Learn to think exponentially or get left behind — Boomer Economists NGMI
While the above tweet is peak engagement farming, it fails to grasp the fact that the price of Bitcoin has had many seeming bubbles and bursts yet each year gains more adoption and more antifragility. Bitcoin and crypto more generally now is Lindy. The Lindy Effect is the phenomenon that the older something is, the longer it’s likely to be around in the future. Why does Nouriel and his other boomer economist friends fail to grasp crypto and more widely the power of technology?
It’s because as humans we are conditioned to think linearly and not exponentially.
Linear chart = bubble?
Log chart = mass adoption?
Deriving from mathematics, the term ‘exponential’ or ‘exponential growth’ explains the rate in which as something grows, its rate of growth becomes faster over time. The most simple and well known example often touted in self help finance books and YouTube channels is compounding. Play around with this compounding calculator and you’ll get the picture: https://www.nerdwallet.com/banking/calculator/compound-interest-calculator
You know who else loves compounding, our crypto enemy Warren Buffet:
My favourite illustrative example of the power of exponential returns can be traced back to a fable about the origins of the game of chess. Legend has it that Paal Payasam invented the game of chess and presented it as a gift to the emperor of India. The emperor was so impressed that he insisted he reward the man for his gift. Paal requested to be paid one grain of rice for the first square on the board doubling for each square i.e. two for the second, four for the third and so on. Without hesitation the emperor agreed and it wasn’t until later that the emperor’s treasurer pointed out that to supply all the rice requested would be such an astronomical amount that it would end up covering the whole of India to a depth of over 50 feet.
I believe this chess example is most poignant as it points to our human nature blindspot to the power of exponentials. We have evolved to think linearly and incrementally.
“Technology is exponential, but humans are not” (Gerd Leonhard)
Another helpful example was shared with me by my good friend Rory:
A lily pond, so goes the French riddle, starts with a single lily leaf. Each day the number of leaves will double: 2 leaves on the second day; 4 leaves on the third day; 8 leaves on the fourth day; etc. If the pond is full on the 30th day, on which day is the pond half full?
Answer: Day 29
As humans we are accustomed to linear series of events. We are born, we grow, we die. The sun rises, it sets. I could go on. Technology has changed all of that and as such we must learn to think exponentially or risk getting left behind (sorry Nouriel). The most well known theory of exponential growth is Moore’s Law, named after Gordon E. Moore who published his ideas in 1965 when he was Co-founder and Chairman of Intel. His theory was that computers become smaller, faster, and cheaper with time, as transistors on integrated circuits become more efficient. More specifically that the number of transistors on a microchip doubles about every two years, though the cost of computers is halved. Moore’s Law has been a driving force of technological change up until this modern day.
We can’t discuss exponential growth and technological change without also mentioning Metcalfe’s law. Ever wonder why network businesses such as Apple, Amazon and Facebook (Meta) command such astronomical market caps? or wonder why Warren Buffet didn’t buy these stocks until very recently?
From a value investor lens these network effect businesses don’t make sense. Many of them have astronomical P/E ratios and other relative valuation metrics. Benjamin Graham proponents in disbelief.
The answer is humans are extremely bad at extrapolating exponential growth functions and as such see these technological marvels as ‘bubbles’ or fads.
Metcalfe’s Law states that a network’s impact is the square of the number of nodes in the network.
Image I had a phone and no-one else. Well, that would be pretty useless right? Now imagine my friend got a phone, that would be better but there’s still only one connection being made. However, as we scale the number of phones linearly, the number of connections scale exponentially where with only 12 phones we have 66 connections.
Consider the example of Uber. The value of Uber is proportional to the strength of its network i.e. that is to say the number of drivers and users in the network. This is known as the bootstrapping problem. With web 3.0 and token incentives, we might have the best shot yet at cracking this problem but the details of that argument are for another post.
What is important to take away here is the fact that network businesses have fundamental value that are are difficult to apply to a traditional linear framework or valuation techniques. If web 3.0 protocols are inherently network businesses, they will make tech stocks look like a drop in the ocean!
If we look at Web 2.0 businesses as largely enclosed garden networks i.e. Meta vs Amazon then Web 3.0 is one open network. We have Interest Rate Swap protocols like Voltz built on top of Aave and in the future will likely see new protocols built on top of Voltz and so on. The open source, composable nature of web 3.0 protocols and the interplay and cross pollination of users and use cases will lead to both valuations as well as dynamic new use cases which will blow web 2.0 out of the water. But sure, NFTs are a scam and crypto will be dead soon right?
Zoom out, focus on user metrics and adoption KPI’s and question the so called ‘experts’. Use these new protocols and make your own mind up. Adopt an exponential mindset to life.