1/ A thread on why there is so much volatility in the crypto market and why I think that is a good thing.
2/ There are a few reasons for all the volatility in crypto markets.
3/ For one, it’s an always-on, casino and many “investors” (read: gamblers) treat as such. For me, this is the least interesting (though perhaps most explanatory).
4/ For another, the volatility of Bitcoin and the crypto market more generally is a result of the fact that it’s supply (and monetary policy) is determined programatically.
5/ For any typical commodity, a change in demand will cause a change in production.
6/ If you grow avocados and the price of avocados goes up 10%, you will grow more avocados the next season (and vice versa).
7/ If supply increases and decreases alongside demand, the change in price will be much milder than in a scenario like crypto where the supply schedule is (more) programmatically determined.
8/ The third, and most interesting reason, is a result of cryptocurrencies more decentralized and more permission-less nature.
9/ When human central planners engineer systems, they tend to engineer them in such a way as to keep volatility low (or at least that’s what they think they are doing).
10/ People like stability rather than volatility. It’s hard to sleep at night when your net assets could be 10% lower by the time you wake up or their job could disappear or their food was stolen.
11/ However, there is a relationship between the complexity of a system and it’s volatility.
12/ Historically, we lived in a less connected and simpler system. This meant there was less potential volatility.
13/ This is true both in terms of postive and negative volatility.
14/ On the negative side, a single caveman with a knife can do relatively little damage compared to a modern day terrorist with an atomic bomb, chemical weapons, etc.
15/ On the positive side, the leverage given to an individual today to help is greater than it’s ever been. The Gates foundation contribution to increase in human well being was simply impossible historically. No one has ever had that much leverage.
16/ Compared to financial systems of the past, the modern financial system is very complex and interconnected.
17/ You can’t control the amount of volatility within a system (without adjusting how complex it is), you can only control how that volatility is expressed over time.
18/ When human central planners try to engineer system in such a way as to keep volatility low, what they are often doing is simply delaying that volatility.
19/ They are taking on volatility debt - trading volatility today for volatility tomorrow.
20/ This is problematic because the damage caused by negative volatility is asymmetric.
21/ The anlogy I like is jumping off a 1 ft wall 100x, a 10ft. wall 10x, vs. a 100 ft. wall 1x.
22/ If you jump of a 1 ft. wall one hundred times, it’s no big deal. Pretty much anyone can do this.
23/ If you jump off a 10 ft. wall ten times then, it’s more stressful. Even if you’re healthy and in good shape, your knees are probably going to be sore, but you don't die.
24/ If you jump off of a 100 ft. Once, well, you go kerplat.
25/ The volatility in the crypto market has the effect that investors are getting thrown off the wall constantly.
26/ This is good for investors because typically investors start investing a small amount in something the don’t understand. Even if someone bought the top of the marketing in December, as long as they only put in something like 1% or 2% of their net asset value,...
27/ ...it’s not that big of a deal.
28/ A 70% loss of 2% of your portfolio is 1.4% of your total portfolio which is manageable.
29/ @wences has made this point by saying that as long as volatility remains high during adoption phase, we are in a good spot b/c there is less volatility debt accumulating.
30/ As always, these threads are just me thinking out loud. Feedback, thoughts and criticism are all welcome.
