Today is a gloomy day in the cryptocurrency space. After January this year, when it wasn’t uncommon to see millionaire’s gloating about their new fortune and catch phrases like “Cryptocurrency is the Bubble That Never Pops”, things started to slow down and, eventually, tumble downhill fast. Today the news is quite bleak. Just googling ‘Reddit Cryptocurrency’ (because I prefer to use google to search Reddit like an 80 year old), these were the top news results. This was definitely not the future many ICO’s and thought leaders promised to their investors. (And after reading the article about the $127K loan… don’t leverage risky assets, kids). The market is now down about 75% from it’s all time high of $800 Billion, sitting a little north of $200 at the time of this writing. So, why did this happen? Who’s to blame for the sudden collapse? To understand that, we have to understand how we got here first. Replaying History In late 2013, The price of Bitcoin went from $100 to about $1,000 after a series of very positive events (culminating in the famous ). Many of the current cryptocurrency blockchain founders were apart of the industry, but only really got serious about the industry after this event. Bitcoin Lovefest Senate Hearing What followed this was a long bear market that didn’t fully bottom out until January of 2016, and didn’t fully recover until 2017. While the industry kept active and continued to innovate, the market didn’t reflect this change until 2017. 2013 through Early 2016, Bitcoin Price If we look at what the overall market looks like today, it’s easy to see a resemblance to this event: Cryptocurrency Market Capitalization: 2017 to 2018 I’m not one to rely on similar looking charts to make decisions about a market, but the circumstances and the subject matter are too similar to chalk up to coincidence. In both cases, we have: Promise of a revolutionary technology (in both cases, decentralized applications/products) A new/improved means of adding liquidity to the market (Exchanges, ICOs, etc) A market of early adopters with compelling stories of making XXX% returns on their investment and promoting the technology An even larger untapped market of people who would very much like to make a XXX% return on their investment Both cases allowed for a market to dramatically expand beyond it’s current size and allowed for the great increase in price and valuation. But the combination of a good story about cryptocurrency and it’s potential, combined with easier methods to invest and an untapped market that had been primed to invest, made the rise very high and the crash even harder. Let’s first discuss the rise in the market. The Rise Most people tend to talk about the cryptocurrency market in the terms of the technological potential . The story in late 2017 was that markets were increasing in value because the technology was revolutionary, allowing for better organizations and applications, and was actively being adopted world-wide at unprecedented rates. and adoption One of the prime examples of this was how the value of XRP was rising dramatically because banks all over the world were beginning to understand the potential of Ripple and, thus, positively benefiting the price. In 2017, you couldn’t talk to someone in the industry without them telling you about all the companies and people adopting cryptocurrency in mass. It didn’t seem to matter that the evidence pointed to lackluster adoption from users, the story was generally accepted by those invested. This wasn’t just true about XRP, but the narrative of all cryptocurrencies from their supporters. (Side Note: the only cryptocurrencies I believe were actually able to make this claim were projects like Monero, where money was truly untracable. Their main base of users, of course, were criminals, but that’s a discussion for another day). While this story is lends itself to the ‘… and the value will continue up’ narrative, there was an alternative narrative that I ended up preferring. In fact, this narrative can explain the same upward valuation curve as well, if not better than the adoption narrative_._ Let’s talk about cryptocurrency through the lens of untapped markets and investment vehicles_._ Early Cryptocurrency Exchange In 2012, the were only two good ways to be able to get Bitcoin (or any cryptocurrency for that matter), mining through the network or buying on a very small, not necessarily user friendly exchange. There were some evidence that this technology had potential and that you could invest in it, but even many of the techie early adopters needed time to really understanding what was going on. Very few people adopted heavily, but that proved to be enough to start what was to come. In 2012, BTC started to move north of $100 and wasn’t stopping. While the insiders who had invested were quite happy with this turn of events, it were the outsiders who really took notice, those that were familar with the industry but hadn’t made a move. Many of the outsiders who were aware of the market saw the rocket ship taking off and didn’t want to miss it. Many of then acted by purchasing through the exchange. Because the market was so small, and the relative influx of people so comparatively large, this meant that the market took on a lot of new cash all looking to do one thing: buy. And given the (aka Net Inflows), this cash was easily able to overwhelm the market, increasing the price exponentially. but given the size of the market by 2017, it certainly was the case. New money overwhelmed the market and rose the price exponentially. asymmetric nature of real cash in the system It’s possible this isn’t what happened in 2013, In 2017, we had the same thing play out, but this time at a larger scale. One of the primary reasons for this was because exchanges have gotten easier to use and the use cases expanded dramatically. Project like Ethereum rose to create new investment vehicles (ICO’s) to allow for crowdfunding of new projects. In addition, the amount of writing, documentation and development tools had also grown, allowing less (but still) technical users to start experimenting. Even though a clear, easy to navigate UI doesn’t seem like a breakthrough, it was enough to grow the potential market (even if these users weren’t 100% certain what they were investing in). In 2017, we had more users entering the market, with even broader news coverage (with major TV networks covering the price increase of Bitcoin and other assets). So it was quite easy for someone to enter the market and add more ‘buy’ support to the exchanges. Irregardless of the actual adoption, speculation seems to have the ability to raise the price of cryptocurrency. To explain a sudden rise in price, we don’t even need adoption to be part of the narrative: traders and speculation alone are enough to explain the massive valuation spike. But this can only be used to explain short term transitions in price. If this valuation isn’t supported by ‘real’ adoption (aka people who actually need your product and are committed to it), you get… The Fall The best and worst thing about speculative trading is that these types of trades are short-sighted. If a speculative trader sees an opportunity to make a 10% return on a trade, they’ll buy heavily and potentially move the price up through their efforts. However, if this person is disappointed and decides to call it quits, they’ll just as easily liquidate their assets and move on with their lives. When this is a lone trader or a small minority of the group, this is not that big of a deal (speculators will always exists). However, given that a majority of the cryptocurrency market (or at least the market valuation) was being driven by this new money, it meant that the only way the price could continue to go up is if the tsunami of new users didn’t stop. New traders betting on speculation are only going to have so much cash and once they’ve invested everything, they’re no longer going to be making ‘buy’ trades and start making ‘sell’ trades. And if too many people do this at once, you get the same effect, but in reverse. Now, this isn’t always what happens to people who invest speculatively. Some people, like many of my relatives, bought cryptocurrency at the peak in 2018 and then just stopped making trades. Some people, even after the peak, brought new cash into the market ( ). However, if you don’t continue to sustain the growth in the market, the newly bought in buyers will either have no impact or become sellers (as they are known in the industry, the ‘weak hands’). If this happens too quickly, many of the other traders (the many, many speculators in the market) get scared of the potential loss and sell off quickly. even today, Coinbase claims to be adding 50,000 users a day If a market is supported by speculation, it will be at the whims of that speculation to support the price. Despite the loud, boisterous claims of being all in on the market, most people were in to make a quick buck. Long term value can only be supported by people who actually need the product. So, why didn’t adoption pick up the slack during the fall? After all, if the technology really was as revolutionary as people said, shouldn’t some percent of the population start buy cryptocurrency for actual usage? The answer to this is, no, that was never possible. The Adoption Curve Could Never Reach the Expectations of the Speculators (at least initially) This crash could have theoretically been prevented if, say, the rate of adoption (and by that, I mean actual users of the products requiring cryptocurrency for their day to day operations) had stayed up with the valuation and the speculators, but this simply wasn’t going to happen, for two reasons. On the one hand, adoption of a new technology is slow and , even for hyper growth products. One of my favorite examples of this was the adoption curve of users on popular web applications: smooth Keep in mind, these are some of the fastest growing products in history, and is all supported by real user growth. If you look at each curve, you’ll notice that there is a natural ‘progression’ to how each application is able to attract users. While the reality of the individual days would be quite jagged (there are likely days in WhatsApp’s history where it grew my over a million people in a day and then 10X less than that the next day), but the overall trend is an even, accelerating progression. What you do NOT see is the application growing by 10X in a few short months (even 10X in a year would be hard to accomplish for anything other than a very small organization). The jagged hockey stick growth is not really possible when dealing with real user adoption. And if we look at our own technology habits, we know this to be true. Think about one of the more popular applications you use today, one that’s now a normal part of your day to day life. Maybe it’s LinkedIn or Youtube or some other social media app. Now, think back to when you first heard about this application, perhaps through a friend or a co-worker. After you decided to give in and sign up of the account, I want you to think about your first few months of using the platform. Were you… A power user within a few days and quickly understood how to use the application to it’s full potential, or… A user who just dabbled on the website to see how you liked it and then, over time, slowly started to integrate into your social/working life? If you’re like most people, the reality is probably closer to the latter (unless you’re switching from one tool to a nearly identical tool, like moving from Hotmail to gmail). Doing this exercise myself, I recalled my first interactions on Quora in 2014, a website that I would eventually use on a daily basis. After creating an account and answering one question, I promptly stopped using the website for about a year. In 2015, I answered about a dozen questions in the middle of the year and began occasionally using the website until I took my writing more seriously in mid-2016. ‘First introduction’ to ‘daily usage’ took about two years in this case. And for most apps, from Facebook to LinkedIn to Twitch and Youtube, they followed a similar, slow pattern. Even if every new speculator that entered the market were fully intending to become active blockchain users, it was still likely that they would slowly start to use the technology before diving in more deeply. And this impact is profound. A theoretical power user of Ethereum could be responsible for $100 of ETH spent a day when a non-power user might only make one transaction a quarter. High cryptocurrency valuations need to be supported by these type of power users, those who will actively support the network, not those that make a transaction occasionally. But even if a fair number of speculators fully intended to become power users from day one, another problem emerges from the technology. Blockchain Is Difficult to Use Today (even for Early Adopters) This fact became quite apparent to me when I went to Ethereal in New York. Consensys was hosting a two day conference (that famously ended when someone bid $140,000 for a rare cryptokitty) for Ethereum enthusiasts. Ticket prices ranged anywhere from $800 all the way up to $1200, and unless you were local to New York, required a plane ticket and two nights in a hotel to attend. I stress to point out the fact that the only people who were going to go to this event were people who were willing to dole out close to $1,500 to hear Joseph Lubin and Co talk about the future of Ethereum. Namely, people who should be way more knowledgeable than the average cryptocurrency user. To my surprise, many (and I do mean many) of the attendees at the event didn’t completely understand how blockchain transactions worked. In my conversations, I had to explain to people on several occassion how to purchase a hardware wallet, how to to send a transaction and even helped a new friend setup a metamask account to receive some newly procured ETH. One of the more illuminating experiences was an art exhibit that required the user to send a transaction at the end of the ‘experience’. This exhibit required a full time attendant in order explain to people how send a transaction via QR code, since so many people were walking away at the end, confused as to how to proceed. Given the ubiquity of smart phones, switching over from SMS messages to WhatsApp is a relatively quick transition compared to explaining how to use a decentralized app, including setting up a wallet, sending a transaction, making sure the transaction actually sends, and seeing the result in your wallet. While the transformation in technology has the potential to be quite profound, the adoption cycle will the long and arduous. This isn’t even mentioning the fact that most users aren’t really sure what to with their wallet (other than trade assets) once they get them. Given that the most impactful decentralized application not tied to trading or investing has been cryptokitties, we are very much lacking in new applications. do Most of the very interesting projects in the industry today are focused on building much needed infrastructure to make the technology scalable and easier to develop for, not making something an end user can easily understand. We can all appreciate the need for good infrastructure (and if you lived in the era of BBS , you understand the miracle of urls and browsers), but also appreciate that this is not going to get more users on quickly. This meant that in-inevitably, adoption was not going to be able to bouy the valuation and a crash was inevitable. We are years away from being at a place where the free market can fairly support a $800 billion market. Speculators simply can’t do that. Result I’m calling this ‘result’, but everyone reading this is living the reality. Without a steady stream of users consistently using cryptocurrency for commerce or applications, and the market of investors today more or less taped, it means that the floor for actually usage was far, far below the actual market valuation. Do not mis-understand my point above: I am not saying that there is adoption of cryptocurrency assets in the market. There are many developers, new investors and business that are not going to easily give up their stake in the industry, even with the crashing price. no We saw that during the crash in 2014–15, where many of the projects that grew to dominate the 2017 rise (Ethereum and Monero come to mind) were being launched. And even some people who were planning on just making a quick buck found themselves completely bought in despite losing 90% of their value. These adopters can’t possibly sustain the highest valuation of the market, but their impact is not going to be 0. These folks are going to be the lifeblood of the industry over the next few years during the crash and, very likely, long-term market recession. So, this is my answer stated more simply: The market grew at a crazy rate because there were new/improved ways to invest in cryptocurrency and enough success stories to get everyone’s friends/family/neighbors interested in joining the party. People talked about how cryptocurrency was being adopted, but really it was only speculation driving upthe price. Because the actual rate of adoption couldn’t possibly keep up with the high valuation expectation being set by speculators (because the value was rising too fast and the use cases too sparse), many of these speculators soon became mass in the market. No one asset or organization caused this crash, it was simply the inevitable flow of the market out. sellers Some questions we can’t answer: When will the Market bottom out? How long with the recession be? Will XXX project succeed? These are all common questions that don’t have answers that can be answered easily today (and can only be understood in hindsight). What we do know though, is that the industry now has more developers and smart people than it’s ever had before. Despite the crash, many project now have funding to experiment for the next few years while the rest of the market ignores them in favor of the next shiny thing. Will these folks create something incredible? I am certainly very hopeful. But that’s not for us to decide.
