Amazon was a bubble too

Friday 14 February 2014

Disclaimer: This article makes comparisons between bitcoin and the dot-com boom and bust of 1999-2001. It’s worth saying that I’m a big believer in bitcoin’s long-term future. The bitcoin protocol is an elegantly beautiful, remarkably powerful solution to the problems of government-backed currencies and banks’ monopoly on money transfer. But I’m not an economist, less still a fortune-teller, and this is not intended to constitute financial advice.

This week I had planned to write about where bitcoin’s price might end up in the long term. After the week the cryptocurrency has had, though, I thought I’d put that off to look at other assets that have crashed in price and recovered, and what conclusions we might draw from those for bitcoin.

Amazon
Back in the early days of the internet, a naïve young man called Jeff Bezos thought he could sell books online. His company floated on the NASDAQ and, thanks to a general optimism about anything with a ‘.com’ in its title, its stock rocketed from an equivalent of $1.50 (taking later stock splits into account) to $107 in 1999. Then the crash came, investors realised you needed more than a website and a vague affiliation with a new technology that no one quite understood yet, and its shares plummeted to less than $6 in 2001.

And that was that for Amazon. Like all the other dotcoms that traded on an exciting new technology writing cheques that their real-world performance couldn’t cash, it was gone for good.

Not quite, of course. You might have bought the odd book or CD from them in the years since the dotcom bubble burst. Their share price recently came off a high of $400. Amazon’s doing ok.

Take a look at Amazon's share price.

 

Specifically, look at the part of the graph from 1997 to the end of 1999.

A slow start, a meteoric rise, a rocky period where it crashes to half its value, then recovers and then...

Now take a look at the graph on the front page of https://www.bitstamp.net/

 

You’ll notice some similarities. But the question is not what has happened up to this point, just before Amazon’s crash: it’s what’s going to happen next.

Boo.com, Amazon or eBay?
As I’ve mentioned in the past, I think it’s clear that bitcoin is a bubble. Not because it’s a bad idea: that’s not what a bubble means. A bubble occurs when something is overvalued. It doesn’t mean it's worthless. (To refer to a persistent comparison on the web, ‘Tulip Fever’ was a bubble. But if you’ve ever visited Holland you’ll know that flowers, including tulips, are enduringly popular and still represent a decent slice of the economy today. Tulip Fever overvalued tulips; it didn’t give something entirely worthless a price.)

Not every bubble and crash is the same. A lot of companies went bankrupt in the early 2000s because they simply didn’t have a viable business model. There was nothing to back up the hype. Remember Boo.com? Neither does anyone else. Amazon itself was wildly overvalued at the time because investors bought into the dot-com promise. Its value plunged. But Amazon didn’t go under, because Jeff Bezos had spotted the potential of the web for sales of books and, in the future, much else besides.

Or take a look at eBay, whose share price only halved from its long-term average at the turn of the millennium. eBay’s crash wasn’t nearly so spectacular as Amazon’s. Both companies survived and are now thriving global businesses.

So there’s the question: which is bitcoin? This article and its graphs [http://ordinary-gentlemen.com/blog/2013/12/12/these-three-graphs-prove-that-bitcoin-is-a-speculative-bubble] make a fairly good case that bitcoin – at least at its recent high of $1,200 – represented a bubble. The reason is that its purchase, and the price people (speculators) paid for it were unconnected to its real value. In other words, bitcoin wasn’t something they bought because it was useful, or to use as a means of purchase. They bought it because they thought the price would go up. It’s the fallacy that lies behind every speculative bubble in history.

That disconnect is something that a lot of people are working hard to change this year, including Gavin Andresen of the Bitcoin Foundation, who has ploughed millions of dollars into funding ventures that will make the bitcoin protocol a part of everyday life. (Gavin is also one of the front-runners for the identity of Satoshi Nakamoto, though he has publicly denied this.) Once the supporting economy and infrastructure are there, the story will change – though exactly what that will mean for bitcoin’s price is another matter.

I see the recent ‘correction’ as not only an inevitability but an essential stage in bitcoin’s development and coming-of-age over the next few years. (If you want a short-term picture, take a look at BitScan's technical analysis of what the market has been up to and the psychological drivers behind it.) Bitcoin, and the protocol that lies behind it, is something entirely new – akin to email and the internet in the early 90s. It’s only been around for five years, and in the public eye for far less than that. As it matures, it will leave behind the wild mood swings of its toddler years.

I believe we are right where Amazon and eBay were 14 years ago, at the end of 1999. Bitcoin in particular and cryptocurrency in general is a radical, epoch-changing idea. Investors have bought the promise but, as yet, we don’t have the ecosystem to make it happen. Just like in 1999 we didn’t have the web culture that would one day make buying pretty much anything online the norm. It wasn’t a part of the landscape. That wouldn’t happen for a few more years, but when it did, companies like Amazon and eBay were in a position to make the most of it.

I sincerely hope, for the sake of those investors who jumped in at $1,000, that bitcoin is an eBay rather than an Amazon. eBay lost half its value (as bitcoin has at points since December) and recovered fast. Amazon took an 85% hit, and though it came back far stronger than eBay, it was a long haul. But Boo.com? Cryptocurrency is too big a deal to be written off that easily.

By Brandon Hurst

Brandon Hurst


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