Three Thoughts on the “Crypto Bubble”

There are lots of warnings being written in the last two weeks about a price bubble in cryptocurrency. Many seem very simplistic in their analysis, focusing entirely on the run-up in price of the leading tokens, and the frenzy around ICOs, as evidence that prices must come down.

Some very savvy investors have echoed this sentiment, with a more nuanced POV: the long-term potential is huge, the short-term pricing is unknown, so don’t invest in a way that will leave you exposed in the event of a massive downswing. This is good advice.

There appears to be a frenzy around the issuance of new tokens in the form of ICOs. Many of these new protocols or new apps based around a token have an interesting premise but little if any market proof. By conventional investing metrics, the “risk-reward” on the pricing of many of these seems off, to savvy investors in the space. Unless you deeply understand the details of the new token being offered and have a strong point of view on its value, this seems more like gambling than investing.

In my view, BTC and ETH are different. There is much that is unproven about their long-term success, but there has been a lot of de-risking of these protocols already. They have vibrant developer ecosystems, a diverse ownership base and highly liquid trading.

With that as context, there are three thoughts I would like to add to the discourse that I have not seen widely discussed:

1. Equity bubbles are a poor analogy for what is happening in BTC and ETH. One can sanely argue an equity is overvalued by forecasting future performance of the business and the resulting cash generated. In the dotcom bubble, a company called Internet Capital Group had $70M in revenue, $150M in net losses, and peaked at a $56 billion market cap. You don’t have to be great at math to figure out the business was unlikely to produce the profits necessary to support that value.

Bitcoin is not comparable: as a unit of value independent of any earning stream or productive use, the total money supply is untethered by economic productivity. Some, like Warren Buffett, view assets like Bitcoin and gold negatively, and eschew asset investments that lack a means of producing cash flow.

But as a unit of money, it also means the value of Bitcoin can sustainably grow at a much faster pace than most real-world businesses because it is untethered by building products or services, it is solely tethered to how many people believe that it is a valid store of wealth. The world believes gold is a reliable store of value to the tune of trillions of dollars. If and when the world believes the same about Bitcoin, it will be worth 100x-1000x what it trades for today, and that can happen at whatever is the speed limit of people “buying in.”

2. It may be true that a price rise in BTC and ETH driven by an influx of speculators is indeed a “bubble” that could burst. However, unlike equity bubbles, the addition of new buyers to the ecosystem literally increases the value of the underlying token. The value (given fixed supply) is simply a product of scarcity, which is going to be directly related to how many people hold the currency. An additional buyer of Tesla stock does not increase the long-term cash flow of the underlying business, but each additional speculator who decides that Bitcoin is valuable increases the underlying value of Bitcoin. If Bitcoin succeeds, there will likely be a series of tipping-points where the value jumps up due to a widely observed new plateau of acceptance.

3. If you believe the long-term potential of BTC or ETH, I think trading in and out of the token based on price movements is shortsighted. Yes, you might be clever or lucky and make some quick money, but if you are in this for the 100x-1000x potential from here, “profit taking” on small moves is picking up pennies in front of a steamroller. What if Warren Buffett or JP Morgan surprises the world and announces tomorrow they are all-in on Bitcoin and the price goes up 10x overnight and never comes back down? If you have “traded out” you will regret it.

Thanks to NR, AR, JH, AW, BS, and the other BS for reviewing the very poor first draft of this.