ReflexivityThe concept of reflexivity needs a little more explication. It applies exclusively to situations that have thinking participants. The participants’ thinking serves two functions. One is to understand the world in which we live; I call this the cognitive function. The other is to change the situation to our advantage. I call this the participating or manipulative function. The two functions connect thinking and reality in opposite directions. In the cognitive function, reality is supposed to determine the participants’ views; the direction of causation is from the world to the mind. By contrast, in the manipulative function, the direction of causation is from the mind to the world, that is to say, the intentions of the participants have an effect on the world. When both functions operate at the same time they can interfere with each other.
How? By depriving each function of the independent variable that would be needed to determine the value of the dependent variable. Because, when the independent variable of one function is the dependent variable of the other, neither function has a genuinely independent variable. This means that the cognitive function can’t produce enough knowledge to serve as the basis of the participants’ decisions. Similarly, the manipulative function can have an effect on the outcome, but can’t determine it. In other words, the outcome is liable to diverge from the participants’ intentions. There is bound to be some slippage between intentions and actions and further slippage between actions and outcomes. As a result, there is an element of uncertainty both in our understanding of reality and in the actual course of events.
To understand the uncertainties associated with reflexivity, we need to probe a little further. If the cognitive function operated in isolation without any interference from the manipulative function it could produce knowledge. Knowledge is represented by true statements. A statement is true if it corresponds to the facts—that is what the correspondence theory of truth tells us. But if there is interference from the manipulative function, the facts no longer serve as an independent criterion by which the truth of a statement can be judged because the correspondence may have been brought about by the statement changing the facts.
Consider the statement, “it is raining.” That statement is true or false depending on whether it is, in fact, raining. Now consider the statement, “This is a revolutionary moment.” That statement is reflexive, and its truth value depends on the impact it makes.
A concrete example of reflexivity in financial markets:
If creditors give lots of cheap loans, then more people have more money to bid on houses. As a result, housing prices go up, which gives homeowners more collateral to borrow against. Some homeowners become real estate speculators, borrowing against the increased value of their own homes to bid on new homes, which inflates housing prices even further.
As Soros puts it: "[There] is a reflexive connection between credit and collateral, the act of lending can change the value of the collateral."
Does reflexivity apply to bitcoin?Yes. In a simple form. A rising XBT:USD price attracts more users. New users bid up the price, attracting even more new users. This has happened several times since 2010, resulting in large new waves of users each time.
This simple form relies on the existence of a large pool of non-users who might join in. As worldwide adoption of bitcoin is still <1%, this simple form still has the potential to continue.
In addition, Metcalfe's law states that the value of a network is proportional to the square of the number of connected users of the system (n^2), which serves to increasingly amplify the self-reinforcing cycle until the market collapses.
Bitcoin's integration with credit markets should allow for a new form of reflexivity. A smaller number of users can now use leverage to control a disproportionately large amount of bitcoin. Borrowing money to buy bitcoin will increase the value of bitcoin, which will allow bitcoin holders to borrow even more bitcoin. This reflexive phenomenon has been largely absent from previous bitcoin bubbles (although Bitfinex allowed a small amount of lending in November 2013 and a few people borrowed against their cars and houses).
It should be very interesting to see how this enhanced reflexivity from credit markets on exchanges will influence the next bull market.
