Act One: A House for Fifty Bucks

About a year ago, I was interning in San Francisco. While walking through Pacific Heights and staring in awe at the then newly constructed lights on the Bay Bridge, my friend pointed to a nice looking Victorian house and began to propose a rather peculiar proposition:

What if the house could be yours for fifty dollars?

"Oh 'cmon that's silly. Of course I'd do it. What's the catch?", I said, getting a little excited at the slight chance the proposition was for real.

Well, the only rule is, whomever owns the house has to sell it for less. Oh, and if you can't, you burn in hell for ever and ever.

"So all I have to do is sell it for $49.99 or less and I'm in the clear?"

My friend nodded. I was confused. Surely that must be easy right?

Turns out, it's a terrible idea.

The inductive logic goes like this:

  1. It's a bad idea to buy the house for a penny, because you cannot sell it for cheaper.
  2. It's also a bad idea to buy the house for two pennies, because nobody would be willing to buy it for one penny because of (1).
  3. Following the logic for higher amounts of money, it is not a good idea to buy the house at any price.

My friend didn't know what this unintuitive proposition was called. Neither did I, and after a few hours of digging online without even knowing what to search on Google, I gave up.

Turns out, this exact proposition has a name, but I found it in a peculiar place. I arrived early to a community chess club that I was running at a local public library. While glancing through Treasure Island, and skimming through RL Stevenson's short stories on a library shelf, I finally stumbled upon my answer. Which brings us to:

Act Two: The Bottle Imp

A short story by RL Stevenson that begins with a nice looking house in San Francisco, no less!

Keawe, a Hawaiian native and our protagonist, starts off the story:

... and he shipped on a vessel bound to San Francisco.
This is a fine town, with a fine harbour, and rich
people uncountable; and, in particular, there is one
hill which is covered with palaces. Upon this hill
Keawe was one day taking a walk with his pocket
full of money, viewing the great houses upon either
hand with pleasure, “What fine houses these are!” he
was thinking, “and how happy must those people be
who dwell in them, and take no care for the morrow!”

I find it interesting that this description of San Francisco in 1891 is still quite fitting today. Read the full story if you're interested, but here is a quick synopsis of the plotline:

  1. Keawe buys a bottle that promises the owner unimaginable riches, knowing that he has to sell it for less or burn in hell.
  2. He gets rich, then marries a beautiful young girl, and sells the bottle.
  3. He then contracts leprosy. Fearing for his life, he tries to buy the bottle back to cure himself, but realizes that the price is now only two cents.
  4. He buys it anyways, lives his now healthy life, but then gets depressed since he knows he can't sell it.
  5. After some drama with him and his wife and more selling of the bottle back and forth with foreign currencies, some rando who thinks he's going to hell anyways buys it for the lowest currency amount possible, thus ending our story.

So it turns out, the name of my friend's proposition derives from the story, and is called The Bottle Imp Paradox.

Act Three: This is Blatantly a Ponzi Scheme

While I was working in the Bay Area, I saw this curious looking message on a Bitcoin message board:

Ponzi.io Get rich off the world's first open Ponzi scheme!

Send money to (bitcoin address here) and get 1.2x back...

Your payout is funded by the investors who deposit after you. For more info, go to http://ponzi.io

The website is down now, but the post is still here.

What was interesting to me is not that somebody would be willing to illicitly make money online like this. Rather, for a blatantly transparent scheme - having the very name of the scam in its domain name, for crying out loud - it did surprisingly well.

How well?

About $225,000 in less than 48 hours.

An approximation of course, for the amount of bitcoins they received. But a hefty amount nonetheless for at most a few hundred lines of code and a marketing effort of 30 seconds.

I had always thought that the inner-workings of a Ponzi scheme depended on its secrecy. Surely, you can't just tell people it's a Ponzi scheme, and hope for it to work. Even more, the type of audience that understands how to obtain and use Bitcoin, and the type of person that browses message boards about Bitcoin, is likely smart enough and educated enough to not fall for this type of trick.

Yet there it was, an undeniable real-world counterexample, hundreds of thousands of dollars forever etched on the Internet on a public ledger.

The Finale: What do houses, short stories, and online scams have in common?

It turns out, there is a unifying theme here. There's a catchy name for this one too: The Greater Fool Theory.

Wikipedia defines the theory as the phenomenon that:

... the price of an object is determined not by its intrinsic value, but rather by irrational beliefs and expectations of market participants. A price can be justified by a rational buyer under the belief that another party is willing to pay an even higher price. Or one may rationally have the expectation that the item can be resold to a "greater fool" later.

The rationale behind why I was so drawn to the Pacific Heights house, Keawe the bottle, and the hordes of cryptocurrency enthusiasts a wildly unreasonable rate of return is the same. Though they were all presumably rational actors, there was the presupposition that there existed other irrational actors, willing to rectify one's own deliberately irrational actions. They all believed that there would be someone willing to buy the house for cheaper, the bottle for even less, to "invest" after they did.

Loose Ends

We can delve into psychological explanations, about how we tend to think our narrative of events is the most objective one, or about how we trivialize others' errors and dramatize our own.

We can philosophically drill deeper, and demonstrate that the common theme is not economics, but an overarching logic paradox that encapsulates everything.

We can talk about nuances in the base case scenario, such as the happy ending in Stevenson's story, or about how infinite divisibility in currencies can change things.

But if there's anything to be learned here, it is that we can't all be right, so long as we believe that we are the only rational ones amidst a sea of greater fools.