Opinion: Are ICOs a dotcom boom déjà vu?

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As Mark Twain famously said, history doesn’t repeat itself, but it does rhyme. Right before the 2000 dotcom crash, there were 541 IPOs raising US$69.1 billion in 1999, a sizable increase from 374 IPOs (and US$36.8 billion) the year before. The current cryptocurrency climate certainly bears a striking resemblance to that. As of August 31, there have been 139 ICOs raising a total of US$2.1 billion this year, compared to 46 ICOs for US$96 million in 2016. This inevitably draws our attention to ICOs and its underlying technology.

Dotcom boom déjà vu

ICOs have been around for a couple of years now, and they have been especially good in helping developers raise funds for their exceptional ideas (a notable example being Ethereum’s sale of its ether cryptocurrency to fund the development of its platform). In recent years, however, entrepreneurs and opportunists alike are increasingly using ICOs as an alternative form of raising capital, bypassing traditional methods.

There are 867 cryptocurrencies and counting as of August 31, each advocating a big idea that would revolutionize an industry. From coins for data storage to payments for writers, these cryptocurrencies sourced funding from both sophisticated and non-sophisticated investors through intense marketing campaigns.

This presents real risks to the startup/investing community. Traditional financing not only provides capital to new companies, but also comes with stringent due diligence and contractual terms that ensure business model viability and instill discipline in founders. This lack of insight might keep retail investors from making informed decisions for their investments.

As this phenomenon continues, more toxic companies will be funded and more capital will pour into the industry, driving prices up and leading to overvaluation. This certainly draws a resemblance to the 2000 dotcom crash: in the 1990s, it almost seemed like anyone with an idea and a business plan could raise funds to start a company. For every conceivable subject or clientele, there are internet companies that raised millions of dollars and IPO’d at billion-dollar valuations without concrete plans on profitability.

Will there be a correction?

Some companies create illusory hype about their ideas/product and exaggerate their metrics while instilling the fear of missing out (FOMO) in investors, who then flock to their IPOs in the 90s and ICOs in the current market. But in this unregulated sphere of cryptocurrency, no one is held accountable for what they’ve pitched or the millions of dollars involved. Ethics are bound to be flouted, rules are bent, and irrational behavior occurs.

At the same time, risk-free interest rates remain low, which sets the benchmark for returns across other asset classes, thus making investors hungry for higher returns. An increase in demand will be quickly followed by an increase in supply capitalizing on the irrational demand; that’s a natural phenomenon of the market. However, this is where the problem arises: with the insatiable hunger of investors to find the next Uber/Bitcoin, due diligence will not be a top priority. Investors want big ideas more than a solid business plan.

The hunger for high-growth internet companies in the 90s led to the dotcom crash, demand for high-yield securities in 2007 led to the subprime mortgage crisis, while the demand for cryptocurrencies led to the increase in ICOs in recent years. But would we see a major correction in the cryptocurrency market, which could be the catalyst for a wider market correction? Nobody knows, but there are several signs one can draw from to reach their own conclusion:

1. The general consensus is that the market is currently trading on the higher end of the spectrum, with a huge number of securities overvalued and investors having a hard time to identify good deals.
2. Regulators are wary about these currencies due to their extreme volatility and the relatively new technology. Various governments have raised concerns about cryptocurrencies and issued guidance on them; the recent ban of ICOs and shutdown of crypto-exchanges in China led to a sharp decline in the crypto-market.
3. Let’s be honest, cryptocurrencies don’t yet have real-life applications that would spur mass adoption, with the bulk of movement volume generated by traders and speculative retail investors.

How we’ll get to long-term sustainable growth

Don’t get me wrong: I’m long-term bullish on blockchain technology and cryptocurrencies. However, in the short/medium-term, market corrections will set in as regulations are formed, cryptocurrencies consolidate, and irrational demand subsides. This will then form the foundation of long-term sustainable growth of cryptocurrencies as standards are put in place and networked applications with genuine use cases are created.

Much like the dotcom bust, companies will emerge from the bear market and grow into market leaders of the new economy. Like it or not, blockchain technology is here to stay; it is only when applications are built and iterated to serve the market that true value of the technology will be created.

Every asset class derives its fundamental value from its ability to deliver a genuine use case to the wider market. The more value the asset class delivers to the wider market, the higher its fundamental value and thus its traded price, which is reflected by its fair value in the market. However, with the current irrational exuberance and unwarranted bullishness in the market, there are two feasible outcomes in the near future:

1. Blockchain technology matures quickly and applications are built on these cryptocurrency protocols, creating genuine use cases that are suitable for mass adoption and thus increasing its fundamental value significantly.
2. Irrational exuberance fades and the market corrects; fair value price steeply declines to reflect its fundamental value.

Conclusion