Reflection on Systems: Hype & Doubt

It’s difficult to predict the future. More specifically, there is error in estimating the derivative of the economic value of a given technology over time. Errors in this estimation are underdamped and have poor impedance matching to true underlying progress. Hype builds on hype, so a high rate of change in the estimation of the value of a technology induces yet a higher rate of change (an unstable system) until the delta between the hype and present performance hits a critical unsupportable threshold, at which point the hype loses momentum, which then compounds downward, sailing south of present performance and undervaluing the technology. This is the “hype curve” and is well understood.

Part of the unstable and self-compounding nature of hype is the “electability” phenomenon — those who trade on hype must not merely judge for themselves what an objectively correct value is for the technology but also they must suppose how the market — others — will value it.

REPUTATION RISK

For one’s reputation, betting on upside is a better deal than betting on downside. Those who claim a technology is overvalued and happen to be wrong about one technology that ends up being very successful are mocked; you’ll never live it down. It won’t matter if you successfully spotted many other overvalued technologies that did indeed plummet after you said they would. You can’t miss even *one* big trend when betting on downside from a reputation perspective.

The converse is quite different — if you are bullish on dozens of technologies very early and most of them are pure quackery but one of them comes to fruition, you will be hailed as a visionary and people will not remember your earlier bets on other technologies. Therefore reputationally it only makes sense to bet on upside.

FINANCIAL RISK

For one who spots an early technology correctly there is financial upside limited only by the ultimate size of the future realized opportunity, which could potentially be vast. This is of course the whole point of the venture capital asset class — if you find only one mega-unicorn it literally doesn’t matter what any of your other investments do. They’re all covered by the one huge success.

For those who bet the downside, returns are constrained by the present hype (since that defines the total addressable market for counter-parties to take your bet) and instruments for betting against early technologies are hard to come by. So it’s difficult to profit financially from early phenomena being overhyped, even if one is very good at it. Financially it only makes sense to bet on upside.

CONSEQUENCES

These two phenomena combine to motivate the underdamping of hype — doubters have little to gain financially or reputationally from calling out legitimately overhyped trends, and those who believe (or want to believe) in a hyped trend have much to gain in both reputation and financial upside from cheering on and compounding hype. If a given bet stops looking like a rocket ship they can get off with little risk and most people will forget that they were wrong.

The danger is that those participating in the hype categorically and uncritically reject the feedback from those doubters who do speak up (despite the fact that it will almost never financially or reputationally benefit said doubters) due to it being important to them for personal and financial reasons that the hype indeed be a success.

We can assume that doubters of a trend may be wrong but are usually speaking out of conviction given the lack of upside; promoters of hype may be right but have much more mixed motives and a much lower net risk profile.