The emergence of Blockchain technology to exchange or transfer anything of value and the use of it as an information repository is undeniable. It could be the technology not just behind financial transactions, but all transactions. Even your child’s education certificate could be sent over the blockchain network. Blockchain can revolutionize exchange of value the way the internet made us use emails over the postal system.
The current world of cryptocurrency however is most likely to be an embodiment of the greater fools theory. The greater fool theory argues that prices go up because people are able to sell securities with no underlying value to a “greater fool,” whether or not they are worth anything. The person buying the worthless asset later on, for a higher price, is deemed the greater fool. Prices of even the most worthless things can potentially go up. That is, of course, until there are no greater fools left. Investing, according to the greater fool theory, means ignoring valuations, earnings reports, and all the other data.
Tulipmania is the story of the first major financial bubble, which took place in the 17th century. Investors began to madly purchase tulips, pushing their prices to unprecedented highs. The average price of a single flower exceeded the annual income of a skilled worker and cost more than some houses at the time. As prices eventually drastically collapsed, many tulip holders instantly went bankrupt.
Tulips were introduced into Europe from Turkey shortly after 1550, and the delicately formed, vividly colored flowers became a popular item. The demand for differently colored varieties of tulips soon exceeded the supply, and prices for individual bulbs of rare types began to rise to unwarranted heights in Europe. By about 1610 a single bulb of a new variety was acceptable as dowry for a bride. In one infamous instance, a flourishing brewery in France was exchanged for one bulb of the variety ‘Tulipe Brasserie’. Before 1633 the tulip trade was restricted to professional growers and experts. However steadily rising prices tempted many ordinary middle-class and poor families to speculate in the tulip market. Homes, estates, and industries were mortgaged so that bulbs could be bought for resale at higher prices.
The crash came early in 1637, when doubts arose as to whether prices would continue to increase. Almost overnight the price structure for tulips collapsed, sweeping away fortunes and leaving behind financial ruin for many ordinary families. Tulipmania is a model for the general cycle of a financial bubble: At first investors lose track of rational expectations. Then psychological biases lead to a massive upswing in the price of an asset or sector. A positive-feedback cycle continues to inflate prices. Finally, investors realize that they are merely holding a tulip that they sold their houses for. Prices collapse due to a massive sell-off and then many go bankrupt.
In 2008, when investors purchased faulty mortgage-backed securities (MBS), it was difficult to find buyers when the market collapsed. One of the reasons that it was difficult to find buyers for MBS during the 2008 financial crisis was that these securities were built on debt that was of very poor quality. It is important in any situation to conduct thorough due diligence on an investment, including a valuation model in some circumstances, to determine its fundamental worth.
Due diligence is a broad term that encompasses a range of qualitative and quantitative analysis. Some aspects of due diligence can include calculating a company’s capitalization or total value; identifying revenue, profit, and margin trends; researching competitors and industry trends; as well as putting the investment in a broader market context—crunching certain multiples such as price-to-earnings (PE), price-to-sales (P/S), and price/earnings-to-growth (PEG).
Dogecoin is a satirical cryptocurrency created by software engineers as a joke, making fun of the wild speculation in cryptocurrencies at the time. Dodgecoin features the face of the Shiba Inu dog from the “Doge” meme as its logo and namesake. It was introduced on December 6, 2013 & quickly developed its own online community. In 2021, with the help of a few well meaning environmentalist billionaires (sic), Dodgecoin has moved up 13,000%. It is now the sixth largest cryptocurrency in terms of market cap.
Dodgecoin has had a long and problematic history of scams. It has been described as a pyramid scheme, where “those who got in early on bitcoin have a huge financial incentive to draw in others by any means necessary.” Akand Sitra of cryptocurrency risk management platform TRM Labs claims that Dogecoin is a scam, with over 65% of Dogecoins held by the top 98 wallets across the world. He also claims that the largest wallet holds 28% of all Dogecoins, and the top five wallets control 40% of the coin’s entire supply.
Bitcoin’s price is often cited as an example of the greater fool theory. The cryptocurrency doesn’t appear to have intrinsic value, consumes massive amounts of energy, and consists simply of lines of code stored in a computer network. Despite these concerns, the price of bitcoin has skyrocketed over the years.