Tech’s Gell-Mann Paranoia
The importance of saving trust
Over the past few months, tech valuations have been undergoing a reset while crypto, in particular, has had some spectacular blow-ups. Hunter Walk has a very informative post about why LPs are concerned about high-profile losses even though individual failures, even big ones like FTX, are only a small amount of the invested capital due to long-term risks. But beyond those reasons, there is a deeper re-evaluation going on, and it is a sort of reverse Gell-Mann Amnesia we might call Gell-Mann Paranoia.
Gell-Mann amnesia is the idea that we often fail to update our credibility scores in response to new information. The effect is named for Murray Gell-Mann, a Nobel Prize-winning physicist. His friend, novelist Michael Crichton, described the effect memorably:
Briefly stated, the Gell-Mann Amnesia effect is as follows. You open the newspaper to an article on some subject you know well. In Murray’s case, physics. In mine, show business. You read the article and see the journalist has absolutely no understanding of either the facts or the issues. Often, the article is so wrong it actually presents the story backward — reversing cause and effect. I call these the “wet streets cause rain” stories. Paper’s full of them.
In any case, you read with exasperation or amusement the multiple errors in a story, and then turn the page to national or international affairs, and read as if the rest of the newspaper was somehow more accurate about Palestine than the baloney you just read. You turn the page, and forget what you know.”
The key concept is that we often receive information that should change our world view, especially about the credibility of a source, yet fail to update. This happens all the time.
The opposite is also possible, though, which I call Gell-Mann Paranoia. The reverse situation is that you receive new information and instead begin to doubt everything else in your mental model, or disbelieve everything from the source. Byrne Hobart points out that Gell-Mann Paranoia, for example, is the reason that traders often cut losses — though the loss itself may not be so bad, it often disproves something deep about the mental model, making the trader fear more future losses with a confidence interval too wide to hedge against, and even worse, that the prior gains might have been pure luck.
Taking the example of the FTX blowup, I don’t believe that LPs are upset at VCs primarily because the losses were so spectacular or because the reputational risk is so great but rather because of Gell-Mann Paranoia: they are now wondering which other marks in the portfolio are wrong. Sequoia put out a memo trying to protect itself, saying that the losses were less than 3% of committed capital and that they had already returned the fund in unrealized gains alone. But with Gell-Mann Paranoia, the problem isn’t the mere $150 million loss, it’s that their investors may be doubting the accuracy of the reported $5.8 billion in unrealized gains; if Sequoia got this one wrong, their estimated other gains may also be wrong, so the fund may have less gains than reported (or even be at a loss) for fundamental reasons that no mere audit or GAAP compliance can resolve.
The scary thing about paranoia is that it is irrational by nature, a form of fearful expectation, and the dangerous thing about expectations is that they can get anchored and then create their own reality. If paranoia gets anchored, it could disrupt trust in tech, which would greatly diminish the entire industry. The high trust in tech is what makes it strong because it requires highly skilled people with lots of opportunity cost to collaborate on ideas that initially sound weird and may have no proof yet. It is what convinces people to take chances and try new things, rejuvenating the industry at every turn; arguably, without tech’s abnormally high level of trust, it would not function.
The history of tech is full of shocking acts of trust. While under the spell of Gell-Mann Paranoia, people will spend more time wondering whether their counterparty is lying to them, and perhaps say no to good-but-weird opportunities. That will mean people not working together, new companies not attracting their first customers, and startups never getting started. Get rid of the safety net of trust and participants will take fewer chances, sapping tech’s vitality. Eric Schmidt only left his public-company CEO job to lead Google because he trusted John Doerr when he promised to find him another job if he failed; what happens if the next Schmidt doesn’t believe it?
There is much to take stock of, and it is clear looking back that the tech industry has made many mistakes over the past decade, but we must beat back Gell-Mann Paranoia to prevent collateral damage. Defeating fear is an emotional journey, not a rational one, that is based in reality and not in reasoning; it requires acknowledging the fear, then accepting and facing it, and finally overcoming it. Flushing out the system will thus require pain — layoffs, down rounds, and even bankruptcies — and reflection as many fields that have mostly avoided skepticism, like web3 or scooter sharing, undergo long-overdue reckonings. But the key is to not give up. The fear will go away as those creating true value reveal themselves, thus validating the evergreen truth that there is still much value being created by technology.