The Big Hairy Audacious Goal of Numerai: network effects in Quant trading

It was Jordan Hauer, CEO of Amass Insights , who introduced Numerai to the Fintech Genome community, earlier this year in a conversation thread around AI in wealth Management.Screen Shot 2017-06-05 at 07.33.56

What is the mission of Numerai?

Numerai wants to crowdsource quant models from Data scientists that develop better ways of trading financial securities. Numerai is creating a meta-model from all the Machine Learning (ML) algorithms developed by “the crowd” with cryptographic data.

Numerai aims to offer a platform that generates alpha in a novel way. It wants to structure a rewarding mechanism for its traders that not only eliminates the typical competitive and adversarial behavior between them but actually, penalizes them.

How Numerai works?

Numerai hosted 12,000 data scientists earlier this year in a tournament. The data used for the predictive models, was encrypted. The participants were anonymous and the aim was to provide ML algorithms that improve Numerai’s investment calculations.

Numerai was initially compensating data scientists with Bitcoin, based on their contribution to the performance of the meta-model. They have now, changed their reward mechanism in order to create a collaborative reward mechanism. Their Big Hairy Audacious Goal (BHAG) is to be the first use case of creating network effects in finance.

Imagine a world in which proprietary data is not the secret weapon, profitable traders are not adversarial and competitive, and there is a financial incentive mechanism that makes traders collaborate to create an even better trading algorithm.

This the BHAG of Numerai: a blockchain world that can solve the classic prisoner’s dilemma by creating a cryptocurrency that is structured in a way that incentivizes “the prisoners” to keep each other out of jail.

This is exactly the aim of the new cryptocurrency that Numerai recently issued, the Numeraire token issued over the Ethereum blockchain. Each participating data scientist receives some Numeraire tokens based on their historical performance. At this point, the new world that Numerai is designing starts.

Numerai introduces a staking mechanism that is the heart of their BHAG!

The data scientist with send his Numeraires to the Ethereum smart contract along with a confidence prediction. Now the predictive model is live and the data scientist will be rewarded based on actual (not historical) performance and his/her confidence prediction. If the predictive power is poor, his/her Numeraire token is permanently destroyed by the smart contract.

As a result, data scientists can only gain by building models that perform well on live data, and stand to lose on models that overfit the past. Their compensation is denominated in Numeraire, which is linked to all the stake payouts which will increase over time.

How is Numerai different?

A data scientist who is getting compensated in Numeraire, has an incentive to invite another data scientist to participate in a tournament, who has the potential to improve the network. This is the collaborative mechanism at work, even though the process is anonymous and decentralized. This is Numerai’s BHAG part 1, which if successful it could become the first business model in finance with network effects.

Numerai’s BHAG part 2, is creating a mechanism of true alpha generation by crowdsourcing algorithms based on actual performance not back testing. Numerai’s target audience is data scientists who can master non-contextual data sets.

Numerai is unique also because they introduced their token, Numeraire, in their already existing platform, without launching an ICO! Numerai has control over the issuance of their tokens and has the right to introduce new features of the token. In their first tournament, Numerai paid out 1 million tokens; the maximum supply is 21 mil Numeraires.

Numerai is backed by Fred Ehrsam, Joey Krug, Juan Benet, Olaf Carlson-Wee and Union Square Ventures. Watch their intro video about their BHAG with Numerai investors Andy Weissman and Fred Wilson of Union Square Ventures; Joey Krug of Augur and Juan Benet of IPFS and Filecoin.

Efi Pylarinou is a Fintech thought-leader, consultant and investor. 

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