Understanding the Limitations of Financial Modelling for Bitcoin
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Chapter 1: Introduction to Financial Modelling
In reviewing Plan B's work, "Modelling Bitcoin's Value with Scarcity," I've noticed that many individuals lacking strong quantitative or statistical backgrounds struggle to grasp the nuances of my analysis. To aid in their understanding, this additional explanation has been crafted.
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Section 1.1: The Role of Assumptions in Engineering
When engineers design structures like bridges or skyscrapers, they operate on a series of assumptions. These assumptions guide their designs, such as estimating the number of people and vehicles the structure must support. Factors like durability and potential extreme weather conditions are also considered, based on these initial assumptions.
Subsection 1.1.1: Consequences of Flawed Assumptions
If the foundational assumptions guiding an engineer's design are incorrect, serious issues can arise. For example, if a bridge is designed to accommodate a maximum of 125 cars, but a sudden traffic jam results in 200 cars crossing, the bridge could collapse under the unexpected weight. The validity of the initial assumption is less important than the failure of the structure to meet actual conditions.
Section 1.2: Financial Modelling and Its Challenges
In the realm of financial modelling, the implications of unmet assumptions are often less apparent than in physical constructions. In my review of Plan B's article, I examined whether the necessary assumptions for applying OLS regression were satisfied. When all assumptions hold true and statistical tests suggest significance, the results can inform predictive models. However, if these assumptions are violated, the predictive power of the model diminishes significantly.
Chapter 2: Revisiting the Bridge Analogy
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Section 2.1: The Bridge Example Revisited
Returning to our bridge analogy, the structure was designed under the assumption that it could support a maximum of 125 vehicles. The engineering specifications, which include stress tests for extreme weather and material degradation, stem from these assumptions. If reality diverges from these initial projections, the entire structure may fail, highlighting the critical nature of accurate assumptions.
Conclusion: The Imperative of Accurate Assumptions
Whether dealing with financial models or structural engineering, any failure to meet foundational assumptions requires a reassessment and adjustment of the design. Engineers—be they in finance or construction—must return to their plans to ensure that their assumptions align with reality.