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, the potential chaos around August 1st appears to have 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 believe that 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 do the strongest trees after a forest fire. In this post, I want to expand on what I talked about previously, offer an explanation about what’s going on, and make clear why I don’t think these market fluctuations matter long term.
It’s safe to say that blockchain has gone mainstream over the past couple of years, as far as a technology that people are talking about; however, the technology behind blockchain is still a long way away from being fully adopted. So what about this correction? Word has it that there is a bubble in crypto markets being 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. But “bubble” implies something filled with nothing but air; even if there is some inflationary movement due to speculation, if you believe as I do that the core technology is fundamental, then these short-term movements should not cause you too much concern.
Let’s take a moment to understand the real value supported by these tokens and how that value translates into value for the underlying currency. For example, Gnosis is a prediction network that allows people to make predictions on outcomes and be rewarded for those 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 has its value supported by the value contained in GNO. The thinking around this is still in development, 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 there may be real value being created in these protocols, the market itself is still relatively small and much of the growth has been fueled by speculation. Ethereum and Bitcoin, which are arguably the two most central protocols right now, have a combined market cap of less than $70B. Here’s a quick list of things more valuable than that:
Bill Gates $89B - (a single person)
Apple cash reserves - $200B (a single company’s cash reserves)
Softbank’s new fund - $100B (a single fund)
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 small markets built on top of massive speculation are very unstable (see the GDAX flash crash).
In my opinion, 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’re building and how it will create long-term value. The problem is that for many of these projects, I either don’t 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 via ICO before they’ve done anything short of publishing a white paper. In my opinion, it’s important for founders to be optimistic about what they’re 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 seems irresponsible. It’s 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 actually is, and when they fall apart, many people will lget 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, so it’s hard to know just what you are buying into. The risks of scammers and phonies entering this market to make a quick buck are elevated. According to Forbes, 90% of all startups fail and this is almost certainly going to be true for companies that get started via ICO.
There needs to be more accountability on the company side, as well as more care taken on the side of the investors in these tokens. The question of “can this team execute?” is an important one. Traditional investors test for this heavily during the diligence process; thus, people buying tokens should do the same. Cases of over promise / under deliver here would be bad for everyone. Additional issues around the security and scalability of these projects could also lead to loss of investor confidence; in addition to the afore-mentioned naïve bad actors, there are also legitimately bad actors. I wouldn’t be terribly surprised if in the future we see massive scam projects that shake up the crypto space (see Bernie Madoff). My point here is: to do your diligence.
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 have been raised in these token launches, and a wide range of projects have been kicked off, which 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’s just the law of the startup jungle. The problem comes in with the combination of speculation driven returns, 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 then 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 the individual companies. Similar to 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’m 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 rather in the transformational companies that are being built. 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’ll come to recognize blockchain technology as a component of our everyday lives.
The future is bright.
Taking all of this into account, there still needs to be a lot of infrastructure built out. In time, more and more institutions and governments will come on board. There’s a lot of experimenting going on with these larger institutions around private blockchains and the work being done by the Enterprise Ethereum Alliance, EEA, and IBM with Hyperledger are certainly helping groups to become more comfortable with blockchain. If you’re working at a major enterprise and want to get involved, those are two great places to go.
In thinking about what needs to happen for the market to reach maturity, one particular problem is the difficulty of trading tokens. Right now if you buy into a token launch and it goes well, it’s incredibly hard to use those tokens directly to buy other tokens. Swap is one company in particular working on solving that problem using a peer-to-peer solution. This means 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. Additionally, there are groups like ConsenSys who are working hard to put standards in place 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.
I would love to hear what others think, so please feel free to engage in the comment section or hit me on Twitter at @lapecc.