Three-Tier Perspective: Navigating the Realms of Existence
In the dynamic world of Artificial Intelligence (AI), understanding the different layers of reality is crucial for executives, investors, and policymakers alike. The AI Valuation Cycle sheds light on these layers, revealing how they can sometimes be confused and misinterpreted.
The Layers of AI Reality
- Layer 1: Reality - This layer is the realm of physical reality where genuine progress happens. It's where we find the ongoing scaling of NVIDIA's GPUs and advancements in models by OpenAI and Anthropic. Hard metrics like FLOPS, benchmarks, and adoption curves are anchors in this layer.
- Layer 2: Distortion - This layer is influenced by policy, liquidity, and monetary conditions that distort how innovation is valued. For instance, the impact of the Federal Reserve hiking rates on the present value of future AI-generated revenue falls under this category.
- Layer 3: Fiction - Headlines declaring an AI bubble burst and subsequent collapses in valuations dominate this layer. Market fiction matters for sentiment, not substance.
The Interplay of Layers
Innovation (Layer 1) compounds steadily, while Policy (Layer 2) distorts violently, and Narratives (Layer 3) amplify chaos. It's essential to recognise how rates, liquidity, and inflation distort valuations (Layer 2), and interpret them correctly, rather than interpreting Layer 3 volatility as Layer 1 regression.
The Consequences of Misinterpretation
AI companies were significantly devalued in 2022-2023, despite accelerating model performance, chip scaling, and adoption. This was due to rising interest rates increasing the cost of capital, reducing the present value of future earnings and causing investor caution amid broader macroeconomic uncertainties like inflation and geopolitical tensions. However, those who operated, invested, or built in technology understood the importance of anchoring in reality, accounting for distortion, and surviving the fiction.
The Importance of Clarity
The task of the strategist is to know which layer they are operating in and never to mistake market fiction for technological reality. AI is simultaneously the most transformative technology of our generation and, in the eyes of markets, just another bubble. Therefore, it's crucial to treat Layer 3 (Market Fiction) as noise, understand narratives for positioning, not for truth, and to anchor in Layer 1 (Reality).
In conclusion, the "Three Layers of Reality" framework provides a valuable tool for navigating the complex world of AI. By understanding the differences between physical reality, distortion, and market fiction, we can make more informed decisions and avoid the pitfalls of confusing one layer for another.
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