In 2009, a decentralised form of exchange was born. Governed by no central institution, be it national, private, or international, the Bitcoin was built around a unique form of public ledger at its core. Dubbed as a Blockchain, the ledger was designed to be a publicly held record of transactions, simple by design and made tamper-proof by the Grandfather Paradox-equivalent of an editing fail-safe. The list of benefits for the Bitcoin is long.  No government control, limited regulations, better security, and a designed scarcity that prevents inflation, are just some of them.

Fast forward to 2021, amidst the blooming valuation of Bitcoin and its crypto alternatives—all unfaced by the COVID-19 pandemic—a startup named Coinbase made global headlines. Valuing itself at 100 billion dollars, Coinbase went public with a direct listing that is the seventh largest in the United States to this date. The platform is one of many catering to the trade of cryptocurrencies in recent times and has helped the average person gain access to crypto markets in a simplified and convenient manner.  Cryptocurrencies have thus grown enormously in value over the years, turning even a pocket’s worth of minor investments into riches today. As a result, they have become extremely popular among young investors and radical financiers alike.

A Coinbase employee celebrates the company’s listing on Nasdaq on the 14th of April [Image Credits: Associated Press]

Trends & Speculation

In the comment sections of pages on Facebook and Instagram, and many forums on the internet, an annoying sight can be found in plenty—A barrage of spammy comments promoting investment gurus that promise to help people make quick money, get debt free and change their lives as a whole. Regardless of how genuine their claims are, the rise and abundance of such personalities indicate that they have surely attracted people to their vocations. This points to another problem. People are being lured into investing into things they do not understand, under the sole promise of making quick money.

The issue with this is that valuations are guided by many different factors, and many of them are impractical and unsustainable to depend on in the long run. In this case, the unsustainable factors are hype and trendiness, both of which are pushing up valuations, and in turn, generating even more hype and trendiness! When people invest into something solely based on media popularity and speculations of high growth, they are failing to evaluate whether these entities have factors that can sustain their growth and value. For a cryptocurrency, the simplest sustainable factor would be how well adopted the currency is. The purpose of money is its use as a standard exchange for making trades, where it serves as a means to eliminate the impracticalities of directly bartering one good for another. A currency that fails to serve this purpose will not be sustainable in the long run.

A good example of this is the Dogecoin. It began as a joke between two IBM engineers, the Dogecoin was never meant to serve as a genuine alternative to the Bitcoin. Yet, the currency received wide acclaim and has grown over 12,000% in value over the last year after references to it by celebrity figures.

Hype or Unwarranted Criticism?

Cryptocurrencies have faced plenty of scepticism regarding their growth over the years, and it comes to no surprise that platforms like Coinbase have received similar attention. Since its inception, the Bitcoin has been called a fad, unsustainable, volatile, and dangerous, by many experts, including Nobel laureates. In 2021, Bitcoin broke several of its own valuation records, with each coin being worth as much as 64,000 dollars at its peak on April 14^th. Nine days later, on April 23^rd, the coin’s value fell to 49,000 dollars, a mini-crash that alone took out nearly half a trillion dollars from the market cap of cryptocurrency. And yet, it continues to break the expectations of both its promoters and critics.

This need not mean that the Bitcoin has proven its worth. A dark side of cryptocurrency is that it has cult-like supporters, celebrity figures and shady mentor-investors backing it. The Bitcoin, being the most used, most traded and widely recognised crypto in the market, is bound to be the most mutually benefited by this hype. This could point to a bubble that is yet to burst. Investments based on a pattern of growth are purely speculative when the underlying causes of those growth are not adequately investigated. Speculative investments, and the biases that it is often based on, have often been a major cause of economic downturns in the past. However, the Bitcoin does have genuine application. Some businesses, such as Tesla, are slowly beginning to accept it as payment. With its finite quantity, it also serves as a scarce commodity, and could eventually come to serve as an asset that works as a good store of value once it stabilises. By principle, the Bitcoin cannot be directly manipulated by banks or any government, it can be used globally without needing to be exchanged and absolutely cannot be counterfeited.

Cryptocurrencies like the Dogecoin however, have little to no basis for their growth apart from the hype that they have attracted. The Dogecoin lacks a limit on its supply and is inflationary, giving it poor potential as an asset as the value of each coin will eventually reduce with time. The coin lacks the potential of mass-adoptability that coins like Bitcoin and Ethereum have, and its odd brand image does not help its case either. The Dogecoin is built on speculation, a coin simply meant to serve those eager for a chance to make quick money through buys and sells—a gamble that is bound to eventually hurt a lot of unlucky investors. Unfortunately, the cryptocurrency market is flooded with such coins and many of them have attracted plenty of attention, even when some exist as a means to troll the market. Coinbase is in no way sheltered from these hype-driven behaviours of the market.

“I made this as a joke, no one told you to buy this shit, it’s called SCAM you stupid m********r,”

—Andre ‘Dre’ Lewis, the creator of SCAM—a cryptocurrency that has done well, despite explicitly being created to ridicule other currencies.

A fan-made graphic depicting Doge on the moon, a symbol of the Dogecoin’s massive price rally. [Image Credits: Reddit]

Scrunching Numbers

A similar fever of contention can be found behind Coinbase’s opening valuation. According to Forbes columnist David Trainer, Coinbase will need to sustain an annual growth rate of over 50% in the next few years and would require a net profit margin of over 25% to justify its 100 billion dollar valuation. At these levels of growth, Coinbase will earn a revenue of over 21.3 billion dollars by 2027, a sum that is troublingly over 50% greater than the current total revenue of Nasdaq Inc. and Intercontinental Exchange (ICE) combined.

Why is this a big deal? ICE operates the New York Stock Exchange (NYSE)—the largest stock exchange on the planet.  It records a trade volume of over 1.4 trillion dollars EVERY MONTH. Nasdaq Inc. operates Nasdaq, which happens to be the second largest stock exchange in the world. These two exchanges list most of the planet’s global corporations, including almost every big name that your mind can conjure. Nasdaq for example is home to all of the Big Five Tech Companies—Amazon, Apple, Facebook, Alphabet (Google) and Microsoft— and giant startups like Tesla and Coinbase itself. The combined market cap of the companies listed on NYSE and Nasdaq stands at over 33 Trillion dollars, a value that is over 16 times that of the entire market capitalisation of cryptocurrency. ICE and Nasdaq Inc generate their revenues by enabling the trade of shares of the world’s top companies. Stock exchanges charge a small margin for making these trades (As low as 0.01%) and compete with each other on this basis.

A crowded day at NYSE’s trading hall, 1987. [Image Credits: Associated Press]

Similarly, platforms like Coinbase serve as exchanges for cryptocurrencies. Coinbase too makes most of its revenue by taking a cut from the trading on its platform, and charges as much as 0.57% for it. The revenue growth needed to justify Coinbase’s valuation is highly dependent on this percentage. However, this margin is quite large, and is bound to be exploited by competitors willing to charge lower fees. As competition between crypto trading platforms develop—which is indeed happening already—these margins are likely to fall as close to zero as possible. Hence, Trainer estimates Coinbase’s valuation to be better positioned around $19 billion dollars. This is a far cry from the original $100 billion estimation, and is still much lower than the $61 billion that it fell to at the end of its first day on the market. Summarised, Coinbase’s estimations are too dependent on ambition and a speculation of unabated high growth in the crypto market.

As mentioned earlier, cryptocurrency’s market hype is playing a decisive role in governing prices and the behavior of its proponents. This, however, is not limited to cryptocurrency.  There has been a rise in speculative investments in recent years, especially in the Tech sector. Tesla for example has jumped over five times in value in the last one year and has its fair share of disbelievers and diehard supporters. While Tesla does indeed have an arsenal of fine products, its valuation would require a perfect growth scenario that is just too ambitious for even the electric vehicle segment as a whole. Like cryptocurrencies, a lot of its value is derived from hype, or more precisely in Tesla’s case, the cult-like popularity of Elon Musk. Interestingly, the Dogecoin shares this quality with Tesla and its rise can largely be attributed to the billionaire’s tweets about it.

One of many tweets by Elon Musk that have referenced the Dogecoin in recent times.

Bubble Blowing

A bubble is said to exist when there is a very large and sustained increase in market value, one that is discrepant with the intrinsic value of the subject in question. For a cryptocurrency to sustain growth and justify its value, businesses will need to adopt it as a legitimate form of payment on a large scale. If this does not happen fast enough, people will start to lose faith in it as a valid currency. Those who hold large amounts of it will eventually want to sell, and a large volume of coins on offer combined with few buyers will make prices crash. Likewise, when the ambitious growth figures of a highly valued company eventually fail to be met, the faith and value that investors place in that company will topple and fall. Such corrections, or bubble-bursts, work to bring valuations closer to the real deal and are important economic phenomena that lead to worse outcomes when prolonged.

These bubbles do not affect only those who had invested and lost money. When a bubble pops, the distrust that arises from it disproportionately hurts smaller businesses in the affected industry. It hurts investor confidence, it causes reductions in wages, and worst of all, it leads to a loss of employment. Hypothetically, for example, if the electric vehicle sector were to experience a bubble burst, small firms will struggle to attract an ample number of investors, regardless of the novelty of their technology. The big firms that groomed the bubble, are likely going to be large enough to survive, and would be equipped to assimilate the smaller firms struggling around them. This will effectively reduce competition, deter new entry to the field, and give birth to oligopolies that can abuse the market.

A chart representing the various spikes in company valuations prior to the crash of the tech sector. It wasn’t until 15 years later that the Nasdaq Composite fully recovered from the crash. [Image Credits: news.gcase.org]

Many investors who predicted and profited off the early 2000s dot-com bubble and the 2008 Global Financial Crisis see these growth trends as a repeat of what they saw in the past. People are increasingly being lured by the shine associated with trends. A tremendous amount of people have put their life savings into cryptocurrencies because of the opportunity to get rich and change their lives. In this game of chance, social media has a tendency to focus on the gains made by those successful, without considering the losses made by those who weren’t. People need to be weary of the bandwagon of hype that they’re being lured towards. The average investor needs to scrutinise their potential investments before putting their money down, and even then, must be equipped to handle potential losses. Until then, these bubbles will continue to grow, along with the size of the crash that is to follow.

Featured Image Credits: Getty Images