CoWritten with Nir Kabessa
The bubble. I haven’t heard the word used so much since my third grade birthday party. It is the kryptonite of every crypto investor, the most common first question, CNBC’s favorite buzzword. No matter the reporter, it’s always delivered with the same deer-in-the-headlights look and the disclaimer “we actually have no idea what we’re talking about.”
Every time I hear someone claim that cryptocurrencies are in a bubble, I fight an instinctual desire to contradict them. Like listening to someone badly misquote your favorite movie. Most make the bubble claim without any semblance of understanding of blockchain, Bitcoin, or bubbles. But while the CNBC reporter is simply throwing darts blindfolded and hoping he hits the bullseye, there may be some truth to these bubble claims.
First, the definition of a bubble: “trade in an asset at a price or price range that strongly exceeds the asset’s intrinsic value.”
There are two metrics I will use: speculation and application. We speculate on what application the asset will have, always contrasted by its actual application. The biggest bubbles always occur when the potential for disruption is enormous. This creates the largest discrepancy between the speculation and the application. This is why a new noise canceling headphone technology probably wouldn’t result in a bubble. The application of the technology is very clear — to drown out the cries of airborne babies — and thus, there’s not much room for speculation. We can base assumptions off the current headphone industry, and besides, the technology only affects one industry, so its potential for massive disruption is limited.
Consider for a minute the Internet during its onset, or especially distributed ledger technologies (DLT — a term encompassing all distributed ledger tech: DAG, HashGraph, etc.) today. The Internet threatened and has now revolutionized nearly every industry in existence. Today, DLT has the potential to do the same, disrupting industries from peer-to-peer payments, finance and the Internet-of-Things, to healthcare, contracts, and supply chains. And there is real potential. But the application is not yet there. This thus creates the environment for a massive bubble. Everyone is free to speculate wildly because there is no way to disprove it. Tell me a toaster will revolutionize the automotive industry and I’ll call bullshit. Toaster-like-technologies haven’t done it, so the speculation holds no water. But tell me DLT will disrupt the aviation industry and make a convincing argument…I can’t disprove that.
This leads me into the following points. The key attributes of every bubble:
New theorized DLT applications will only spur more speculation. Eventually however, the application production will truly begin. Challenges will arise. Disruption will be difficult. Adoption even harder. The application implementation will rise dramatically. But because the speculation was set so exceedingly high, the application will inevitably fall short. And when it becomes clear that the application will never reach the speculation, the markets will correct…and hard. The Bubble will pop.
We’re talking Internet bubble, great depression, first day behind the wheel crash. The markets will plummet so drastically that the speculation will suddenly be far below the application. It will suddenly be fundamentally undervalued. It will stay there for months, when, from the ashes, the strongest companies will begin leading the markets upwards again.
But unlike many who use “bubble talk” as justification for not investing, this is not my argument. We’re always in a bubble; virtually every market is just a cycle of bubble formations and pops. Even the $18.5 trillion New York Stock Exchange adheres to this cycle; as the speculation on the future of the U.S. economy rises, reality must eventually catch up. When the market over-values reality, a bubble forms. When reality fails to meet that expectation, the market crashes. These aren’t necessarily wild, 40% drops like we see in crypto, but the fact remains that bubbles are simply a natural component to investing.
So the real question is not: are we in a bubble? But rather, how big will the bubble get? If we respect the natural evolution of disruptive technology, then we must understand that with every massive speculative run-up, there is an equally massive crash. From the tulip bubble of the 1600s to the Internet bubble only 15 years ago, the crashes are inevitable. Thus, the question is, what can we learn from past bubbles, and how much can they guide our actions within the cryptocurrency market?
“Those who cannot remember the past are condemned to repeat it,” said philosopher George Santayana. And as Peter Lamborn said, perhaps more aptly, “those who understand history are condemned to watch other idiots repeat it.”
The psychological factors that lead towards enormous speculative buying are intrinsically human. They unfold similarly no matter the time period, no matter the asset. Fish gotta swim, birds gotta eat, and humans need to speculatively buy. Based on this principle, we can explore other historical bubbles to understand the present cryptocurrency bubble. Understand the reasons, understand the consequences, understand the signs, and you can better anticipate the trajectory. Be the one to pull a “Big Short.”
To be clear, my argument does not revolve around Bitcoin. If you don’t understand the difference between Bitcoin and other distributed ledger technologies, read this. Bitcoin’s value is tenuous. With slow and expensive transaction fees, Bitcoin doesn’t have much functionality; without functionality, Bitcoin’s value depends heavily on people’s perception of its value. DLT on the other hand, has serious potential applications. Since this article revolves around the speculation and application of cryptocurrency, DLT projects are where the focus should be, not on Bitcoin.
Every technological adoption follows the same curve:
It’s known as the Technological Adoption Curve. It directly relates to my earlier discussion about speculation and application. The rise through the innovator, early adopters, and early majority phases are driven by speculation. But by the time the late majority begins adopting, demand for actual implementation and application becomes critical; the implementation can’t meet the massive speculation and the crash begins.
Tulips in the 1630s exploded in Holland in what is today known as the Dutch Tulip Bubble. Historical accounts estimate that tulip prices increased 2000% within four months before crashing by 99%. In the late 1980s, a massive stimulus effort by Japan catapulted their economy and resulted in massive speculation. From Investopedia: “At the peak of the real estate bubble in 1989, the value of the Imperial Palace grounds in Tokyo was greater than that of the real estate in the entire state of California. The bubble subsequently burst in early 1990.” This was known as the Japanese Real Estate and Stock Market Bubble.
But for our comparison, the most relevant bubble is what’s commonly known as the Dot-com Bubble of the 1990s and subsequent crash in 2001–2002.
By the new millennium, it was clear that the Internet was going to change the world. It began to disrupt every industry and usher in a new economy, a new manner of conducting business, of peer-to-peer connectivity…sound familiar? The application lived up to all speculation and then some. It was likely the single most impactful, most revolutionary technological development since the Industrial Revolution; some would say even greater. Yet despite its groundbreaking success, an enormous crash still occurred.
Let’s rewind the clocks 22 years. It’s 1999 and you are a savvy investor, passionate about the internet revolution. The 6 biggest tech companies are valued at $1.65 trillion, 20% of the US’s GDP, yet you’re still constantly laughed at by your friends for investing in the new “fax machine.” Imbeciles. You know that if you do your due diligence you will find golden dot-com companies to invest in. One day one pops up on your radar. It checks all your boxes: strong team (the two founders of Borders books) and powerful institutional backing (Sequoia Capital and Benchmark Capital — later Goldman Sachs). The company is WebVan, an online grocer that promised 30 minute deliveries. In their ICO in 1999, they would raise $375 million before quickly exploding to $1.2 billion. Bullish? Disruptive? Sound familiar? Yet in July of 2001, the stock price dropped from $30 to 6 cents and WebVan lost $700 million in a day.
Overall, $5 TRILLION was lost between 2000 and 2002. 25 bitcoin markets gone. Poof. Only 50% of dot-coms survived the pop, as a graveyard of startups lined Wall Street and Silicon Valley. And sad to think the internet wasn’t advanced enough to allow these people to mourn in meme form.
In today’s world of ubiquitous connectivity and seamless experience, it is hard to imagine that the internet and its many applications once had difficulty cultivating a network of users. But in the mid 1990s, internet still had only minimal uses and yet, anything.com’s began popping up everywhere. Putting “dot com” in your company name was enough to land you a golden ticket to IPO stardom; not to mention a few hundred million.
Pets.com, Webvan, the examples are endless. Stars who burned too bright and then died. The speculation grew too fast. It outgrew its fundamental value: it’s users. The speculation of what it could be was suddenly replaced by the realization of what it was. In the long run, speculation led to overvaluation that destroyed many companies. Companies need a reality check; they need pressure and obstacles — a $500 million valuation directly after IPO does not lead to success.
Unfortunately, the poorly managed were not the only ones to suffer. Everyone plummeted. With the momentum of the crash, NASDAQ suffered. Amazon plummeted; Apple stock was decimated.
Amazon crashed even more dramatically, from $85.06 in 1999 to $5.97 by 2001. When a market correction comes, no one is safe.
Everyone makes the dot-com / cryptocurrency comparison.. Both are/were driven by promising new technologies that are difficult to evaluate correctly. As we said earlier, bubbles are bubbles no matter the asset. However, the terms of the game have changed. 2018 is not 2000. Can we use the dot-com bubble as a viable metric? Is DLT’s future similar to that of the internet? Let’s explore the key differences between these two giants:
If the Dot-com Bubble was your favorite Disneyland roller coaster, the digital asset market is that Sling-Shot that you’ll “definitely ride one day.” The blockchain market moves faster than any other market. It’s more volatile; life-changing gains, devastating losses.
Blockchain is like Texas, and in Texas, everything’s bigger…even the losses. Even WebVan’s doomsday of $700 million daily losses don’t scrape the surface of some crypto’s biggest losers, such as Ripple’s $25 billion rainy day on Jan 8 this year.
These fluctuations are a result of several factors: the access investors have to cryptocurrency and the massive availability of information via the internet. This creates a perfect storm for cryptocurrency volatility. Additionally, the plethora of exchanges, both centralized and decentralized, allow for crazy arbitrage and market manipulation. Since there are very few regulations on insider trading and market manipulating in the blockchain space, one can be sure that these malicious acts are happening by the boatload. A millionaire can easily affect the price of a $5 million mkt. cap blockchain with $100k 24h volume. Whales are no strangers to these small coins, and the average small-time investor can’t differentiate between these manipulations and market sentiment.
Harvard’s endowment isn’t in digital assets. Your parents’ retirement isn’t either (if it is, get out!). The investors today aren’t seasoned institutional investors; they’re young, inexperienced, speculative, out to get rich quick. During the 90’s NASDAQ rise, investments could only be made through brokers and by institutional investors; with cryptocurrency anyone can participate. You just need a device connected to the internet. Even a shepherd from Pakistan can become a crypto trader. What is mountain shepherding compared to the excitement of day trading?
These investors are accessing their portfolios 24/7, receiving twitter updates instantaneously. They don’t fully understanding the technology behind their investments. The internet provides market updates and information at a pace inconceivable before the internet. Many times, this information can be highly misleading. Other times, you’re learning from outright scams. As a result, panic selling happens frequently. Fear Of Missing Out dominates. Huge run ups are followed by massive crashes on a level far exceeding that of the Pre-2000 NASDAQ .
But this also means that the crypto bubble could dwarf the Dot-Com Bubble. NASDAQ reached a high of $5.048 trillion in March of 2000. But that high was limited by the accessibility barriers placed on investors, by the difficulties encountered when sharing information quickly and on a massive scale, and by the fact that dot-com investing was largely limited to North Americans. Cryptocurrency, accessible to anyone, from anywhere, provided they have some money and a cellphone, means that as the globe begins to understand the value of DLT, $5 trillion could look miniscule.
But this is to simply acknowledge that predicting the top of the bubble is a fool’s game. Instead, we should focus on the identifiers that scream “warning.” Here are the indicators:
Considering the fact that the public and mass media largely has no understanding of DLT supports my conclusion that we are nowhere near the top of the bubble. The world is now only beginning to legitimize Bitcoin. It will take years before the true value of blockchain is understood by the masses. In the meantime, cryptocurrency will continue to progress through periods of massive volatility. However, the general trend will be upwards — and dramatically so — as the market progresses towards its peak, and inevitably, its crash.
What differentiates last week’s crash from the ultimate “bubble popping” crash? Perhaps nothing. It’s possible that the digital asset markets will continue to rise, fall, rise, fall until the point that adoption brings stability. It could be that last week’s crash will be the most dramatic that we ever see. However, I think the significant difference is that during last week’s crash, nothing fundamental changed about the assets. The crash was entirely based on speculation and market uncertainty. I think the ultimate crash will occur because of some fundamental change in the underlying assets. This may be a series of DLT companies that cease development because of poor management or implementation hurdles. It could be that a security flaw is discovered in a number of large cap projects (IOTA anyone?). Regardless, I think in the wake of the crash, many previous blockchains will die, condemned for an eternity of existence with no further development.
It’s also possible that blockchain and cryptocurrency defies all predictions, all historical models. It’s possible blockchain transforms every industry and never sees a crash such that dominated the early 2000s. It’s possible that blockchain and cryptocurrency rivals today’s equity markets. It’s possible that decentralization is so dramatically different and successful that it fundamentally changes the way companies and projects develop, the way humans psychologically interact with markets. It’s possible….but I doubt it. We may be playing a brave new game, but we have a lot to learn from the players and games that came before us.
Digital assets and DLT may very well change the world. But the journey is going to be bumpy.
FOLLOW us on Twitter: @noamlevenson — @TheBlock_x — @kingkabessa
Disclaimer: We are invested into cryptocurrencies. This is not investment advice, merely our opinion on the markets. Do your own research.
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