“I can calculate the motions of heavenly bodies, but not the madness of people.” — Issac Newton, after losing his life savings in the South Sea Bubble.
The market cap of all cryptocurrencies dropped 65% from it’s high of $824M on Jan. 6 to $283M on Feb. 6. The reckless speculation has come to a complete halt, and with more harsh regulations coming from China and credit card companies, many believe the bubble has popped.
In Burton G. Malkiel’s fantastic book, A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing, he goes through some of the most spectacular market crashes in history and how mass psychology and tribalism have led to the same outcome over and over again. Reading the book in the context of today’s cryptocurrency market, it’s hard to ignore the eerie similarities.
When there is no intrinsic value in an asset, Malkiel says that “the successful investor tries to beat the gun by estimating what investment situations are most susceptible to public castle building and then buying before the crowd.”
This strategy is known as the Castle in the Air Theory, coined by famous economist John Maynard Keynes. In what can be better described as “the greater fool theory,” Malkiel says that “a sucker is born every minute, and any price will do as long as others may be willing to pay more. There is no reason, only mass psychology.”
Keynes’ theory applies to all speculative bubbles, but particularly the crypto bubble. The argument for tokens having intrinsic value can be made, but to justify the price is a tougher task. The rising prices are attributed to investors telling others through word of mouth about their astronomical gains and driving FOMO (fear of missing out). This FOMO causes new investors to irrationally throw their money into the market without doing proper research, and telling others about their favorite tokens. And so the vicious cycle continues.
In the 1700s, the South Sea company took on a $10 million IOU from the government, and in exchange, they were granted a monopoly over all trade in the South Seas. To the public this was a very bullish sign, but internally, the South Sea was orchestrating a massive charade, disguising the fact that they were hemorrhaging money with no revenues.
Malkiel talks about how “not a single director of the company had the slightest experience in South American trade, but the directors of the South Sea Company were wise in the art of public appearance. An impressive house in London was rented, and the room was furnished with thirty black Spanish upholstered chairs that were handsome to look at but uncomfortable to sit in.”
Many projects in the blockchain space that seem legitimate are backed by very little substance. Take Confido, self-described as “a trustless escrow payment solution using smart contracts.” Confido had a clean website, interactive animated videos explaining their business plan, and the smiling faces of four of their team members with their LinkedIns under their name.
After raising nearly 1000 ETH for their ICO, the website promptly shut down, and it was found out that the LinkedIn profiles on their website were completely fake people or identities of random people not associated with the project at all.
Malkiel says “the public it seemed would buy anything. New companies seeking financing during this period were organized for such purposes as the building of ships against pirates, encouraging the breeding of horses in England, trading in human hair extracting sunlight from cucumbers. The prize however must surely go to the unknown soul who started ‘a company for carrying on an undertaking of great advantage, but nobody to know what it is.’ The prospective promised unheard of rewards. Within five minutes one thousand investors handed over their money for shares in the company. Not being greedy himself, the promoter promptly closed up shop and set off for the continent, and he was never heard from again.”
Take the Prodeum ICO which claimed it was “developing a system to use blockchain technology for agricultural commodities, like fruits and vegetables.”
Prodeum set out to raise $6.5 million, but used completely fake profiles, similar to Confido, and vanished from the internet by unceremoniously putting the word “penis” at the top of their website.
Malkiel goes on to say that “not all investors in the bubble companies believed in the feasibility of the schemes to which they subscribed. People were ‘too sensible’ for that. They did believe, however, in the greater fool theory. That prices would rise, that buyers would be found, and they would make money. Thus, most investors considered their actions the height of rationality, expecting that they could sell their shares at a premium in the ‘after market’, the trading market in the shares after their initial issue.”
For the “reasonable” investors, the incentives to invest in ICOs are clear. Especially if you’re a high net worth individual that can contribute over the minimum investment, you can receive between a 40–80% bonus on the ICO price available to the general public. This is the reason crypto hedge funds have been so successful in 2017. They would at least double their initial investment if there was no lock up period by dumping all of their investment the second the token gets listed on an exchange.
I do think that cryptocurrency is a bubble, but it hasn’t even started yet. I think the token market is incredibly saturated with projects that will inevitably fail, bringing their tokens down with them, but there will be a few tokens that will be around for a long time. In the same way that Amazon made it out of the dotcom bubble after losing 90% of its value in a year to now becoming the most dominant company in the world, I believe in the longevity of Ethereum and a few other projects.
Take a look at the juxtaposition between Amazon stock’s price action during the dotcom bubble vs. the chart now. Strong companies like Amazon survive much longer than the Pets.coms, SwapIt.coms, and TheGlobe.coms.
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