The Cryptocurrency Bubble vs. The Dot-Com Bubble

The current cryptocurrency bubble (yes, this is most definitely a bubble) is drawing strong comparisons to the 2000 tech bubble. Many people are speculating that the technology behind cryptocurrencies, blockchain, is the way of the future. Although blockchain technology offers many potential usecases, the speculation has gotten out of hand. A cryptocurrency bubble of massive proportions is building. Will you get sucked in? I hope not.

What is Blockchain?

Blockchain is a digital, public register (or ledger) of transactions. The chain is made up of decentralized blocks that are stored in minuscule bits across the entire network of users. When a transaction is completed, the block is recorded and added to the chain. When a new computer (node) is connected to the network, a copy of the blockchain is downloaded automatically, meaning that each record is kept public and transactions are not kept by a single bookkeeper.

Blockchain was originally created by Bitcoin as a way to decentralize a virtual currency. Because a block cannot be deleted, and because they’re added to the complete chain via cryptography, they are essentially tamper-proof. Each block carries over the information from the previous block in a “chain link” fashion, including data about previous owners, transaction details, and balances. This process is meant to eliminate fraud and forgery.

For an extensive list of potential blockchain applications, click here.

What is Cryptocurrency?

First, let’s define what a currency is. According to Investopedia, a currency is defined as “a generally accepted form of money, including coins and paper notes, which is issued by a government and circulated within an economy. Used as a medium of exchange for goods and services, currency is the basis for trade.”

Cryptocurrency is one use of blockchain technology, whereby a person can use a digital coin to purchase goods. As with any blockchain, data is stored in a decentralized fashion and is independent from a government or central bank.

Let’s focus on the hottest cryptocurrency of the year: Bitcoin.

What is Bitcoin?

Bitcoin has been around since 2009 as likely the first, and definitely most popular, digital currency that uses peer-to-peer technology. In order to get a Bitcoin, you first need to “mine” it. In other words, computers have to process complex formulas (hashes) in order to “discover a new block.” Once added to the chain, the miner receives a few Bitcoins. Each new “block” or “hash” can only be awarded to one miner. Once that calculation has been solved, it can no longer be solved for credit again (you cannot duplicate a bitcoin). Thus, in order to discover new blocks, the computations have become exceedingly difficult. In 2009. people could perform a mining operation with a home computer. Now, miners must invest in ASICs (Application-Specific Integrated Circuits) and GPUs (Graphic Processing Units) in order to unlock new coins. This is the primary factor for Bitcoin’s meteoric price increase.

Is Bitcoin worth it’s current valuation?

On some level, the intrigue around Bitcoin as an investment makes sense. Since there’s a finite supply, Bitcoin’s price (in theory) should be semi-regulated by the laws of supply and demand (price increases as supply decreases).

Those that argue the current valuation is justified will tell you that it’s pretty much the only cryptocurrency you CAN use to buy things. First, they will point to articles where people have bought pizza, cars, and even a house, with Bitcoin. Next, they will point to the market cap of the USD or Gold and suggest that because they’re so big (in comparison), Bitcoin could become that big. To me, that’s like saying if I open up Mr. Cobo’s Bank tomorrow and I accept a few deposits from friends, “you should really value me based on the potential growth of a $JPM, $BAC, $C, or $WFC” because “look how big those banks are and I’m a bank”… yeah, okay.

But, probably the funniest point I’ve heard as to why Bitcoin is a currency, is its concentration of wealth. It’s actually striking: The earliest miners hold nearly all the wealth due to the ease of mining at the beginning. It’s actually far worse than the striking wealth inequality the United States faces.

This inequality is actually quite a big problem, should Bitcoin want to actually become a currency that’s widely adopted. In order for Bitcoin to be compared to other currencies, or to succeed, it NEEDS to be used by the masses. If it’s wealth is not distributed, the total conceivable number of transactions is far less. Less transactions = less traction = less of a currency.

The Dot-Com Bubble: A brief history.

The dot-com bubble was an amalgamation of factors. The story really begins in the 1980s. The decade began with a major recession, high unemployment and absurd inflation, followed by Ronald Reagan’s tax cuts in 1981 and 1986, the resulting increase in consumer credit, and the stock market’s single worst day in history (Black Monday). It was a roller-coaster ride for investors in the 1980s. By 1990, George H.W. Bush needed to raise taxes in order to balance the federal budget and keep the economy churning. Though Bush took a hit to his popularity at the time, he set Bill Clinton’s presidency up for success. Government budgets were no longer a fear and the bull market continued throughout the 90s, beginning to pick up serious steam in 1995.

Asian Financial Crisis & Irrational Exuberance

In what later became known as the “Asian Financial Crisis,” 1997 and 1998 were the first signals of trouble. Countries were grappling with stagnant economic growth, resulting in their inability to support their currency’s “peg” to the USD. George Soros famously became one of the first hedge fund managers to short Thailand’s Baht after he noticed the discrepancy. Soros has taken heat for “causing” the crisis with his bet of nearly $1B (of his $12B fund) against the currency, however, Julian Robertson’s Tiger fund had nearly $3B invested in the same short position against the Baht. Fact is, these shrewd investors saw a “can’t miss” opportunity and banked an easy win for their investors – as any fiduciary should.

As frustrations in Asia increased, investors began pouring more money into the United States, where a bull market was in full force. Part of the reason for the bull market came at the hands of Alan Greenspan, the Chairman of the US Federal Reserve Bank. Greenspan had begun to toy with interest rates more frequently. When the markets hit a downturn, he’d cut rates. This form of easier monetary policy would provide somewhat of a ‘safety net’ for investors because as rates drop, it is easier for companies to borrow money, and invest in themselves. Thus, as rates drop, markets increase. These actions ultimately paved the way for a “can’t lose” scenario. If the markets increased, great! If the markets went down, no worries, Greenspan will cut rates.

During a televised speech on December 5, 1996, Greenspan remarked:

Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?

Of course, this all ended badly.

Tech Innovation, the Internet, and the Bubble Burst

Technology was just starting to accelerate. From Sony’s Walkman, to VCR’s, to faster business computers, to personal computers, to software and even financial markets, it was abundantly clear that technology would someday rule the world. As the internet became more widely accessible, investors began piling into any technology or internet related stocks. Valuation metrics that had been used for decades were thrown out the window. Investors didn’t care about the company’s intrinsic value or fundamental value. Rather, they acted solely on the fear of missing out.

Here was the average tech investor’s investment thesis during the dot-com bubble:
“OH IT’S INTERNET? TAKE MY MONEY”

Internet stocks became absolutely absurdly overvalued. Practically overnight, many companies went from just an idea to a multi-billion dollar company. Here are some of the most classic examples from the decade.

Pets.com

promised to provide a way for people to buy pets online! Sounds super cool, right? And with a cool mascot that was plastered all over TV ads, the company had to be doing right, right? They even advertised during the Super Bowl!!! Say it with me… “shut up and take my money!”

Unfortunately, many investors did. In February 2000, Pets.com raised $82.5 million through it’s IPO (Initial Public Offering), only to go bankrupt within 9 months (November 2000). It’s nearly impossible to find a chart of the stock, but if you did it’d show a falling price of $11 to $0.19. The bubble had burst and investors had realized the company wasn’t reinvesting money into the business. Instead, it was buying up more ad space.

Webvan.com

Pets.com is the dot-com bubble’s poster child because of it’s cute mascot and it’s swift evaporation in value. Webvan.com, though, is the dot-com bubble’s biggest flop. Webvan.com was a grocery delivery service. In just a year and a half, the company had decided to expand its services to eight cities. As if that growth didn’t seem fast enough, in the summer of 1999, the company said that it would make a $1B investment and expand to 26 more cities within 2 years. In November 1999, you guessed it, the company went public.

Webvan’s IPO raised $375M and valued the company at over $1.2B ($30/share). Unfortunately, this was the peak. Like many other internet stocks, the company’s ambitions didn’t meat reality. The company’s margins simply weren’t good enough to support the expansion and in July 2001, the company went bankrupt at just $0.06/share. The failure forced Webvan to lay off 2,000 employees.

Those are two of the most famous examples, but there are many others. Read about them here.

This time, it’s different……..right?

I can see why people are excited about the idea of Bitcoin. I can see why they’re excited about some of its competition: specifically Ethereum and even Ripple. (If you’re curious as to the differences, read this). However, I haven’t found anyone (aside from one Harvard professor) who could accurately describe WHY these cryptocurrencies are not a bubble, and why any are still good investments. That is, of course, outside of “because they’re the future.”

My issue isn’t with the statement that “blockchain is the future” or that “cryptocurrency is the future.” In fact, many of the people that lost money in the dot-com bubble were “right” when they said “technology and the internet are the future.” The problem was that they were too late to the party. In investing, when everyone knows the secret, it AIN’T A DAMN SECRET ANYMORE. We’re in almost unanimous agreement that blockchain, as a technology, will be a large part of the world in the coming years. That doesn’t mean that everything “blockchain” is instantly investment-worthy.

Here’s a novel point: If you want to make money in investing, things have to go up. The more people know the “secret” the more demand for the investment. The more demand, the higher the price goes. Sometimes, unjustly high.

Examples of Lunacy

Over the past few months, we’ve seen countless “what the actual f***” stories that demonstrate a cryptocurrency bubble that are eerily reminiscent of worse than the 2000 dot-com bubble. Here are a few of the more absurd things these speculators have done because…. blockchain.

#1) Longfin Corp ($LFIN) just goes up 1,000% in 2 days to $3.1 billion… because it bought a blockchain company. Watch the CEO say the market cap isn’t justified.

Small-cap Longfin soars 2,000% after acquiring blockchain company from CNBC.

Here’s $LFIN’s chart of the lunacy:

I feel bad for those who bought so high. Their wealth has evaporated.

#2) Long Island Iced Tea Company rebrands as “Long Blockchain Corp” and people gift them money.

“Long Island Iced Tea Corp. shares rose as much as 502.98 percent after the unprofitable Hicksville, New York-based company rebranded itself Long Blockchain Corp. It’s the latest in a near-daily phenomenon sweeping the stock market, where obscure microcap companies reorient to focus on some aspect of the mania sparked by bitcoin’s 1,500 percent rally this year.” SOURCE

So, wait, in today’s world, you can just put out a press release announcing a rename that includes “blockchain” and say you’re investing in blockchain, and in a matter of minutes you’re worth 5x? Okay…

#3) Kodak, yes that Kodak, was up 300% after announcing their cryptocurrency named “KodakCoin”

Meet the Kodak-branded KashMiner from CNBC.

So you want me to believe that the 100+ year old camera/film company, who’s struggling because iPhones and Androids have commoditized their main product, is suddenly a stock to buy in the crypto game? In other words, just because they plan to do something with blockchain, you should buy their stock? Yeah, nope.

Via CNBC: Part of their move is a Kodak-branded mining rig called the KashMiner, which was showcased at this year’s CES. It’s created and run by a company called Spotlite, and has licensed the Kodak name.

Here’s how it works: Users pay $3,400 to rent the mining machine for two years. Kodak claims the KashMiner will produce about $375 worth of new bitcoins every month, which would lead to estimated revenues roughly $9,000 over those two years.

This one may actually be criminal fraud. Seriously. As one Twitterer pointed out and as discussed above, this scheme will only work if Bitcoin’s mining difficulty increases. Since that’s not going to happen, the people being promised a $375 check each month are essentially being lied to. But…. BITCOIN!!!!!!!!!!

There is no way your magical Kodak miner will make the same $375 every month, unless Bitcoin mining difficulty stays the same. It is currently increasing at around 15% a month, so mining output should drop around 15% a month, too. Good luck to everyone who bought this deal! pic.twitter.com/0xA2HNtHFc

— Saifedean Ammous (@saifedean) January 10, 2018

#4) DogeCoin is valued at over one billion dollars.

Remember these memes?

They were all the rage in 2012-2014. The meme’s founder created a parody “coin” named “DogeCoin” as a joke in response to people talking about Bitcoin. Guess what? These cryptoncurrency “investors” have made the coin worth over a billion. Umm what?

RED ALERT: A COIN THAT IS WAS CREATED AS A JOKE…. IS NOW WORTH $1,000,000,000.

Here’s what founder Jackson Palmer said:

“The fact that most conversations happening in the media and between peers focus on the investment potential is worrying, as it draws attention away from the underlying technology and goals this movement was based [on], … I have a lot of faith in the Dogecoin Core development team to keep the software stable and secure, but I think it says a lot about the state of the cryptocurrency space in general that a currency with a dog on it which hasn’t released a software update in over 2 years has a $1B+ market cap.”

That’s my favorite one. It’s not even close. The irony here is just perfect. If this doesn’t scream cryptocurrency bubble, I don’t know what does.

What does Warren Buffett have to say?

The Oracle of Omaha weighed in on the cryptocurrency bubble the other day. Buffett said “I can say almost with certainty that they will come to a bad ending.” In an interview on CNBC’s “Squawk Box” he added “When it happens or how or anything else, I don’t know,” and “If I could buy a five-year put on every one of the cryptocurrencies, I’d be glad to do it but I would never short a dime’s worth.” You can watch the interview here:

Iconic investor Warren Buffett on bitcoin, his health and the state of markets from CNBC.

Buffett makes a great point. Will the cryptocurrency bubble pop tomorrow? Who knows? But when it happens, it will happen very quickly. It may keep going up for another year, maybe two, but it could also crash for good next month. The point is, when valuations get stupidly out of whack, reversion to the mean eventually happens.

So, what happens next?

This entire cryptocurrency bubble is an utter disregard for valuation…. again. Just like in the years leading up to the dot-com bubble, companies (or coins) are popping out of nowhere. Don’t believe me? Check out this list of the 1401 cryptocurrencies that exist today. You really think they’re all a “currency” that will be widely adopted?

P.S. – check back tomorrow — the list keeps growing.

Remember this meme?

Anytime buffoons like this show up, and wildly speculate on something without doing any research, with the fear of missing out, the supply will always follow. ICOs (Initial Coin Offerings) are flooding the market day by day. They’re eating up all the stupid money. Greed has taken hold of their emotions and valuation metrics have gone straight out the window.

The cryptocurrency bubble is nearing $1,000,000,000,000 ($1Trillion) in market cap. That’s just silly. In all likelihood, what happens next is a massive crash. Most “coins” are going to vanish and a few winners will remain for the long haul; just like the dot-com stocks back in the 2000’s. The question is, which ones will be able to withstand the cryptocurrency bubble’s eventual popping? For me, I’m content to sit on the sidelines and watch. We have seen this movie play out too many times. This time isn’t different.

I’d rather invest in the companies that are using blockchain in production today, like Microsoft (via. Azure). I’d rather invest in companies like Nvidia, who create the GPU’s needed to mine Bitcoins. While they won’t have the insane meteoric rises seen in speculative cryptocurrencies, they won’t have the swift gravity plunges either.

The theme of this blog is based on a Warren Buffet quote. I’m going to follow it word for word.

Be fearful when others are greedy. be greedy when others are fearful.