The irrational exuberance in crypto markets

Millennials and members of Generations X and Y cumulatively represent a demographic accustomed to practices such as irrational consumption. Doesn’t ring a bell? Well, imagine yourself standing at the checkout counter at your local H&M store, and buying a pair of socks or a hat just because the waiting got you bored. We are governed by emotions and give in to our urges and impulses. This characteristic trait, to a certain extent, can be extrapolated to our investing behaviour as well.

The phrase ‘irrational exuberance’ first came into being when former Federal Reserve chairman Alan Greenspan elucidated upon the fact that stocks of internet startups had started getting too hot and attributed this trend to investors acting in an overly optimistic manner. Irrational exuberance is characterized by a state of mania that drives investors to massively overestimate asset values and as a result, the asset prices warrant undue inflation. In this state, investors tend to become so smitten with the urge to gain profits that they overlook the assets’ fundamentals and try driving prices up higher. This leads to peers investing into whatever asset is rising, thereby creating an asset bubble. This bubble is supported by a mass delusion that the increase in prices is justified. However, when the bubble bursts, the optimism turns into panic because the assets return to their inherent values. This collapse causes a ripple effect in other asset classes as well, causing an economic contraction, ultimately giving way to recession.

Let’s look back at the 1990s. It was a prosperous and optimistic decade; well for the most part, for it ended with the dot com bubble burst. Initially, the internet culture was slow to take off, partly due to a dearth of user-friendly web browsers. However, the release of the Mosaic browser in 1993 made the internet increasingly accessible to the masses. Netscape launched its IPO in August 1995, and within five months, the Netscape stock price skyrocketed.

This internet startup mania, popularly dubbed as the dot com bubble, arose due to a lot of external factors like the East Asian financial crisis, the ruble crisis and the launch of the euro.

The period between 1998 and 2000 was characterized by a Silicon Valley gold rush, where dozens of new startups were being launched every week. The Nasdaq peaked by reaching 5,048 in the middle of March 2000, falling to 3,321 in April and then finally bottoming out at 1,114 in October 2002. Hence came to hiatus the dot com bubble, finally bursting.

However, soon after, the investors’ fanaticism for technology was replaced by globalization and investors went back to the housing sector. This resulted in the creation of another bubble, and this time in the real estate sector. It goes on to perfectly illustrate how some short-lived phases of euphoria are baseless and lack a ground to stand on or any other economic parameters. The exuberance in markets can also be attributed to the flood of liquidity across different geographies arising out of an active pursuit of unmatched fiscal and monetary stimuli.

A very popular parallel that is often drawn up in the context of irrational exuberance is how the case of the crypto market is analogous to the dot com bubble. There are very obvious reasons for the same, namely the sheer similarity between the emergence of early applications of disruptive communication technology and the massively volatile market that emerged around the blockchain ecosystem. The recently disruptive trends in the crypto market make the similarities more conspicuous.

A person invests in the crypto market not because of his/her belief in its fundamentals, but out of an inherent FOMO (fear of missing out) on being a part of a scheme that is supposed to make you rich quickly. The pandemic has indubitably stretched far too long, and people have started looking for alternative sources of income. Cryptos are alluring and attractive investment avenues. One might argue that the crypto bubble is composed of players who have substantive information about the market, unlike in the case of the dot com bubble. So, it is reasonable to assume that this time around, the story might end a little differently. Some also argue that just about every market is a bubble and growth can only be secured through a series of inflations and pops.

Obviously, as per the trends in 2021, unsustained price drops are inevitable, but just the way the internet industries ultimately flourished, the sun just might shine on the crypto market as well.

This goes out on the limb to strengthen the notion that nothing important had ever been built without a little irrational exuberance. So, what tide will the crypto markets go on to surf? We should probably let time be the better judge.

Anand K. Rathi is managing partner and head of strategy at Augment Capital Services.

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