The cryptocurrency market had a spectacular 2017: currencies such as bitcoin, Ripple, and ether effectively became household names as they saw their values multiply immensely. The market is showing no signs of slowing down in 2018 either, with Russia recently introducing the crypto-rouble, and the price of Ether moving above $1,300.
Despite these successes, the likes of Warren Buffet and Joseph Stiglitz assert that cryptocurrencies are a bubble, and are thus tremendously overvalued. In order to evaluate these assertions, it is useful to compare the cryptocurrency market with the dot-com bubble of the early 2000s.
The Dot-Com Bubble
The late 1990s saw a period of incredible growth in the usage of the internet, for both consumers and businesses. As a result, investors were willing and eager to invest at any price, in any company which harnessed the power of the internet or had a “.com” suffix in its name, causing the NASDAQ index to rise from 1000 in 1995, to 5000 in 2000. At the height of the bubble, it became possible for any promising company, with a “.com” suffix to become a public company and raise large amounts of capital via an IPO, despite the fact it may never have turned a profit, or even recorded any tangible revenue.
The bubble burst when some of the biggest tech companies, such as Dell and CISCO placed huge sell orders on their stocks at the market’s peak, resulting in investors panic selling huge quantities of stocks. Without large quantities of investment capital to sustain them, an enormous number of dot-coms went out of business, taking trillions of dollars of investment with them.
The tech market has taken 17 years to recover from this crash. The stock price of Microsoft was at $59 per share at its peak in 2000, and only exceeded this value in October 2016. CISCO’s peak share price was $79 per share in 2000, fell to $11 in 2002, and is currently around $41. Similarly, a share in Intel cost $74 in 2000, and is currently priced at $43. On a more positive note, companies such as Amazon and Adobe have managed to exceed their share prices beyond their peak dot-com bubble values.
The Cryptocurrency Bubble
New technologies are prone to overvaluation because it’s difficult to determine their fundamental value using traditional methods as they generally don’t start generating revenues until far into the future. This is especially true of cryptocurrencies that may never generate any cash flows.
Without tangible revenues to illustrate fundamental values, markets succumb to the excitement and ‘fear of missing out’ as investors eagerly speculate on all of the new applications of new technologies, without considering the time-scales or feasibility of these applications.
This kind of speculation leads to overvaluation, and presents the first similarities between cryptocurrencies and the dot-com bubble: cryptocurrencies can attract investment in the same way that most seemingly promising companies with a “.com” suffix could attract venture capital.
This is best illustrated by the recent example of Kodak, who recently launched a new cryptocurrency, ‘KODAKCoin’, as part of an image rights management platform. Kodak has so far released no details on how the system will work, but still saw its share price double in the 24 hours following the announcement. Even more incredibly, Long Island Iced Tea Corp. (an American brand which manufactures Iced Tea and Lemonade) saw its share price rise 289% after rebranding itself as Long Blockchain Corp.
On the other hand, it can be argued that cryptocurrencies are only at the beginning of a bubble, or not in a bubble at all. During its peak, the market capitalisation of the dot-com bubble was $3-5trn (not adjusted for inflation). As it stands, the market capitalisation of all cryptocurrencies is $750bn, suggesting that this is only at the beginning of a bubble.
Another important point is that some companies (such as Pets.com) went bust in the dot-com crash because they were losing money and lacked innovation, whilst some cryptocurrencies are building the next iteration of the internet. Firstly, bitcoin is now genuinely seen as an alternative to money, with over 100,000 merchants worldwide (including Microsoft) accepting it as payment.
Additionally, by introducing smart contracts, Ethereum has become a new platform for projects in the blockchain environment and has disrupted traditional investing by enabling individuals to invest in any token startup and own the core asset they are investing in.
In 1996, John Rothschild wrote, “Joe Kennedy, a famous rich guy in his day, exited the stock market in a timely fashion after a shoeshine boy gave him some stock tips. He figured that when the shoeshine boys have tips, the market is too popular for its own good.” Similarly, social media is saturated with posts about cryptocurrencies from investors of all ages, with even Paris Hilton backing an ICO. This coupled with the fact that any company with a cryptocurrency or with “blockchain” in its name seems to see its share price skyrocket strongly suggests cryptocurrencies are at the beginning of a bubble, much like the early days of the Dotcom era.
Finally, in the same way that Amazon and Adobe survived, and then thrived after the dot-com crash, it’s likely that few innovative cryptocurrencies such as bitcoin and ether will survive the bubble bursting, and will remain household names in the decades to come.
Even if the market capitalisation of cryptocurrencies increases into the trillions before bursting, there may be a silver lining: in the same way that the dot-com bubble gave us the ‘backbone’ of the internet we have today, the cryptocurrency bubble may give us the next iteration of the internet, web 3.0.