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title: Crypto as memery a.k.a asset valuation as Schelling game part one V2

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# Crypto as memery a.k.a asset valuation as Schelling game part one V2


### Overview
In this article I will argue that most investors are confused about asset valuation. I will argue from first principles why "value investing" or "fundamental analysis" are bad valuation models when used outside yield bearing assets and why thinking of any asset as having some "intrinsic" value is either misleading or harmful. 


[TOC]




## Definitions 

- YBA - yield bearing assets 
- "fair" price - price, or price range that an individual investor considers the asset will approximate in the particular time in the future, hence he is motivated to buy below the price, or sell above it. Important to note that price is "fair" only from a perspective of an individual investor and this price may not be expected for other investors. 
- DCF - Discounted Cash Flow model 
- Dominant strategy - a dominant strategy is a strategy that gives a player the best outcomes, regardless of the actions of the opponent. [source](https://study.com/academy/lesson/dominant-strategy-in-game-theory-definition-examples.html)
- Nash equilibrium - In a Nash equilibrium, each player is assumed to know the equilibrium strategies of the other players, and no one has anything to gain by changing only one's own strategy [source](https://en.wikipedia.org/wiki/Nash_equilibrium)

### Schelling point
(skip if familiar with the concept)

simple definition (from wikipedia): 
	*Schelling point is a solution that people tend to choose by default in the absence of communication.*

general example (from wikipedia): 
	*"if you are to meet a stranger in New York City, but you cannot communicate with the person, then when and where will you choose to meet?"*
the Schelling point:
	*the most common answer was "**noon at Grand Central Terminal**"*

### Schelling game 
Well, what are markets other than price discovery mechanisms that choose a coordinate around  price? An asset price at a particular time $T_o$ can be thought of as a Schelling point.

Let's transform the Schelling point question from above to better apply for asset valuation:
> *"What price should an asset trade at?"*  

This most basic question, although true can be better transformed to: 

> *"How will you determine the price of an asset? What models and inputs will you use?"*  

This question below is practically the same as above and quite easy to answer given agents have roughly the same functions with the same inputs. 

In YBAs both inputs to the model (e.g. company report) are the same for all participants (disregarding insider trading here) and everybody uses different flavors of the same model. 

In investing though, investors are not trying to coordinate with other investors but rather every investor is trying to front run every other investor by guestimating the future Schelling point of an asset price. 


Thus a better question is:

> *"How will other investors determine the price of an asset? What models and inputs will they use?"* 

I will call this game of guessing the future Schelling point of an asset price a **Schelling game**.  


## Maps and Models 
Thinking about Schelling game instead of fundamental analysis becames useful exactly when these two frameworks diverge. If there is a dominant and stable Schelling point as there is in case of YBA there is not much to be gained by using this meta game. Why? because the models are stable, the inputs are public, thus the whole game boils down to guessing future inputs into the model. 

To give a practical example, when investor is evaulating a stock, his main question is: "how will the company fare in the future?" what do they mean by this is "what will be the future financial results of the company" or "what will be the future inputs to the general FCF model?". 

To reduce this problem of finding a future Schelling point into a subproblem of guessing inputs to a function (evaluation model) is possible only because the function is constant. 

But if there isn't and ideally other investors are using evaluation models that will not be the future Schelling point that's when you make a killing.  

Most investors are thinking about assets as if they had some "inherent" or "fundamental" value, buying the currently undervalued ones. I will argue that this paradigm is highly misleading in the context of crypto and applicable only to yield bearing assets such as stocks or bonds. 

It is true only in the special case where the Schelling point of a particular asset determining the price is some form of fundamental analysis. What is usually meant by "fundamental" in this context is some kind of guesstimation of future cash flows of a particular project and deriving the price from there. It has dominated the investment field for the last 50+ years and for a good reason. 

The reason being that FCF(future cash flows) analysis is the only dominant strategy in investing.  

## The (only) dominant one



There exists a special case when an investor may be oblivious to the dominant Schelling point and games played by other investors. 
This is the case with YBA assets held for long horizon (decades), in which an investor can collect his gains from interest payments or dividends. 
Even if the market is completely "irrational" in the traditional sense of the term and were to follow compelety different schelling points in the future such as memetic potential of companies' CEOs a long term investor can still collect his profits. 

Put in game theory terms, there exists a dominant strategy for players with a preference for a long time horizon.

Ok, but how many investors (in terms of capital) are ready to hold an asset on a multi-decade basis? Is it 1% is it 5%? Whatever the number, we can safely assume it is very small number of the overall capital deployed. 
So why would it have such disproportionate effect and in fact determine the Schelling point for YBAs? 

**Because the mere existence of a singular dominant strategy in the sea of pure memes makes this Schelling point stand head and shoulders above all other meme based ones.** 

To illustrate the point, a good analogy from crypto is that the existence of BTC maxis like Michael Saylor who will buy or at least not sell no-matter-what makes all other crypto investors more comfortable holding BTC in times of strife. 

The crucial difference between crypto and stocks is that although BTC may seem like a dominant asset, it has no dominant strategy. If in 10 years people no longer believed BTC has any value it will make it so, you are screwed and your profit is zero. 
If you have the same scenario but with a stock paying out dividends you can still be made whole and make profit purely from collecting those. 

In other words, if we discover a new planet full of martians with thriving economy and have no knowledge of social or economic interaction within, we could still use DCF since it would not matter that "no one else except me gets it". 

## Missing forest for the trees 

If investors play on the field of well established trad markets, they may in fact live and die looking for the fundamental value and invest successfully. 

Good analogy arise to this arise when we look into Physics, as models in physics are the easiest and some would argue the only ones that can be well tested. 
We know that Newton's physics is wrong on an fundamental level, since it breaks once we zoom into the particle world, but we use it for most use cases anyway since it is "good enough". 
As with investors investing in traditional "vanilla" markets, physicians before 1900s thought that their model of world does not approximates reality, but actually describes it. 
Drawing on this analogy we could say that investors are trying to use "Newtonian physics" for everything, but are currently struggling because they use it in the new domain(crypto) where traditional laws of physics don't apply.

Also, I am well aware of the fact that even my arguments proposed here are need to be taken with a grain of salt, since unlike physics the model I am proposing cannot be rigorously tested. My argument why this model may track reality closer is that it makes fewer assumptions. It does not assume rationality on the part of the economic agents, nor it assumes any esoteric notion of "expected" or "fundamental" value.
A funny trivia from history of physics that highlights the need of simpler models and Occam's razor is the period after Copernicus published his heliocentric model, but before it was widely accepted. His model became widely used by his antagonists also, because it was much simpler to calculate movement of celestial bodies using his heliocentric one, than the geocentric one which was heavily overfitted to reflect the actual planet movements. Before Kepler, the heliocentric model wasn't actually better at predictions but it was much simpler to use.

Hence I would argue even if both models of valuing assets; the "fundamental value" and "Schelling points" models have the same predictive power, the one making less assumption should be used, both because it is simpler and because it has better chance to be closer to reality. 




However, if the predictive value of both was the same, nobody would care and I would argue that it is actually strictly better, when thinking about crypto assets which do not have established Schelling points. 

## What is the price made of?  
Price a function where the only inputs are supply and demand, no fundamentals, nor memes, as Metallica sings "nothing else matters". Important to note that there are no fundamentals as inputs into the price function. In fact I would argue that the reason why fundamentals matter is, because it is a dominant Schelling point that lot if not most investors play in traditional investing. 


Let's get back to the price function. We can write it as  $price(S,D)_{t0} = Price_{t_0}$  where $Price$ is a function dependent on Supply and Demand at time `t0`. We can think of it as an outcome of the Market point at a particular round/time `[Ti]` . It can be thought of as point of infinite rounds, where every agents(market participant) takes action. there are 3 types of action in the point, `buy, sell, hold` which can be thought of outcomes of agent's utility function. Every round each agent takes an action  `buy=+x, sell=-x, hold=0` two of which `buy,sell` will affect the price. Thus we can rewrite price function for any round as a sum of actions `a` of market participants `p` in each round/time $T_i$ : 
 `∑(a[p])[Ti] = Price[Ti]`

### If you do not care about math
To gist of the paragraph above is that the supply and demand are basically outcomes of preferences of buyers and sellers. Thus we can care only about the preferences of market participants as they are the sole thing determining the price. 

### Preferences of market participants 
There are many preferences `p` affecting agent's utility function such as` a(current price != "fair" price) b(need to pay out LPs), c(need to pay taxes), d(need to realize profits)`, and others. So the utility function of agent `[i]` is `U[i] = p[i](a,b,c,d...)`. If agent's utility is positive he will `buy` if negative `sell` if `0` `hold` (more realistically we would talk about a range, rather than specific points, but the reasoning is the same.)


We can further divide the preferences into two distinct classes. 
	*1. class* - profit maximizing reason - investors think the asset is overvalued / undervalued - only preference `p[i](a)`
	*2. class* - "forced" non profit maximizing reasons, real world needs - Cash flow needs, need to pay taxes, need to realize profits - all other preferences `p[i](b,c,d...)`
	

We can see the second class in full force in times of stress and volatility such as forced liquidations, FED rate hikes which were not foreseen by the markets when the agents are forced to buy or sell assets without a regard for the profitability of the trade. More mundane reasons, such as paying taxes or following fixed strategy such as automatically buy/sell to track index are also at play here. 

This class of preferences has a profound effect on the price as we could have seen after the 3AC liquidations, especially in immature market like crypto, but will not determine the price in the long term. Especially if you take the price average on a longer timeline, it will trend to price target determined by the first class of profit maximizing.
Why? 
 Because the first class of preferences sets the price equilibrium which is at times broken by the second class, but never the other way around. 
If investors who are not forced buyers / sellers observe a price deviates from what they consider to be the "fair" price, they will realize their preference (buy or sell) until the price equilibrium is restored. There are important caveats here though. 
 
 *The first* caveat here is that it can take months even years in a market like crypto for the equilibrium to be restored since the volumes of forced buying / selling could be much higher than those of profit maximizing. Especially in crypto where the believers have much higher price targets than available capital at hand, and no way to push the price to this target. Think of Michael Saylor who will always buy $BTC under 100k, but simply does not have the capital to push the price to this level. 
 
 *The second* one is since there are no widely established Schelling points in crypto, the price itself has a profound effect on the equilibrium as it directly affects the preference  `p[i](a)`  . Think of "crypto is dead" narrative in bear market, or "crypto solves everything" narrative in bull market, both of which influence investors' considerations of the "fair" price. 


### Determining the price equilibrium 
Since there is no widely accepted Schelling point in crypto the majority of investors would subscribe to, investors have very heterogeneous views on what the "fair" price is. There is no clear price target the current crypto market is moving towards and the equilibrium is in much greater flux than in traditional markets. It is illuminating to contrast crypto with traditional markets, where either most investors use the same models with slightly different values, or slightly different models with similar values, both resulting in majority of investors to be more or less in agreement on what is the "fair" price range. Here you can think of valuating stocks, where everyone basically agrees that the right way is to get to the "fair" price is by discounting future cash flows. The main differences between investors is only in determining what trajectory will a particular company / industry take, if it will grow to a giant like Google or not.    


## Rationality of Degens 
Finally we come to a part where this Schelling point model actually helps to explains obvious market "irrationality". The current movement of meme stocks and meme investing viewed by traditional investors as irrational may be in fact highly rational if viewed by the right lenses.  

Let's look at the Gamestop example. 

To quickly recap what happened with Gamestop saga for those living under the rock, Gamestop is a company selling computer games via physical stores. Because of covid restrictions big hedge funds reasoned that this company's shares will go down and shorted it in large volumes, outstripping the actual supply of outstanding shares. This was picked up Wall Street Bets reddit community, who started buying the stock off the market and created a short squeeze. 

Was the WSB community irrational? If so, by what metric? 

You could use DCF and say that this company has no future thus no value. But you would be missing forest for the trees here. Investors need not have decades long time horizons or use your valuation model. If they are large(Soros drowning British pound) or coordinated enough(WSB Gamestop saga) to actually move the price and create new equilibrium to match their target, they will do so and take healthy profits along the way. 


By traditional investors this phenomenon is usually dealt with the phrase "market can stay longer irrational than you can stay solvent", which can be sometime be fundamental in the sense that price equilibrium is disrupted by the second class of market forces and will slowly return to the old equilibrium, but many times is simply untrue, since there is no clear equilibrium the market is moving towards, or a new equilibrium is created.



## It's memery all the way down 
So far I used stock as an example, mainly because it has a clear valuation model and is easy to understand. However, it is not a very good example to show the rationality of irrational investing, since there exists a very robust default Schelling points for YBA assets as I have explained above. 

But let's look at some extreme examples where memes alone determine the dominant Schelling points and if there is any utility, it is all derived from the memes. 

## pure memes
Why is Mona Lisa one of the most valuable works of art? Is the artistic quality million times better than the next thing? How much would the exact copy be worth? Perhaps a bit more than a poster? Its value is clearly determined by the memes alone. Interesting to note here that the world actually forgot about Leonardo for 300 years and only came into vogue in 1800s. Mona Lisa is a shorthand for Leonardo and his legacy. On top of that she was stolen twice and has many legends surrounding it, in other words great memery!  
Now imagine an alternative universe in which Leonardo's notebooks were lost to history. Without them there would be no legend of him as renaissance master and lone genius to build on, perhaps his works wouldn't even make it Louver and nobody would care to steal them. 

If you go a step further you get to art NFTs, where there is not even any actual thing in the meet space. People have raised the arguments that these NFTs like Bored Apes actually have utility, since you can commercialize them, get access to exclusive groups etc. But this is a "tail wagging the dog" type of argument. How much utility could you derive from them if their price suddenly dropped to zero? Who would be eager to use your Bored ape in a movie if nobody had cared about it? Aren't there in fact thousands of different NFT projects trying to emulate their success with the exact same attributes like BAYC and even better utility mechanisms but with no actual value? 
The bottom line is that the whole idea of utility of this class of NFTs is built on their meme value on which it is fully dependent.


## meme assets
By meme assets I mean assets whose value is mainly derived from their memes but which have some utility value, making them valuable even if they lost completely their meme potential.

Examples of these are assets like Gold, Ethereum and other crypto, where the most value subscribed to the asset is not tracking actual utility of the asset all bets are off and Memery rules. It is important to note that although both these assets would have some demand even if they had zero meme potential from microchip industry and ETH gas market respectively, it would be hardly 10% of the market cap they occupy today.

Gold is as much of a meme asset as ETH, but its memes and Schelling points are already well established. Gold has been around much longer than ETH, hence the meme and the Schelling points of gold as store of value, money or whatever else is much more stable than ETH in the short term. Of course there is no certainty that money memes which are dependent on credible neutrality and scarcity will be attached to gold a 100 years from now, if we have assets like ETH that satisfy these properties one could argue in a better way. 

## Meme wars 
The main difference cryptos and gold is that gold memes are already well established and somewhat stable hence it is hard to change the price equilibrium. In contrast we as a Ethereum tribe are in the process of establishing and coopting the best memes for our asset. The image of the IQ bell curve comes to mind where the left 5% and the right 5% understand this intuitively or explicitly while the majority seems to be surprised at every step. 

We have two ways to go here, coopting existing memes of store of value, moneyness, ... and creating completely new ones like triple-point-asset meme. This process is organic but this does not mean it will happen on its own.

We can see this in twitter wars were different tribes are getting more tribal as the time goes. This happens to a great extent when two tribes are fighting for the same meme. Think of BTC  "sound money" vs ETH "ultra sound money" both vying for the same money meme. Or think of "credible neutrality" "decentralization" "inclusion" and other meme wars. All memes that have already been created have a zero-sumness to them because in people's mind there is always a hierarchy of objects connected to a particular one. Ask yourself, what is the best store of value? Doesn't matter what the answer is for you, there is always one crypto that will occupy this place (hint, its ETH). Hence, every crypto tribe tries to establish itself as being the best representative of a particular meme or set of memes. 


## ETH as ultra sound money, a new asset and a completely new beast.

Since it's memery all the way down and there is no default Schelling point, the price will never approximate some "fundamental" value we believe it will reach if we just wait long enough. The though that "the market price will trend towards the fundamental value on its own" is a mirage as there is no "fundamental" value in the absolute sense and the price that investors deem "fair" is not yet established. You could say that if you were to predict all the future social interactions and the memes they will create you could predict the price, but as Lincoln said "the best way to predict the future is to create it". 

Thus, it is up to us to meme the best possible Schelling points for ETH into existence and establish the price equilibrium as high as we can. 


We need to create, coopt and spread these memes as much as we can, since not only our bags but also the future of credibly neutral financial system depend on it. 