Feasibility of Crypto Investing through the Rhymes of History
What a potential crypto consolidation in the future would mean for you
Although it is becoming clear that cryptocurrencies are a disruptive technology that is here to stay, the viability surrounding which cryptocurrency to pick or which is going to be around in five to ten years is not clear. There are at least 19,000 cryptocurrencies (blockchains) in existence today, and 30 new cryptocurrencies have been added to coinmarketcap.com in the last three days (May 31 - June 2, 2022). The sheer volume of cryptocurrencies has created a market frenzy, making it difficult to select which currency will succeed in the long run. This is largely due to the lack of true backing in crypto and the uncertainty surrounding a relatively new industry that has yet to consolidate.
The rapid growth of the cryptocurrency market in the last few years can be compared to the automobile industry at the start of the twentieth century when there were over 3,000 automobile companies. However, by the 1920s, the “Big Three” of Ford, GM, and Chrysler emerged in the automobile industry – and by the mid-twentieth century, the Big Three had captured an 80% market share.
Although the World Wars and the Great Depression were some of the push factors that prompted the number of automobile companies to dwindle, these extenuating circumstances do not outweigh the fact that the automobile industry consolidated into the “Big Three.” Ford, GM, and Chrysler succeeded by stiffing out competitors in the emerging industry at the time. This portrays just how hard it is to pick the correct emerging technology because it is unpredictable which companies will succeed and which will crumble. While investors would have predicted that automobiles were a transformative technology, they would have had a 1 in 1,000 chance of picking the winning automobile company.
“It’s different this time.”
If you think that crypto is different from the automobile consolidation in the early 1900s, let’s look at other historical events that will tell you otherwise. Reaching further back into history, the tulip bulb mania of 1634 was a bubble that was rooted in Dutch merchants and aristocrats buying into the hype. Tulips - yes, the flower - became a symbol of luxury and status in Dutch culture during the mid-1600s that grew to such prominence that people were trading entire properties for a single tulip. Graham Weaver, Founder and CEO of Alpine Investors, explains the bubble well:
As prices continued to increase, many made fortunes trading the bulbs. At the peak of the mania, some farmers traded their homes for a single tulip bulb. The prices remained volatile but continued to increase for several years. In February 1637, buyer demand dried up, prices collapsed, and fortunes and lives were destroyed.
History rhymes. Once the demand for an overvalued asset peaks, buying into the hype - especially in industries that cannot be measured by their intrinsic value - can result in financial turmoil for individual investors.
To look at a more recent example, let's take a look at the Dotcom bubble of the late 1990s and early 2000s. While it was apparent that the Internet was going to have a transformative impact on the daily lives of humans, people invested into Internet startups simply with the hope that they would become profitable in the future. Most of these investments were made based on the fear of not being able to cash in on the increasing use of the Internet in society (aka FOMO). This form of speculative investing failed when dotcoms could not turn a profit, which led to the NASDAQ falling 75% from March 2000 to October 2002, erasing the previous gains of the NASDAQ from January 1995 to March 2000 when it increased by 582%.
Although Internet startups have transformed society, they were not sound investments at the turn of the century because of their overvaluation. As a result of the Dotcom bubble, investors lost over $5 trillion. That’s more money than the total value of all major cryptocurrencies in the world ($2.48 trillion as of November 2021).
This jaw-dropping loss in capital should be a warning to all who are investing in exciting new technologies. After the market frenzy of crypto ends, how are you able to predict which cryptocurrency will survive? An instance of this is evident in comparison to two companies in the Dotcom bubble:
Is Dogecoin the Google of crypto or is it the modern day equivalent of defunct search engine Askjeeves.com?
You’re probably asking yourself, “What is Askjeeves?” That’s the point. Although Dogecoin is seen by most as a meme coin, it still conveys the point. How are you able to predict which exciting, yet unseasoned, cryptocurrency will succeed?
History is cyclical. As the great Winston Churchill once said while paraphrasing George Santayana, “Those who fail to learn from history are condemned to repeat it.” I’m not saying don’t invest in crypto. I believe that it will be an emerging industry in the coming years. I’m just warning all of the high schoolers who think they know which currency to invest in or which NFT will make them money. Don’t believe all the hype from influencers on social media. Almost none of you will make a profit in NFTs like Gary Vee.
Definition of a Bubble
Renowned Yale Professor of Economics Robert Schiller defines a bubble well as he compares Bitcoin to previous bubbles:
In my book Irrational Exuberance in 2005, I defined a bubble as “a situation in which news of price increases spurs investor enthusiasm, which spreads by psychological contagion from person to person, in the process amplifying stories that might justify the price increases, and bringing in a larger and larger class of investors who, despite doubts about the real value of an investment, are drawn to it partly by envy of others' successes and partly through a gamblers' excitement.”
Many researchers would find this definition unworkable, because it has psychological terms in it. But the Bitcoin events clearly fit this definition, in 2013 in the original flush of excitement for Bitcoin, and then, after a temporary collapse in Bitcoin value, again now in 2017.
The investor enthusiasm for cryptocurrencies is real and here to stay, but it has driven the prices of these currencies up substantially in a relatively short period of time. This frenzy could end badly for many investors because the winners who emerge from manias are often unpredictable.
Conclusion
How do you know the currency you're investing in now is going to be the one that will give you returns in five to ten years time when blockchain and crypto adoption will be even more prevalent? If you believe you know that the currency you are investing in will give you returns, how are you calculating its intrinsic value? Remember, the intrinsic value of crypto cannot be calculated by the growth of FOMO. Do you have to calculate its intrinsic value more like a commodity rather than as a business? If you do not have answers to any of these, but you are still investing into crypto, ask yourself “Why?”
While I am not calling for Gen Zers to avoid investing in the crypto market, I am trying to educate those who have invested and those thinking about investing about all the uncertainty and speculation surrounding this asset class. Allocating capital into Bitcoin has been difficult to time for individual investors with the cryptocurrency dropping by 50% from its peak last November in May of 2022. The reverse is also true: If you shorted Bitcoin in December 2020 when it was at $18,000, you would have timed it so poorly as it rose to $63,000 just five months later in April 2021.
So don’t invest in any asset - not just crypto - if your only strategy for valuing a company is in the belief that someone will pay you more for it than you did in the future. Consolidation is inevitable - especially in emerging technologies.
More links:
CIO & CEO of Soros Fund Management Interview - David Rubenstein Show
Crypto, Though Vulnerable, is Here to Stay
Interesting take on Ethereum gaining more traction than Bitcoin due to ESG concerns of Bitcoin
Why should it be assumed that the cryptocurrency market will consolidate (like automobiles) or completely die out (like TB Mania)? Is it possible for a diverse coin market that has come down to earth to thrive in the future - which appears to have more of a correlation to the Dotcom crash (insane overflation of market before regression than steady growth)?