Does Crypto = Dotcom?

The great challenge of bubbles is that they can really only be identified in hindsight.
— Tadas Viskanta

2017 has been a wild year for cryptos. As the year progressed and the price increased, so did the volume of those clamoring that we are in the midst of a bubble that is destined to end in tears and disappointment. Unfortunately, nobody knows. We certainly might be, but bubbles are notoriously difficult to spot when you’re in the midst of one. Yet, labelling an asset or market as a bubble is the easy and safe path because eventually, when correction day comes, the detractors will feel vindicated. The fact remains though that nobody keeps track of how many times these voices were wrong in calling a top and how much profit they missed along the way. It reminds me of the headlines we see each year claiming that this will be the year the stock market collapses — only for the market to continue ascending to new highs.

Yesterday, the Wall Street Journal published this article questioning whether Bitcoin was in bubble territory. The article came with the chart below showing the blistering pace that Bitcoin appreciated in 2017 alone. But I find the chart, and the thinking behind it, a little misleading. At first glance, it’s certainly startling and it looks like we’re all fools for holding a flaming bag of ****. However, when I compare the crypto frenzy with the dotcom bubble, there are a few important differentiators to think about.

Chart credit:    Wall Street Journal   .

Chart credit: Wall Street Journal.

Global Investor Base

Firstly, the dotcom bubble was generally centered in the United States. Investors were either based here, or, if they were international, were sophisticated enough to have access to the US markets. The dotcom stocks were therefore supported by a smaller investor base with a smaller pool of capital relative to the global crypto market. Access to the market was easy in the US but was far more complex for international investors. Crypto assets can be purchased anywhere in the world (although in some jurisdictions, like China, they do require some hoops to jump through due to regulatory restrictions). This global base gives them a much larger pool of capital to draw from than the dotcom stocks had — meaning that this “bubble” has the potential to get much larger.

Dotcom Market Cap Dwarfs the Crypto Market Cap

Secondly, at the bubble’s peak, the dotcom market cap was worth roughly US$1.6 trillion in value. A hefty amount, which largely vaporized once the bubble burst. Comparing that to crypto assets, the current crypto market cap(at time of publication) is “only” US$300 billion, which is less than 1/5th the size of the dotcom bubble. Of that US$300 billion, Bitcoin represents about US$160 billion —just over 50% of all crypto assets being tracked. The chart above does not compare those metrics as it only shows the 2017 rate of change. That is an important indicator, but by looking at Bitcoin’s vertical yellow line in the chart, the reader is left to think that it is being valued at a greater level than the dotcom stocks were. If we want to compare apples to apples, Bitcoin would need to grow 10x to have an equal market cap. Now, the crypto asset market cap does not need to match the absolute dollar value of the dotcom market cap before the “bubble” bursts. But when you consider that crypto assets are accessible by an enormous global market (not just the US), most of whom are still skeptical, it makes me think that we probably have not yet reached the point of investor saturation. As such, there is probably a lot more capital due to flow into this new market.

It’s the Reverse Bubble

Thirdly, most speculative bubbles in that chart were initially inflated by institutional investors. For example, the dotcom bubble did not start with your grandma funding It started with venture capital checks that were written by some pretty bright people. This was then followed by the investment banks, hedge funds and private equity. Only after the startups went public (so that the institutional investors received liquidity on their investments), did retail investors get a bite of the apple.

With cryptos, this pattern is operating in reverse. What began as a grassroots movement of cypherpunks, enthusiasts and early adopters, was not treated seriously by institutions who dismissed it as a bubble and/or fraud. Their myopic outlook can probably be chalked up as another case of the innovators dilemma. However, the institutional investors are starting to stir, especially as they realize that the help on their Connecticut estates got better returns with Bitcoin this year than they did. In all fairness though, the financial infrastructure for the institutional entry is only now rolling out (CME futures in less than 2 weeks, Nasdaq futures soon after, and, hopefully soon, ETFs), and so the big money may only just be joining the party. This makes me think that either all those ivy league MBAs are either incredibly foolish as they start entering at levels their detracting peers claim to be the top of a bubble, or we’re in the early innings of something much bigger.

Just the Warmup

Taking all this into account, perhaps this monstrous run to $10,000 (the scale of which we probably won’t see again in our lifetimes) is just be round one. We probably won’t see 1,000% returns in 2018 and beyond, but if we get a more modest 100% gain from here, it still gets us to $20,000. Of course, it won’t rise in a straight line and there’ll be plenty of opportunities in the near term for pessimists to pat themselves on the back. But if over time the bullish case turns out to be right, then in a few years we may look at this period as just a little bump on an outrageous chart.

Disclaimer #1: This is not investment advice. Do your own due diligence.

Disclaimer #2: I currently hold bitcoin, as well as other crypto assets.