- Smart people like the venture capitalist Bill Gurley are beginning to worry that so-called initial coin offerings are a bubble.
- People are investing in bitcoin and other digital coins even though they hold no equity value and offer no claims on any kind of underlying asset.
- On that definition, ICOs are actually worse than dot-com stocks in 1999 – at least back then investors owned a piece of a company with a revenue stream.
- Crypto bulls keep saying bitcoin is “an established store of value.”
- The problem is that the value being stored is simply everyone else’s agreement that there must be value here. There is no other asset. And that is what a bubble looks like.
The venture capitalist Bill Gurley was recently asked whether he thought cryptocurrency “initial coin offerings” were in a bubble. Billions of dollars have been poured into more than 1,000 new digital coins issued by startups this year. These coins mimic the construction of bitcoin, meaning they can be freely traded on digital exchanges and have no central bank standing behind them.
Gurley had an interesting answer. Yes, he said, ICOs look speculative, because interest rates are so low and “there is nowhere [else] to put money.”
“As long as those interest rates stay as low as they are, I think you’ll continue to see some form of speculative behaviour, and tech is a great place for speculation,” he told CNBC. “Look at what is going on in the ICO market, in cryptocurrencies, and you see that no one is afraid to speculate in this market.”
The ICO sector today has one big thing in common with the dot-com bubble of 1999: People are “investing” vast sums of money into “assets” that have no history of producing revenue, and those assets are rising in price only because other people are also pouring money into them.
Ethereum, the second-biggest cryptocurrency after bitcoin, was launched through an ICO in 2014. Ethereum has risen by over 3,000% against the dollar in 2017, and its success is one of the reasons people are feeling good about crypto right now. But many of the other coins that have sprung up in its wake look a lot more risky.
$US200 billion invested in something that cannot be described as an ‘asset’
The amount of money being poured into ICOs is vast. As these charts from Goldman Sachs show, ICO investment is now a larger source of new investment money than traditional early-stage VC tech-startup investment:
The total market, including bitcoin, is now worth more than $US200 billion, or £151 billion, according to CoinMarketCap.com:
The chart below from Shane Oliver, the chief economist and chief investment officer at AMP Capital, puts bitcoin in historical perspective with other major asset bubbles. The lines on the chart are indexed to make them comparable to one another and show that the rush into bitcoin is roughly comparable to the dot-com bubble in 1999-2000.
Investing in poker chips, hookers, and a really big fish tank
In an ICO, a company offers to sell digital tokens to fund its business. The tokens (or “coins”) may allow the buyer to get a product or service from the new company at a later date. Like bitcoin, their value can go up and down, and they can be bought and sold in an open market. The ownership of the coins is recorded on blockchains, which are secure, open-source ledgers that underpin the currencies and are protected by cryptography.
The bet with an ICO is that a token will rise in value. There are two sources of demand for tokens: from people who need them to redeem services from the company that issued them and from other investors who think the token will rise in price like a stock or a currency.
There is an argument that many ICOs should not be described as “investments” because they do not give buyers actual equity in the companies that offer them, only credit that can be redeemed at a later date. At Ethereum’s launch, for instance, the founder Vitalik Buterin made it explicit that Ethereum and its ether currency were not the same as an equity investment:
“Ether is a product, NOT a security or investment offering. Ether is simply a token useful for paying transaction fees or building or purchasing decentralized application services on the Ethereum platform; it does not give you voting rights over anything, and we make no guarantees of its future value.”
My favourite example of this phenomenon is the cryptocurrency casino that wants to give buyers nonnegotiable coins that can be gambled inside a hotel that will float in the sea off Macau. The company, Dragon Corp., is literally asking you to “invest” in poker chips.
That isn’t even the wildest ICO so far. We have also seen:
- An ICO to build the world’s largest aquarium.
- An ICO for prostitutes.
- An ICO for avocado growers.
- An ICO for dentists.
Worse than the dot-com bubble of 1999
In some ways, ICOs are worse than dot-com stocks in 1999. At least with a dot-com stock you owned an actual piece of equity in the underlying company (even if, like TheGlobe.com, a failed social-media network, it had revenue of only $US780,000 a quarter).
The assets being offered in an ICO aren’t backed by an existing revenue stream. Rather, it is a speculative bet on the success of some future product, and you must make that bet before the company has created the product you’re buying.
On that measure, dot-com companies actually looked more solid than ICOs. Pets.com actually sold pet food. Boo.com actually sold clothes. There was something there, even if it didn’t make profits as a business.
With ICOs you don’t even have that. It’s a bit like Mark Zuckerberg funding the early days of Facebook by offering you credit for free “likes” instead of common stock.
Bitcoin and Ethereum are Google and Amazon … ICOs are Pets.com and Boo.com
It’s perhaps worth drawing a distinction here between the two big cryptocurrency players, bitcoin and Ethereum, and the thousands of “altcoins” that have been issued this year. Unlike most ICO coins, bitcoin and Ethereum aren’t geared toward specific projects. Bitcoin is an all-purpose digital asset, and Ethereum’s ether is meant to underpin an all-purpose application platform, which multiple blue-chip companies are looking at using. Bitcoin and Ethereum are useful because they are widely used, like cash. Altcoins, however, are credits for a limited, defined service.
It is obviously not the case that because much of the crypto sphere is a bubble that it is all a bubble. The dot-com bust of 2000 didn’t prove that the entire internet was useless – just that it was inflated with immature ideas. Bitcoin and Ethereum may turn out to be the Google and Amazon of crypto, but there will be plenty of altcoin equivalents of Pets.com and Boo.com, too.
Gurley was also asked whether bitcoin was a bubble. He said no. Bitcoin is different, he said.
I don’t think it’s a fraud.
“I think of it as an incredible store of value in the rest of the world,” he said, adding: “I don’t think it’s a fraud.”
At the massive Web Summit tech conference in Lisbon, Portugal, this year, I heard a version of that phrase a lot: “Bitcoin is an established store of value.” It was like a mantra. People said it as if merely repeating it made it truer.
But there is a real problem with that formulation.
A “store of value” is a term used to refer to an asset that can be saved and reliably sold at a later date because it predictably maintains its value over time. Traditional stores of value include money (pounds, euros, and dollars), stocks, bonds, gold, and property. There are many others. These assets “store value” because when you want to exchange them they have most likely retained most of their value or increased it. They achieve this by giving the owner a claim on an underlying asset that has its own use: Money is backed by a central bank guaranteeing its value with actual assets on a balance sheet; stocks offer dividends and future earnings; bonds pay interest; gold can be used for jewellery or manufacturing; and you can live in or rent property until it can be sold.
When the property bubble collapsed in 2008, at least people still owned houses
The problem with bitcoin is that it isn’t backed by a useful asset. Its price is set only by supply and demand. That means bitcoin can go to zero, because there are zero assets behind it, if people suddenly agree that bitcoin on its own is worthless.
Stocks, bonds, and houses can collapse in value too, of course. But even when they do, you still own a stock, or a bond, or a house.
In terms of underlying assets, there is no fundamental difference between bitcoin and any of the other cryptocurrency ICOs on the market. Sure, bitcoin is now a few years old, and its price has generally gone up over time. If you bought bitcoin years ago, then it really does feel as if you stored value.
But bitcoin has no houses or stock certificates or interest coupons, and there is no company behind it generating revenue whose profits you might share. And neither do any of the other crypto coins. If these coins – including bitcoin – go to zero, then you own nothing.
This is why the crypto space has so many similar characteristics to 1999. (Take it from me: I lived through 1999, including the worthless stock certificates and the unemployment payments that came after it).
With cryptocurrencies, the value being stored is simply everyone else’s agreement that there must be value here. There is no other asset.
And that is what a bubble looks like.
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