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One of the best parts about working in finance is not working in politics.


American politics has devolved into a barbaric arena rarely serving the best interest of constituents. A self-interested, bickering clown show. Disagreements turn into political rackets, ad hoc insults, and general indecency.


But in finance, when people disagree, instead of barking at cameras (or for some, in addition to barking at cameras), they place bets behind their opinions via buying and selling securities.


And prices change based on the supply and demand of these participants. There must be an equilibrium — where smart people are lining up to be buyers, directly adjacent to smart people lining up to be sellers. There are no minor leagues in investing, so if you find a competitive marketplace with lots of opinions being manifested into trading activity, then you should have a well-functioning system.


The equilibrium is the price.


In The Wisdom of Crowds, Jim Surowiecki tells the story of Francis Galton at the Fat Stock and Poultry Exhibition, back in 1906.



Francis asked 787 people to guess the weight of a cow. The broad distribution of guesses was scattered, but after everything was calculated:

  • The average guess was 1,197 pounds.

  • The actual weight was 1,198 pounds.

It's just one example, but just like a price, averages embed both collective wisdom and stupidity — and with enough guesses, they're likely informative. If we can see outcomes like this when people guess cow weights, or how many jelly beans are in a jar, consider the mechanism's efficacy in a market of investors risking real money.


Many people are familiar with the philosophy of passive investing for stocks: if I believe prices are fair...isn't it silly to try and guess which stocks will do better than other stocks?


Instead, invest in the entire market through something like an index fund, buying a tiny bit of nearly every stock. Accept the market average, and avoid being belligerently wrong.


In cow terms: guess last, and tell Francis that your guess is the average of all previous guesses.


The smartest minds in finance think this way, too. It reflects awareness and humility, and leverages the pressure cooking of disparate opinions and knowledge-bases into a singular price, rather than ignoring the information embedded by other peoples' bets.


Et tu, Bitcoin?


But in my experience, when it comes to Bitcoin, many smart people don't believe that the price is fair, and very far from it:

  • It's either genius, will revolutionize finance, and is worth $1,000,000+ per coin, OR

  • It's illegal, a fraudulent Ponzi scheme, and going to $0

Like politics — crypto debates are highly contentious and subjective. Everyone just shares their opinion louder and louder. Here's my own Bitcoin perspective, for enthusiasts and skeptics alike:


The price is probably fair.


It doesn't mean I think you should or shouldn't buy it. Unless you're a client, I don't know your circumstances.


And I don't say the price is probably fair because I've done any painstaking valuation.


I say this because there are over 300,000 transactions of Bitcoin each day. There are lots of smart people buying and selling. And just like a stock, or a box of cereal, or a meal at a restaurant, if economic pressures exist between supply and demand, and people can willingly transact, prices will adjust toward fairness.


It's why McDonalds has a great business selling $8 meals, and Ruth's Chris has a great business selling $80 meals. If the price was too low, the business couldn't make profits. If the price was too high, people would stop coming. You don't have to like hamburgers or steak to appreciate the mechanism.


Which also means you don't have to like Bitcoin to not hate the price.


Prices contain information about the product, and about broad consumer preferences for it.


Bitcoin enthusiasts and skeptics should consider this: your opinion about the true value could be right, but it's only one opinion amongst all possible future outcomes.


$1,000,000 is possible. So is $0.


Today, the price of a Bitcoin is about $20,000. Lunacy to some because it's too low; lunacy to others because it's too high. But these opinions are reflected by people's willingness to trade, and they currently synthesize to equal $20,000.


So instead of boorish politicians screaming at each other to little avail, we actually get somewhere in finance debates. We get a price.


For simplicity, consider two binary outcomes —

  • Bitcoin should be worth $1,000,000, OR

  • Bitcoin should be worth $0

We now have information from the current $20,000 price, because it tells us that there is a 98% chance that $0 is right, and a 2% chance that $1,000,000 is right.


$20,000 is an equilibrium between these two inputs and the accompanying probabilities:


$20,000 = (98% * $0) + (2% * $1,000,000)


This is a VERY simplified version, but all investing is this — a complex canvas of expectations, probabilities and unknowns, all harmonized into a price based on the opinions of global market participants.


You want to reverse-engineer the information that prices tell you, not spend time trying to outguess everyone else.


Of course the possibilities for the true value of Bitcoin are infinite (not just the two prices I've used). But you can leverage probabilistic thinking to better grasp the types of opportunities and tradeoffs that other investors are willing to accept. You will move away from thinking they are idiots, to thinking well, that's just not a distribution of possible outcomes that I want in my own portfolio. And that's fine.


Remember: just because something likely won't happen, doesn't mean it won't happen.


Last week, the San Diego Chargers were winning 27-0 at halftime against the Jacksonville Jaguars. It seemed like an insurmountable lead for an NFL game. How can casinos and bookies get people to keep betting when games turn lopsided like this?


They create enormous potential rewards for betting on highly unlikely outcomes, and paltry potential rewards for betting on highly likely outcomes.


Since it was a blowout, the "line" at halftime was -12,500...which means that if you wanted to choose the likely outcome, you must risk $12,500 to win just $1! And you probably would win, of course. Probably.


And indeed, someone bet $1,400,000 that the Chargers would win, a highly likely outcome. They risked this amount to win $11,200 (same math as above).


But it didn't happen. This person lost $1,400,000.


Rarely is anything fully certain. Last week in a New York Times op-ed, Mihir Desai, a Harvard Business School professor, shared his crypto skepticism:

The unwinding of magical thinking will dominate this decade in painful but ultimately restorative ways — and that unwinding will be most painful to the generation conditioned to believe these fantasies.

But he left out a critical word: LIKELY. He believes it will LIKELY dominate...


Investors, and those advising investors, should rarely speak in absolutes. What if you're wrong? Investors on both side of the Bitcoin trade are accepting an unknown distribution of future outcomes.


At every moment, the price of Bitcoin has useful information for both sides. If you have an opinion about what Bitcoin should be worth, and how strongly you feel about that (i.e. you can attach a probability to you being right), you can begin to reverse-engineer how much the aggregate wisdom disagrees with you.


I've personally never encouraged investors to own Bitcoin, but I don't think Bitcoin investors are stupid. The market price tells me that they are not. It's more related to my belief that, on expectation, the distribution of possible outcomes won't add value to the investment experience my clients are seeking.


And sure, maybe new information will cause future prices to make current Bitcoin investors look stupid, but maybe new information will cause me to look stupid. I don't know. Neither outcome would be sufficient to know whether either of us made a high or low quality decision with the information we had at the time.


The future just tells us what happened, not what most likely was going to happen.


Speculating on complex distributions of unknown possibilities is tough. Anyone who speaks with extreme confidence about Bitcoin, or similar assets, is likely ignoring the collective wisdom of crowds. Investors are best off assuming that in competitive marketplaces, prices are likely fair.


What belongs in your own portfolio is a decision between you and your advisor, but choosing to not own something doesn't mean the other side is crazy. Prices adjust to create equilibriums, and diplomacy between informed buyers and sellers. It isn't politics.


Here's what I remind myself:


I don't know everything.

I can't know the future.

There's information in prices.


End.

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My blog posts are informational only and should not be construed as personalized investment advice. There is no guarantee that the views and opinions expressed in my posts will come to pass. They are not intended to supply tax or legal advice, and there is no solicitation to buy or sell securities, or engage in a particular investment strategy. 

Any discussion of investment products reflected on Fortunes & Frictions are objective and unpaid.

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