Is Bitcoin Antifragile?

A look at the Lindy effect

One of the trendiest follows in finance is someone who despises most financiers. Many bitcoiners are attracted to Nassim Taleb, author of The Black Swan, Fooled By Randomness, and Antifragile due in part to his anti-establishment nature, and because bitcoin fans revel in the triumph of mathematics and algorithms over fallible human institutions.

He holds most public intellectuals in contempt, and finds successful traders indistinguishable from lucky fools. At a time when tail events seem to be happening with disturbing regularity, Taleb’s influence is enormous.

Even if you are not a fan of his, he has coined some incredibly useful heuristics for trading. This post introduces one of his simplest and most effective rules: the Lindy effect.

Apparently the cheesecake isn’t all that good (Image courtesy of Jim)

You may have heard of this heuristic before. It is named for a New York deli where actors realized the following:

Broadway shows that lasted, say one hundred days, had a future life expectancy of a hundred more. For those that lasted two hundred days, two hundred more.

The Lindy effect is introduced and discussed in Taleb’s book Antifragile. Put into heuristic form, the Lindy effect states that, for a nonperishable asset, life expectancy is proportional to age. This means that the older something gets, the more likely it will continue to stick around. This naturally only refers to assets that do not depreciate with age. The Lindy effect does not apply to potatoes.

“The moldy effect”

It does, however, apply to things like ideas, political ideologies, technologies, and systems. Since cryptoassets are all of those, they seem very suitable candidates for the Lindy effect. Additionally, the market is competitive, and cryptoassets have very short lifespans (on average), so age tells us quite a lot about the asset.

The Lindy effect holds here because the cryptoasset market exhibits continuous extinction pressure on assets and protocols. The mere fact that a protocol or cryptocurrency has survived a meaningful amount of time in a competitive environment is an indication of value. Fragile systems are destroyed with age. Antifragile systems gain from the disorder that accompanies longevity.

Think of cryptoassets as elaborate bug-bounties. The longer they exist, and the more popular they get, the more incentive there is for a black hat hacker to probe them. This is why ethereum is a target for hacks: it has a large attack surface, and it is worth a lot. If ethereum were to weather a decade of constant attacks, we might imagine it to be relatively safe. The sample size at present is too small to draw a useful conclusion, but the recent spate of attacks is not cause for optimism. Bitcoin has 8.5 years of evidence of its security. In the grand scheme, this is relatively little, but relative to some of its month-old competitors, this is worth a lot.

I was motivated to write this post in part because the Lindy effect is used as justification for finally taking the plunge into bitcoin. Take this sentiment from a wealth manager who recently bought in:

There are three principal conclusions I would draw from the application of this heuristic on this market:

1. Bitcoin is the only existing cryptoasset with any serious Lindy justification

The top 15 coins at time of writing (ordered by USD mcap on CoinMarketCap)

At 8.5 years of age, bitcoin appears positively ancient by cryptoasset standards. However, we have to remember that we still have relatively little data. We’ve only ever known bitcoin in the inflationary phase of its development, and have not witnessed its ability to serve as the settlement layer for a multi-layer network, or see a fee market develop, or realize any other long term design.

In novel cryptographic systems, only time and experimentation tell us whether the parameters are well-chosen and the economic incentives that drive the system are appropriately balanced.

Even bitcoin, the grandaddy of all cryptoassets, is young. That said, it’s exactly half as old as the median fiat currency. (This comes from data compiled by Mike Hewitt in 2008. The median deceased fiat currency lasted 17 years, the median living fiat currency was 37). Bitcoin’s lack of crippling protocol-level bugs, ironclad cryptography, constant uptime, and change-resistance all generate a continued flow of information reinforcing it as a store of value asset. (We evaluate store of value arguments in this post.)

Note: this is an arbitrary selection of the top 15 cryptoassets by mcap as of July 21.

2. Lindy tells us about the quality of encryption, too

The effect doesn’t just hold for cryptoassets, it applies to their underlying cryptographic algorithms as well. Even if you are totally non-technical, this grants you some information on the relative strength and security of zk-SNARKS compared to RSA. As Peter Todd, a participant in the Zcash initiation ceremony, puts it:

The cryptography behind Zcash is both highly experimental, and relatively weak. Fact is, if zk-SNARKS turned out to be totally broken, unlike more mainstream crypto, it just wouldn’t be all that surprising:

This isn’t to say zk-SNARKS are useless. We simply have less information on them due to the fact that they are new, by cryptographic standards.

3. We still have very little data on our hands

Skepticism is certainly warranted. We do not yet know what a radically up-scaled bitcoin would look like. We don’t know what the lightning network will look like, or whether sidechains will ever be incorporated and make altcoins obsolete. We don’t know whether the powers that be will consent to a private and fungible bitcoin. We don’t know whether smart contracts will ever be economical, or scalable. More generally, we don’t know whether dis-intermediating every conceivable service is actually worth the hassle of a distributed ledger. The little data we have suggests bitcoin’s time is not up. But beyond that, it’s hard to draw meaningful conclusions.

That’s an introduction to the Lindy effect. For more detail, pick up a copy of Antifragile. You won’t regret it. If you are still unconvinced, I consider a few objections below.

Objection 1: There are exceptions to the Lindy effect

Of course there are exceptions, as new ideas come into existence all the time. The Lindy effect is a heuristic, not an ironclad law. It is a rule of thumb, not an universal property of financial assets. It’s also probabilistic. The physicist Richard Gott took a snapshot of the broadway shows running in May 1993 and found that the Lindy effect held almost universally — the longest running shows (at that time) ended up outliving their younger peers 95 percent of the time.

A Lindy analysis of bitcoin might lead you to believe that gold has it beat, by about 5,000 years. You wouldn’t necessarily be wrong, but you’d miss that bitcoin is not a gold substitute, but a completely different entity altogether. Bitcoin is digital gold — if gold could be sent anywhere on earth within a few minutes for a couple dollars in fees, infinitely divided, programmed, fixed in supply, and upgraded. While cryptoassets have some ways to go as far as being considered ironclad stores of value, each additional year that they reliably store value is another year of evidence that they are indeed suited to this purpose.

Despite the limited information set at our disposal, the Lindy effect can be used to sort cryptoassets. Due the to the ease of copy-pasting code, hundreds of altcoins have appeared in the last few years. Passively buying the altcoin index has historically been a terrible strategy (until early 2017, although those gains have pared off somewhat). This lends credence to the applicability of the effect to the store of value thesis, and reinforces the winner-take-most hypothesis.

Objection 2: Is the Lindy effect just a case of survivorship bias?

Is it circular to say that the oldest members of a set facing continuous extinction pressure are the most valuable? By definition, an actively traded financial asset is worth more than an extinct one. However, this misses the forward-looking nature of the Lindy effect.

The Lindy effect is predictive. For ideas in a competitive marketplace, age indicates quality — and forecasts longevity. Survivorship bias is only a problem if the sample you’re looking at would be more accurate if you include defunct assets. So the Lindy effect is only concerned with survivors. It asks, “why did they survive, when others died?”

Objection 3: Age is a poor predictor of value, as there are old but useless cryptoassets floating around

This is true. Many abandoned cryptoasset projects continue to trade despite no active development. These zombified projects are often indistinguishable from active ones, especially if one’s research does not extend beyond CoinMarketCap. This is why a Lindy analysis of a coin should include reference to forum activity, lively and productive development teams, and trading data. This can be faked, so be wary of developers manufacturing illusory development activity. For instance, a cursory look at Litecoin’s longevity may impress you. However, it was a zombie coin for a long while, so those intermediate years probably shouldn’t count.

So there you have it. Non-perishable things in a competitive environment age backwards. Three hundred years on, Bach’s music is still popular, and it probably will be for another 300. Let this insight guide you and fuel your skepticism as you invest in cryptoassets. Brand new tech is exciting, but not guaranteed to win out.