Wednesday, 6 April 2022
Hey guys, the past few days have been tough. Tested positive and all. Can’t say I’ve bounced back quite yet, but I am feeling much better. I’m on sick leave from work so I had a lot of time on my hands today too.
Spent one-third of the day sleeping, the other third relaxing with some Netflix and the last on NFT work. Got quite a lot done today, I must say. An issue has been the lack of topics I am finding for the 50 Hours of Research. Sometimes, I do find topics but they are things that are not of great interest to me, so I put them off as items for later days. I do think I need to expand my following list so I have access to more content that I can learn from. I will work on it towards the end of today. I also determined the best times to schedule my posts on Twitter. It will be a tough change but I think this will allow me to reach and provide value to more people. I will schedule posts on the new timings starting from today.
Although it was tough to find, one topic did pique my interest today. As an investor and aspiring venture capitalist, I understand how the Power Law and Pareto’s Principle works in the world of finance. I know of its application in NFTs and crypto as well. However, until today, I hadn’t gone deep into truly understanding it as a whole.
The Power Law in NFTs
6529 states that NFTs follow the power law.
But firstly, what is the Power Law. To answer this question, I relied on ‘Power Laws: How Nonlinear Relationships Amplify Results’ on Farnam Street. The Power Law is defined as a ‘relationship between two things in which a change in one thing can lead to a large change in the other, regardless of the initial quantities’. While linear relationships are simple, non-linear ones are more complicated. With such relationships, you don’t need an additional X amount of effort to get an additional X amount of results. Small changes in a complex system can cause sudden and large changes, as those small changes cascade down the connected parts of the system, resulting in a large change. There is also the aspect of diminishing returns which refers to the point where more input yields in progressively lesser output.
NFT Investing has been compared often to Venture Capital. Peter Thiel suggests that the Power Law holds true in Venture Capital, where funds try to profit from exponential growth in early-stage companies. However, the reality is that a few companies attain exponentially greater value than all others. Often, the best investment in a fund outperforms all others. Thiel suggests an interesting rule for VC Investing (which should hold true in NFTs as well) — ‘Only invest in companies that have the potential to return the value of the entire fund’. As a result, the fund should be fairly concentrated, because there aren’t that many businesses that you can have that high a degree of conviction about. In his view, a better model is to invest in maybe 7 or 8 promising companies from which you think you can get a 10x return.
The tweets on the subject are generally supportive. Thus, there is little to be gained from analysing the Bull & Bear Case. However, there are certain interesting perspectives or tweets that go in-depth in the application of the topic.
Idea 1: Hold and ideally double down on your winners
The Power Law works in a way that winners do significantly well, and everything else is next to worthless. Winning projects are scarce and difficult to find. Only a small portion of all projects will ever fall into winning territory. As a result, when you find a winning project, you must hold on to it and ride it to the top. When you have identified winners that have already yielded significant returns, the best-case scenario is to double down and invest further. Often, due to The Power Law, the top is still really far away and the potential yield is still very significant.
Idea 2: The longtail will be economically worthless, but socially priceless
An interesting perspective because most Power Law concepts are focussed on identifying the 1% of projects that will yield well. However, this perspective focuses on the other 99%. Most projects will not be investment-grade and will not appreciate greatly. However, that does not mean they are completely worthless. If a collector connects with the piece or enjoys it, even if it is not a good investment, there is nothing wrong with buying into it. In the end, NFTs can act both as investments and art pieces. If you identify with an NFT, not as an investment but as art, you should buy into it. There is more to NFT Land than being an investor, you should also be a collector.
Idea 3: Power laws are driven by network effects and positive feedback loops
While this is a concept that I do not fully grasp, my current understanding of it makes me very bullish on NFTs. The Power Law is the state where a small portion of projects performs exceedingly well. As discussed in prior entries, Network Effects are the phenomena in which more users of a network make the network more valuable. Positive Feedback Loops, adapted for NFTs, in which initial collectors drive up the interest in a project which leads to increases in price, which then results in greater interest, and so on. This eventually results in a high price and great cultural value of the project.
The interaction of these 3 concepts is really interesting. The project founders and management are responsible for setting the foundation of the initial network effects and giving them a boost. In essence, they have to make the project worth sharing for initial collectors (above their natural incentive to share on the project they are part of). This sets off a positive feedback loop (as described above) which brings more users into the network. As the positive feedback loop works, more users enter and as a result, the feedback loop gets strong. In time, the project has many users that are contributing to the financial and cultural value appreciation. The positive feedback loop and network effects work hand in hand to raise the project’s profile and floor. Once they have worked their magic, the project will be in that 1%.
This is important as a collector because you have to analyse how a project’s network effects and positive feedback loops will play out. In addition, you also have to determine if the team will be able to set them off, maintain them and achieve the result desired.
Idea 4: Good to hold many NFTs so as to increase the chances of 100x outliers
This was an interesting one, which I don’t agree with. Perhaps, I am biased because I know that I don’t have the capital to diversify myself in this way. However, I disagree on a few other areas as well.
Basically, this concept says that you should hold many NFTs in your portfolio to ensure that some will fall under The Power Law. Technically, it will work, because the gains from your winners will outstrip the losses from losers.
Personally, I disagree because I don’t think it’s possible for me (or anyone) to find many different projects that they can have a high degree of conviction about. I realise that my perspective is the antithesis of the above concept, i.e. I’m saying that you should focus on finding that 1% while the concept says to invest broadly and hope you hit that 1%. I guess my personal investing philosophy is to go deep and study hard to identify the winners. That doesn’t mean that the above concept is wrong, just that I don’t agree with it.
Honestly, today’s work sent me down a much broader rabbit hole. It got me thinking about NFT investing as Venture Capital and thinking about learning as much as I can on the subject. First Principles Thinking, Network Effects, and The Power Law are all ideas that I have to learn in greater depth to be able to apply them. It’s really daunting right now. I am also somewhat discouraged by the fact that most blue-chip investments have high prices (even before the network effects) that I just cannot put in. Nonetheless, I trust it will work out.
While I am feeling better, I still think it’ll take me a while to get back to 100%. I have a lot planned for tomorrow and I hope to be able to get it all done. If I can come up with an entry for tomorrow or not is a mystery to me. Of course, I will try my best to get it done. See you!
