Power Laws: Small Changes, Big Ramifications
This edition seeks to cover the following:
- What is a power law?
- Power laws in price
- Power laws in competition
Imbalance
Power laws are about nonlinear relationships.
Altering one side of the supply/demand equation results in an exponential change to the other side.
A market that undergoes a significant change in conditions, for example a drastic increase in demand without a comparable increase in supply, experiences disequilibrium.
Halvings
The Bitcoin protocol's predetermined issuance schedule and fixed terminal supply means it's entirely irresponsive to changes in demand.
Every 210,000 blocks (~4 years) the amount of new bitcoin minted per block is reduced by 50%. So while the existing stockpile continues to grow, it does do at a decreasing rate.
Once newly issued coins are totally absorbed by market participants, any excess demand can only be satisfied by convincing existing holders to become sellers. The way this typically occurs is via price.
When Push Comes to Shove
In the physical world, a crowd moves like a liquid. As it tries to pass through a narrow passage pressure builds up. Individual actors can also decide to push (with sometimes disastrous consequences).
Markets are similar in that supply-side bottlenecks result in squeezes, expressed via price. Individual actors can once again decide to push, except their force can be multiplied by capital.
In simple terms it's no wonder that assumptions about bitcoin's long-term price is largely binary- astronomically high or zero.
"We can debate whether or not bitcoin is going to be a big deal in the future. But I don't think we can debate that if it is it's going to have an enormous right-tail." -Ross Stevens (NYDIG)
Winner-Take-Most
A power law dynamic in one company or asset naturally creates a power law in terms of market share among competition.
If bitcoin does eventually reach an astromonically high value (denominated in USD), than it will likely have become the dominant digital store of value in what is a winner-take-most competition.
"The world is ruled by fat-tail events, or seemingly improbable occurrences that have an outsized impact, and all indicators so far point to Bitcoin being one." -Bill Miller
Further Reading
Bitcoin: The Mother of All Fat Tails
Bill Miller IV on the latest opportunity in a procyclically positioned income strategy.
