Perverse market theory and the perversion of crypto-currencies

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I recently tweeted:

I was later asked for more information about perverse market theory, and after digging around I have drawn a blank. The term “perverse market” is usually used to refer to unintended or unanticipated market responses, but that is a different meaning from the one I referred to here.

Perhaps my memory fails me on the concept’s name (let me know if you can instruct me on this!), but the idea really struck me when I heard about it in my early career working in financial markets.

Do markets want to hurt people?

The idea of perverse market theory essentially anthropomorphizes the markets, attributing it intent, not dissimilarly to how Kevin Kelly describes directional behaviors in the development of technology in his book What Technology Wants.

Of course a financial market does not have intentions. However its movements often do effectively hurt market participants, drawing increasing numbers of unsophisticated investors into speculative asset bubbles, giving people hope and getting them to buy more when prices bounce on the subsequent fall, and generally suckering people into extreme market mis-timing.

The manifestation of greed and fear

This makes sense in that a market is in fact an aggregation of human behavior, and specifically an aggregation of the primal emotions of greed and fear. As such its fluctuations are an expression of human emotion.

Greed pushes up prices which attracts increasing degrees of greed, meaning most purchases are made when prices are too high. When things go awry the fear is compounded, pushing down prices so that sales are made below true value, with bounces along the way allowing human fallibility and cognitive bias to weak the most damage.

It is an valid point that algorithms are increasingly driving markets, however these are all overlaid on the underlying human behaviors that drive markets, only adding variations, not fundamental dynamics.

Crypto-currencies have become almost purely speculative assets

Which bring us to Bitcoin and crypto-currencies. A number of people responded to my tweet saying that Bitcoin is entirely unlike traditional financial assets.

It is true that crypto-currencies come from a completely different intent to existing financial assets, and are substantially different kinds of assets.

However once people start to treat an asset as a speculative investment, its behavior will be exactly the same as any other asset, be it shares, property, or tulips.

Only a tiny minority of people today are buying Bitcoin for transactions. In fact it is now being used less for financial transactions – which is what it was created for – due to its volatility and increased transaction costs, with one major online sales channel Steam stopping accepting Bitcoin earlier this month.

As such Bitcoin today has become almost purely a speculative asset – a complete perversion of its original intent.

The true value of crypto

Vitalik Buterin, the founder of Ethereum, last night tweeted a thread beginning:


(Click on the link to see the full thread)

His conclusion was that crypto-currencies have created real social value, but nothing like the financial asset value attributed to them.

As Bitcoin creator Satoshi Nakamoto, Buterin designed his crypto-currency to create “real” value, not financial value. The two have become fundamentally misaligned through speculation.

The future value of Bitcoin

Financial analysts refer to Bitcoin going through a “price discovery” process, fluctuating as we find what its “true” value is.

When I was faculty on a Singularity University program a few years ago, Bitcoin Foundation President Brock Pierce was asked what he expected the value of Bitcoin to be in five years (it was around $400 at the time). His answer was “either zero or $50,000”.

Thinking in terms of scenarios from today, it is certainly possible that the long-term value of Bitcoin will substantially exceed $100,000. This could happen if it eventually becomes a widely used currency, or if it is perceived as a store of value.

It is also possible that the long-term value of Bitcoin is significantly less than it is today, with the recent spike proving to be a classic asset bubble that will go down in history.

It is impossible to know today. I am not fundamentally pessimistic about the long-term value of Bitcoin. However its extreme volatility today is making that less likely.

People will get hurt

Which comes back to today’s bubble. It is frightening to see highly unsophisticated people pulled into buying Bitcoin with absolutely no idea what they are doing. Some of them have done well, and some of them may continue to do well.

But markets often hurt people, particularly those driven by greed, which is the only way to describe the motivation of the latecomers to the Bitcoin party.

Whatever happens, many will get hurt.

And the really sad part is that all this is taking away from the dream and the potential of Bitcoin and crypto-currencies.

  • Gordon Vala-Webb

    It seems to me that at least part of what is going on get is, to paraphrase Marshall McLuhan, first we shape our markets, and then they shape us.

    • The original quote is one of my very favorites, that’s a very interesting and apt adaptation Gordon 🙂