speculations on speculation

January 2023

Speculation gets a bad rap, but it’s much more than punting on memes and treating life as a series of lottery tickets. It’s a tool for technological progress.

In Carlota Perez’s model of techno-economic paradigm shifts, technologies start with a messy installation phase of creative destruction, where speculative financial capital fuels nascent infrastructure and experimentation. After the bubble pops, a recession sets in; then, the technology enters a deployment phase, bringing a golden age of shared prosperity as production capital takes over and the gains diffuse.

This pattern has repeated in the last five technological transformations: the industrial revolution; steam and railways; steel, electricity, and heavy engineering; oil, automobiles, and mass production, and information technology.

Breakthrough technologies start as speculative because they’re non-obvious. There’s potential but no proof yet. Risk-taking capital is critical to get these technologies off the ground in pursuit of progress and asymmetric returns. If capital only flowed to proven technologies, we’d be stuck with incrementalism.

Demonising speculation is akin to accepting things as they are. To speculate is to express rational optimism about the future. If we want to do brand new things, not just old things better, we need to take a long-term view and use speculation to bootstrap imagination into reality. Killing speculation would be just as bad for society as letting it run wild.

Crypto looks different and toy-like. Critics write it off as a self-referential casino, but they’re ignoring history.

Price speculation has been a leading indicator for crypto fundamentals. Summarising Balaji: without people speculating on future value, cryptocurrencies wouldn’t have had a price. Without a price, they couldn't be treated as money. Lacking that, it would have been impossible to build applications with just zeroes getting exchanged.

There’s a price-interest-activity feedback loop where people enter the space to speculate on prices during the bull market, and then they become builders in the bear.

Ben Graham distinguished between investing and speculation: an investment promises safety of principal and a satisfactory return; everything else is speculative.

But it’s a false dichotomy. Sure, there’s a difference between trading off lines on a chart and the fundamentals of an asset, but in our stochastic internet age, it’s all making bets on the future.

To achieve above-average returns, you have to be contrarian and right. Conformism might not be called speculation, but it still is. And at best, it delivers average performance because consensus opinion is reflected in prices, so there’s no arbitrage with value. Said differently: to get nonlinear outcomes, you have to make nonlinear bets.

When you accept this reality, the optimal strategy is to do things that others call speculation, but you have informed conviction on.

As Morgan Housel says: it's only called speculation when you disagree with someone else.