An Opinionated Comparative Analysis of the Cryptocurrency Market and the Dot-Com Bubble - Charles Hartwell
Abstract
The similarities between the Cryptocurrency market that stands today and the Dot-Com Bubble of 1995 to 2001 have drawn extremely close over the past decade. Originally this study was to be done between the Dot-Com Bubble and the current Electric Vehicle market, however thanks to a suggestion from Mr. Matisoff, he pointed out an even closer similarity between cryptocurrency and the Dot-Com Bubble, hence the topic of this paper. Research on this study was done with the use of various cited online articles and research papers. After research has concluded, it can be determined that the crypto currency market and the over speculation of internet companies in the early 2000’s, do in fact share many similarities such as the fueling of both over valuations by venture capital and investors, the lack of due diligence from investors, and the support from the media that would point to a cryptocurrency bubble coming in the future. One similar to the aforementioned Dot-Com Bubble in magnitude, due to the large value of the cryptocurrency market today.
The History of Cryptocurrency and its Modern State
Currently there exists 21,940 crypto currencies globally. However, only a majority of them are active and traded. They all crowd the crypto market hungry for their share, the market itself worth about 1.3 trillion dollars today. But it took time to win the hearts of young investors and tech savvy entrepreneurs. It began in 2009 with the creation of the grandfather of all crypto currencies, Bitcoin. The coin was created by an anonymous man who goes by the pseudonym “Satoshi Nakamoto,” and to this day his identity has never been confirmed, however Nakamoto himself owns 29.4 billion dollars worth of Bitcoin in today's value.
Cryptocurrency Today
It wasn’t until the launch of the first “alt-coin” in 2011, that the crypto market actually became what it is today. The term alt-coin is popular in today's crypto market, and refers to any coin that is not Bitcoin and Ethereum. As coins are created, their functions are completely up to their creators, someone can design a coin that you can only trade with other people, or a coin that only stays at one dollar. This allows for new crypto creators to have a chance to add value to the market. In fact, the current crypto market relies on a coin with a special function called Tether. It was designed to stay pegged to one U.S. dollar and you must use it in order to trade on the largest crypto exchange platform, Binance. Originally the two largest competitors for the top crypto brokerage were Binance and FTX, notably run by Sam Bankman-Fried. But due to fraud and embezzlement, the young billionaire was forced to close down FTX and only Binance remained, neither of which were and are regulated by the SEC. As of date, Binance is not considered the most well run brokerage either, they are currently in a lawsuit with federal regulators after secretly telling their VIP clientele how to avoid taxes on their crypto gains. The only popular brokerage option for traders is also not well run. Furthermore, a prominent problem in the crypto world is legitimacy and scamming within the brokerages. Because of the lack of regulation on crypto currencies it can be easy for people to artificially inflate the price of crypto currencies so they can make a quick profit. Overall, the state of crypto at the time of writing (6/5/2023) is shaky and unstable. With all of the excitement and buzz around the new phenomenon of crypto currency being gone, people are now looking for some legitimate uses and investment opportunities from the sector, of which it’s lacking.
The Dot-Com Bubble of 1995 to 2001
The use of the internet for the public began on April 30th, 1993. Although its use was limited at the time, it shook the world as some called it a fad and suggested that the excitement around it would soon pass, and others calling it a life altering invention that was here to stay. Nevertheless, companies certainly took advantage of this new tool and began launching online based businesses building up to the 2000’s, examples include Amazon, Pets.com, 360Networks, and Boo.com. As the world’s jaw dropped in awe of this new “internet,” investors wanted to get in on these revolutionary companies who were making use of it. Venture capital firms began dumping money into internet companies that everyone seemed to be talking about, such as Pets.com which raised 82.5 million dollars through a 2000 IPO. On an even larger scale World.com raises a whopping 3.8 billion dollars. The problem? They weren’t making any money. These companies were all invested in without proper due diligence being performed. Investors simply saw the phrase “.com” and knew without even checking that this company was going to take off, hence the name the “Dot-Com Bubble.” Most startups did not adopt viable business models, specifically no cash flow generation. On top of that, outrageous valuations were placed on these companies. The media also played a big part in incentivising everyone to invest in riskier internet stocks and encouraged people to invest in risky tech stocks by peddling overly optimistic expectations on future returns and the “get big fast” mantra. Nevertheless, with the success of the internet the market took off, and the NASDAQ Composite index rose by 582% from 751.49 to 5,132.52 from January 1995 to March 2000.
Why didn’t internet companies fail sooner if they weren’t making a profit?
Although most internet companies weren’t making actual profit they were being propped up simply by the massive amount of capital investment they received from venture capital. VC firms instead of slowly injecting capital into the company based on needs and success, they gave them their entire investment at once, meaning that they could survive for years just by burning capital to keep them afloat. Because of this failure VC firms no longer take this approach and instead give them capital over a long period of time.
The Bursting of the Bubble
Ultimately the bubble burst in 2002 due to mass panic selling following the over speculated internet companies running out of capital and having no profits to back them up. Total losses of investors are estimated to be about 5 trillion dollars.
The Winners and The Losers
The Dot-Com Bubble wasn’t all bad, there were in fact successful companies that came out of it. In fact some of the most popular and successful companies today can be attributed to this era in American history. Companies such as Amazon, Microsoft, eBay, Qualcomm, and Cisco all were successful that were started and invested in during the Dot-Com Bubble. What set these “Winners” apart from the rest of the internet companies at the time? It was simply due to a successful business model that this group of companies didn’t meet the same fate as their counterparts. All of these companies which still operate today had a legitimate business model that was focused on making profit unlike other companies. It was the thoroughness and legitimacy of these companies at the end of the day that allowed them to be resilient to the bubble’s burst.
The Instability of Today’s Cryptocurrency Market
It’s no secret that investing in cryptocurrency is not necessarily “safe,” in fact it is often publicly discouraged or put down by experts and famous figures in the finance industry. However, they’re not forming their opinion based on their personal disliking for the asset, instead it possesses an unstable persona that would scare off any investor who isn’t willing to risk all of the money that they invest.
The crypto market is an entire industry built centered around two main platforms of trading in order to keep it alive, FTX and Binance. Without knowing anything about them you'd probably assume that they are trustworthy, reliable, and stable. What if I told you that one of them has already failed due to a massive lawsuit dealing with mismanaged funds, and the other is currently in a lawsuit for helping clients evade taxes. How stable do you think the crypto market is now? The crash of FTX, the formerly world’s largest crypto trading platform, has had a substantial impact on the perspective of cryptocurrency from the outside world as the news reached mainstream media. Clearly, cryptocurrency is widely regarded as an unstable investment, not only due to the fact that it’s unregulated, but due to the lack of trust with the trading platforms that support the industry. But it wasn’t only the trading platforms that were failing, it was also the investing and financial institutions that were fueling the fire by being heavily invested in crypto, similar to the investments of companies into the Dot-Com Bubble. Following the bankruptcy of FTX, several other exchanges such as Gemini, and lending platforms including Genesis prevented customers from withdrawing their funds when their investments became unstable. On top of that, Three Arrows Capital, one of the largest crypto hedge funds defaulted on loans in 2022, and major crypto-lending companies Celsius and Voyager filed for bankruptcy as the price of bitcoin collapsed.
Venture capital dried up in the crypto sector. It’s only a matter of time until we see more startups go bankrupt who attempt to invest in crypto. Ultimately there needs to be another pump in BTC price for investors to be confident enough to invest again, in fact, that’s the only thing that would encourage investors to jump back in. However a rise in Bitcoin price only seems to come every recession as people attempt to hedge their losses, and it’s nothing to found an entire industry on.
Scams and Crypto for Criminal Usage
While in the world of cryptocurrency investing you may become a victim of “spoofing,” by a professional or amateur scammer. Spoofing is the act of placing a large amount of fake orders (either buy or sell) with the intent to fool the average investor and never actually fill the order. Pictured left is a chart of Bitcoin to the U.S. dollar to Tether (The main cryptocurrency required to be used by Binance). The X Axis are the timestamps of the trades, and the Y axis is the price of the Bitcoins traded. This chart is an example of spoofing, as you may be able to tell there is a large amount of fake ask orders being placed. The layers are then canceled all at once and the release of sell-side pressure allows bids to move rapidly up the price ladder as spreads widen.
While traders use illegal methods to profit, crypto is also used by criminals to conceal payments to one another. They use a strategy called Cryptocurrency Mixing, where they send a payment through many intermediate wallets to trick and confuse authorities, then finally the payment is received to the final wallet.
Comparing the Crashes of Crypto and Internet Companies
BTC-USD reached its peak of $19,140 in 2017. This was followed by a sell off and a consolidation period for about three years. The Covid-19 pandemic then struck the world, keeping everyone at home with stimulus checks and lots of disposable income to contribute to the economy. With everyone staying at home came the influence of social media and the message to buy crypto. This caused a huge buy up in 2020 in order to hedge the fall of the markets, this marked Bitcoin’s all time high date as Nov 8, 2021 at a price of $65,466. However, when the pandemic was coming to an end people began to take their profit which resulted in a sell off of about 30k. Since then this has left many people questioning whether the coin will rise again or if it’s experiencing a dead cat bounce, as the price as of Bitcoin today is $26,888.00 (6/1/2023). When compared to the Dot-Com Bubble many comparisons can be drawn between the two crashes. The most noticeable one is the effect of the media on investors. In the 2000’s the news excited investors over the public use of the internet and encouraged them to buy internet company stocks. The same could be said for crypto with the use of social media, specifically TikTok, which boasts 1.6 billion users and is one of the most influential platforms that Generation Z has access to. Users on this app create a culture that encapsulates young and hungry investors looking to ‘get rich quick’ without any hard work. This, along with the ease of access given by Robinhood, who gamifies crypto trading, was a recipe for over speculation and mass investment into risky cryptocurrencies. The only difference between the two bubbles is the fact that the internet companies that crashed in the early 2000’s never made a recovery whereas crypto is still being invested into by people today.
The Prominent Role of Venture Capital in both booms
Venture capital is a type of private equity where investors give the capital needed to a small startup company in hopes of turning a profit. The VC industry is mostly known to be prominent with tech startups in the Silicon Valley area in California, and it has been unofficially named the startup capital of the world. Although the location of venture capital hasn’t changed the industry has experienced drastic changes from what it once was in the 1970’s. In the early days of Venture Capital investors in Silicon Valley wouldn’t ever try to out-bet each other for an entrepreneur. There was an inherent and unspoken rule that you shouldn’t compete for an entrepreneur, and investors truly did value the success of the entrepreneur and assumed their role as the catalyst in their success. However, these norms seemed to have worn off during the 80s during the first venture capital boom under the extreme growth of the American economy under Ronald Reagan. Today there are many types of venture capital, and firms started to specialize in different sectors in order to remove themselves from general competition with everyone. There are also new adapted strategies, such as Kleiner Perkins, who began having their invested companies connect with each other and even with larger and more successful companies
In the late to mid 90s the structure of the industry and competition shifted yet again as investment bankers flooded the industry. The influx of venture capitalists with deep technological or managerial expertise lowered as the new entrants were attracted to the high bonuses and salary.
The Role of Venture Capital before and during the early 2000’s
However Venture capital isn’t all greedy young employees, it still has a goal to help small startups succeed under their wing. In fact, the probability of bringing a product to a market increases by 79% when backed by VC, as they carefully choose the companies they want to invest in, and then monitor them over time. The companies can be categorized into 2 main sections, those who are pushing for innovation and to make a new market, and those who are trying to compete in an already established one. Venture capital helps to speed up time to market especially among innovator companies. There are downsides to venture capital however, as they’re known to mistreat founders and remove them from CEO. They either choose friendly or hostile CEO replacement; friendly is when the founder stays after being replaced and helps out; Hostile is when he/she refuses to comply or becomes difficult. VC however makes surprisingly no change in the rate of founder retention, however it simply helps companies find professional CEOs. This was in fact not the case for the Dot-Com bubble as at the time they were only expected to play the role as the capital provider in the industry.
Venture Capital During the Dot-Com Bubble
In venture capital mostly all investment went into a company over a 1 to 2 year period so that if the company fails they haven’t put all of their money into it. It can be easy to see the success of companies now if you invest some of your money into them, as they will show a turn of profit because of their reliance on a good business model. However, during the internet boom we saw winners arise more quickly and losers took more time to be revealed as losers due to VC firms pumping massive amounts of capital into companies instantaneously.