A Crypto Bubble?

Over the past few weeks, there has been a lot of volatility in the world of crypto, and that certainly seems to have people on edge. Thankfully, it seems that the potential chaos around August 1 has been figured out thanks to consensus around Segwit.

However, ever since the run up in the crypto markets earlier this year, I have been talking about a correction, and I believe we could see one in the next six months. Speculation has driven the rally, and at some point, it will be time to pay the piper.

That said, corrections are not all bad. Often the strongest companies emerge out of difficult times, as only the strongest trees remain in a forest after a fire. In this post, I want to expand on what we talked about previously and, hopefully, give you some tools to understand what is going on here and why I do not think these market fluctuations matter in the long term.

Over the past couple of years, it is safe to say that blockchain has gone mainstream as far as being a technology that people are talking about. While blockchain is certainly being discussed all over the place, however, the technology behind blockchain is still a long way away from being fully adopted.

So what about this correction? The common term being thrown around right now is that there is a bubble in the crypto markets fueled by speculation. The financial definition of a bubble is “an economic cycle characterized by rapid escalation of asset prices followed by a contraction.” Certainly, the first part of this is true, and while there has been some pullback in the past couple weeks, these markets are still significantly above where they were at the beginning of the year — if you’ve been even tangentially watching this market, you’ve made money.

I do not like the term "bubble" because it gives the impression of something filled with nothing but air, and comparing the technology behind blockchain to air is insulting. So, even if there is some inflationary movement due to speculation, if you believe that the core technology is fundamental, than these short-term movements should not cause you too much concern.

The Value In Tokens

Understanding how there can be real value supported by these tokens and how that value translates into value for the underlying currency is important, so let’s look at an example.

Gnosis is a prediction network that allows people to make predictions on outcomes and be rewarded for accurate predictions. If you believe that those ideas have value and that value is contained within GNO, then those tokens absolutely are supported by something that contains real value. Taking it a step further, since Gnosis is built on top of Ethereum, ETH itself should have its value supported by the value contained in GNO.

The thinking around this is still being developed, but I do think that if the value being represented is real, then that value will also be reflected onto the underlying protocol. However, while these protocols may be creating real value, the market itself is still relatively small and much of the growth has been fueled by speculation.

Ethereum and Bitcoin, arguably the two most central protocols right now, have a combined market cap of less than $70 billion. Here is a quick list of things more valuable than that:

  • Bill Gates' net worth: $89 billion (a single person)
  • Apple's cash reserves: $200 billion (a single company’s cash reserves)
  • Softbank's new fund: $100 billion (a single fund)
  • Bernie Madoff's stolen funds: $65 billion (a single scam)*

Maybe Softbank should just buy up all the ETH and BTC. Masayoshi Son, if you do this, I am claiming credit.

Jokes aside, my point is that the market is still small, and markets that are small and built on top of massive speculation are very unstable. See the GDAX flash crash.

A Coming Correction

I think a few components will contribute to a pending correction in the crypto markets.

First, I doubt the stability of many of the ICO projects that have been funded to date as well as the diligence process most of them are going through.

I spend a lot of time reading white papers of companies launching tokens and building new protocols. For each one, I try to understand what they are building and how it will create long-term value. The problem is that, for many of these projects, I either do not see where the value will be created or proof that the team behind the project will actually be able to deliver.

Many groups have raised money via ICOs before they have done anything beyond getting a white paper together. In my opinion, it is important for founders to be optimistic about what they are working on, but they should also be honest about where they are in their progress and how much work it will take to move forward.

Just putting a white paper together and raising a ton of money to work on a project that has no clear roadmap feels irresponsible. It is reminiscent of the headiest days of the dot-com bubble, when just about anyone could launch a successful IPO for a company with either “.com” at the end of the name or the letter “e” at the beginning.

These naïve bad actors may end up misleading people into thinking a product is bigger or more revolutionary than it might actually be, and when they fall apart, many people will likely get burned. (It took the S&P 500 information technology index 17 years, as of this week, to recover its lost ground from the dot-com crash.)

Given that the blockchain space is unregulated, unlike public stock offerings, there really aren’t any rules surrounding what a company can or can’t say about their project. This makes it hard to know just what you are buying into, which elevates the risk of scammers and phonies entering this market to make a quick buck.

According to Forbes, 90 percent of all startups fail, and this is almost certainly going to be true for companies that get started via ICO. The failure rate may actually be higher than 90 percent.

There needs to be more accountability on the company side as well as more care taken on the side of the people investing in these tokens. The question of “Can this team execute?” is an important one. Traditional investors test for this heavily during the diligence process, and people buying tokens should do the same.

I believe that we may see many cases of over promise / under deliver here, which will be bad for everyone. Issues around the security and scalability of these projects could also lead to loss of investor confidence.

In addition to these more naïve bad actors, there are also legitimately bad actors. I would not be terribly surprised if we see massive scam project that shakes up the crypto space in the future (see: Bernie Madoff). My point here is to do your diligence.

Massive Growth, Massive Potential

The first half of 2017 was a rocket ship, especially for Ethereum and the ERC20 ICO market, as well as for new protocols such as Tezos and EOS. Hundreds of millions of dollars have been raised in these token launches, and a wide range of projects have been kicked off.

This is great. Some of these projects have incredible teams and are working on important problems that will make the world a better place and help to move the new world of blockchain forward. In the same breath, many of these will fail; it is just the law of the startup jungle. The real problem is the combination of speculation-driven returns with the inevitable failure of massive projects and a sprinkling of a few bad actors.

As massive amounts of value have flowed into these markets, individuals have seen incredible returns, which drive more people to invest in the space. However, if a loss of confidence in the market happens and prices start to go down, people might start pulling their money out in order to conserve value, which will in turn affect the value of the companies who have raised via ICO. These companies could start selling as a way to preserve their own value, which would then lead to increased panic on both the investor front as well as within the individual companies.

Not too dissimilar from the way a run on a bank can spiral in on itself, turning a bad situation into a worse one, this market seems to be inflated on itself and thus ripe for a correction. I personally wouldn’t be surprised to see ETH go to $55.

While this is certainly reason to proceed with caution, I am by no means trying to keep people from getting into blockchain companies or investing in these projects. If you believe as I do that blockchain is the most important technological advancement in our recent history, these temporary market fluctuations shouldn’t bother you at all.

The value is not in the speculation that is going on currently, but in the transformational companies that are being built here. As tokens are used to build businesses that could not even have existed before, that value will persist in the protocol, and over time, we will come to recognize blockchain technology as a component of our everyday lives.

The future is bright.

A Sturdier Foundation

Taking all of this into account, there still needs to be a lot of infrastructure built out, and in time, more and more institutions and governments will come on board. Right now, a lot of experimenting is going on with these larger institutions around private blockchains, and the work being done by the Enterprise Ethereum Alliance (EEA) and IBM with Hyperledger is certainly helping groups become more comfortable with blockchain. If you are working at a major enterprise and want to get involved, those are two great places to go. I’m biased toward the EEA.

In thinking of the future and what needs to happen for the market to reach maturity, one problem I have seen in particular is in the difficulty of trading tokens. Right now, if you buy into a token launch and it goes well, it is incredibly hard to use those tokens directly to buy other tokens.

Swap is one company I know is working on solving that problem using a peer-to-peer solution. What this ultimately means is that there will be a more efficient market between tokens, and with a more efficient market, there should be fewer dramatic market movements. It may also make transacting across platforms easier because there might not be the need to ever move back into fiat to do business. Obviously, I think what they are working on is really cool, but I would love to hear what others think, so please feel free to hit me on Twitter (@LaPecc).

Additionally, groups like ConsenSys are working hard to put in place standards for token structures, diligence, and a wide range of other frameworks to build confidence in the space.

Often, people attempt to put things in terms of a hype cycle, but I think these sorts of structures end up giving people false confidence. Instead, I choose to focus on finding and investing in long-term value, and I see plenty of that in the world of blockchains.

Disclosure: Several members of the Futurism team, including the editors of this piece, are personal investors in a number of cryptocurrency markets. Their personal investment perspectives have no impact on editorial content.

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