Why Crypto Crashes and then Bounces Back

The crypto markets are collapsing. Bitcoin has lost more than half its value, and tons of smaller projects are imploding left and right. Lots of pundits have tried to offer explanations for what's going on, but none of them really capture the full picture. By now, we've all heard the basic high level a global pandemic, unprecedented levels of stimulus, manufacturing slowdowns, record inflation, rising interest rates. While it's generally true that higher interest rates have triggered market sell offs and a big move away from high risk assets like crypto, recent Fed actions don't tell the whole story. Fundamentally, crypto is undergoing an identity crisis. Is it a store of value or a way to make payments? Should we call it Web3, or is that just confusing? And is any of this stuff actually fully decentralized? All of these points are actively being debated right now, but the biggest question of all is, what year is it? This question isn't a joke in crypto circles, though. This is a new technology, and we don't quite know where it'll go. So what should we compare it to? Is crypto, just like the Internet in 1995, poised to explode and change everything about the way we interact? Or should we look to a different time in history to understand what's going on? Well, if you ask a crypto critic, they'll tell you that we should be comparing crypto to a much earlier period in history. 1637, to be specific. That's because 1637 was the year that tulip mania collapsed during the Dutch Golden Age. And it's useful to study previous speculative bubbles to understand current market conditions. See, tulips were not indigenous to Holland in the 16th century, but once they started getting imported through Dutch trade routes, they became a luxury item. Anyone who owned a mansion with a large garden had to have tulips to impress their neighbors. Not all tulips were created equal, though. And those with interesting multicolored patterns or stripes could sell for much more than plain tulips. Sound familiar? Well, demand for the most exquisite tulips led to rising prices as wealthy collectors began paying higher and higher prices. Eventually, that led to speculation, with a long chain of traders buying expensive tulips in the hopes of selling them down the line. At the peak of the mania, a single bulb could be worth as much as a mansion in Amsterdam. This also sounds a bit familiar. Eventually, people started using credit to purchase bulbs, which further fueled price spikes. It was unsustainable, though. Ultimately, tulips were just flowers, nice decorations, but essentially useless. Beyond their visual aesthetic. So the bubble burst, the market rationalized over, leveraged tulip buyers went bankrupt and prices collapsed. The entire saga was documented in a book called Memoirs of Extraordinary Popular Delusions and the Madness of Crowds, and lives on as a warning about the dangers of speculative frenzies to this day. So you can see why critics of crypto point to the tulip mania of 1637 so frequently, which we've seen crypto prices soar, we've seen individual NFTs that sell for as much as a mansion, and we've seen people use credit to leverage their bets. There's one problem with this analogy, though. The entire tulip bubble really only lasted from November to May, just seven months from the beginning to the end. Crypto, on the other hand, has been going on multi year bull runs now, regularly for the past decade. And perhaps most interestingly, historians are now debating whether or not Dutch tulipmania actually existed at all. While there are few verifiable accounts of tulips selling for more than six figures in today's dollars, there isn't substantial evidence that the mania was anywhere near as widespread as had been reported. So while there are clearly parts of the crypto world where comparisons to the seven month tulip mania make perfect sense, it doesn't quite fit the overall story here. There's a lot more going on. So let's dig into what the major proponents of crypto have to say about it. After all, we're talking about a new technology here, not some random flower. So it makes sense to look at how other technologies developed, right? Well, that's what the pro crypto crowd argues, and they've anchored comparisons to the Internet in 1995. The impact of the Internet is undeniable now, but back in 1995, it wasn't so clear. Only 15 million people had Internet access at the time, and the technology was widely mocked as a joke. There's a great David Letterman clip where he makes fun of Bill Gates for suggesting that the Internet could be a better way to stream content compared to the radio Internet or on some computer deal. They were going to broadcast a baseball game. You could listen to a baseball game on your computer, and I just thought to myself, does radio ring a bell? The clip looks hilarious in hindsight, since Internet streaming is now completely dominant. But perhaps most importantly, very few people predicted exactly what the Internet would unlock. A lot of the first generation Internet businesses were simple ports of existing services, like listening to a baseball game on your computer. But all that changed as the Internet became ubiquitous and entirely new. Services developed on top of it. It's easy to compare YouTube to traditional television, but it's clearly very different now when you look at the recommendation algorithm, comments section and ability to subscribe, which you should do, by the way. Only 15 million people used the Internet in 1995, and it went on to change everything. So that's why the crypto community loves drawing comparisons to this time period. The total number of Ethereum users is right around 15 million. So it's easy to say crypto usage is right where the Internet was in 1995. This is about to explode. And the Internet also had a very slow initial phase. It all started with Arpanet in 1969, then the first email client launched in 1975. In the 80s, we got the domain name service and the launch of America Online. And it wasn't until 1993 that HTML was introduced, allowing for the easy creation of new websites. It took the Internet 25 years to get to the point where 15 million people could use it. And it was still a joke. Looking back at the history of crypto tells a similar story. 25 years ago, the first cryptocurrency project, Digicash, launched and didn't get very far. And it's been a full 13 years since Bitcoin launched. So if we compare Ethereum usage data in 2022 to Internet usage data in 1995, we get a very rosy picture. After all, in 1998, Google was founded, and by 2005, more than 1 billion people had Internet access. If the comparison holds, we would expect a billion people to be using crypto regularly by 2032. There's a problem with this comparison, though. See, picking Ethereum users as a benchmark is a bit arbitrary. You could just as easily broaden the scope to include all cryptocurrency users. And when you do, the numbers don't track quite as well. Although it's hard to measure, Most estimates peg 2015 as the year when 15 million people were using crypto. And if we benchmark against that, we should see nearly a billion crypto users today. And we're pretty far away from that. And then there's the question of user value. It's one thing to say that crypto will continue to grow and eventually transform the Internet. It's an entirely different thing to price that future transformation in today. It's useful here to look at the value created by your average modern Internet user. There are around 5 billion people using the Internet, and the total value of all Internet companies is around $10 trillion. That implies a value of $2,000 per user. It's a rough number, but it's a reasonable benchmark. Now, let's look at crypto. At the peak, crypto was worth around $3 trillion. If we divided that by the 15 million users, you get a value per user of $200,000, a full hundred times more per user. So you can see why critics of crypto think that the sector is so overvalued. Even if you accept the idea that it's early and usage will continue to grow over time, that growth is basically priced in. And most critics argue that the vast majority of the 15 million active users are just speculators, not people who get real value from Web3 services. Back in 1995, people went to the Internet to find niche information, Connect with other people on messaging boards, or send messages faster than mailing letters. They didn't have a financial incentive to use the Internet. They chose to log on because it delivered real value over newspapers, radio, and the postal service. But this comparison isn't completely fair. After all, a big chunk of that $3 trillion in crypto was tied up in bitcoin. It's a completely separate use case from web3. Bitcoin isn't about transforming the Internet. It's about storing value. And here's where we get back to timelines. Bitcoin believers don't want to anchor to 1995 because this isn't about the Internet. It's about money. They say that we should instead be looking at the year 1920, specifically in Germany. This is because Germany went through a period of staggering hyperinflation, and bitcoin famously has a fixed supply. World War I was incredibly expensive for Germany, and in order to cover the costs, they suspended the gold standard. Instead of using an income tax to fund the war effort, German Emperor Wilhelm II decided to use debt. The idea was take out a big loan to fight the war, and after they won, they would be able to impose war reparations on the defeated allies to pay back the debts. The strategy failed, though. Germany lost the war, and the country was saddled with massive war debts that it couldn't afford to pay back. Instead of getting reparations paid to them, the Treaty of Versailles mandated that Germany would have to pay. There was still hope that Germany would be able to pay these debts. The western front of the war had been fought mostly in France and Belgium, so the majority of German factories were left untouched. But once the first payment came due In June of 1921, inflation started spiraling. Every time the government Printed more money, the value of the currency would collapse further, leading to a single US dollar being worth over 4 trillion German marks. It was an economic disaster, and any German citizen who held wealth in cash got absolutely wiped out. And so you can see why proponents of bitcoin like to compare the United States today to Germany in the early 1920s. We're already seeing increases in the money supply, and now inflation is starting to spike. If this gets out of control, holding a fixed supply currency like Bitcoin could be incredibly valuable. There are a few problems with this, though. First, proponents of crypto have been saying that hyperinflation is right around the corner for over a decade now. After all, bitcoin was created shortly after the 2008 financial crisis as a direct response to government bailouts and money printing. But inflation has finally arrived, so it should be bitcoin's time to shine, right? Well, we certainly haven't seen that in the market. Even though inflation has been higher than expectations for months now, Bitcoin is in free fall. Gold, which has historically been seen as the ultimate inflation hedge, has held up pretty well. But bitcoin hasn't. So what's going on? Well, it likely comes back to speculation. Even though there are a lot of bitcoin holders who believe in the inflation hedge story, that's not what's been done driving the price for the last few years. Instead, cheap money from low interest rates and fiscal stimulus have led people to hunt for higher returns. High growth tech stocks spiked a ton, and so did cryptocurrencies. As interest rates rise and people begin pulling back on riskier investments, prices fall. And that's what we're seeing today. In a previous video, I said that bitcoin had proven itself as a sort of digital gold. Someone recently called me out in my discord for this, which you should totally joined by the way, and they were 100% right. Bitcoin isn't functioning as a digital gold at all. In fact, it's inversely correlated with gold. But the real question is, will bitcoin ever function as an inflation hedge? Even if it doesn't, today gold is worth around $10 trillion. So if Bitcoin could replace gold as the go to inflation hedge, it would certainly be a good investment, right? Well, that's a complicated question because again, it all depends on the timeline. Sure. If bitcoin suddenly becomes as stable as gold next year, you could see the price 10x, but that seems unlikely. If, on the other hand, it takes 30 years to stabilize, the price could still 10x. But that doesn't make it a good investment. Making 10x in 30 years is roughly an 8% gain annually, which is less than the average stock market return. Gold has been used for thousands of years. Bitcoin has only been around for 15. So it's worthwhile to think about where you want to benchmark these assets. The time it takes to realize a big return is incredibly important. It underpins the entire technology investment process. It's not enough to make 10x if it takes 30 years. Most technology investors have a 10 year time horizon. This idea of annual return rate drives so many decisions in our economy. And misalignment here can really shift the deployment rate of a new technology. It's possible for a new technology to be transformative, but still not make for a great investment. Perhaps instead of 1637 or 1921 or 1995, we should instead look at something more recent. 2006. See, in 2006, venture capitalists were extremely excited about a new type of technology that could potentially reshape the world. The market was absolutely massive and consumers wanted the products. I'm talking about cleantech. And it wound up being one of the biggest investment disasters in history. In 2006, Al Gore Gore released An Inconvenient Truth, popularizing the idea that climate change was real and needed to be stopped. The public quickly got behind the idea and began envisioning a future powered by clean energy. Solar, wind, nuclear and even tidal energy began gaining traction. Investors poured more than $25 billion into clean tech companies from 2006 to 2011. But it didn't work. They lost over half their money and it led to a decade long stagnation in the sector. It was an unexpected outcome because the value seems so obvious. Clean and abundant energy is always in demand. But a variety of factors dragged the industry down and led to subpar investment returns. Today, the clean energy umbrella still contains some incredibly promising technologies. But the investment returns during the 2006 funding boom just didn't live up to expectations. So what's the relationship to crypto here? Well, I think it shows that it's important to separate technologies, technological considerations from investment considerations. Whenever people start arguing about crypto, they tend to fall in one of two categories. Either they love the technology and think the price will only go up, or they think the technology is useless and the value will ultimately be zero. There is an alternative path though. The hype could be real. The technology could be impactful, but it could still make for a bad investment. The best investment you could make in CleanTech back in 2006 was probably just buying solar panels and putting them on your house. Even though clean tech companies underperformed, the technology itself really was valuable. Now, regardless of your view of crypto or any other financial market, you need an investing app to express that view. And that brings us to today's sponsor, Public.com Public is an app where you can invest in stocks, ETFs and crypto with any amount of money. 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