Updated Cryptothoughts — Bubblemania
Less than 10 weeks have passed since I last wrote about the Cryptobubble and while that might seem like prescious little time, in crypto terms it is the equivalent of a few years. The update also seems necessary to put into writing due to the never-ending line of people asking me about Bitcoin et al.
Before I go on, let me state a few things very clearly: I am positive on Cryptos and believe they are just starting to revolutionize the internet and perhaps finance. Also — you will note that my tone on some assets may have ‘moderated’ from my last post. I too am a learner after all. In that same breath: I have about 5 years of crypto experience, but I am not a coder and while I try to improve, my technical knowledge of the blockchain is probably just better than a beginner’s. I have a grasp of how it works and read some books and blogs, but I am by no means even close to an authority. And finally, all of this is opinion, nothing is investment advice.
Despite my assurances at the beginning some people would likely call me out for this bubble talk. However, I would like to remind those that a bubble is not recognized by falling prices. So Bitcoin swinging from all time high to all time high is precisely what a bubble makes. The main reason I think cryptos are in a bubble are as follows:
If you read the guys who are getting richer in crypto on Twitter, the analogies to 2000 are deafening. “You cannot use classic valuation tools for Crypto assets” or a claim that via some “network effect” (read: more people buying stuff) all digital tokens and assets have a skyrocketing value even if and when the start ups that ICOed them publically state that they will be a non-profit and that the token they emitted will not receive payments or have any other product use are happening constantly. This is verbatim what happened in 2000.
- Bar talk
It does not matter where I go. Everyone talks about Bitcoin. A taxi driver recently tried to convince me of his magical crypto trading ‘skills’. People not yet invested attentively listen to the get rich quick stories of others who ‘flipped’ their first ICO.
- ICO mania
If you have not yet heard of ICOs, they are “initial coin offerings”. It basically means that a group of people with an idea whether it is a start up product or another improved blockchain sell a digital token to investors by asking them for either Ether or Bitcoin (mostly ether) in return. 90% of tokens carry no promise of an eventual dividend but do offer a vague promise of use in an eventual product. They certainly do not carry voting rights (admittedly some do) akin to equity. Ie the money raised via these ICOs is for ‘hot air’. Also please note that showering 5–10 people organizations with no working product with 200m USD that has no strings attached and no voting rights might not be very strong motivation to still work hard to succeed. At best most of the ICOs are very expensive kickstarters. ICOs have raised over 1.4bn USD in 2017. Let that sink in. For hot air. I do not know of a technology related start up or small company not contemplating an ICO (that is within my circle of friends). This is very much what happened to IPOs on the technology-leaning ‘new markets’ in 2000.
Why the bubble will burst
Regardless of the promise of blockchain technology and even Bitcoin and Ethereum, along with some other cryptos (Blockstack, Filecoin, Monaco, TenX, Tezos), the bubble will burst. Note that the internet bubble burst despite companies like Amazon, Google and Facebook dominating our age. History will repeat. Here are my reasons:
- A new generation of investors
There are people in crypo that have experienced 2000–2004. However those are in the minority. Just like the current US voting generation and even some European ones have no more sensors for Hitler-like propaganda machineries, these investors lack the radar for investments in the classical sense. Yet all the same human behaviour that applies to stocks, applied to tulips and applies to any other market will also apply to cryptos. With the bubble-experience missing for most people in crypto today they won’t spot it.
This is perhaps the most important reason. I know that cryptos are decentralized, but the SEC has been pretty clear in looking at the DAO: Token are securities, even if they lack any economic promise. As long as people buy them primarily to make a profit they are securities. This means that the entire 1.4bn USD ICOmania with very few exceptions is in breach of US regulations. The SEC has also made clear that it does not matter if US investors are excluded as the token firm cannot prove the identity of their investors so US investors could be among them. What is more important, exchanges that allow trading in US securities need to follow regulations and need to ban trading in token that do not follow the rules. While most ICO firms are not in the US, a lot of large exchanges are… the likelihood the SEC cracks down on one of them to make an example, leading to a suspension in ERC 20 token trading or worse a seizure of assets is highly likely in my view and I cannot imagine it will take longer than end of 2017 nor that other jurisdictions would not follow suit. When it happens, expect token prices to tank (as they should).
Cryptotrading is spread out amongst more than 20 exchanges. Volume at many of these places is wafer thin compared to the masses of people who might want to get out. If and when people get scared, any move down will be amplified quickly as ‘cashing out’ into fiat is quite hard depending on how much you want to cash out.
What it might mean for Cryptos
While the short term ramifications would be clearly negative, over the medium term, I would expect the bursting of the bubble to be a positive. Regarding different cryptos, here is what I think:
- Bitcoin (and some others)
I think that independent blockchains / technologies will be reasonably immune. Ie Bitcoin, Tezos, Litecoin, Lisk, Stratis and quite a few others should be fine. They have not been the major outlet of the ICO craze and their value proposition is different. Most have been around for a long time as well. I would expect the effect to be 2–3x as bad as the rejection of the Winkelvoss ETF was on the price of Bitcoin in terms of price move and time to recovery. Bitcoin should be fastest back up and I would say a 20–35% drop on the news with buying following pretty quickly is likely.
Ethereum is the primary vehicle (as the underlying blockchain as well as currency) for the ICO wave. I do think its price has been inflated due to this and I expect it to be hit hard. -50 to -60% is not unlikely. However, one should not forget that ethereum is first and foremost a major technological breakthrough and as long as it remains a go to place for developers of DApps, it will have appreciating value. Therefore it should definitely recover. Once proper ICO regulations are in place, it should even prosper and hit much loftier heights. Only then do I think the “flippening” will actually be a realistic outcome (ether supplanting bitcoin as the highest market cap). It does mean developers will need to stick with ethereum though. When they leave, Ethereum might become irrelevant. Does not look that way though and would only happen if a better technology came along paired with significant network effects on that technology.
- ERC20 Token
These will be hit hardest. Basically they will need to comply with regulations or will become irrelevant. Not all of them obviously, but I do not buy the argument of “we are creating a new wonderful world of public good where profits are irrelevant and we can create value out of thin air and some network effects” for one second. However, the token firms that will choose to comply form, in my opinion, the future of the stockmarket. All others I would expect the same fate of a lot of .coms (-95%).
So as you can see, I do not believe the bursting of the bubble will be a bad thing medium term. After all, Amazon was also worth only a few percent of what it is now at the low point of the internet bubble. Almost all survivors have multipled their earlier highs and the same will happen in crypto. Furthermore the argument that a lot of institutional money is looking to get into cryptos is absolutely valid. Once regulations are in place it will push the revived crypto market to much, much higher highs than where it stands today. After all, I recently saw a report by a large Wall Street bank that said “Bitcoin can be hacked BECAUSE it is decentralized”. Now, I am no technical expert, but this cause-effect relationship is quite far off I believe. So imagine these guys learning more… governments are next of course.
And finally: yes, I personally would still invest. As a beginner I would simply stick to 75/25 Bitcoin/Ethereum and invest 1/3 now, 1/3 after a big step down and 1/3 a few months later, then add regularly. Only invest what you can live without. You can also wait for the regulation clamp down to happen, though the risk is Bitcoin just falls from 8000 to 5000 by that time and today it is at 3800… Let me repeat: this is my opinion, not investment advice and strictly personal.
Thanks for reading and sorry if any concepts should indeed be totally wrong. We always learn…