Red-Blooded Risk: The Secret History of Wall Street

The Negative Side

So far we have been speaking only of positive exponentials. Things can also shrink at exponential rates. Since rate of growth is proportional to level, this means the rate of shrinking is constantly going down. Moore's law—the claim that the cost of computing power falls 50 percent every 18 months—is an example of a negative exponential. If you bet on an exponential and it's positive, your gains are continuously accelerating. If you are right that it's exponential but wrong because it's a negative exponential, your losses are continually slowing. These properties make betting on exponentials attractive and betting against exponentials very dangerous.

Consider the Internet in 1990. Its growth was clearly going to be exponential. Every new Web user would make the Internet more attractive for business, which would pull in new users. More nodes made investment in servers and cables more attractive, which made nodes cheaper, which meant more nodes. What was not clear at that time was whether Internet growth would ignite to a level that would make any investment in it pay or whether it would hit some limiting factor such as willingness of people to use the new technology or a breakdown in Moore's law.

Regardless of your assessment of the likely prospects of the Internet in 1990, betting on it had much more favorable risk characteristics than betting against it. If you win, you can win very big. If you lose, your losses are limited. That doesn't mean it's always a smart ...