The onset of the crypto bear market in the past six weeks and the demise of high-profile projects resulting in some estimated $2 trillion in crypto losses sparked a lot of discussion about the future of crypto. Comparisons are made between today’s blockchain industry and the dotcom bubble of 2000.
After going through the evolutions of Web 1.0, 2.0 and now 3.0, I want to answer the question: is this the moment of implosion of this crypto? No.
There is certainly room to argue for similarities: rising interest rates, a regulatory environment challenged to keep pace with innovation, expensive marketing tactics to grow the user base, and very enthusiastic venture capital investments. There are also some key differences: risky reliance on leverage and lack or limited consumer education.
Understanding the similarities and differences is critical to ensure we emerge from the crypto winter even stronger. What can the past and present tell us about how we are delivering this transformational technology to the masses so that it lives up to its origin story as an equalizer for financial access? Here’s my opinion.
What the dotcom bubble tells us
In March 2000, I was an associate at a law firm representing the newest and most innovative technology companies in the dotcom space. At that time, business opportunities on the Internet had not yet been mapped out. Regulations were secretive. We were navigating how to draw boundaries based on statutes that had nothing to do with and never thought about the digital world.
What were the monetization opportunities for ‘Internet companies’? Where did privacy play a role? What did the terms of service look like and how did you get users to agree to them?
We operated in the gray, with nothing set in stone, and were challenged by the important (and motivating) opportunity to define and set the standards for the future. The regulatory environment did its best to catch up with the technology – which was an opportunity, coupled with the risk that the regulation would be reactionary or based on a limited understanding of the tech stack. (Sound familiar, crypto natives?)
Everything felt like it had the potential to change consumers’ lives. In retrospect, that was partly due to the marketing hype (I’ll get to that later), but the dizzying explosion of websites and companies launching on the Internet was real. Between 1999 and 2000, the number only websites grew from 3,177,453 to 17,087,182. That’s 528% in just one year!
Do you remember pets.com? I do. It is a company often used to showcase the excess of the dotcom days of 1998. With two rounds of funding, pets.com raised more than $110 million. In 1999 and 2000, it had run out of funding with massive marketing campaigns—a spot in the Macy’s Thanksgiving Day Parade, an ad in the Super Bowl, TV appearances on national networks—combined with a business model that cost too much to bring in. new customers and to deliver products nationwide. The company went public in February 2000 and in November it was… out of money.
There are a few factors that are most commonly used to explain the dotcom bust. One was that companies were built on customer growth strategies such as heavy marketing and selling products at a loss to maximize market share. Another example is that IPO mad companies and investors led to a gap between valuation and profitability.
Consider that 199 internet stocks (totalling $450 billion in market capitalization) were representative of companies whose combined annual revenues totaled $21 billion, and losses totaled $6.2 billion. And more macroeconomic shifts, such as low interest rates in 1998, created an environment ripe for entrepreneurs who then saw interest rates rise. increased three times in the course of 1999.
In retrospect, it is not surprising that the bubble burst. Honestly, even at the time, it wasn’t a huge shock to those of us who were observant, as unsustainable prices and valuations clash with reality. At the same time that institutional investors started cashing in, individual investors bought into dotcom companies — and sadly lagged behind, with 70% of 401(k)s losing at least a fifth of their value. Large investments dried up and unprofitable companies were without a runway and without a sustainable customer base.
Shortly after the bubble burst, regulations tightened and technology began to consolidate around a few major players with the resources to survive the brutal bear market that followed. Unfortunately, these decisions ultimately led to many of the problems we have on the internet today.
Will the same mistakes be repeated?
Some of this looks familiar when you consider what’s happening in crypto today (I mean, have you seen the Super Bowl ads this year?). In the past year, more than 1,200 crypto firms led funding rounds, accounting for a total of $25 Billion in Investment. In the first half of 2021 alone, CoinMarketCap added 2,655 new crypto assets, bringing the total number of coins listed to 10,810.
The past 12 months have been a crazy journey through high-profile headlines about how to get returns, which smart contracts are best, how to use decentralized autonomous organizations (DAOs), and whether you’ve created a non-replaceable token (NFT) for you. . Macy’s even offered one for Thanksgiving last year. The economy was buzzing, interest rates were bizarrely low, capital was flowing freely and valuations were high. This all happened. . . until it wasn’t.
Unlike the bursting of the dotcom bubble, access to capital was not a trigger for where crypto is today. In fact, capital was plentiful. In the first quarter of 2022, there was a total of $9.2 billion in investments, new high of the previous record in the fourth quarter of 2021. And while slowing in the current economic environment, capital is still flowing: $4.219 billion in May, which is still up 89% from last May. And crypto is highly visible marketing: celebrity notescryptocurrencies stadiums and sponsorshipmainstream commercial break.
And then is contributing? Yes, interest rates are rising. Yes, the stock market is under pressure and the connection between it and crypto became clear this cycle. And yes, to some extent, some crypto companies have not yet come up with real revenue models, but have high valuations and access to a lot of capital.
But I would say that the main factor for crypto’s downturn is being driven by unsustainable yields and subsidies. Seeking an edge to capitalize on returns results in over-reliance on cheap loans. The backing of digital assets on borrowed capital to drive these incredible (translated into unsustainable) returns, otherwise known as leverage.
Take Terra. Immediately before its fall, Anchor, a crypto lending platform, offered 20% returns for users to borrow UST (20%?!). Unfortunately, people still like to believe in things that seem too good to be true. According to TimeTerra’s team knew this wasn’t right, that it wouldn’t be possible to offer this return to everyone, but justified it as marketing spend as a form of customer acquisition. (Hello again, pets.com.)
So when market volatility hit, which appears to be coming from investors looking to short-sell in UST, Terra’s subsidized returns were hollow. Terra had too much leverage and couldn’t handle the bank run. In the end, individual investors took the hit and lost millions.
Terra was the first, but Celsius came a month later. And the story is similar. Celsius praised high yields on deposits of 17%. The loans were largely backed by bitcoin. So when bitcoin and the crypto market started to fall, Celsius customers rushed to back out, only to find they couldn’t. Celsius had stopped withdrawals because it had developed a strategy around unsustainable, excessive returns and leverage. Without fundamental assets, it didn’t have the liquidity to give customers their money.
Unfortunately, Terra and Celsius are not the only crypto companies with shaky foundations. We will likely see more tumble as the crypto winter continues.
So what happened? To put it bluntly, people got greedy. Or, more accurately, people got caught up in the excitement. And unfortunately some of those people couldn’t afford it. Regulations always follow consumer harm. That’s why we need to make sure as an industry that we provide road maps, signposts and words in flashing bright lights about the risks. If individual investors continue to hold the bag, as in the dotcom bust, we lose confidence. When we burn consumer confidence, we harm the industry.
This is not the end of crypto
To be very clear at this point, this is far from the end of crypto. In fact, it is just the beginning. This is certainly going to be a tough time for the industry, but it will challenge us to mature just as the dotcom bubble changed the trajectory of internet companies.
The internet survived the 2000 bubble burst. But it forced surviving and new businesses to focus on real products with viable business models. If selling pet supplies delivered to your door at unbelievable prices seems too good to be true, guess what? Probably. After the bubble, pets.com and others had no choice but to find out what a successful, sustainable Internet business looked like.
That’s what we need to think about. This should be a humbling moment for all of us in blockchain and crypto, seeing it as a challenge to prove the real practical value we can bring to the mainstream. For crypto to return to its core, the real value of what makes this technology transformational for businesses and consumers, we need to focus on things like interoperability, transparency, innovation, accessibility, inclusion and decentralization.
We need to avoid the biggest risks of crypto today. That would be the risks to consumers, putting them in positions where their entire savings evaporate in hours, and the risk of centralization and consolidation as a means of surviving the current market environment. That’s where we risk stifling innovation, competition and the ethos that leads so many in the industry who believe in this technology as the means to an open, accessible financial system.
These are the lessons we need to learn now and the decisions we need to make to chart the course for the future of crypto.