10 Mental Models for Bitcoin Investors
To the person with a hammer, everything looks like a nail.
You’ve heard this phrase before. It means when you have one tool, you see it as the solution to every problem. When you have one viewpoint, you see everything through that lens.
This is an enormous problem for blockchain investors, because the models are constantly changing. We need new mental models, and I’ll share several of these with you today.
In blockchain investing, there are many people with a “single hammer.”
Bitcoin maximalists: These are people who believe that bitcoin, and only bitcoin, will take over the world. “To heck with the thousands of other crypto investments!” they say. “It’s bitcoin or bust!”
This is a single mental model — a single hammer. So to the bitcoin maximalists, every other investment opportunity looks like a nail.
Technical analysts: Traders who base their decisions entirely on “crypto charts” have a single hammer. They view everything in terms of visual patterns (usually random) that their brains turn into a story. They make investing decisions based purely on dots and lines.
If technical analysis is all you’ve got, you’re working with a single hammer.
Traditional economists: Unbelievably, the efficient market hypothesis is still taught in schools. The price of a stock, they say, reflects all the information that’s known about a company, so everything should already be “correctly priced.”
Anyone who’s invested for more than a week knows this is not how the world works. Human nature — the “madness of crowds” — plays an enormous role in the price of stock investments, and even more so in block investments.
These people all have a single hammer. So when they come across a screw, they bang it with the hammer. Electrical wiring: hammer. Pane of glass: hammer.
We need more tools — more mental models — to understand blockchain investing. A hammer is useful, but we need a toolbox. A toolshed. A well-organized garage.
The great investor Charlie Munger talks a lot about mental models. He says:
“The first rule is that you can’t really know anything if you just remember isolated facts … you’ve got to have models in your head. And you’ve got to array your experience, both vicarious and direct, on this latticework of models.
You may have noticed students who just try to remember and pound back what is remembered. Well, they fail in school and in life. You’ve got to hang experience on a latticework of models in your head.”
Munger says he has over 100 of these mental models that he uses to evaluate investments, and aspiring whales would do well to read this excellent summary of the most important mental models. (If reading makes you sleepy, here’s a 7-part YouTube series that’s also terrific.)
Having a variety of mental models, from a variety of disciplines, is key for understanding what’s going on with blockchain investing. The hammer is not enough.
Remember that Munger calls it a “latticework” of models, like the lattice on top of an apple pie.
10 Mental Models for Blockchain Investing
Here are a few of those Munger’s mental models to get your latticework started.
Velocity (Physics): Velocity is change in displacement (position) over change in time. If you’re taking two steps forward and one step back, that’s a slower velocity than two steps forward at the same speed. Investor takeaway: Don’t just watch the speed of growth, watch the overall velocity of bitcoin, compared to traditional investments. That’s where investors will likely gravitate.
Activation Energy (Chemistry): You build a fire with wood, kindling, and newspaper, but you still need a match to get it blazing. This “activation energy” is what happens with big events in the crypto world (like the recent bitcoin ETF listing, which pushed bitcoin to new all-time highs). Investor takeaway: Be on the lookout for “Activations,” like new code rollouts and regulatory approvals.
Compounding (Finance): When your 401(k) earns interest, and that interest earns more interest, and so on … that’s the magic of compounding. As we know, a blockchain’s value is correlated with the number of users, because blockchains also have compounding effects. More users = more value = more awareness = more users, and so on, in a positive upward spiral. Investor takeaway: measure user growth and velocity.
Creative Destruction (Economics): The wonderful idea that humans will constantly compete to out-innovate each other, resulting in the “creative destruction” of the old way of doing things, replaced by something newer and better. Viewed this way, blockchain can be seen as the creative destruction of the entire global financial system, the way we think about money. Investor takeaway: Which industries are being disrupted by this creative destruction? Find and invest.
Double-Entry Bookkeeping (Accounting): This was the record-keeping innovation that changed the world. Every credit should also be balanced with an appropriate debit, recorded twice in the books, to reduce errors. Blockchain technology improves on double-entry accounting, verifying each ledger entry not just twice, but many times, by many different validators. Investor takeaway: Which blockchain companies and projects will disrupt accounting itself?
Scarcity (Game Theory): Why is real estate a good investment? Because, as the saying goes, “they’re not making any more of it.” Why is bitcoin a good investment? They’re not making any more of it. The perceived scarcity can also explain the sky-high valuation of NFTs, even though your one-of-a-kind GIF will be worthless in the future, if no one wants to buy it. Investor takeaway: Beware! Scarcity does not necessarily mean long-term value!
Mr. Market (Investing): Imagine a guy who comes to your door every morning, offering to sell you his bitcoin, according to his mood. Some days he’s on top of the world, and will sell it for a sky-high price; other days he’s down in the dumps, and will sell it for half as much. Investor takeaway: As a patient and careful investor, you can watch the “moods” of the market, and buy only when it’s feeling “down.”
Boredom Syndrome (Psychology): We all want to do something, especially when things are moving quickly (like bitcoin reaching a new all-time high). Sometimes this tendency to act can lead to worse outcomes than if we simply sat and did nothing (like waiting for things to cool down before buying). This need for constant stimulation explains a lot of the craziness going on, for example, in the hype-fueled DeFi markets. Investor takeaway: Resist the need to act; say “no” to a lot of opportunities to give a “YES” to a few big ones.
Safety in Numbers (Sociology): Also called “Social Proof,” this is our natural human inclination to follow the crowd. Most of the time, this serves us well — but it makes it hard to break away and achieve enduring success. This is especially true in investing, where we must occasionally bet against the market, in order to beat the market. Investor takeaway: As Apple famously advertised, “Think different.”
Bias from Incentives (Human Nature): It’s our bias to see the best in something, when it’s in our best interest to do so. You see all kinds of bitcoin pundits (including me) who have invested in bitcoin themselves: are we biased because we own it? Can we put aside the bias to see the negative aspects, the warning signals, the danger signs? Investor takeaway: It is well worth listening to the haters as well as the HODLers.
Making Room for the Mental Models
The problem is our own minds.
When we are locked into that single mental model — the hammer looking for a nail — it makes it difficult to see situations any other way.
We have been releasing a new MP3 series called “Investor Mindset,” designed to break up this rigidity of thinking, and allow our minds the freedom to consider new mental models. This in turn makes us better investors, as the healing influences of freshness and light can pour in.
Think of them like guided meditations for investors.
With this series, we are learning to quiet the noise of our own minds, to make room for new mental models. Paid subscribers can download the first three episodes here, plus our just-released Episode 4:
- Investor Mindset, Episode 1
- Investor Mindset, Episode 2
- Investor Mindset, Episode 3
- Investor Mindset, Episode 4
A hammer is a handy tool, but let’s not stop there. Let’s buy the entire hardware store.
John Hargrave is the author of Blockchain for Everyone: How I Learned the Secrets of the New Millionaire Class, the bible of blockchain investing.