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Cryptocurrency Bubble May Not Be a Bad Thing

Stan Ward

Stan Ward

October 10, 2017

We in the tech world are no strangers when it comes to investment bubbles, having experienced the dot-com bubble of the late 1990s. If you’re too young to remember the dot-com bubble, suffice to say that every week it seemed a new digital startup would come to market and immediately skyrocket. In those heady days, anything that had a “.com” in its name was soaring. This would happen regardless of whether the nascent company had any earnings or earnings potential down the road. It didn’t matter.

The IPO (Initial Public Offering) would be a smash simply because no investor wanted to be left out of the feeding frenzy. Earnings, shmernings! The stock’s price rise ensured that investors could exit with a profit at any point (until they couldn’t) and maybe, just maybe catch lightning in a bottle and ride that baby to the moon! It worked for a couple of years until the price bubble did what bubbles always do – it burst. Not all investors were losers, however.

Some prescient (or lucky) folks were able to snag shares in companies during the dot-com mania that made them rich. These were the ones who jumped on startups that today are household names. The dot-com bubble created a lot of failed companies – but it also created Amazon, eBay, and Google.

The so-called digitally-savvy are now agog at the potential to strike gold once more, thanks to the burgeoning cryptocurrency market. Investors are flocking to cybercurrencies like moths to a flame. As a result, the market is quite top-heavy. In fact, it may be a bubble about to burst. If so, not all currencies are likely to go belly-up. Let’s take a look at the lay of the land in this often confusing cybermarket and see if we can make some sense of it and maybe debunk some misconceptions.

Cryptocurrencies Myths Debunked

The first major misconception is that there are only Bitcoin and Ethereum, and nothing else. There are actually at least 100 cryptocurrencies with market capitalizations in excess of about $40 million, and hundreds behind them. And, like a good bubble story about to burst, more currencies are joining the party. Seemingly, each month sees a new ICO (Initial Coin Offering). There are folks out there who saw Bitcoin skyrocket from $1 to its present per token value of over $4,000. Naturally, they want a piece of the action.

Investors getting into the mushrooming market are hoping they can pick the Amazon, eBay, or Google version of the next valid cryptocurrency crop. However, to do so, one will have to sift through the hype to find potential value. Some cybercurrencies are simply all hype, looking to piggyback on Bitcoin’s appeal. An example is a recent ICO touted by none other than Paris Hilton. She seems like a reliable, credible spokesperson for an investment, don’t you think?

Hilton endorsed LydianCoin with the cliched,

“Purpose isn’t defined by what you want to achieve but what you want to live for to achieve happiness.” 

What’s not to like about that?

The problem is that it’s difficult to get past the hype and separate the wheat from the chaff. Indeed, some contend that a bubble may be just what’s needed to shake out the losers and separate the strong from the weak.

One such individual is Peter Van Valkenburgh, an expert at blockchain advocacy group, Coin Center. Amazon et al emerged not only unscathed by the dot-com bubble but stronger, and Van Valkenburgh thinks that bubbles aren’t necessarily a bad thing. He comments,

“You can look at bubbles as being socially productive.” 

He also cited bubbles as allocating “capital to long shot, paradigm-shifting innovation” instead of incremental improvements to existing technologies.

Lessons from the Dot-com Bubble

Harking back to the dot-com bubble, it has been pointed out that while many startups had no intrinsic value or earnings. The paper profits that investors made were often plowed back into other startups. Some of those became not only solvent survivors but enormously successful. This could be what’s happening as copycats piggyback on Bitcoin and Ethereum’s backs.

The rising price of Bitcoin and Ethereum also means that early investors in these currencies have a lot of paper profits that they can throw at new projects, just as dot-com millionaires often became investors in subsequent ventures. Blockchain investor William Mougayar comments,

“There’s a lot of new wealth. Everyone who’s gaining from it is being very generous, they’re re-circulating the gains into these ICOs.”

In short, many people who initiated the IPOs of the dot-com era, or who are initiating the ICOs of this cryptocurrency mania, are now make big money. They are then reinvesting it into other shares or coins. This, in turn, makes the market healthier, even as their offerings fall by the wayside.  In the last year alone, hundreds of coin offerings have “floated.” Many raised barely any money, but some have raised tens of millions. A handful have even topped $100 million. Sometimes nothing propels them but hot air.

Some cryptocurrencies have limited appreciation potential, because they were created to represent conventional assets. These currencies can purchase only specific products, from bananas (BananaCoin) to real estate to luxury vacation bookings. It’s easy to see why they may fail. They not only have limited applicability but also lack the trust that makes, say, Bitcoin so popular. If for example, a currency is based on the strength of the banana harvest and there is a poor harvest, that is an additional risk to this type of currency. No so with the most popular currencies, such as Bitcoin, which aren’t hamstrung by being tied to a product or commodity risk. They just face the usual market risk associated with a security or a currency (as if that’s not enough!).

When the dot-com bubble burst in the 2000-2002 period, the strong survived. Then, they thrived. This could well be the case with cryptocurrencies, too, especially as the underlying blockchain technology grows in favour. Ultimately, you need to look before you leap into just any ICO!

Opinions are the writer’s own. 

Nothing in this article is intended as investment advice and should not be taken as such. 

Image credit:By Wit Olszewski/Shutterstock.com
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