One quantity varies as a power of another.
You may not know now, but soon you’ll find out I’m a huge nerd. It was tough to adjust after moving from Bermuda to Phoenix, AZ. First, 16-year-olds have a tough time figuring out being a teenager, now add moving to another country where I don’t know a single person.
The first three months after moving, I spent a lot of time in the library, and there was only one thing to do in a library. Be a nerd! I started reading many sci-fi books, eventually leading to my minor obsession with physics, space, natural law, philosophy, and tech.
I’ve recently been reading about Power Law and its impact on all of us. Keep reading to learn more about what power law is and how it applies to:
- Venture Capital
In statistics, a power law is a functional relationship between two quantities. A relative change in one quantity results in a relatively proportional change in the other, independent of the initial size of those quantities: one amount varies as a power of another.
The distributions of various physical, biological, and manufactured phenomena follow a power law over multiple magnitudes.
This section is for all the $BTC holders playing the long game. In the last 90 days, the bitcoin price has dropped like a rock. However, even the stock market is recovering from a small crash to start 2022. With the growth of bitcoin and cryptocurrencies, future price predictions are receiving more speculation. Bitcoin’s price evolution has moved within a corridor defined by two power laws based on time.
This model allows us to make broad predictions concerning the long-term future price of bitcoin, e.g.
- The price will reach $100 000 per bitcoin no earlier than 2021 and later than 2028. After 2028, the price will never drop below $100 000.
- The price will reach $1 000 000 per bitcoin no earlier than 2028 and later than 2037. After 2037, the price will never drop below $1 000 000.
The price corridor splits into two bands, one at the lower end of the price predictions, and is relatively thin. The other is much larger and lies at the higher-end predictions. Bitcoin’s price spends about equal amounts of time in both bands, implying that large bubbles and busts are likely to exist.
The hoax of venture capital
Things change week to week while working at a seed-stage tech startup. One major factor behind every decision is cost. Building a bootstrapped company is excellent, but you must raise capital to accelerate growth. Venture capital firms are the best outlet designed to help startups become the next member of a Forbes list. So what’s happening to the Venture Capital scene today is ironic.
As an industry aiming to search for innovation frontiers and scalable models, little is done to scale itself. As a result, despite creating more value and economic impact than any other sector, Venture Capital remains a niche asset class with all its limitations.
All investors seem to be chasing the same (high-expected-return) deals, while many companies remain un- or under-funded.
VC portfolios frequently are skewed because most build on the power law. Of course, they are because that’s the most efficient strategy a VC can follow, given the current state of things. But I don’t see how this structure can hope to scale. Few deals can aim at billion-dollar exits, but tons more can aim at lower ones — the bigger the fund, the bigger the target exit, but the lower the chances of finding one.
Remember that the power-law distributions can result in observations that are surprisingly far from our expectation of “average.”
As an entrepreneur, you can launch a dozen companies in a lifetime. Yet, out of all the seed-stage startups, only 4% of companies generated any return for investors. Founders tell me to make some money. Yet, according to investors, the 4% round is the most profitable round to invest in. Why? Because about 1% of those companies (for example, 12 out of the first 1000 at Y-combinator) become unicorns.
That’s the effect of a power-law distribution of returns. Those big wins pay for everything else. Investors can reliably make money, and society can get a lot of excellent valuable startups if they invest in about 500 companies at the accelerator stage. So the return can be good, even if 495 companies don’t pay off. Founders are just meat in this machine. 1% of the time, they do great. 90% of the time, they don’t do well. Keep in mind that the public markets are skewed the same way on a larger scale.