How Narratives Create Value
In my first brain dump The narrative of narratives I jotted down alot of initial thinking I've been carrying around about narratives, particularly in the crypto space.
In this essay, I'm going to work out my initial thoughts more specifically around the value of narratives. (Then I'll start to do some research to find out what people who really know what they are talking about say.)
Crypto projects need a strong narrative for two reasons: one of the reasons is why even web2 or any project needs a strong narrative; the second is the nature of crypto projects.
I'm not going to spend as much time on the first reason in this essay. But the tldr is that the narrative drives category creation, product strategy, and demand creation. I talk about some of these concepts in my brain dump, but plan to dig deeper in the future.
But one of the things that makes crypto different is the power of shared meaning driving behavior, and the value of that behavior has been financialized.
Whether this can sustain long term is a social experiment we're seeing unfold. But that we see some gravity-defying valuation suggestions truly "this time as different."
While what could occur is the morphing of shared meaning into true utility, I think the "premium" of a solid narrative can't be overlooked.
So while the language of "narrative" is popular, I think the actual art suffers from the problem that everything can readily access it. When the barrier to entry of a skill or discipline is low, then the quality while revert to the mean (or potentially to the lowest value, weighted by influence, pay, or rank of the people involved). I'm thinking of writing more on this under The Law of Low Barriers to Entry Disciplines
With narratives, some very successful narratives can occur via happenstance.
Someone effectively gets "lucky" and hits the perfect meme + timing + delivery.
But I actually think that the exception prove the rule.
Those "lightning strikes" moments illustrate how hard it actually is to execute this well.
But instead of going into why it's hard and the common traps of companies trying to manufacture the narrative, I'm going to keep exploring why it's so critical for crypto-related projects.
The mimetic, reflexive nature of these projects means the shared meaning matters as much as, if not more than, the underlying technology, itself.
Because much of the technology involves communities, ownership, word of mouth, events, social media, the narrative is very much a part of the project. But I would argue that it's not just about marketing; in fact, narrative creation is part of the product management.
This intersection becomes key to the financial returns because it relies on "belief."
"Credit" comes from the Latin for belief, "credo" -- and while credit is a specific, more narrow financial product than the host of crypto projects -- the essence of belief extends beyond just credit-related products.
The irony is that this kind of faith or trust has a bigger role in a space where "trust minimization" is actually a core principle.
This tension makes the narrative both harder and more critical; it must be separated from the individuals, and the more encoded the narrative is (as I discussed to be the case with Bitcoin).
Does this mean that dislocation from normal, underlying value such as discounted cash flows now reigns? There's still truth behind Buffet's quote, "In the short run, the market is a voting machine but in the long run, it is a weighing machine."
My hunch is that the rise of belief-driven financial systems, the voting machine, will still fall "in the short run"; it's just that the short run is longer than most people are used to.
Perhaps the corollary is the quote attributes to Keynes: "The market can remain irrational longer than you can remain solvent."
I think the core ideas behind Prospect Theory come into play when thinking about the role of narratives in mimetic crypto markets.
The research challenges the more traditional utility theory where decisions are made amongst options (or prospects) based on maximizing utility.
However, the paper argues that when there's high uncertainty, actors behave differently.
I would argue that the new behavior we see has as much, if not more, to do with the economic uncertainty of our times than the technology; but the technology's overarching narrative, as well as behavior enabled by such narratives, invokes different behavior.
Prospect Theory shifts the curve's concavity to convexity in the case of losses, such that the overall curve looks more like an S-curve than a concave curve.
The dynamics were broken down into the following concepts:
- Certainty Effect
- Reflection Effect
- Probabilistic Insurance
- Isolation Effect
The short versions of these concepts are the following:
Under the Certainty Effect, people are more willing to get a lower positive return if it is certain than a higher effective, but probabilistic return (e.g. a certain $400 than a 50% chance of $1000).
Under the Reflection Effect, the reverse is true: more people are willing to risk an 80% chance of losing $4000 (an effective loss of $3200) than a certain loss of $3000.
Under the Probabilistic Insurance scenario, people were averse to insurance which had a 50% chance of not covering their loss, versus see no advantage between paying the full premium and paying 0. An alternate view of this is people preferred contingent coverage -- guarantees of specific coverage which may not cover all events -- over the probablistic scenario, even if the potential outcomes were the same.
Isolation Effect means that, if given two scenarios, each with two choices, and Scenario B has a $100k bonus for both choices under Scenario B, people will still choose the outcome that gives then more certainty or lower loss, discounting the $100k bonus because it is shared in the two options under Scenario B..
Narratives in the face of uncertainty
One way to see the results is that people much prefer certainty, and are willing to take a lower value than the potentially higher-pay off from risk. Conversely, in the event of loss, they have a higher aversion to loss and would rather seek risk.
The "community" aspect, the open conversations, the shared meaning, creates a different reference point and perhaps even a different sense of loss aversion.
Instead of a utility loss, the loss potentially becomes a loss of community, a fear of being kicked out of the tribe.
In fact "belongingness" is a factor which could be one of those facts which tilts both the perceived gains and losses.
In some ways the "community" notion is drawing on human's need for attachment, and it becomes weighted far more than we think. There is likely a subset of people who don't value it, and purely treat assets as a utility.
But the combination of uncertainty, and the desire for certainty, plus the implicit pain of losing "belongingness" contributes to the power of a narratives.
Narratives, based on this, provide two forms of value: certainty in the face of uncertainty; and a sense of belongingness when fear of tribal loss is huge.
Those are two parts of Narratives that are critical; but they can't be so easily done.
Interestingly, because narratives are perceived to have low barriers to entry, it can invite people who are on the wrong side of the "Bell Curve" meme to take control.
Some of the missteps are that those with sociopath tendencies and cannot truly empathize or stick with truth-telling will fail in the narratives.
And while the uncertainty may drive a certain amount of gullibility, I think the counter position can be made: people care much more about the narratives now because they know there's nothing else supporting it.