Reassociation with Ethena

Recently, I have been reading the Q&A transcripts from Buffett's annual shareholder meetings.

During the afternoon Q&A session of the 2002 shareholder meeting, a shareholder asked about the A.W. Jones model.

The shareholder mentioned that according to this model, using short selling in a portfolio is very convincing for investors like him and worth trying. This model provides a framework for short selling and the returns that can be mathematically calculated.

He wanted to ask Buffett for his opinion on this matter.

Before sharing Buffett's response, let me provide some relevant background information:

The A.W. Jones model is a model that simultaneously goes long and short on stocks. According to this model, if an investor goes long and short on a series of stocks at the same time, theoretically, he can achieve ideal returns.

Here is a summary of Buffett's response to this question. You may especially want to pay attention to the parts I have highlighted in bold.

Many people know A.W. Jones; he founded the famous hedge fund in the late 1950s or early 1960s.

A.W. Jones's initial idea was to have roughly equal amounts of long and short positions, creating a market-neutral fund so that market movements would not have any impact.

However, in reality, Buffett's mentor Graham had already used this method when he established his own fund in 1924, and he even employed paired securities.

For example, after Graham studied both General Motors and Chrysler, he judged that the value of one was deviating relative to the other, so he would go long on one and short on the other.

Graham made profits using this strategy.

The fund established in 1924 is almost identical to today's hedge funds on Wall Street. He was over 30 years ahead of A.W. Jones. Graham is the true pioneer in this field.

Despite this, Graham did not consider this method to be very successful. In his later writings, he summarized the problems that this approach encounters in practice:

For instance:

To illustrate, if he operated this way four times, in three of those instances, as long as the designed ratio was appropriate, he could achieve substantial profits. However, in the fourth operation, even a slight deviation or a small mistake could result in losses exceeding the profits from the first three.

This model is theoretically valid. But in practice, some of the theoretical short selling operations cannot be executed. These slight deviations between practice and theory can lead to catastrophic consequences.

A.W. Jones established his fund based on this model. Interestingly, he did not continue to adhere to the "market-neutral" strategy he designed in his later operations.

After A.W. Jones established his fund, it gained fame in the 1960s, but by the 1970s, he was hardly heard from in the market, and few articles were written about him.

That is my summary of the old gentleman's response.

I wonder what readers think after reading the above Q&A?

What immediately comes to my mind is the stablecoin project Ethena.

In a previous article, I expressed my views on the Ethena stablecoin project: while I appreciate its creativity and exploratory spirit, I do not believe that this type of algorithmic stablecoin can succeed.

In that article, my skepticism stemmed from the fact that its long and short operations rely on many off-chain factors, and whether these off-chain factors can coordinate closely is questionable.

After reading the old gentleman's response, the phrase "market-neutral" reminded me that the Ethena project also emphasizes that it uses a long-short combination to form a neutral price, hoping to ensure that the stablecoin is pegged to the dollar and unaffected by market fluctuations.

However, the old gentleman has already provided the potential outcomes of such a strategy by reviewing history.

Here, I will boldly speculate:

This stablecoin may develop well in its early stages and even show a robust upward trend for a considerable period. However, once it encounters an unpredictable deviation, unexpected consequences may follow.