The big blockchain and ICO boom: have we seen this movie before?

Surging markets, heady times in blockchain’s BSO (Bright Shiny Object) Era

There’s no question blockchain and cryptocurrencies are experiencing a period of frothy obsession, with breathless hype from true believers, ubiquitous coverage in tech and financial media and an eerie sense of déjà vu from experienced market hands. With the price of Bitcoin surging toward $8,000 and with over $1.7 billion raised in ICOs this year, stories of fantastic returns and overnight multimillionaires are attracting attention from everyone from professional investors to techies to regular citizens to unscrupulous scammers to regulators…

Are we in a crypto bubble?

Absolutely yes, but there is value in the promise of the underlying technology. There are numerous parallels to the Internet boom in the 1990s, when investors tossed money at young founders, driving valuations to Himalayan levels. After the irrational exuberance imploded in 2000–2001, vaporizing trillions in paper market wealth, it was a long slow climb for the winners to emerge from the ashes but two decades on, the US economy is being reshaped by many of the same crazy ideas that came out of the first Internet Bubble.

Bubbles inevitably end, but good ideas will persist. Akamai is a poster child of the Internet boom. Founded as a content delivery network for websites content after the IPO, the stock shot up to a high of $344, then collapsed to around $2 after the crash, slowly recovering to trade around $55 today. Most companies that experienced that kind of wild ride did not survive, but a few have become giants. Amazon.com, Ebay, Google and Salesforce.com have decisively shaped the current business and economic landscape since they were founded in the 1990s.

We’ve seen this movie before, (almost) everybody dies in the end

There are numerous parallels with the Internet in the early 1990s, both positive and negative. Back in the early days of the ‘Net, when AOL dial-up was how most Americas got web access, the Internet “gold rush” created an unprecedented bubble in the stock markets. A flurry of IPOs flooded exchanges with stocks of companies that often had limited track records, inexperienced management teams and shaky financials. What these newbies offered was a way for the average investor to get a share of the “New Economy” — a traditional business had only to add an “e” or “i” prefix, or a .com suffix to their brand to see a boost to the stock price. With the innovation of Initial Coin Offerings and Initial Token Offerings, there are similar patterns emerging.

Drawing parallels between the Internet bubble and today’s ICO frenzy

There are several common themes between the blockchain mania today and the Dot.com bubble in the 1990s:

1) Hot new technology with exponential characteristics. There’s no question that both adoption of the Internet and interest in Bitcoin evidence “viral” growth. Growth like this attracts the interest of entrepreneurs, investors and regular folk who want to get in on the action.

2) Young wizards with scarce, arcane knowledge. Back in the first dot.com era, technologies like TCP/IP, HTTP and web browsers were brand new, and the clever young computer science and networking experts held the keys to the kingdom. Today, blockchain technologies draw from experts in cryptography and advanced mathematics, and the young sages often of Eastern European origin are the high priests of the universe of distributed ledgers.

3) Cambrian innovations — with new ideas in every sector of the economy. The early Internet was about changing everything from the physical world to doing it online — reading newspapers, buying pet food, ordering books…many of the early businesses didn’t survive, but there was experimentation in every part of the economy. Glance at a list of current ICOs and the same dynamics are in play.

4) Creative metrics to value investments. Without earnings or even revenues to justify stratospheric valuations, dot.com touts highlighted “eyeballs” and other non-financial metrics as a way to benchmark growth. Today’s ICOs often lack revenues, customers and even product prototypes due to their early stages, so creative investors toy with metrics such as the number of developers in the community or code commits.

5) Complete silliness and FOMO (Fear of Missing Out). Buying pet food online wasn’t really a bad idea, it was just ahead of its time. One of the popular themes in the Dot.com era was the creation of Internet Incubators like CMGI or Internet Capital Group, or Vengold — the Canadian gold mining company that sold its assets to become an internet incubator. There’s plenty of that in the crypto world — from DogeCoin (started as a joke and now with a $153 million market cap), and my favorite — the Useless Ethereum Token — a token so useless that the creator tells people it has no value — and not to buy it, and it STILL raised $109,000 in Ethereum tokens.

What do these parallels mean for the ICO market?

Much of the demand for ICOs is coming from crypto investors long Bitcoin or Ethereum, who want to diversify their gains their rather than cash out completely. Back in the dot.com bubble, companies with inflated share prices were able to do enormous M&A deals involving pure stock-for-stock transactions. Big deals like the $4.2 billion Kana-Silknet merger or the $6 billion Phone.com-Software.com merger ended up with the shares of the combined companies tanking when the bubble burst. Kana software was acquired in 2010 for a grand total of $40 million by KKR. Phone.com (later OpenWave) was delisted from the NASDAQ in 2008 for failing to report its results.

The inflated value of stock prices driven by speculation created a lot of paper wealth, and many ended up with little or nothing to show for it. Not everyone can be Mark Cuban and sell at the top! There’s the risk that ICOs or ITOs that have banked big balances of Ethereum or Bitcoin could experience a lot of pain if there is another crash in crypto valuations. Companies that will be survivors will spend wisely, focus on creating great products, and grow their businesses as they pursue their visions.

Diligence and a critical eye needed to evaluate blockchain opportunities

I am very much a believer in the potential for blockchain to transform and reshape industries over the long term, and it’s too early to whether this could take a few years or a couple of decades. There’s no doubt that the potential is compelling, and there will be good things that arise from the increasingly higher quality of management teams and established companies drawn to the space. That said, it’s not a bad idea to exercise extra prudence as an investor. Bubbles have a way of causing sensible people to lower their guard when there’s opportunities for huge returns.

As an equity research analyst with a deep background evaluating enterprise software, I’ve seen how difficult it can be to effectively value early stage companies whose assets are their people, and whose products are nothing but code. ICO’s and ITO’s are at their core software companies, and it will require a combination of art, science and business discipline to effectively evaluate the new class of crypto assets. Will the next Amazon or Google emerge from blockchain? Nobody knows which ones for now, but what’s undoubtedly so is the potential for compelling innovations ahead.