is that this is a business without moats, and while I agree that moats matter, I am not sure that I go along with the notion that this business will get commoditized. The truth in technology is that unlike consumer products or old economy companies, where the moats take the form of brand names, patents or cost advantages, the companies that win find ways to make their products stickier to their customers, where stickiness implies that customers will not switch to alternatives, even if these alternatives are technically superior and cheaper. I recognize that Anthropic has work to do in creating stickiness, but I can visualize ways in which Claude agents, twinned with client data on customers and employees, can become sticky, allowing the company to preserve its pricing power and market share. Continuing investment needs: While much of the focus on Anthropic has been on their compute commitments, disclosed (loosely) in their prospectus, my valuation of Anthropic is driven by expectations of what those commitments will look like over time, and especially if my growth story for the company comes into fruition. Delivering a trillion dollars of revenues will require Anthropic to not just maintain and replenish the compute power that is has already locked down, but add to that power over time. Implicit in my story line for the company, where the company is able to add this compute power at lower costs (reflecting declining chip prices) and in time, is the assumption that the compute power story moves along smoothly, working through resource constraints and pushback: If you have been tracking news stories about data centers, it seems clear that building new data centers is getting more difficult, as local communities push back, and politicians realize that opposing them is a net vote winner. Regulatory risk: You may find this surprising, but risk, in my story, is not as critical as my first four inputs, partly because it is determined by shifts in operating variables. Put simply, Anthropic will become riskier, if revenues do not measure up to expectations and the pathway to profitability becomes rockier, making it more an output than an input variable. I know that for some of you, the cost of capital of 9.74% is the main stumbling block, but I will provide a more cohesive (and hopefully) more persuasive argument of why it is not as critical to value as you may believe it is. I also know that for others, the notion of a money-losing company borrowing hundreds of billions, either directly as debt or through contractual commitments, creates a failure risk probability that is so high that the rest of the valuation is moot. I agree with you on the general argument that some players in the AI ecosystem, such as Coreweave, have abandoned corporate finance first principles and risk bankruptcy, but Anthropic is no Coreweave, especially if you consider that most of its debt is in contractual commitments spread out over time and that it will have a cash balance large enough to cover its first few years of those commitments. It is on the regulatory risk front that I worry the most about being wrong, because regulatory risk is as much driven by politics as it is driven by economics. You could be one major election away from onerous regulations on AI, where unlike my base case, where those regulations cost you only a small slice of your operating profits, they take a major bite out of revenues and profits. In sum, not only will I be wrong on any of my key inputs, but being wrong on one (especially target revenues) will cause me to be wrong (in the same direction) on my other inputs, causing value to shift more dramatically in response. Investment Followthrough At this point, you are probably why, if I am this uncertain about a company's future, I would even consider investing in it and it is a question that I have pondered as long as I have been an investor. Uncertainty is a feature of investing, no matter what you invest in, with the differences across investments lying in how much uncertainty you face, rather than whether you face. There are four responses that an investor can take to uncertainty: Ignore it: There are investors who are capable of ignoring uncertainty and going in fully even on the most uncertain investments. They are able to do so because they are far less risk averse than the rest of us and are willing to live with the consequences of investments (and their portfolios) blowing up. They are more gamblers than investors, but with good instincts and timing, gamblers can get wealthy too. Avoid it: If you completely want to avoid uncertainty, you cannot invest in equities, corporate bonds, which have risk of default, and even treasury bonds, which have price risk from shifting interest rates. Unless you want to hold just hold cash, you have to therefore decide what your threshold for risk is, and stay within that threshold. In conventional value investing, that would lead you to restrict your investments to companies with assets in place (captured in book value) and earning power from those assets (high current earnings and cash flows) and stay away from growth companies, since growth is "speculative" and therefore risky. While I understand the impulse, this choice comes with a cost, which is that your portfolio will be almost entirely invested in mature and declining companies, with no growth companies in emergent technology. Margin of Safety: The third approach to dealing with uncertainty also borrows from conventional value investing and imposing a margin of safety, where you will buy a stock only if its price is less than your value estimate by a margin (20%, 30%, 40%) that you specify. While your inclination, if your risk averse, is to keep increasing your margin of safety, it is worth remembering that like almost everything else in investing, it creates a trade off between type 1 errors (where having a higher margin of safety protects you from the losses of investing in stocks that you should not be investing in) and type 2 errors (where that higher margin of safety keeps you from investing in good stocks that you should be holding): The question of whether you should have a margin of safety, and if so, how large it should be, will be a function not only of how many opportunities you see in the market, relative to your portfolio size, and how much cash you have in your portfolio (with larger cash balances suggesting that you should lower your margin of safety). Law of large numbers: If I had a million dollars in investable funds, would I invest that entire amount in Anthropic, even if it trades at well below my assessed value? The answer would be no, given the uncertainties associated with the future of the company, but that answer would change if my portfolio became less concentrated, since its performance would be less a function of any individual company's performance (good or bad). In effect, I am using the law of large numbers as an ally to not only reduce my risk exposure to individual companies, but also as a basis for making investments in far riskier stocks than I would be otherwise inclined to invest in. As you assess your story and valuation of Anthropic, it is crucial that you frame the question that you are trying to answer with your analysis. Is it whether you should buy or sell short Anthropic, as a stand-alone investment or are you looking at Anthropic as an add-on to an existing portfolio? If it is the latter, how concentrated (across stocks and sectors) is your existing portfolio? The answers will vary, as a consequence. Keeping the feedback loop open: Your pushback on my valuation In the days since I posted my Anthropic valuation on multiple platforms (X, LinkedIn, Google, Substack and YouTube), I have heard from many of you, and in the interests of keeping the feedback loop alive, I did a breakdown of two statistics - the percent of people who thought that I was over valuing and undervaluing Anthropic, and among the majority who thought I was overvaluing, their reasons for disagreement. I used the Google shared spreadsheet that I created last week, where some of you were kind enough to enter your story/inputs and value for the company, and here is what you found: Clearly, a lot of people disagree with my assessment, with more feeling that I have over valued Anthropic, rather than under value the company, with the crowd assessment of its value closer to $1 trillion, rather than $1.5 trillion. I also used your inputs from the shared sheet, as well as a reading of the comments on my valuation, across platforms, to see the source of your disagreement, especially if you believed that I have overvalued the company. Among those who disagreed with me, the reasoning varied, but I was disappointed, albeit not surprised, that the biggest single reason outside of "my gut tells me that Anthropic is worth nothing" was a judgment that my cost of capital estimate for the company (9.74%) was much too low. I was disappointed because I don't think that the cost of capital is at the center of the DCF universe (and I used words to that effect in my original valuation) but the lack of surprise at its prominence comes from observing appraisers and analysts obsess over this number, often without understanding what it is designed to measure and without a frame of reference (as to what a reasonable value for it is), and using it as a receptacle for their hopes, fears and fantasies. The Cost of Capital - The Swiss Army Knife of Finance I teach and practice across three different areas of finance - corporate finance, which looks at the first financial principles that govern how to run businesses, valuation, which looks at those businesses and tries to attach a value to them and investing, which is about finding market mistakes and taking advantage of them. I describe the cost of capital as the Swiss Army Knife of finance, because it is in every aspect of finance, performing different roles for different players (businesses, investors, activists). I won't bore you with an extended discourse of all of these roles, which I have expanded on in a practitioner paper on cost of capital, but you can get a glimpse of its uses in the figure below: For many analysts and bankers, the cost of capital is the discount rate that they use to value businesses, but its usage in corporate finance is deeper and more impactful. It is the hurdle rate that businesses use to decide whether to invest in a project or make an investment, tailored to the risk in the business, the optimizing tool that businesses can use, if they so choose, to determine the right mix of debt and equity to fund themselves and the divining rod to determine whether businesses should be returning more or less cash to their owners. It is true you can break the cost of capital into its components, by categorizing the funding into debt and equity and attaching a cost to each: At the risk of stating the obvious, all debates about cost of capital become discussions of what comprises a reasonable cost of equity, what the cost of debt should measure and how they should be weighted. Estimating the Cost of Equity - Checks and Constraints While there is much to be learned from modern portfolio theory, one of its more deleterious consequences has been a dumbing down of the cost of equity, where intuition and common sense are supplanted by heated arguments about asset pricing models and parameters. To bring the discussion back to steady ground, start with a recognition that the cost of equity for an investor should reflect what investors can earn elsewhere in the market on an investment of equivalent risk, i.e. it is an opportunity cost, and understand that is what you are trying to measure, often imperfectly, in every model. That number has subjective elements, and can vary across investors, based on risk aversion, but the requirement that you can earn that number elsewhere creates reality checks. a. History What do you think the cost of equity for the average US company is today? In an unbounded world, you can give me any answer you want, from 3% to 30% or higher, but one check you can run is against history. On my webpage, I maintain a dataset of historical returns on US stocks from 1928 to 2025, and in the graph below, I compare the average annual returns you would have earned on US equities (all as well as just small cap) over 25 years (2001-2025), 50 years (1976-2025) and close to a hundred years (1928-2025) to annual returns on treasuries (3 month and 10-year): There are two ways this historical data can be used to frame cost of equity estimation. You can use the average annual return on stocks over the period, which ranges 8.74%, if you look at just this century (2001-2025), 11.92%, if you go back fifty years (197-2025) or 10.13%, if you go back all the way to 1928 (1929 -2025), and use that as your cost of equity. Since investors had the alternative of investing in treasuries, and rates over treasuries have varied over time, a second option is to look at the premiums you would have earned investing in stocks instead of treasuries. That number has a tighter range, between 5.5% and 5.75% over the 10-year bond and 7-7.5% over treasuries; using the 10-year treasury rate of 4.9% on October 26, 2026, that would yield a cost of equity of about 10.4-10.65% for the average risk firm. There is value in knowing history, but it is worth recognizing that these returns capture stock market performance over a century in the United States, the most successful equity market in the world over that period. There is a selection bias that may be leading to overestimate future returns, if you use historical averages. That would make using a cost of equity higher than what this history delivers even more indefensible. b. Market-Implied If the essence of cost of equity is estimating an opportunity cost, i.e., a return you can make investing elsewhere, I would argue that a better way of estimating the cost of equity for a company is to back it out of market prices. In effect, you can start with what the market is pricing equities in the aggregate, estimate expected cashflows from buying these equities and solving for the expected rate of return. If that sounds familiar, it is the process I use at the start of each month to compute the implied expected return and resulting equity risk premium for the S&P 500: In a post earlier this month, I reported on what those numbers are at the start of October 2026: Note that the expected return from investing in US equities, in the aggregate, at the start of October 2026 was 8.99%, and this number is model-agnostic. Thus, you can choose to believe or disbelieve the CAPM and think that betas are a waste of time, but the expected return from investing in US equities will still be 8.99%. I know that there are estimates of growth and cash flows that help determine the number, but almost every pushback I get (the cashflows cannot be sustained, the growth rate is too high etc.) will lead to a lower expected return, not a higher one. So what? If this is the market you are in, contending that the cost of equity for a median US company should be 12% or 15% borders on the delusional, since you cannot make that return on an investment of equivalent risk in this market. To see why costs of equity that are 15% or higher are indefensible, you can check out the graph below where I report the expected return on US equities (using the implied premium approach) going back to 1960: The expected return on US equities, and by extension, the cost of equity for the average US company has not exceeded 10% since 1994. If you are reaching for 15-20% costs of equity, you have to go back to the early 1980s, when the 10-year treasury rate was 10% or higher. c. A Pricing Perspective There is a third way to assess the reasonableness of a cost of capital, and this approach is especially effective if you think in terms of pricing multiples (PE and price to book ratios) and have a frame of reference on those (in the sense that you have a measure of what a reasonable multiple of earnings stocks should trade at). There is a simple (and perhaps simplistic) way to think about the cost of equity and capital in terms of pricing multiples. You can convert a cost of equity assessment into a price earnings ratio, with relatively few assumptions. To see how, start with a simplistic valuation model where the value of a stock is the present value of its expected dividends over time, and the company is in stable growth: If you believe that the cost of equity is 15% for the average US firm, given that nominal growth in the US economy is about 5% and that the average return on equity across US firms is about 20% (and that is a generous estimate), the PE ratio for US firms today should be roughly 7.5. Given that the actual forward PE ratio is closer to 20, you have two choices. One is to sell all your equities, though I am not sure where you would put that money, and the other is to revisit your cost of equity assessment. The cost of capital maps on to enterprise value multiples, using a similar approach, with a 12% cost of capital translating into an enterprise value multiples of 9 times operating income and 6-7 times EBITDA for the entire market, numbers that are vastly below today's values. Put simply, if you content that the cost of equity for US firms is 15% and in the same breath argue that a PE ratio of 15 for the market is reasonable, you are being internally inconsistent, and you have to decide which of these assertions you plan not just stick with, but act upon, as an investor. The Cost of Debt: Intuition and Estimates One reason that the Anthropic cost of capital discussion may have been hijacked is the almost mindless use of debt in funding data centers, a practice that I have attacked as senseless for both the borrowers and for the lenders. With Coreweave as poster child, this has led to an explosion of concerns about default risk and in market-implied default rates and spreads for some companies in this space. By extension, Anthropic has become part of this discussion because of the compute commitments that it has locked in, for good and bad reasons. In fact, the argument for a higher cost of capital goes as follows. If it costs Anthropic 10% or more to borrow money today, it should have a much higher cost of equity to reflect the residual risk. It is true that the cost of debt will tend to rise as worries about default risk rise, and that ratings operate as a shortcut to measuring that default risk. Using the default spreads that you can observe in markets right now, with a 10-year treasury bond rate of 5% as the base, here are updated default spreads and costs of debt, by bond rating: As you can see, the default and cost of debt for companies rises as the rating drops and kicks into hyper drive at a B rating. You may have a hard time reconciling the very high costs of debt at the lowest ratings with the earlier table that constrained cost of capital, but that is because at the lowest ratings, the risk of default is imminent and large. It would be inconsistent to incorporate this cost of debt, in its entirety into a cost of capital, a going-concern concept, and that is why I separate out failure risk as a way of capturing that risk. My estimate for the cost of debt for Anthropic reflects my estimate of a bond rating of BB+, and a recent news story in the Financial Times suggests that they will remain below investment grade. Anthropic may owe a lot in commitments, but they are spread out over time, with about $70 billion coming due next year and $76 billion the year after. Those are large commitments, but Anthropic has a cash balance of $114 billion, which will increase to over $200 billion after the IPO. There are lots of reasons to take issue with Anthropic, but worries that it may default in the next year or two or even the next five don't make it to my top ten list. That does not mean that I am ignoring the risk of default, because I am incorporating a failure risk of 10%, where Anthropic does run into headwinds, is unable to meet its contractual obligations and has to have fire sales. If your concerns about default are higher, teh failure risk is the number you should be moving, not the cost of capital. In fact, if you were ignore failure risk, as many analysts do, and try to jam default risk it into cost of capital, you would need a cost of capital of about 11% to arrive at an estimate of value close to mine, in my valuation. Cost of Capital - The Cross Section I know that you may still argue that if you have a very risky company, and you throw Anthropic into that grouping, you could have a much higher cost of equity than a median company. That is true but you may be vastly over estimating the divergence in costs of equity across companies, when you do so. At the start of every year, I estimate the cost of equity for every public company in the world, and graph the distribution to get a sense of what high, low or typical numbers look like, and the start of 2026 numbers are shown below: In almost every sector, take heed of the tight range between the first and ninth deciles. In technology, a sector where investors perceive wide differences in risk, 80% of all firms have costs of equity between 9.88% and 14.49%, and costs of capital that range from 9.02% to 12.27%. When you have this little room to diverge, you can see why spending your time finessing the cost of capital is an exercise that will bear little fruit, especially if you also factor in that your starting numbers for these costs in valuation will change over time, as your company becomes larger and more profitable. This table is in US dollars and for US companies, and if you are working with a different currency and with a company in a different country, you should add the differential inflation and country risk premium to the cost of equity. In the table below, I have the adjustment computation for a subset of currencies/countries: Thus, if the inflation rate is 1.77% higher in Indian rupees, and the Indian equity risk premium is 2.49% more than the US, you should add 4.26% across the table to get the ranges in rupees for Indian companies. A median Indian company would therefore have a cost of capital of around 12.05%, in Indian rupees, and a median Swiss company would have a cost of capital of about 5.85% (adjusting for an inflation rate about 1.71% lower than the US and an equity risk premium about 0.23% lower). It is true, based on this table, that you could push the cost of capital for Anthropic higher, perhaps towards the 90th percentile of technology firms, and give it a cost of capital of 12%, but there are two caveats. The first is that you would then have to set the failure rate to 0%, since the costs of capital in this table do not adjust for failure (and especially so at the higher risk percentiles). The second is that your cost of capital, in your valuation, has to change over time to be consistent with your story line for Anthropic as a company. Thus, if you see Anthropic scaling up revenues over time and turning the corner on profitability, its cost of capital will move towards a more typical cost of capital for tech companies over time. If you don't see that happening, you don't need a high cost of capital to conclude that Anthropic is worth little or even nothing. You will notice that nowhere in this discussion have I used a greek alphabet (beta) or a finance acronym (CAPM) because not only do I not need either to make my point about costs of capital but also because they have become easy excuses for laziness on the cost of capital front. I don't estimate costs of capital as an academic exercise, but for purely pragmatic reasons, since I need them in my corporate financial analysis and valuation. I need a relative risk measure for a firm to estimate how much higher or lower than the average company its cost of equity should be, and all that beta provides is an estimate of relative risk. If you like it, use it. If you don't it, come up with your alternative, and if you cannot think of any, try any of the following: Put simply, if you don't like betas (or the CAPM), you should consider why (and it cannot just be because Buffett or Munger told you so) and follow through to come up with your proxy for risk. I am okay with any of your choices, since I can use them to estimate costs of equity and capital, and to be honest, none of them will make or break my valuation. Cost of Capital Delusions - Investors and Businesses I know that there are analysts and investors out there who have picked a required rate of return as their hurdle rate, sometimes arbitrarily, for investing and never revisit that number, and almost as many CFOs who do the same for the hurdle rates at companies. That number can be 10%, 12% or 20%, and when you push back, the response is that it their choice to make, and that they are just setting high standards. With individual investors and privately owned businesses, the consequences of setting an artificially high cost of capital are personal, and if, after being made aware of them, they stick with a 25% cost of capital, they are entitled to do so. With institutional investors and publicly traded companies, where you are investing other people's money, you have to consider the costs that they will bear for your overreach. Professional Investors - Grasp exceeding Reach! With subgroups of professional investors, especially venture capitalists and private equity, the numbers that they offer as target or expected returns are so staggeringly out of sync with reality that the cynic in you should wonder whether these numbers are marketing props, rather than financial metrics. Let's start with venture capital, where VCs routinely set target rates of 20%, 30% or even 50% for their investments, depending on how early in the process they invest, with angel financing commanding the highest rates. Private equity fund sponsors also present potential investors with investments that least on paper deliver internal rates of return of 20% or higher. We know that these target returns are fiction, because the returns that venture capitalists and private equity investors actually deliver are not just much lower but surprisingly close to what investors can earn on public equities, say on index funds. Cambridge Associates Note that not only do VC and PE funds lag public equity indices over long periods, there is not a single number in these tables that comes remotely close to the target returns that PE and VC claim up front. You may be tempted to cut venture capitalists and PE investors slack for using fictional target returns, viewing them as sales and negotiating tools, but those fictional values feed back into how much founders have to give up in exchange for capital, and may also explain the failure of VCs and PE investors to deliver value for their investors. As a generalization, I believe that active investors who promise their clients too much (as an expected return) will overreach in terms of the risks they take, and if the target returns they promise are set too high (relative to what they should be), they will spend their time looking for ten or hundred baggers, rather than solid long term investments. Publicly Traded Companies - Inertia and Herding While it is true that company hurdle rates are for internal use and not often visible from the outside, surveys of CFOs, asking them about what the costs of capital are for their company, often come back with the conclusion that hurdle are set about 2-3% higher than justified by market numbers. Often, these hurdle rates are either arbitrary or reflect the history of the company, where high returns earned on projects taken in the past are employed as hurdle rates for the future. You may be tempted to let this practice go, as just being conservative, and protecting companies from taking bad investments, but here again, there is a trade off. For companies that estimate returns on projects rigorously, having a higher hurdle rate than justified will mean the good investments will be left untaken. Early in a company's life, when project choices are plentiful, this may not be a deal breaker, but as companies mature, that underinvestment will cost them (and their investors). There is another, and potentially an even more dangerous consequence that undermines the entire process of investment analysis. When hurdle rates are set unrealistically high, relative to what you can earn in the market, managers, recognizing that they will never find projects that earn more than those hurdle rates will start to skew cashflows and growth upwards to compensate for discount rates being too high. Top managers will then push up hurdle rates to compensate for the bias, and when managers respond with even more positive skews in cash flows, you have set in motion a process where both the cash flows and the discount rate become fictional and made-up numbers, rendering the entire process moot. Ultimately, though, as with PE and VC, the proof is in the pudding, and with publicly traded companies, the returns on equity and invested capital reflect what they actually earn on projects, rather than what they claimed they would in the original analysis. With my sample of publicly traded companies, in 2025, here is what the numbers look like: As you can see from the 2025 statistics, and this is with my cost of equity and capital calculations from the earlier table (which you may have found too low), less than 30% of companies earn returns on equity (capital) that exceed their costs of equity (capital) and less than 20% beat their hurdle rates by more than 5%. If you raise the costs of equity and capital to 12% or 15%, that underperformance will only get worse. Individual Investors and Privately owned businesses As an individual investor, investing your own money, you do have more freedom on setting your required returns, but there will be consequences to setting unrealistically high hurdle rates. If you stick with these "high" hurdle rates. you will find it difficult, if not impossible, to find equities that can deliver those rates. I can assure you that with a 20% cost of equity, for instance, there is not one firm in the S&P 500 that will be undervalued for you to invest in, and if you do find firms that look undervalued in the broader market, it is because they are basket-case firms on the verge of tipping over. Thus, a reasonable and logical follow-up would be to reduce or even eliminate your equity exposure in your portfolio, though if your unreasonableness on hurdle rates carries over into other asset classes, you will find no risky asset class that meets your rate of return criteria. More dangerously, it will leave you open to scams, where your search for high return investments will lead you invest with a "friend of a friend" or a "YouTube investment celebrity", claiming to have found a way to deliver more than your hurdle rate with investing alchemy. I have long heard critics of intrinsic valuation argue that it does not work for them because it seems to find everything that they try to value to be over valued. That is less a problem with the approach and more a reflection of using unrealistically high costs of equity and capital in your valuation. For businesses with private owners, setting the hurdle rate too high will lead them to be more conservative in taking investments, opening the door to more aggressive competition, often from publicly traded companies or private business competitors with more reasonable hurdle rates. The bigger danger here again is when you get ready to sell, you will sell your business for too low a price. You will facilitated in this process by private company appraisers who come up with costs of capital that are outlandishly high, usually getting there with what they call the "build up" approach, a piling on of premiums that are either thinly sourced (a small cap premium that ceases to exist in 1981), double counted (an illiquidity premium, with an additional illiquidity discount of value) or just made up to (a non a company-specific risk premium, where a number is added on to get to whatever discount rate you want). Conclusion This post started with a sell assessment of my Anthropic valuation, and I hope that you can see that while I believe in the plausibility of my valuation, there are multiple dimensions on which I can (and will) be wrong. In my view, the key assumption that drives almost of the others is my trillion-dollar revenue projection in a decade for that company, insofar that if that does not come to fruition, it will ripple through my other assumptions, with lower profit margins and higher failure risk following. That should make it the central question that we should be debating, and my extended discourse on why making cost of capital your central discussion point is misguided is designed as much to bring attention back to things that matter as it is to restoring balance to discussions of what a reasonable or high cost of capital for a company can be. You are, of course, welcome to quote any number you want as the cost of equity and capital (and they are not interchangeable), but while you are entitled to your opinions, you are not entitled to make up facts. When you claim that the cost of equity is 12%, 15% or 20% for a typical firm, you are either valuing a company in Turkish lira or Zambian kwacha (where inflation is 15%+) or a company in Afghanistan or South Sudan (where country risk is daunting) or you are just making up stuff! Would I like to make 20% returns on the stocks I invest in? Of course, but I would also like to have a milk shake with every meal, without affecting my glucose and cholesterol scores, and get older without any of the symptoms of aging. YouTube Video Data Costs of equity and capital (in US $), by Industry (US, Global) Historical returns on US stocks. bonds and bills: 1928 - 2025 Implied Expected Returns for US equities: 1960 -2025 Blog Posts on AI in 2026 To a Trillion Dollars and Beyond: A SpaceX Odyssey! Revisiting SpaceX: A post-Prospectus valuation OpenAI, Anthropic and SpaceX: The S&P 500 Inclusion Question and Investment Consequences AI Scenarios: From Doomsday to Do-nothing! AI's Bar Mitzvah: From hope & hype to business questions! Stock Prices, Earnings and Cashflows: The AI Effect! From Eyeballs to ARR: Buzzy Pricing Metrics and the Anthropic Pricing The Anthropic Prospectus Arrives: My (but not the) valuation of Anthropic
This is Essay #9 in the series Truth Be Told. The core dynamic of this era is the notion that controlling the narrative controls the world, as persuading the populace to believe something is true controls their convictions which then control their behaviors. Centralized powers discovered the potential for narrative control to control the world in the 20th century, as mass communications enabled centralized control of what is presented as true and important. Propaganda has an ugly tone, so now we say narrative control, which is of course a comically obvious propaganda technique. We call propaganda designed to financially benefit a private entity marketing, a key component in what I call privatized totalitarianism: establish a monopoly that controls a key mass communication technology--a social media platform, search, smart phones, etc.--and voila, privatized totalitarianism controls the medium which controls the message. Controlling what the populace believes to be true appears to control the world, but Controlling the Narrative Is Not the Same As Controlling the World. This is becoming increasingly clear as the status quo narratives--everything's going great, AI will deliver super-abundance to everyone, inflation is low, etc.--are now so detached from what we experience that they are inducing mass psychosis. The incentive is obvious: persuade the populace to accept an arrangement that enriches and empowers those in control, and you no longer have to deliver authentic Progress or Prosperity, you only need to deliver artifice: fake statistics, fake claims presented as certainties, a ceaselessly promoted narrative in which everything is fake. But narrative control doesn't actually control the world. A rancher told us the cost of fodder has doubled in the past year. That's the real world of weather and the cost of energy. Telling us that inflation is only 3.6% while healthcare premiums go up 13% a year, insurance costs triple and beef is now a luxury item is a parody of factual reporting. The Pendulum of History has reached an extreme of artifice and narrative control that will break the status quo as the gulf between the fake and the real widens to the point the bridge connecting them collapses. The social control of replacing authenticity with artifice will backfire and the pendulum will swing back to punishing self-serving artifice rather than rewarding it. Yes, yes, I know this is "impossible." Those wielding the machinery of social control have god-like powers that will never diminish, they will only increase, etc. But everything is fake and mass psychosis are not stable arrangements. Artifice is self-liquidating. The pendulum has reached an extreme of parody that cannot be pushed any further, and as the real world intrudes, all the narrative control in the world won't actually control the real world. New podcast: Global Uncertainties may result in Nonlinear, Self-Reinforcing Instability (26:31 min) New collection of five intriguing stories: Jumble Bin Stories (Kindle $6, print $12) read samples for free (PDF) My book Investing In Revolution is available ($18 for the paperback, $24 for the hardcover and $8.95 for the ebook edition). Introduction (free) Subscribe to my Substack for free NOTE: Contributions/subscriptions are acknowledged in the order received. Your name and email remain confidential and will not be given to any other individual, company or agency. Thank you, Paul C. ($300), for your beyond-outrageously generous subscription to this site -- I am greatly honored by your support and readership. Thank you, James B. ($70), for your monstrously generous subscription to this site -- I am greatly honored by your support and readership. Thank you, Craig F. ($150), for your beyond-outrageously generous subscription to this site -- I am greatly honored by your support and readership. Thank you, Gary F. ($100), for your outrageously generous subscription to this site -- I am greatly honored by your support and readership. Go to my main site at www.oftwominds.com/blog.html for the full posts and archives.
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Binance’s first day back, OpenAI wants a nicer word for data centers, Google prices space compute at 100x, and a benchmark where the best AI scores 12%.
The ultimate truth is revealing the truth of the situation and our feelings about it are a relief, and the starting point to moving forward in a positive direction. This is the first in a series of posts around the theme of Truth Be Told, a theme that demands some interpretative explication / context. There is a spectrum of ways to tell the truth. There's the angry rant ("I'm mad as hell and I'm not gonna take this any more!"), the tearful confession, the accusatory diatribe ("you can't take the truth!"), the dispassionate accounting of facts and evidence, and many variations that combine the human emotions these express. My series is built around a special form of Truth Be Told, the kind only a true friend can tell us. It's human nature to hide truths that hurt, and it's human nature to lie to ourselves to maintain a front that all is well and whatever's crumbling can be shored up by our belief that everything is still as it's always been. The acquaintance responds to our doubts and fears with superficial encouragement: you'll get through this, it's just a rough patch, every relationship / enterprise goes through these low spots, you just need a weekend off to regain your perspective, and so on--well meant but not the truth. Only a true friend will risk telling us the truth, knowing it will be painful and that we will likely respond poorly, defensively at best and lashing out attacking the friend at the worst. The true friend accepts the responsibility reluctantly, torn between the desire not to hurt us and the knowledge that the only way out of our misery is to finally face the truth, mourn what is no longer what it once was and accept the truth of what we feel beneath what we've been telling ourselves to keep going. A true friend is not passing judgement, they speak the truth with sympathy for our plight, sympathy for the suffering of living a lie, however attractive the lie may be, fully aware of the pain we're experiencing as the gulf between what we tell ourselves and what we truly feel widens to the breaking point. The truth is the most personal, consequential truths are often painful because accepting them means the end of something we wanted and cherished, the end of an era and the acceptance of an uncertain, perilous future. I use the examples of relationships and enterprises, because these are life's most demanding commitments. To end a relationship or close an enterprise is difficult on multiple levels, and the true friend knows this from their own experiences. The path of least resistance is to maintain the facade of a happy marriage and successful enterprise, even as living a lie eats away at us. It's often a shock that someone else sees through the facade and discerns the truth within us. The true friend must make a difficult calculus, as truth be told risks the friendship for a highly uncertain gain. The true friend is aware that sometimes we're not ready to confront the truth, and the precipice has to crumble beneath our feet before we're ready to accept the truths behind the facade. Or we're finally at a point where hearing the truth from a trusted friend who has our best interests at heart unleashes a great relief, for the truth is not just pain, it's also relief. A true friend is more likely to expose the truth by asking us questions rather than making statements. Our answers to questions such as "when was the last time you had an honest heart-to-heart with your partner?" reveal the truth we've avoided. I anticipate angering many readers in this series, because deeply held mythologies will be bulldozed. In a very real way, the facades we cling to to maintain relationships and enterprises are personal mythologies, and their collapse generally spawns an emotional tornado. The ultimate truth is revealing the truth of the situation and our feelings about it are a relief, and the starting point to moving forward in a positive direction. To share a series around Truth Be Told makes me feel like the guy in a bedraggled white robe on the street corner, murmuring about redemption while passersby cross the street to avoid me. So be it. I'm just asking questions, and the truth is revealed by your answers and your emotional reactions. New collection of five intriguing stories: Jumble Bin Stories (Kindle $6, print $12) read samples for free (PDF) My book Investing In Revolution is available ($18 for the paperback, $24 for the hardcover and $8.95 for the ebook edition). Introduction (free) Subscribe to my Substack for free NOTE: Contributions/subscriptions are acknowledged in the order received. Your name and email remain confidential and will not be given to any other individual, company or agency. Thank you, Darth L. ($70), for your marvelously generous subscription to this site -- I am greatly honored by your support and readership. Thank you, Djanyja ($70), for your monstrously generous subscription to this site -- I am greatly honored by your support and readership. Thank you, Amarnakar ($25), for your massively generous subscription to this site -- I am greatly honored by your support and readership. Thank you, Eugene K. ($20), for your most generous subscription to this site -- I am greatly honored by your support and readership. Go to my main site at www.oftwominds.com/blog.html for the full posts and archives.