Weighing Machines and Voting Machines: September 24, 2017 Snippets
This week’s theme: when perception and reality mutually reinforce each other, we get consequences like reflexivity, the stock market, and fake news. Plus an update from Social Capital about some of our recent initiatives around the IPO process.
Last week, we saw an introduction to how non-linear relationships between variables can cause us to make mistakes. As it turns out, there is a far greater category of cognitive errors and errors that we make on a regular basis that have the potential to be much more serious, not only because are they easier to make, but also because these kind of errors can multiply and spread between people. They’re found in relationships between variables when our perceptions and observations are an input variable to our decisions and actions, which in turn re-inform our perceptions: a type of relationship we call reflexive.
For the next few weeks, we’re going to talk about these kinds of relationships: how human fallibility and reflexivity combine with what economist Frank Knight and financier George Soros call the Human Uncertainty Principle, how these relationships shape markets (and especially the network-effect market power that we frequently see in the tech industry), and how reflexivity helps us understand other recent phenomena like fake news and a strange new kind of warfare that may be in our future. For today, we’ll introduce a few basic concepts, using Soros’ definitive explanations as our starting guide.
The phenomena we’ll learn today, as describes by Soros, rests on two fairly indisputable pillars. The first is the principle of fallibility: in situations where people have to think, their view of the world can never be perfectly correct. The world is simply too complex, and human minds too imperfect and biased, to ever have a 100% objective and correct understanding of factual state. The more generalizations and reductions we must make to grasp a situation, the more opportunity there is for our perceptions to be different from the actual state of the world; this is an inevitability.
The second is the principle of reflexivity: when those people are able to act to act in any way that alters the world, then their beliefs, flaws included, will materialize in the real world in some form. When our perception can affect reality, it will in turn affect our perception even more, in a recursive feedback cycle. Sometimes these cycles are self-correcting, which we call negative feedback, but other times they are self-reinforcing, which are less common but more interesting, as their consequences will be more extreme. This is positive feedback. Positive feedback is problematic for anyone trying to get at the truth, and very potent (as we’ll see in future issues) for someone who wants to wield it as a weapon.
Reflexivity is one of those concepts that you start seeing everywhere in daily life once you understand it. Imagine meeting somebody for the first time, when a friend has forewarned you that this person is mean. So you approach the encounter in a more guarded way, which puts them on guard as well, and you each progressively become more hostile towards one another, your suspicions being visually and mutually confirmed. Perception and reality are reinforcing each other. On the other hand, had your friend told you instead that this person was a very warm and friendly individual, you might have instead introduced yourself with a smile, setting off the opposite cycle of a returned smile, and a happy positive feedback loop in the other direction. Reflexivity applies just as well to more supposedly “rational” environments like the stock market, where a company’s share price going up causes others to perceive them as being in a stronger position, and therefore buy more shares. Reflexivity is so powerful, it even beats the law of supply and demand that we all learned in school: “if prices go up, demand should go down.” The more you understand reflexivity, the more you understand how blind you are without it: prices and perceptions are affected far more by reflexivity than most people realize.
The type of guessing game required when investing in the stock market — often called a Keynesian Beauty Contest after its development by John Meynard Keynes, shows how fast reflexivity can overwhelm any attempt to evaluate what the price of something should be worth, given that we’re actually placing bets relative to what other people think it will be worth. When you buy a share of Apple stock, at a simple level you’re paying for what you expect will be Apple’s future earnings. But those who think about it for a minute will realize, no: I’m paying for what everyone collectively believes will be Apple’s future earnings. I’m paying for perception of reality. But those who understand reflexivity understand it goes a level beyond that: everyone else will be facing the same dilemma as well. You’re paying what everyone collectively believes that everyone else collectively believes are Apple’s future earnings! The price we pay reflects the perception of perception of reality. This is why we have that famous line describing the stock market: “in the long run it’s a weighing machine, but in the short run it’s a voting machine.” The thing that people are voting about is other people’s votes. This is why it’s possible for the stock market to be both efficiently incorporating all available information but also be completely wrong: prices don’t necessary reflect genuinely expected future outcomes, and in fact they are not even trying to do so.
Of course, it’s not only perception that will drive the ultimate outcome: we genuinely do not know what Apple’s next quarterly results will be, or the quarter after that. Reality actually matters, and as the future happens it will change both the facts and our subsequent perception once more. But in the meantime, we must make decisions today about whether how to act. And our actions can profoundly affect that future reality, especially when we’re dealing with startups that are raising money to grow rapidly. And in the tech industry, we deal with one particular type of company and market power that is especially susceptible to these kind of reflexive games: companies with network effects. For more on why that’s the case, and what we can do about it, check back next week.
Electric Shifts:
As electric motors improve, more things are being electrified | The Economist
Flying car contenders taxi for takeoff | FT
US solar plant costs fall another 30 percent in just one year | Christian Roselund, RE New Economy
For wind power, bigger is better | MIT Technology Review Graphs
Michael Liebriech: State of the Industry keynote at Bloomberg New Energy Finance EMEA Summit 2017
The Arts Section:
How Donald Glover’s Atlanta expanded the limits of storytelling | Jason Parham, Wired
How do you decode a Hapax? (Also, what’s a hapax?) | Maya Nandakumar, Atlas Obscura
Fear, Doubt and Wonder in Cryptoland:
If I’d known what we were starting | Ray Dillinger
China’s interference on Bitcoin tests currency’s foundation | Chao Deng, WSJ
Huge Ethereum Mixer: 68% of total transaction value controlled by one system | Satoshi Fund
Ethereum’s Byzantium Testnet just verified a private transaction | Rachel Rose O’Leary, Coindesk
Territory Expansion:
Alphabet looks for land to build experimental city | FT
How Satya Nadella helped Microsoft focus on what mattered most | Harry McCracken, Fast Company
Other reading from around the Internet:
AWS announces per-second billing for EC2 instances | Frederic Lardinois, Techcrunch
Eric Jonas on: “could a neuroscientist understand a microprocessor?” | Rationally Speaking podcast
New platforms, AI and evolving the organization | Jason Costa
iPhone X: the demo gods are cheeky | Jean-Louis Gassée
MongoDB IPO S-1 breakdown | Alex Clayton
And just for fun:
A nine-year-old reviews the Tesla Model X | Benicio Quinones, The Verge
As you may have heard, last week we officially launched a new product called “IPO 2.0” in the form of a blank-check company (officially known as a Special Purpose Acquisition Company, or SPAC) called Social Capital Hedosophia Holdings Corp. on the New York Stock Exchange. SCHH has profound implications for private technology companies, so we’d like to take a moment today to discuss technology, capital, employees and liquidity, and what we hope to achieve.
Social Capital’s CEO aims to get billion-dollar startups ‘liquid sooner’ | Polina Marinova, Fortune
Blank-check IPO raises $600 million, search begins for tech unicorn | Maureen Farrell, WSJ
Our goal at Social Capital is to help put technology and capital to work towards solving the world’s most difficult problems. We draw encouragement every day from the fact that there are many other companies, founders and employees who share the same values and are working towards the same goals. We know we’re not alone. Although it certainly isn’t perfect, Silicon Valley and the broader tech industry is still an amazing collection of people who are putting their talent, time and effort towards solving hard problems and improving the lives of people around the world. We’re fortunate that every day we get to meet with amazing founders, engineers and really anyone who shares these values with us.
Part of why Silicon Valley and the software industry has been so successful at building important, world-changing companies like Apple, Alphabet, Microsoft, Amazon and Facebook is due to a unique social contract between employers and employees that is much harder to find elsewhere in the world. That social contract is the idea of sharing in the upside: incentivizing and rewarding employees with stock options and restricted stock units has been hugely consequential, because it helps reward employees who work hard for years towards important goals. When everyone can share in the upside, people are especially motivated to do great work.
But the current climate in the tech industry, due to both inside and outside forces that are beyond any one person or company’s control, is that companies are staying private longer and longer. This has a dangerous side effect: a liquidity crisis where the social contract between companies and their employees is in danger of coming apart. You can’t ask an employee to pay to live in an increasingly expensive region like the Bay Area with stock options or RSUs that might be worth something one day, but aren’t liquid now. That’s not fair. And when we see employees leaving companies at greater frequencies than ever before, churning from job to job in search of a genuine liquidity event, that’s not their fault. It’s something we need to fix.
We believe that solving this problem by providing new, alternate paths into the public markets is one of the most important things we can do to help restore this social contract in Silicon Valley and in the broader tech industry. We want to support entrepreneurs working on important problems at all stages, and that includes the path and transition into becoming a public company, and look forward to sharing more with you very soon.
Have a great week,
Alex & the team from Social Capital
