Is cryptocurrency a bubble? That’s the 800 billion dollar question. In the past, we have seen Bitcoin hit new all time highs followed by a frenzy of new investors buying their first cryptocurrency.
In this article we will analyze bubbles throughout history, draw parallels with the cryptocurrency market and reveal our buying strategy for cryptocurrencies.
- 1 What Is A Bubble?
- 2 Is Cryptocurrency A Bubble?
- 3 Crypto Bubble. What Other Evidence Have you Got?
- 4 What Is The Rational Price For Cryptocurrencies?
- 5 3 Major Bubbles Of The Past And What They Can Tell Us About The Future Of Cryptocurrency?
- 6 Common Themes Of Bubbles
- 7 Why Bubbles Are Good?
- 8 When To Buy Into The Crypto Bubble?
- 9 What Do Historic Bubbles Teach Us To Invest In?
- 10 Conclusion
What Is A Bubble?
It is a point in a market cycle where rational investment goes out the window and is replaced by ‘emotional investing’. This type of investment is not driven by the assets actual worth, but by expectations for the future, the fear of missing out and greed.
In financial markets we see ‘emotional investing’ leading to a herd mentality time and time again. If an asset is “hot” then naturally news outlets start to report on the asset more frequently and this increases public awareness and enthusiasm. The result is that more and more new people buy the asset and this pushes up demand and the price increases as a result. We saw this type of behaviour peak with Bitcoin in December 2017, resulting in a $20,000 all time high for Bitcoin.
Once the euphoria subsides then the price corrects. The fall in price is usually driven by denial, fear, capitulation and despair. This is known as the ‘bubble popping’. The thing with market cycles is that they tend to repeat themselves over and over again. A bubble pops and usually a new bullrun is born. This explains Bitcoin’s volatility over the years.
Is Cryptocurrency A Bubble?
In short, we believe that cryptocurrency is in a bubble. The reason is that price action for the overall cryptocurrency market cap seems to be largely driven by emotion. A great example of this are the big movements in cryptocurrency prices based on rumours e.g. the rumour of Ripple being added to Coinbase on 5th March 2018 which resulted in a nearly 6% price increase.
We are not intending to spread fear, uncertainty and doubt in the market. It is just that our analysis leads us to believe that new technology and bubbles come hand in hand. In fact we could go as far to say that it is inevitable for new technology to cause bubbles.
Crypto Bubble. What Other Evidence Have you Got?
Currently in the market there is a disconnect in the large gap between crypto prices and the technology:
- Cardano has no working product and has a current market cap $6.5bn (all time high of $33bn).
- EOS has no working product and hit an all time high marketcap of $12 billion.
How can something with no working product ever have been valued so highly? It is due to the expectation of future results. There is no inherent problem for there to be a tech and price gap, provided that the project delivers in the future. If blockchain technology and cryptocurrency are adopted widely, those that actually deliver products and solve real world problems are likely to become the Amazons of tomorrow.
We think cryptocurrencies are in a bubble because the difference between price and the underlying tech / adoption is as large as it is. The price of crypto is not driven so much by fundamentals such as; number of users, revenue and working products. Instead the chief driver of crypto valuations is expectation:
- The value and adoption that may occur from new partnerships.
- The marketshare that the project may take in the niche it’s competing in.
- The product will be rolled out as outlined in their white paper.
- Cryptos will increase in price in the future.
This is why we think cryptocurrency prices have currently been driven beyond “any accurate or rational reflection of their actual worth”. Because of this, the cryptocurrency market is in a bubble.
However, being a bubble doesn’t actually destroy the investment case at all. If you think about any new technology, value is always based on expectation. No new technology is created and instantly achieves mass adoption. These things take time and cryptocurrency is no different.
What Is The Rational Price For Cryptocurrencies?
It’s very hard to determine what a specific cryptocurrency is actually worth. A lot of crypto projects have no working product and only a promise to deliver in the future. We are sure you have heard people saying something like this:
‘crypto X is amazing and will revolutionize [insert niche] which is a [insert value] dollar market. If crypto X even gets Y% market share then it would be worth [insert value]. Today’s prices are amazingly cheap when you consider this. Get in now to make lots of money.’
With cryptocurrency we must accept that no one knows for sure if it will be adopted at scale. The value in cryptocurrencies is their ability to provide better solutions to real problems. These solutions only become really valuable if they are mass-adopted.
In business we call this a network effect. For example: if there is one person on Facebook, it has essentially no value whatsoever. If 2 billion people are using Facebook then the FB network becomes extremely valuable. The same is true with cryptocurrency. This is why you will hear so many people making a big deal of crypto or Bitcoin adoption. Adoption simply means that there are more users on a network and this drives up cryptocurrency valuations.
Anyone who tells you that a cryptocurrency should be valued at X, frankly doesn’t have a clue and is just speculating. We think the important questions to ask are:
- Does the project you are interested in solve a real problem?
- Is the solution better than what is out there?
- In time do you think lots of people will actually use the solution?
- Is now an acceptable entry price for investment?
It’s quite simple: if a cryptocurrency has zero users, it will eventually be worth nothing.
3 Major Bubbles Of The Past And What They Can Tell Us About The Future Of Cryptocurrency?
Most readers will probably believe that bubbles are a bad thing. We at TC beg to differ and see bubbles as a good thing. Let us explain and review what happened in historical bubbles.
The UK Railway Mania Of The 1840’s
The first steam locomotive railway was launched in 1804. In the early days of railway building, any new project would require the authorisation of Parliament to go ahead. There was a mini railway mania between 1836 to 1837 where Parliament authorised the creation of 59 railways.
In the 1840’s less regulation and a stronger economy resulted in the creation of 100’s of UK railway companies in a very short space of time. Share prices for all these companies were going through the roof and many ordinary people became heavily invested in railway projects. This resulted in the asset bubble known as Railway Mania.
It should be noted that the steam locomotive was not new technology in the 1840’s. People saw the value of being able to transport people and goods, faster and at a lower cost than ever before. Investors foresaw the creation of a ‘new economy’ and wanted to invest in that.
You know, railway investors were correct. Railways were indeed the future. But whatever country you are in right now, find out how many railway companies operate in it and how long they have been in business for. We would bet on it being a very short list.
The Railway Mania bubble was essential for the existence of the railways we see today across the globe. The bubble funded the technical infrastructure (railway lines) and enabled mass railway adoption.
The Dotcom Bubble 1997 – 2001
A huge number of companies were set up in a short space of time. Share prices for online business were going through the roof. Revenue and fundamentals didn’t matter. Simply being online meant a business would have it’s share price driven upwards.
Even adding .com on the end of a company’s name was enough to see a massive increase in share price. We can see this impact on share price today with companies like Kodak. In Jan 2018 Kodak announced its intention:
“to build a digital rights management platform—dubbed KODAKOne—that will utilize blockchain technology and continually crawl the web to monitor and protect the IP of images registered to the system.”
After the announcement the Kodak share price increased by 250% within two days. This seems very similar to what happened in the dotcom boom to us. Like with the dotcom boom, many people have been interested in cryptocurrency trading and investing in projects with no revenues.
Yes, investors buying into companies during the dotcom bubble probably lost money. But those that invested in the right companies and HODL’d, did very well indeed. Amazon was founded in 1994 and had a share price of over $100 at the peak of the dotcom bubble. After the bubble burst it had a share price of less than $10. Today, Amazon shares are trading at $1,545 a share. Those that invested in Amazon even at the peak, still have a 15 times return on their money if they HODL’d it til today.
It is actually the investment made in the dotcom period that we have to thank driving the upgrade of technical infrastructure. This includes the connection of houses, cities and countries to the internet. This infrastructure was the foundation of our online world today.
Dutch Tulip Bubble 1634-1637
Maybe this is one of the most insane bubbles in history. One tulip bulb reached the price of a house in this mania. What people don’t talk about is that long term this was probably great for Holland. Sound mad? Well, a fun fact is that Holland exports around €214 million worth of tulips a year. That’s every year. If the Tulip mania had not happened, Would Holland have become a tulip powerhouse? We would actually argue that the tulip bubble created a lot of long term value.
Common Themes Of Bubbles
With any bubble, investors invariably say things like “New Economy” and “this technology will change everything”. More often than not, this claim is actually true and the masses have predicted the future. The problem with such expectations is that many are disappointed with how long it actually takes for the new technology to be widely adopted.
With cryptocurrency, we think there is a bubble, but we also believe that blockchain projects will change the world long term. The fact that many people are now asking the question ‘is cryptocurrency a bubble?’ is actually good news for the technology and eventual mass adoption, if we study the history of past bubbles.
Want more evidence cryptocurrency is in a bubble? Well, let’s look at ICO mania between summer 2017 and present.
- The number of ICOs has increased dramatically. This is similar to what happened with lots of internet and railway companies being set up in a short space of time.
- Most ICOs have no working product and ICOs are valuing their companies at ever higher levels. This means there is a increasing gap between the cryptos price and technology. The valuations are instead driven by future expectation, rather than fundamentals.
It should be noted that we believe that there are many good ICOs and real innovation happening in the space. We are conditioned to believe: Bubble = Bad. In fact we think its the opposite and Bubble = Good.
Why Bubbles Are Good?
With any new technology or innovation, it needs funding for it to become an actual product and then to be adopted widely. Quite simply, people do not work for free. The media hype surrounding bubbles is good, as it makes more people aware of the technology. This is important to help mass adoption at a later date.
In an ICO, the company is actually raising the money they think is required to achieve the full roadmap. Sometimes this is over 5 years into the future or longer. This results in the existing projects already being paid up in full. There is no nasty investor there to pull funding and kill the project. This means innovation is free to prosper without funding concerns and we think this is a great thing for the future of cryptocurrency projects.
The infrastructure built now should serve future cryptocurrency projects well in the future. What kind of infrastructure does crypto need?
Simply buying cryptocurrency requires infrastructure. I might have to deposit on Coinbase and transfer my Bitcoin to Binance to get some hot coin. Coinbase and Binance are a type of infrastructure for the crypto world.
Another example would be a developer platform like Ethereum. The decentralized applications built upon it benefit from the infrastructure already laid down by Ethereum.
Remember, bubbles signal good things for the future of cryptocurrency.
When To Buy Into The Crypto Bubble?
If you are thinking about investing in cryptocurrency, only you can decide if the risk is worth taking. However, we personally follow a few rules of when and how to invest.
- All Time High, Do Not Buy. We never buy cryptocurrencies when they are at an all time high. This prevents you from being the poor guy buying Bitcoin at $20,000 and panic selling at $6,000. We believe that every asset is worth buying at the right price.
- Dollar Cost Averaging Is Powerful. Putting aside a fixed amount every month and investing means that you spread out your entry point e.g buying fewer tokens when the price is high and more when the price is low. This strategy helps avoid going all in at really high prices and the temptation to sell when the market dips.
- Do The Opposite of What You Hear On The News. Hear that Bitcoin is dead? It’s probably a good time to buy. See CNBC making a video on how to buy Ripple? Chances are that the market is near the top and now is a good time to sell out.
- Don’t Buy The Hype. Is everyone talking about cryptocurrency or some hot new coin? Chances are the price is inflated and it’s not a good time to buy the crypto. Better to wait when no one is talking about it and the market dips.
What Do Historic Bubbles Teach Us To Invest In?
From what we have learnt from past bubbles, what survives after the bubble pops? The common theme is new infrastructure. This is why we love the investment case for cryptos that are infrastructure plays. Not all of them will succeed, but we are confident that when the bubble pops, the next Amazon to rise out of the ashes will be an infrastructure crypto.
No one knows if cryptocurrency will have a long term place in the world or create the New Economy as so many claim. Is cryptocurrency a bubble? We do believe so but argue that bubbles are actually required for new technology to prosper. If you are thinking about investing in cryptocurrency, just remember that if projects do not deliver and close the gap between price and tech, then the price will very likely go down.
Only invest what you are willing to lose. But remember that if crypto succeeds, your support for the cryptocurrency market was necessary to make it possible.
Love crypto? Then you should love news of crypto bubbles!