Bubble, Bubble, Toil & Trouble

As an investor, I missed the Dot-Com bubble bust. I also missed the Real Estate bubble that led to the Global Financial Crisis in 2008.

How? Well, it was not some superior knowledge or intellect…The secret is I was not active as investor for both of those periods*. As they say:

“Wisdom Comes with Hindsight”

As an active investor (with a track record) the last 4 years, since finishing my MBA**, I also have missed the the development, surge and popularity of Cryptocurrency.

But I have spent the better part of 2017 reading, researching and studying this market (and/or asset class). I find the technology (behind it) fascinating and there does seem to be some practical applications for it.

In each of these booms, no doubt, a lot of money has been made. Some investors (deservedly) reaped large returns on investment, as they were:

1. Early,
2. And/or had foresight in the future,
3. And/or exited and took profits.

The devastation of a bust affects those who are left holding the bag.

So the reason I pen this article, is to provide some caution about one part of the Cryptocurrency market; that is, the Initial Coin Offering (“ICO”).

Let us revisit my previous article, “How to Lose $37,700,000”. Here I distinguished between Price and Value:

In regards to Cryptocurrency generally, the total market cap is approximately $150bn as at 8th October 2017. The leader is Bitcoin ($74bn), followed by Ethereum ($29.5bn) and then Ripple ($10bn).

Consequently the top three account for 76% ($113.5bn)of the Total market cap of all Cryptocurrencies.

So the question as investors is what is the Value of all Cryptocurrencies? And is the market capitalisation greater than, less than or equal to your value estimate?

Essentially, I don’t know the answer to this yet. And I’m not long/short anything Cryptocurrency related. In a future post, I will try and answer this question more fully.

But we don’t need to answer this question now to spot a Bubble.

It’s already ridiculous - There are 1,148 Cryptocurrencies currently. So 0.2% (3/1148) of all Cryptocurrencies account for 76% ($113.5bn/$150bn) of the entire market cap.

How is this so? Why do the other 1,145 even exist?

Well, the answer to this comes from the ICO. The Ethereum Blockchain has enabled anyone to create a “Cryptocurrency” and raise capital from investors in an unregulated environment. Ethereum accounts for more than 50% of the ICO market. I highlight the term “Cryptocurrency” here because they are in fact pseudo-Cryptocurrencies (given the blockchain is the same). The better word to use is Tokens. Here are some:

1. BagCoin — Namely called because you’ll end up as a Bag-holder.
2. FuckToken — The irony being you’ll be F***ed holding this.
3. Billionaire Token— Sure…the place where billionaires invest.

I could go on…But I think you get the gist of this...

This will end badly.

Check out the Monthly $USD raised from ICO’s and cumulative $USD raised, courstesy of CoinDesk:

I know what you’re thinking…You can’t lose right? I repeat:

This will end badly.

To put these $USD raised in ICOs into perspective. I decided to look into how much is raised in the Venture Capital industry.

PWC and CBInsights provide the following chart:

There are a few things to note:

• $2.5bn has been raised from ICOs since 2016, versus, VC financing which is $73.2bn.
• There is a downtrend in VC funding since 2015.

So what forces are at play here?

Well, whilst one could argue the ICO market is only 3.4% of that funded by VC, and so it’s early in the game and not over-cooked. I tend to disagree:

1. You see, VC is on the downtrend because valuations were getting lofty in a zero interest rate environment — too much capital floating around bids up prices (sounds familiar?). Evidently, as interest rates have started to increase gradually, prices paid have fallen (not seen here) and the total capital put to work is less (seen here). This is opposite to the ICOs trend.
2. The total VC funding is 29x greater ($73bn/$2.5bn). But this includes all the various rounds of VC funding — Series A to F. Therefore, it would only be correct to compare total series A rounds to ICOs (which I can’t find data for). This seems fair, because these ICOs are start-ups and are not going-concern businesses that a series B-F would cover.
3. In venture capital, when a funding round is completed, the venture capitalist is receiving equity (or convertible debt/notes) in the business. They are entitled to voting rights, board seats, liquidation preferences and a multitude of other things which are individually negotiated for when capital is provided to grow a business. In ICOs, you get nothing but a token.
4. These tokens are not Cryptocurrencies if they all run on the same Etherium blockchain. They are derivatives. They are not equity in the business. You don’t own the upside of whatever business is being developed.
5. People are sending $USD in the form of Bitcoin or Ether for a token with no underlying value. (I’m ignoring the ambiguity/debate that Bitcoin/Ether have value long-term, because right now they are priced as if they do).
6. Venture Capitalists get the opportunity to invest first, and they get the best start-up businesses. I have no evidence for this (apart from my own experience), but I’m quite confident that these ICO companies are those that couldn’t attract real VC regulated funding.

Does it still looks attractive to jump in?

If that hasn’t pushed you over the edge, let me ask you the following question?

What do Paris Hilton, Floyd Mayweather Jr. and Jamie Foxx have in common?

Let me show you:

Now, all these celebrities are talented in their own field. And in their defence, these may be paid/sponsored tweets that they may not be aware of (Assuming someone manages these accounts for them)…I don’t know.

What I do know, is that one shouldn’t take financial advise from any of them. If they are paid tweets, or if they are actually investing, their incentives are not aligned with yours. So the takeaway is:

Lesson 2:

Run when a celebrity tries and sells you an “asset”***. Incentives matter.

In summary, I’m calling a Bubble on ICOs for the following reasons:

1. 76% of the Market Cap of all Cryptocurrencies comes from 0.2% (3 out of 1148)
2. The Ethereum Blockchain platform/tool-set is providing the fuel for the insurgence of ICOs (>50% of ICOs)
3. The trend in VC pricing is down. The total funding of VC is down from 2015. Yet, ICOs are growing exponentially.
4. People are sending real $USD (or the equivalent in Bitcoin/Ether) for the opportunity to own a Token that has zero value, zero voting rights, and zero equity in a business.
5. ICO businesses (if you were getting equity, which you are not) are the ones that couldn’t get capital from traditional venture funding (regulated).
6. You shouldn’t take financial advise Paris Hilton, Floyd Mayweather Jr. and Jamie Fox.
7. The tokens created in an ICO are all derivatives. And as Warren Buffett has highlighted before:

“Derivatives are Weapons of Mass Financial Destruction.

I repeat:

This will end badly.

I’m still new on Medium. And I want to hear your opinions in the comments where you see this going. Please follow me for future articles and my Twitter is The Protagonist here: https://twitter.com/protagonistblog

*Incidentally, I graduated with my first degree in Actuarial Science in 2008. Then worked through the financial crisis. My only ever real job.

**I actually have 2 MBAs, completed at the same time.

***Definitely, using the word “asset” here loosely. Liability is probably more accurate.