22 - The People's Narrative | Ben Hunt

welcome to bankless where we explore the frontier of internet money and internet finance this is how to get started how to get better and how to front run the opportunity this is ryan sean adams i'm here with david hoffman and we're here to help you become more bankless david how are you doing today absolutely fantastic we had ben hunt on the podcast ben hunt is a very well respected writer in the legacy world he is the writer of epsilon theory

newsletter and he does a fantastic job bringing in new ways to think about the world to an audience that might not have gotten exposed to it and the the need and demand for the thinking that ben hunt offers to the world is definitely well reflected in the size and community that he's generated around his epsilon theory newsletter yeah i've been reading epsilon theory forever david it's just a fantastic body of work and i think the main ideas the core ideas ben started

this this newsletter in 2013 the core ideas have really played out like he's been right the world is turning into a place that is valued more by narrative than by fundamentals and he caught that switch very early and i think he's got a lot to teach us in the crypto space about how narratives and game theory affect asset prices and virtually everything around us they really are the base layer of the human experience

that's the social layer and so we get into these topics and then we get a chance to apply them to crypto at the end we really wanted to get ben's perspective on crypto and to bring these mental models that he's come up with in creative for as he said david the legacy world to crypto and uh get his thoughts on it so he shares that at the end too this is just a fantastic interview incredibly fascinating i think you will pick up new mental models you'll be able to apply them both to the legacy world

and equities and what's going on with central banks and also to apply them to crypto so i really think you're going to enjoy this one we talk a lot on the bankless podcast about narratives about memes and how they are baked into these systems and so the crypto world is pretty familiar i would say with the world of narrative in the world of memes and i think we appreciate it more than the the rest of the world right and what ben hunt is doing in my opinion is bringing that perspective to the legacy system using different words other than like

memes because you know it's very that the word meme is is much more relevant to to crypto but in in the legacy world it's it's it's the narrative right and ben hunt calls this the epsilon where he talks about the alpha and the beta but then there's also the epsilon which is uh the the human side of things the world in my opinion is separated into the physical world of atoms and science and physics but then there's also the world of the stories that the human that that humans create in order to determine

what is valuable right so how to act based off of what we know and that's what ben hunt is doing in the legacy system and so why ben hunt is such a good guest for the bankless podcast is because he's taking some of the things that we know the story side of things the narrative side of things and he's applying it to the legacy markets and applying it to investing in a world that we thought was perhaps based off of you know hard facts and evidence and and fundamentals but turns out it's actually based off of narratives and stories and

so this is really where we overlap with ben hunt and so getting him on to the banquet podcast to talk about these things was an absolute treat all right we're gonna bring ben hunt on in just a few seconds but first we want to tell you about our sponsors as we all go westward we need to get our values into the crypto world but hopefully escape the tyranny of centralized rent-seeking institutions and that's where monolith can help you get your value into the crypto world while skipping over the crypto banks monolith coming soon to monolith is an

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mention bankless and get started all right guys now that that's done let's go ahead and get right into the interview with dr ben hunt hello bankless nation we are incredibly excited and honored to have dr ben hunt he is a former fund manager tech entrepreneur poli-sci professor he's the writer of epsilon theory which i read

frequently he writes narratives about game theory for investors and in general for people trying to understand the world and i would be remiss if i didn't say he's actually part of the inspiration for starting the bankless newsletter for me personally ben how are you doing in these uncertain times sir i'm doing great ryan well well thanks for that introduction and i'm uh so glad to to hear that you know something good came out of out of my work if it if it helped inspire you guys

and uh also hello to david behind the glass as uh as they say on the radio hello hello cheers and welcome well absolutely we we are just so excited to uh to talk with you today because i think i mean you talk so much about communities and about um you you call it the pack um and you know bankless we we sort of we we sort of use the analogy of the nation for the bankless pack because it's kind of a tribe that's rallied around some similar ideas to the ideas

you're talking about on epsilon theory all of the time so what we'd really love to talk about today is some of those common base values between our communities between crypto and between epsilon theory movement i would call it a movement um you've talked about the lowercase l values like freedom and liberty uh you know and thought in the lowercase c values yep yep yep small small l liberal and small c conservative yep exactly and uh

those are i think our values base values that our communities share so we just want to explore some of those and honestly expose the bankless nation to some of your fantastic ideas because they are so relevant to crypto what else is crypto except narratives and game theory and that's that's a lot about what you talk about um so um i guess ben maybe maybe to start we could uh set some context for one of your biggest ideas which is

rooted in the epsilon theory name itself um you know kind of where you got the name where you came up with the name what this what this epsilon uh what what the meaning of epsilon actually is and maybe we could talk a little bit to introduce folks to a an idea that comes from science which is the the three body problems so could you describe maybe the three body problem and then let's talk a little bit about the meaning of epsilon and uh how can

explain the world yeah yeah you bet ryan in fact if you know if you don't mind i'll kind of flip that around i'll kind of describe what what epsilon is first and then kind of why i call what i do um and you're right i i do hope it's a it's a movement right i do call it uh epsilon theory and kind of where that comes from so you know in i started writing epsilon theory uh this would be the the summer of 2013

right so just a little over seven years ago and you know i i i wound down my hedge fund and we could talk about that a little bit it was a big hedge fund we had about a billion dollars there and uh i was trying to make sense of a world that from an investment perspective didn't seem to make a lot of sense to me anymore and you know my background from from academic days and you know professorial

days was in game theory you know it's always so silly you know people say oh there's you know game theory and it has become kind of a meme in and of itself kind of of kind of silly silly science so yeah i mean it's not it's it's a it's a real thing and i've in a lot of years oh oh we love game theory we love games we're in crypto so i you know i i i knew i wanted to to write this note and blog whatever you want to call it

uh i was trying to figure out what to what to call it and what i finally hit on was that in in investing the core i'll call it formula right the core uh econometric description of what investing is is that the the value of your portfolio the the performance of your investments depends on alpha you know we you see that in places like

blogs like seeking alpha and you know people talk about hedge funds and what's your alpha alpha is basically your out performance right alpha is the the idiosyncratic performance of your portfolio what's what's special about you right that's your alpha and then your performance is also your beta which is how much of your portfolio your performance goes up and down with with with broad markets right so so so beta it's it's

you know the performance of the the overall market and how closely linked you are to that and then alpha is your idiosyncratic performance you know what what what you do that's special to you but those those actually aren't the only two terms in this econometric formula uh and in fact in almost every econometric formula there there's a third term or a final term that's tacked on to the end and it's the epsilon term

so in in this formula the the full formula if you write it out it's not just oh your performance is alpha plus beta it's alpha plus beta plus epsilon and and epsilon is you know the greek letter e and the way people think of it is well that's e for error yeah right it's it's everything that's left over that you can't explain from your uh variables and your formulation

whatever goes into your calculation of alpha it's all the stuff we don't understand it's all the stuff we don't understand that's exactly right all the stuff that's outside of your formalization of alpha and beta like i say look at any econometric formula in any field and there's always this tact on epsilon term e for error and the truth is and this is a truth that comes after you know a lot of years and a lot of scars in

you know lots of different fields but but including investing is that you know there is a lot we don't understand and just because we don't understand it just because we don't formalize it in whatever we are putting into our conceptualization of alpha and beta doesn't mean it's not real and doesn't mean that it's error it means that it's outside of our scope of thinking well you you've used the analogy of dark

matter right ben to describe that yeah yeah yeah yeah that's a great way to think about it that's a great way to think about it so so so the epsilon term is you know think about is like the dark matter in the universe which you know as you know you know dark matter and dark energy you know it's probably 95 of what's out there in the universe it's just we can't see it or measure it or understand it so we just kind of put it over there to the side and we spend all our time talking about the the five percent that we can see and measure and

visualize and all that so in investing what is particularly left out of alpha and beta and what is particularly i think frankly something we can extract from epsilon is the strategic behavior of market participants that's a mouthful right what i mean by that is there's this old poker saying right that you don't just play the cards you also play the players

and the cards think of those as the fundamentals right so that's going to be in alpha and beta but playing the player that's not an alpha and beta that's an epsilon and playing the player is as good a description an informal description of what game theory is as anything i know that's what game theory is is trying to understand how do you play the player right not just playing the cards or playing the player so so that's what epsilon theory is all

about it's trying to look at the strategic interaction of market participants it's trying to look at the strategic behavior of investors of voters of of of any sort of social interaction because you know like your example about dark matter and and invisible matter i i really think that in a lot of times in circumstances it is that strategic interaction it is

that playing the player that's so much more important than just playing the card you're dealt so you know that i started writing epsilon theory i sent it out you know an email to about 100 people and today we've got you know over a hundred thousand people on that on that email list and you know get about a quarter million people a month to the to the website and that's all from word of mouth you know we've never done any marketing never any advertising or

anything around it and i look i think i'm a pretty good writer and and i think that's you know i like to think that but but that's not really what's responsible for the appetite for this for the growth of this what's responsible and i'm certain of it is that you know we are told over and over again you know these these these overly scientific and i'll say overly didactic kind of pronouncements about how to

understand the world and and when you're in the world for a while you realize hey you know the world's a lot more than that that the world is so much about stories and narratives and the way that impacts our behavior all of this stuff is outside of the rules that we're told that that govern markets or voting and all like that and and i think that as as people have frankly woken up or been forced to confront the fact

that these old rules don't work i mean i mean frankly i don't think they ever worked that well but we all believed in them so that they did you know it's it's it's a it's really interesting to see over the last seven years ten years whatever you want to call it that i think everybody is now thinking in terms of narrative and playing the player in these strategic interactions and i think that's so important for coming to grips with the real

power structure of the world and frankly what we can do to change it so anyway a long involved conversation but but it's but it's it's it's important to me this notion of epsilon and and why i call what i do epsilon theory so ben i i've always thought that like if you want to win in the investing game like you have to do what you said which is to play the player along with playing the beta and also trying to play the alpha right like you can't you have to pay attention to all three of these things they're

they're interlocking with each other and there it's like this rock paper scissors game but it's the playing the player side of things the epsilon side of things that we are thinking is perhaps underappreciated or undervalued and when we discuss about like how to play the market what we're really talking about is like trying to understand like if i do this then they do that and if they do that then i'll do this and we and it's this uh hall of mirrors of trying to put

yourself in the shoes of other people playing playing the market right and so and this is it just converges back onto game theory right so like if i do this uh if my if my opponent does this and i'm going to do this and then that recurses over and over and over again and what to me what epsilon is is the substrate for thinking what your opponent is going to do right and so it is the the narrative of sorts of the world that

we live in what we perceive to be valuable based off of the narratives that we share are how we try and frame what we think our opponents are going to do right and so um it works i'm speaking in very general terms so it's pretty difficult to make something yeah no but but listen you're you're exactly right because this this strategic interaction game playing right it's not random and and there there are

i'll call them rules but what i mean by rules is there are predictable uh patterns predictable because they're very rational predictable patterns in human behavior in these sort of strategic settings so the the one that i think is most powerful for markets the one that i think is is is most powerful for really any sort of social market and that can be investing markets that can be voting markets is certainly true for

for for crypto markets is the the strategic interaction of what's called the common knowledge game and you know we're all familiar with a couple of games right we're all familiar with prisoner's dilemma because you see that on every police procedural tv show right that's that's one where they they question two people in separate rooms and the the the predictable behavior you know to use the ten dollar economic word the equilibrium

is that both prisoners will rat each other out it's it's the smart move it's the rational thing to do now there are ways to get around that right by setting up structures of the game that reward or punish ratting someone out right so if you know you're going to be sent to prison with the buddies of the guy you just ran it out that's an incentive structure that changes the parameters of the game and may you know change the the the predictable behavior the

equilibrium but but it but there really are these sort of predictable behaviors depending if you can understand the structure of the game and the one you know like say we're familiar with most of you are pretty familiar with prisoner's dilemma most people are familiar with uh the game of chicken right if you've ever seen any you know movie like footloose right or you know driving your tractors at each other with kevin macon you know we're all familiar with that game yeah some people familiar with the game

called the stag hunt which i think is is actually pretty important particularly when you're talking about politics and international relations but the the common knowledge game is is one that i think most people aren't so familiar with even though like i say i think it's the game of markets and and it's hard to get familiar with it because it doesn't lend itself as well to a tv show or a movie right it doesn't boil down to a

you know a single tense moment right of tractors going at each other or you know an interrogation in a in a police squad but the the common knowledge game and this this goes back to the 1930s when a you know very famous economist then and still today john maynard keynes came up with this idea and and i think it's so right it's it's really think of it as like the game theory for crowds right and what what the example keynes gave was what he

called the newspaper beauty contest and this was you know back in i mean it sounds crazy today but but in the the 1930s the newspapers the social media of the day uh they would frequently run a contest where they would run they would print the pictures of 10 pretty girls again it's inconceivable to think of this today but this is really a thing right in the 1930s and they would invite their readers to vote for who they think the prettiest girl is

and send in your vote and if you the people who the if you vote for the girl who gets the most votes then those voters will be entered into a sweepstakes drawing you know we'll we'll pick one of those voters names out of a hat and you'll win an all-expense paid trip to atlantic city for the miss america pageant right so i again inconceivable today but this is really this is a thing and

so kane said well you know let's think about how you play this game i said you know what he called the first level of thinking is that you really would look at the pictures and say oh i think you know top row third from the right i think she's the prettiest i'm going to vote for her and so you would fill out your little card and you'd send it into the newspaper that's my vote and kane said well you know it doesn't take too long before you realize yeah hey that's that's not the way to win this game right the what i'm trying to do is i'm trying to win that prize that

trip to atlantic city i i shouldn't be voting for the girl i actually think is the prettiest i need to vote for the girl that everyone else thinks is the prettiest you know what's the consensus view of who the prettiest girl is because i i want to be in that sweepstakes drawing so he called this the the second level of thinking and then he he said but but then you figure out he said well somebody said a lot of people don't get past that second level of thinking

but they said well most people ultimately do get past it because they realize well helen am i the only one who's smart enough to figure out how to win this game right i mean otherwise in other words the thing is is everyone else so stupid that they're going to vote for who they really think is the prettiest girl or is it as cain said is there a third level of thinking where it's everybody trying to figure out what everybody thinks

about the relative prettiness of these girls right it's it's not the consensus it's kind of like what's the consensus of the consensus and it's that third level of thinking that that cain said was so powerful because he said look forget about these newspaper contests and you know voting for pretty girls what about the stock market where what you're doing when you buy a piece of stock is you're voting you're saying oh i think that's a pretty company i'm going

to vote for that and and kane said you know the first level of thinking would be to say oh i i think that company is very attractive it has great fundamentals and it's got you know good cash flow and a sound management team i'm going to buy that stock and then you realize well no no no that's not how i'm going to win what i would have to win is that second level of thinking i want to i want to buy stock in a company that everyone else thinks is attractive and then you go to that third level thinking where you say

well every isn't everybody doing this isn't it the crowd looking around to see the crowd who we think is the most attractive and cain's kind of left it at that and and then in subsequent years the and this is how the common knowledge game comes around the question then becomes well how does the crowd figure out what the crowd is looking at in terms of you know a pretty stock dubai

and and the answer is you introduce this concept of the missionary uh the the the missionary that we call that in game theory because the there's a famous thought problem about how the crowd figures out what the crowd is thinking and the the the game or the game the thought experiment usually goes by the the name of the the island of the the green eyed tribe

and so the the setup for this thought experiment is all right there there's there's there's an island all the people there on the island have blue eyes it is taboo to have green eyes meaning that if you do have green eyes you have to leave the island immediately the the next day you have to get in a canoe and you have to leave the island uh uh immediately but

what's also taboo on this island is to talk about eye color and in this thought experiment there are no mirrors on the island so you know so there could be people on this island who have you know green eyes but they'd never know it because nobody's going to tell them hey you've got green eyes you need to leave the island and there are no mirrors so you'd never look at yourself and you'd say oh i've got green eyes i've got to get off the island but then one day you know so this this island even though

it has this taboo structure where green eyed people have to leave the island uh it can nobody ever leaves the island and life goes on happily you know for for for generations until one day the missionary comes and the missionary gets there and you know he's going to tell you know the truth to people and so he gets up there stands up on up on a box and he says to everybody on the island because you know he's not part of their

taboo system he says i just want you to know there are people here on this island with green eyes and so the methodic question the thought experiment is okay well what happens next and what happens when the missionary comes up and makes a statement like that is that the missionaries creating common knowledge common knowledge is what we all know that we all know

right so before the missionary said that each of us each of those islanders individually knows that there are people on the island with green eyes but that thought stays inside their head right after the missionary makes that public makes that public statement the people in the eye it doesn't change what each individual islander knows but now they know that everybody knows now they know that everybody knows so so the question is what happens well

the answer the question is if there's the answer is trivial if there's one person on the island with green eyes right because now there's common knowledge that there is at least one green eyed person on the island that one person who has green eyes looks around he looks at everybody in the island you know it's a small island you can see everybody he says well everybody on this island that i see has got blue eyes and he goes oh that must mean i'm the guy