Author: Tom Mitchelhill

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On June 20, Nassim Nicholas Taleb, a very successful former "quantitative" trader, published a 5-page paper on the topic Philosophy and Mathematics of Probability in Finance, criticizing Bitcoin as a viable future market Asset availability.

Taleb provides 3 main arguments through which he concludes that Bitcoin’s timeline is inherently doomed and will be reflected in its price in the not-too-distant future.

How Nassim Taleb Predicted Bitcoin's Graduation into Digital Antiquity Is it fair to expect Bitcoin to be nothing more than a smoldering ruin somewhere in the great museum of the Internet age, a failed experiment imprisoned in a glass case?

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Argument 1: The fragility of the no-income bubble

Taleb begins his thesis by claiming that the actual value of Bitcoin is exactly 0 until its demise. Investors just don't know it yet. He begins by arguing that Bitcoin provides its holders with “no expectation of future returns,” a central tenet of the securities pricing literature.

“Non-yielding assets are problematic” he continued; since there is no expected dividend, reverse dilution or buyback that can provide holders with future yield, once the miners die out, Bitcoin will be worth zero. He stated that if we can expect such an outcome at any time in the future, then the value of BTC is already zero.

This seems to me a fair criticism. What value can we expect Bitcoin to provide if after the last coin is mined, all current yield incentives are lost? Clearly, the decentralized ledger technology underpinning the Bitcoin project is of enormous and revolutionary value, but what's to stop any other cryptocurrency with a mature trading market and greater value of use, combined with a known future earning potential for holders , surpass and replace it in the next few years?

Ethereum: Bitcoin Assassin?

Given my own naive understanding, Ethereum is an asset with great real-world potential as it provides a platform for DApps and other de-fi services and acts as a smart contract intermediary. It has an active use function; namely, replacing a host of antiquated "accounting" and banking services that cost us nearly $3 trillion a year as passive users of the fiat system.

Currently, Ethereum accounts for about 0.05% of all potentially captureable financial gains in banking and accounting services in the fiat world. If we assume it is able to earn just 0.5% of the total revenue in fiat currency by providing smart contracts and its range of financial services related to the blockchain, then its price will be around $40,000 per token. Also, contrary to Bitcoin, this will be done through a practical application of its utility, rather than just sitting there as a "store of value" and serving as a symbolic flagship of a cryptocurrency project like Bitcoin?

Not quite digital gold?

Speaking of "digital gold," if we continue down the ladder of criticism from Taleb, he argues that making the "Bitcoin is digital gold" comparison, as many people (myself included) do, is a poor analogy, as opposed to The truth is far from it:

"Gold and other precious metals are largely maintenance-free, do not degrade on a historical scale, and do not require updating their physical properties over time.
Cryptocurrencies need sustained interest in them. "

Taleb emphasized that gold and other rare earth minerals are indeed non-dividend-free, much like Bitcoin, but they are fundamentally different because they have over 6,000 years of financial status, and those who own gold and silver can safely continue to own these properties Another thousand years (they don't degrade or mutate over time).

Here, Taleb appeals to something called the Lindy Effect; a theory that states that the future life expectancy of non-perishable things is directly proportional to their current age. Put more simply; if something has been around for 100 years, chances are it will be around for another 100 years. The fact that our culture has created value for gold and silver used in jewelry for thousands of years suggests that we will continue to do so for the foreseeable future.

Also, unlike Bitcoin, gold has ample industrial use, with half of the gold supply being used in jewelry, a tenth in industry, and a quarter in central bank reserves. It has various strong and anti-fragile methods by which it can serve as a store of value, maintaining that status despite being largely unencumbered by modern money in 1971. I must admit that the case Taleb makes here is interesting.

path dependency

Next, Taleb dropped the term "path dependence," which roughly means that things survived the past because of their resistance to change. If something is path dependent, it is effectively dependent on a "set path" and thus lacks the ability to survive critical shocks and stressors to its underlying system. Accordingly, he believes:

"We cannot expect that a book entry on a ledger needs to be actively maintained by interested and motivated people to maintain its physical existence over any such period of time, which is a condition of monetary value - of course, we are not sure about the interest, mindset and the preferences of future generations."

As we have seen, gold is not path dependent. Almost everything that exists today is a replacement for something older, less useful, or less attractive. The fundamental truth of progress is innovation destruction, which renders the old useless. It's just the natural process of evolution, or: "selectors". Relative to past lifetimes, technologies tend to be replaced by other technologies.

If you look back long enough in history, you'll find that 99.9% of species that ever existed went extinct either through improvement or extinction. However, despite dramatic changes throughout history, items such as gold and silver have been shown not to become extinct because we really can't find anything better than these minerals to function as we intended them to do as they age over time. And change.

Taleb then offers the following principles:

"Cumulative bankruptcy - if any non-dividend-yielding asset is most likely to hit the 'absorption barrier', it must have a present value of 0"

Absorption barrier is a term from the social sciences that refers to barriers that prevent the spread of innovations and cultural forms. Taleb defines it more colloquially in his book Skin in Games as the following:

"Absorptive barrier is a point where you can't get past it. If you're dead, that's an absorbing barrier. So, most people don't realize that, as Warren Buffett keeps saying, he says in order to make money, you have to survive first. It's not like an option. It's a condition. So, once you get to that point, you're done.

In the case of Bitcoin, this absorption barrier will be the point at which the last coins are mined. All incentives to make money cease, and the asset (unless our business provides it with an exchange function in the future (such as using it to buy a Tesla)) drops to zero. Whether Bitcoin will hit this absorption barrier remains to be seen.

Now, I know many bitcoin purists will rush in and individually scream: "bitcoin has survived crashes before!" and then go on to urge "bitcoin will do it again". Why is this so? Claiming that things will happen again because they happened in the past is a fatal epistemological error, and it is the main reason we continue to make mistakes. Just because something has happened in the past definitely doesn't mean they will continue to do so in the future.

Things that survive into the future do so because of their true utility plus their respective longevity and past proven ability to resist shocks. Bitcoin is only 12 years old, and yes, it survived the crash, but it seems to do so only by speculating about its future utility, which as Taleb pointed out is likely to be zero. Admittedly, the case Taleb makes is sweeping and should prompt die-hard Bitcoiners to revise their long-term assumptions, which is something to watch.

However, I still disagree with the assumption that Bitcoin cannot act as a gold-like substitute, as it does offer unique advantages over physical gold. Whether these advantages will prove useful over time remains to be seen.

Bitcoin: Advantages Over Gold

• The full supply of gold cannot be independently verified, whereas the full supply of Bitcoin is instantly verifiable through the set of blockchain ledgers it is built on. Any financial institution can do a quick check and find out the total supply of bitcoins in seconds. This can't be done with gold, as we don't know how much is left in the ground, nor where every existing shard is.

• It is also difficult to verify that the gold is genuine. China's largest jewelry company, Jinjin Jewelry, defrauded a $3 billion contract with 83 tons of fake gold, eventually forcing the company to be delisted from Nasdaq and costing investors billions of dollars. Fake gold has also found its way into federal vaults in the United States and investment firms such as JPMorgan Chase & Co. Bitcoin solves this problem because it is built on a virtually unbreakable encryption code that is instantly verifiable and impossible to counterfeit.

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Argument 2: Success in the wrong places

The argument is very brief, but Taleb points out that the fundamental flaws and contradictions of most cryptocurrencies are:

"The system's originators, miners, and maintainers currently earn money from the inflation of their currency, not just from their underlying transaction volume."

From Taleb's perspective, Bitcoin's complete failure to become a recognized currency (so far) has been overshadowed by the inflation of Bitcoin's value, which in turn has created enough profit for a large number of people to get into Bitcoin, the relevant discussion Far ahead of any real utility provided.

Put more simply, Taleb's concern; that any increase in the price of Bitcoin has nothing to do with its utility and is simply false inflation, providing enough financial "proof" for zealots to hype its worth.

Speed, cost and no fixed price

He then effectively takes aim at the current (high) cost and slow speed of Bitcoin transactions. How Bitcoin can compete with MasterCard or VISA, which can verify the purchase of any item in milliseconds, while it takes about 10 minutes in BTC. No one wants to stand awkwardly in a coffee shop for an extra 10 minutes just because you're a crypto enthusiast. If Bitcoin, or any other cryptocurrency for that matter, wants to be considered an effective payment system, it needs to be both fast and secure.

Additionally, Bitcoin currently uses a staggering 700KWh of energy per transaction. This makes Bitcoin in its current form completely incapable of accommodating a large number of transactions, which is, in my opinion, an essential feature of any large or ambitious payments system.

Taleb ends the section by stating the following:

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Argument 3: Principles of money

Here we return to our analysis of gold, but this time Taleb is more inclined to use it as a basis for money creation, focusing specifically on fixed prices and the arbitrage potential of cryptocurrencies against fiat currencies.

Examples are as follows:

Examples are as follows:

In the early 1970s, the Hunter brothers (then oil billionaires) started hoarding silver. As their holdings of silver accelerated in the late 70's, there was a price squeeze in the silver market, leading to a speculative explosion in silver prices. This in turn led to a general increase in the price of precious metals by about 5-10 times. When the bubble finally burst, the metal dropped more than 50% in value and then remained at these new lows for more than 20 years. The same thing happened in the 2008 financial crisis. After the financial crisis, the price of gold and silver soared by more than 100%, and then fell again after the economic recovery.

Gold, silver and other precious metals are often seen as a hedge against inflation, but they don't always rise with inflation concerns (look at the price of gold right now). They tend to only serve as a store of value during periods of great crisis or artificial market "squeeze". This leads Taleb to conclude that potentially speculative assets such as precious metals are not the most efficient benchmarks for currencies, and in fact the most efficient figure is the majority of wages paid (in fiat currency).

All consumer tier prices are directly related to the income they earn, so items can be considered expensive or cheap relative to that income. Things like Lamborghinis are expensive because they represent 5 to 6 times the value of the median US wage, while things like coffee can be considered cheap because they are less than 0.01 of the median wage %.

It is here that Taleb attacks:

"A childish libertarian fantasy that a transaction between two adults ... can be isolated and discussed as a pair"

Any transaction in an open economy cannot be viewed as a pairwise analysis; this means that the prices of goods and services fluctuate according to the instruments people pay for, as the value of those instruments also fluctuates. For a currency to function, its price must be relatively stable.

Therefore, in order for people to be able to buy bitcoin-denominated goods on a regular basis, they must also have a regular income in bitcoin. Now, for employers to pay salaries in Bitcoin, the employer must receive a fixed income also in Bitcoin. Furthermore, in order to create and manufacture goods sold in bitcoins, they must have their expenses fixed in bitcoins. We can now see how scalability issues can be a death spiral.

In order for all of the above to happen, there must be low enough volatility between BTC and USD that changes remain insignificant to Bitcoin users. Any divergence between BTC and USD prices large enough to be noticed will lead to direct or indirect arbitrage.

Arbitrage is when assets are bought and sold simultaneously to take advantage of different prices for the same asset. Customers will buy from Bitcoin when the exchange rate for fiat currencies is favorable, and will buy elsewhere when they are unfavorable.

Taleb details:

“[Currently] the only projects that seem to be priced in Bitcoin are other cryptocurrencies. Even so, there are still many differences.”

The concept of arbitrage quickly negates the idea of ​​running a dual-currency (bi-metal) model, because we want to see if Bitcoin will become a legitimate form of exchange. The recent globalization and hegemony of forex/options trading does not seem to allow two or more different/unique currencies to coexist in the same market. One of them has to win.

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my own concluding thoughts

When I started reading this paper, I was about to deconstruct it with a fine-toothed comb and show you its many flaws. Unfortunately, as far as effective criticism goes, I've come away pretty much empty-handed. All of the issues Taleb points out are very valid and backed by strong evidence. Even though the paper is only 5 pages long, it effectively deconstructs many things about Bitcoin that I consider favorable or at face value.

I remain a firm believer that cryptocurrencies more broadly will provide enormous utility to the financial sector, and only a wealth of new, well-researched information will change that. As far as I know, Ethereum and many other function-based tokens are one of the most revolutionary financial technologies, and I will continue to hold a large number of cryptocurrencies.

Of all this, it’s not Taleb’s thorough dissection of Bitcoin that worries me the most… but the response of his former colleague and respected economist Saifedean Ammous.

Instead of finding flaws in Taleb's position with a rational rebuttal, Ammous offers a sharp two-word answer:

“CRY HARDER.”

I can't say it makes me more confident...