From my own experience reading the literature, I propose the following: The Bimodal Market Hypothesis.
The BMH states that the market is either a terrifying beast of infinite power that has priced in the number of grandchildren you will have into McDonald’s stocks, or is so stupid it kinda makes you want to cry. Evidence for this includes:
1. The Dot-Com bubble, the fact that Bitcoin has a price exceeding $0 despite there currently existing cryptocurrencies that are strictly better in every way, and that time the market proved to be incapable of doing addition. Maybe it’s when tech is involved?
2. But also, the Peso problem, where an apparent decades-long anomaly in the markets turned out to exist because the market was accurately estimating the probability that the Mexican government would be unable to maintain its peg.
Situation 1 occurs when idiots outnumber financial experts, and overwhelm the ability of “Smart money” to accurately price a stock in the face of a hype wave. Everyone reasonable avoids these stocks like the plague; shorting them exposes you to the possibility of bankruptcy in the case that the madness fails to subside in time. Situation 2 happens when financial experts poring over spreadsheets determine the value of a stock by rereading every statement until it’s become their favorite work of literature before making a decision.
Policy proposal: Make it illegal to trade stocks if you haven’t read A Random Walk Down Wall Street, don’t know what a PE ratio is, if you do know what a candlestick graph is, or if you think that the reason why stocks go up is something like “Everyone thinks they will.”
Bitcoin has a price exceeding $0 despite there currently existing cryptocurrencies that are strictly better in every way
I’ve seen people often express an impression that the “best” cryptocurrency should win. Well, I want to point out a particular way that one cryptocurrency could be better or worse than others that is often overlooked: the percent of potential early adopters who already hold it.
Every new cyrptocurrency faces the drawback that all of its most likely potential users are already financially invested in the success of the incumbents. It’s like standard network effects, except where all the users of existing networks are also shareholders of them.
To get people to switch you have to not only get them to pay the normal switching costs of moving from one platform to another, but also the transactions costs of buying and selling assets.
(I also think there’s another layer, where because people don’t want other people to switch away from their crypto of choice, they develop a sort of tribal emotional bias in its favor. I think this is where the phenomenon of bitcoin maximalists comes from. It’s like the opposite of the virtue of lightness.)
I agree, in that a very small improvement on a cryptocurrency shouldn’t actually result in it outcompeting everything else. The thing is that Bitcoin has at this point been completely pummeled by other cryptocurrencies like Ethereum or stablecoins in terms of usefulness, to the point where it seems clear to me that Bitcoin mostly exists and will continue to exist only for speculative purposes.
(Also: The opposite of the virtue of lightness usually goes by the name of conservatism bias in the cognitive science literature.)
I agree, in that a very small improvement on a cryptocurrency shouldn’t actually result in it becoming
I disagree that only very small improvements will have a tough time against incumbents. On the other hand, I do agree that Ethereum and stablecoins offer pretty significant improvements.
it seems clear to me that Bitcoin mostly exists and will continue to exist only for speculative purposes
This is perhaps fair. But another way of saying it might be that Bitcoin has captured the digital gold niche. And other coins will capture other cryptocurrency use cases. Notably, ETH and stablecoins aren’t really better than BTC as digital gold (a fungible digital asset of fixed supply).
that time the market proved to be incapable of doing addition.
The caveat from the link that this mistake couldn’t be arbitraged seems important.
I need to resist the temptation here to leap from “can’t be exploited” to “therefore not stupid”, because that’s not what you mean by stupid. But I think it seems important even if I resist that temptation.
This is fair and an important caveat. Pure arbitrage disappears quickly in the market. At the same time, though, no pure arbitrage profits is only necessary and not sufficient for full efficiency. An efficient market means no (or very few) positive expected utility opportunities still left around. The EMH still implies the price of shorts should have fallen until it became economically feasible to correct the mispricing.
From my own experience reading the literature, I propose the following: The Bimodal Market Hypothesis.
The BMH states that the market is either a terrifying beast of infinite power that has priced in the number of grandchildren you will have into McDonald’s stocks, or is so stupid it kinda makes you want to cry. Evidence for this includes:
1. The Dot-Com bubble, the fact that Bitcoin has a price exceeding $0 despite there currently existing cryptocurrencies that are strictly better in every way, and that time the market proved to be incapable of doing addition. Maybe it’s when tech is involved?
2. But also, the Peso problem, where an apparent decades-long anomaly in the markets turned out to exist because the market was accurately estimating the probability that the Mexican government would be unable to maintain its peg.
Situation 1 occurs when idiots outnumber financial experts, and overwhelm the ability of “Smart money” to accurately price a stock in the face of a hype wave. Everyone reasonable avoids these stocks like the plague; shorting them exposes you to the possibility of bankruptcy in the case that the madness fails to subside in time. Situation 2 happens when financial experts poring over spreadsheets determine the value of a stock by rereading every statement until it’s become their favorite work of literature before making a decision.
Policy proposal: Make it illegal to trade stocks if you haven’t read A Random Walk Down Wall Street, don’t know what a PE ratio is, if you do know what a candlestick graph is, or if you think that the reason why stocks go up is something like “Everyone thinks they will.”
I love this comment, but one nitpick:
I’ve seen people often express an impression that the “best” cryptocurrency should win. Well, I want to point out a particular way that one cryptocurrency could be better or worse than others that is often overlooked: the percent of potential early adopters who already hold it.
Every new cyrptocurrency faces the drawback that all of its most likely potential users are already financially invested in the success of the incumbents. It’s like standard network effects, except where all the users of existing networks are also shareholders of them.
To get people to switch you have to not only get them to pay the normal switching costs of moving from one platform to another, but also the transactions costs of buying and selling assets.
(I also think there’s another layer, where because people don’t want other people to switch away from their crypto of choice, they develop a sort of tribal emotional bias in its favor. I think this is where the phenomenon of bitcoin maximalists comes from. It’s like the opposite of the virtue of lightness.)
I agree, in that a very small improvement on a cryptocurrency shouldn’t actually result in it outcompeting everything else. The thing is that Bitcoin has at this point been completely pummeled by other cryptocurrencies like Ethereum or stablecoins in terms of usefulness, to the point where it seems clear to me that Bitcoin mostly exists and will continue to exist only for speculative purposes.
(Also: The opposite of the virtue of lightness usually goes by the name of conservatism bias in the cognitive science literature.)
I disagree that only very small improvements will have a tough time against incumbents. On the other hand, I do agree that Ethereum and stablecoins offer pretty significant improvements.
This is perhaps fair. But another way of saying it might be that Bitcoin has captured the digital gold niche. And other coins will capture other cryptocurrency use cases. Notably, ETH and stablecoins aren’t really better than BTC as digital gold (a fungible digital asset of fixed supply).
The caveat from the link that this mistake couldn’t be arbitraged seems important.
I need to resist the temptation here to leap from “can’t be exploited” to “therefore not stupid”, because that’s not what you mean by stupid. But I think it seems important even if I resist that temptation.
This is fair and an important caveat. Pure arbitrage disappears quickly in the market. At the same time, though, no pure arbitrage profits is only necessary and not sufficient for full efficiency. An efficient market means no (or very few) positive expected utility opportunities still left around. The EMH still implies the price of shorts should have fallen until it became economically feasible to correct the mispricing.