Cryptocurrency: Both a Revolutionary Technology and a Bubble in Waiting
Indeed, the question itself has reached bubble status. Frequently, the question confuses whether crypto is (or will be) a bubble with whether the technology has long-term value. Both are true. Cryptocurrency is a revolutionary technology, and the excitement over revolutionary technology creates bubbles.
Revolutionary technologies result in over exuberant investors. In 1761, the Duke of Bridgewater completed construction of the Bridgewater Canal, a huge financial success which allowed him to efficiently transport coal from his mines to Manchester, England, rather than relying on horses. The venture was a huge financial success and reduced the cost of coal in Manchester by 50%.
This success brought frenzied investors who poured money into suspect canal projects, many of which were never built. Similarly, after the success of early railroads, an emerging British middle class poured money into dubious railroad ventures in the 1840s, leading to the “Railway Mania” bubble.
More recently, the release of the Mosaic web browser opened up the Internet, and investors poured money into anything with a “dot-com” in its name, leading to the dot-com bubble.
Professor Carlotta Perez of the London School of Economics has examined each technological revolution from the Industrial Revolution to the Internet boom. Her research indicates that anytime there is a transformative technology, money quickly flows into the space, creating a bubble. While many projects fail, this influx of capital is used to build infrastructure to support the new technology so that it can be deployed to consumers. As Perez explains:
Investment in the new industries is carried out by new entrepreneurs while the young financial tycoons create a whirlpool that sucks in huge amounts of the world’s wealth to reallocate it in more adventurous or reckless hands…a part of this goes to new industries, another to expand new infrastructure…but most of it is moved about in a frenzy of money-making money, which creates asset inflation and provides a gambling atmosphere within an ever-expanding bubble. Eventually, it has to collapse. But when it does…[n]ew industries have grown, a new infrastructure is in place; new millionaires have appeared; the new way of doing things with the new technology has become ‘common sense.’
Likewise, the early success (and spectacular returns) of cryptocurrencies like Bitcoin and Ethereum will continue to result in investors funding questionable projects. While some projects have amazing teams and tremendous potential, others have soared to billion-dollar valuations with little more than dressed up whitepapers and code cut-and-pasted from other projects. Those investing in these projects look eerily like the frenzied investors who threw money at 19th-century railroad projects that were impossible to construct.
The inevitable question, of course, is whether the cryptocurrency bubble has fully inflated. I don’t think so. For context, the entire cryptocurrency market is valued at about $400 billion (down from its peak of over $800 billion). During its peak, the dot-com bubble reached $2.9 trillion in value before crashing in 2000.
The cryptocurrency market, unlike the dot-com boom, is largely limited to retail investors, which limits the amount of capital that can flow into the market. Institutional investors still lack fully developed custody options for holding cryptocurrency safely, and other financial products such as Bitcoin ETFs have yet to receive regulatory approval.
As custody and regulatory solutions develop for institutional investors, I anticipate the cryptocurrency market inflating further. Indeed, the market for cryptocurrency may grow even larger as the market is global in scale, while the Internet boom was was largely limited to the United States.
There are, however, two unique aspects of the cryptocurrency boom that may serve to make it even more volatile than past bubbles.
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