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First published on Medium on Mar 28, 2022 |
While browsing a cryptocurrency forum recently, I stumbled upon an intriguing perspective. It proposed that the Price-to-Earnings (P/E) ratio, a man-made metric, is fundamentally a meme (according to the definition on Wikipedia: A meme is an idea, behavior, or style that spreads by means of imitation from person to person within a culture and often carries symbolic meaning representing a particular phenomenon or theme). The efficacy of the P/E ratio relies on widespread investor belief in it. This belief influences their investment behaviors, creating a self-fulfilling prophecy where the P/E ratio becomes effective.
This does not imply that there is no logic behind the P/E ratio and similar memes. Rather, it emphasizes that the mechanisms through which these memes influence pricing are different from those taught by conventional pricing formulas. These memes operate based on people's beliefs in them, not on any known natural laws.
In my economics and finance classes, the core logic I learned for pricing was:
Intrinsic value is usually derived from established asset pricing models. Fundamentally, intrinsic value represents physical utility. For example, a cup holds water, a knife cuts fruit. These objects derive their "usefulness" from natural laws: the cup holds water without it spilling due to gravity, and the knife's sharp edge concentrates force, allowing it to break through fruit skin to reach the flesh. Under natural law, a cup with holes or a knife made of paper would fail to function, thus losing their intrinsic value.
The Deviation Factor represents the influence of complex real-world conditions on value, such as liquidity, inflation, scarcity, etc. For example, the value of water is physically constant, but in a desert, scarcity (a Deviation Factor) makes it extremely valuable.
While this pricing formula is useful in most cases, it struggles with items that have zero intrinsic value, such as NFTs and meme coins.
Clearly, this model is incomplete. Besides the "usefulness" supported by natural laws, the influence of human belief on the value of goods should also be considered. This offers a more direct path to determining prices: it doesn’t require interaction with the physical world or analysis of "usefulness"; instead, belief alone can directly translate into trading behavior.
This logic has always been at play in the traditional physical world with examples like P/E ratios, luxury goods, etc. However, in blockchain, where the constraints of natural laws are minimal, this logic is maximized. Many digital assets on the blockchain have almost zero intrinsic value in the traditional sense.
Blockchain provides an ideal environment to observe how memes influence pricing. When we try to understand the value of a product, we are essentially understanding the beliefs and motivations of the people trading it. Fundamentally, pricing is the art of understanding the human psyche.
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