All Markets Are A Dark Forest
“The Dark Forest” is a 2008 science fiction novel by Liu Cixin. In the book the idea is explored that universe is a Dark Forest of dangers and civilizations that reveal themselves to others will immediately be considered a threat and be destroyed by other more advanced civilizations.
Markets are Dark Forests?
Have you ever heard of a startup that starts to gain a little traction and is subsequently sued for spurious allegations of software patent infringement by a larger more established player? I have heard of many such cases.
How about when a company looks to be bleeding out with falling revenues and increasing debt and every regulatory filing that shows the situation worsening is met with relentless shortselling? How about a company like this that then attracts so many short sellers that it finally attracts sharks looking to trigger a short squeeze? We saw all of this play out with Gamestop in the final weeks of January this year.
What about an asset that was specifically designed and engineered to trigger speculation and supply squeezes that others latch on to and engineer ways to further trigger supply squeezes? Here of course I’m thinking about Bitcoin and the actions of Michael Saylor and Elon Musk.
Market Participants Run Risks in Revealing Their Actions
Just as in “The Dark Forest” as soon as new information is revealed about the actions of participants, consequences may follow. The Redditors on Wall Street Bets and the retail traders on Robinhood are being closely observed to be relentlessly exploited.
Robinhood used to publish an API showing showing the collective interest in stocks their users held. This was shut down in August 2020 and thanks to forum posts we know many people were using this data to bet on or against the retail trader’s collective movements.
After the short squeeze on Gamestop started to occur Melvin Capital was hurt even worse when other market players used their 13-F filings to target their other short positions and trigger even more losses for the fund.
Months earlier the Wall Street Bets crowd had targeted Paltanir (PLTR) which became a meme stock on the forum. It quickly rose from the low teens to $30 a share. This was targeted by Citron Research and it relentlessly sold off. Later the same WSB crowd got revenge on Citron as they were involved in shorting Gamestop as well.
Promoters Vs Shadow Operators
Unless you are a huge participant with a lot of sway and a cult following (think Chamath Palihapitiya or Elon Musk), what is the advantage of telegraphing your moves to the public? Chamath publicly touts his SPAC investments letting speculators build a frenzy around them. He has so much clout that nobody else seems to be having success in peeling off any of his success (or thwarting it for that matter).
The largest players normally do not need to fear The Dark Forest of the market because they know who all of the other large players are. But how about medium sized players? They can always be destroyed or countered by the other larger or medium size players. The Ackman / Icahn Herbalife saga comes to mind here.
Who is Fading You?
If you write a newsletter or offer market commentary, why do you do it? Do you know how many people follow you because they want to fade your “insights”, versus who is actually taking your advice?
There are several people I follow who I use as an indicator to do the opposite of. I know most experienced market participants do things like this. I like to read the writing of people who disagree with me, but I like it even more when they disagree with me and they are frequently wrong.
The Crypto World Is A Dark Forest
The proliferation of alt-coins in the crypto space is a side effect of bitcoin being open sourced and anonymous. Anyone can use bitcoin, read the source code, copy bitcoin, and ultimately anyone can clone it and attack it’s marketshare.
In 2017 several high profile civil wars were fought inside the Bitcoin community which led to the forks of Bitcoin Cash and BSV. Ultimately the current “Bitcoin” won and retains the largest share of the miners and the highest price per unit. It seems like this is settled, but is it? Further forks could certainly develop as events unfold.
The DEX wars
More recently, decentralized exchanges (DEXs) built on top the Ethereum network such as Uniswap were created. These allowed you to swap ECR-20 tokens directly through smart contracts built using liquidity pools with algorithms called “Automated Market Makers” (AMMs). You don’t need to sign up on any exchange, or create any account with a 3rd party. You just interact directly with software to do trades.
Clever copycats quickly replicated Uniswap and created Sushiswap. They attracted Uniswap’s users with a “Vampire Attack”. Other exchanges soon started to airdrop free tokens to users of Uniswap in what were termed “Vampire Airdrops”.
These attacks on the user bases were possible because Ethereum is a public ledger and you can see every address that has interacted with a DEX like Uniswap.
Ethereum Gas Fees
Ethereum network congestion has created a new lever to be pulled when attacking Ethereum’s primacy in the smart contract space. Now because gas fees are so high it can cost anywhere from $30 to $100 to swap tokens on Uniswap. This means if you swap $1000 worth of tokens at Uniswap you might pay a 10% fee!
This has happened so fast and there are so many competitor decentralized smart contract base layers that Ethereum now faces the existential risk of many of it’s users being stolen because of the network congestion.
Because all of this is happening out in the open with almost 100% information visibility we are seeing these Dark Forest like dynamics play out in the crypto space at a rapid pace.
How to protect yourself?
I think the real question is how do you work with these Dark Forest dynamics?
Hide in the shadows?
Travel in the wake of the largest monster you can find?
Become the biggest player yourself?