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Author Topic: Memories of a Mania  (Read 10611 times)
Alonzo Ewing
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April 09, 2013, 07:36:58 PM
 #1

I remember the dot-com mania and hope to give some perspective into what happens during a mania.  I was burned by it, too.  I gleaned some powerful lessons from that mania, and my purpose here is to spread the knowledge.

Before I begin, let me state that if you think I’m spreading “FUD”, feel free to leave this thread.  I’m actually long bitcoins, though I’m looking to sell soon (in the next week or two).

During the dot-com mania, the Nasdaq doubled in about 5 months.  Given the recent run in Bitcoin’s price, you may not be impressed, but keep in mind that the Nasdaq market capitalization is on the order of trillions of dollars, a thousand times greater than Bitcoin’s.  Some companies in the Nasdaq did go up a thousand-fold.

Good companies with solid earnings became wildly overvalued.  As an example, Cisco, one of the behemoths of the tech space at the time grew into a crazy valuation.  Analysts extrapolated this exponential trend (that’s essentially the only thing most analysts do: extrapolate) and predicted that in 2-3 years, Cisco’s market cap would be greater than the US GDP.  Yes, they actually did that.

Despite continuing to grow earnings over the last 13 years, Cisco’s share price is basically where it was in 1998.  Overvaluation is a bitch.

Predictions were crazy like that.  People simply assumed in 2000 that the Nasdaq’s level would exceed the Dow in a year.  Keep in mind that the Dow was about 11,000 at the time. 

Henry Blodget became famous in 1998 for making a 1-year price target on Amazon of $400 when the price was $240.  He was widely ridiculed.  Yet, it reached that $400 price in a month, and went on to $1200 two years later.  (It then fell back down to $80, though over the next decade, it would exceed the dot-com peak.)

So lesson #1 is that even good companies can become highly overvalued during a mania.  Lesson #2 is that to jump aboard the train, investors will bid up the price of crappy companies like Pets.com into similar prices, and for the average Joe, it becomes very difficult to separate the wheat from the chaff.  Litecoin’s recent run-up seems reminiscent of that phenomenon (though I admit I’m not savvy enough to conclude that Litecoin is, indeed, chaff.)

The sociology of a mania is fascinating.  There were bearish commenters like Bill Fleckenstein who would warn people that the mania couldn’t last and a lot of people would lose their savings by being reckless.  He routinely got mocked on CNBC and elsewhere.  People with much less insight and experience than him would accuse him of not understanding what was going on.  Yet he was right. 

This was cult-like behavior:  rather than believing someone who was bearish had analyzed the data and come to a different conclusion, and that perhaps you could learn from this person, the bear took on a moral quality.  He was a bad guy.  One might even say he was evil.  He's probably motivated purely by nefarious intent.  If he got enough people to disbelieve, those people would convince their friends, and the whole thing would snowball. 

In that mania, the future took on a mystical quality.  It was called “The New Economy”.  In the New Economy, profits didn’t matter.  Only market share mattered.  So if there was a company with no profits, investors would say, “They’re spending all of the revenues to get more market share!” and justify a high valuation.  The New Economy also threw out the old valuation techniques.  The internet was so big that the sky was the limit.  There were no constraints.

Yet a decade later, really only 3 dot-com companies remained:  Yahoo, Amazon, and Ebay, and Yahoo is a shell of its former stature.

One of the key characteristics is that more people were convinced there was a mania in 1998 than there were in 1999.  Late in the mania, many former skeptics began to believe.  They stopped thinking there was anything out of the ordinary going on.  They bought into the New Economy mysticism.  As the Nasdaq rose higher, fewer and fewer skeptics remained.  Only believers were to be seen.

People who knew nothing about stocks suddenly became experts.  Middle class dads grew to know the balance sheets of the high flying companies and weren’t shy about offering their opinion at the water cooler.  Students boasted of their profits and contemplated dropping out of school because it was useless to be a wage slave when the market was so easy to play.

Perhaps the most vital lesson the dot-com mania taught me is that the market will keep going up until the staunchest bear throws in the towel.  I became a bear on the dot-com stocks in 1998.  The Nasdaq was about 1700.  As the market went up, I grew more disgusted with what was going on.  I saw my buddies become rich overnight and grew envious.  The Nasdaq went up to 2500, then 3500…4000.  Eventually, I couldn’t help it.  I knew it was a mania, but I couldn’t help but try to get in on the action.  My little account grew from about $6000 to $250000 in just a couple of months. 

The market peaked at 5100 very soon after I went in.  And then it all came crashing down.   At the new bottom, it went down to 1200.  I lost everything.  I know most of my friends also lost everything.  Luckily, “everything” was only stuff I invested.  The biggest losers were the ones who quit their job to daytrade, or the ones that took loans to invest. 

It all makes sense in retrospect.  If someone as skeptical as me—if the staunchest bear—buys!—then there’s nobody else left on the sidelines to bid up the price.  The lesson for today is: think of the biggest bitcoin skeptic you know, and when he throws in the towel and registers for a Mt. Gox account, it’s time to sell.

I hope this was informative.  I see similar things going on right now in the Bitcoin world—exponential price increases, outlandish predictions being made about the price, people quitting their jobs and putting all their eggs in the Bitcoin basket, mockery of prudence, cult-like behavior, mystical beliefs, etc—and I worry about the damage this mania is going to do.

 
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April 09, 2013, 07:38:52 PM
 #2

This time it's different
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April 09, 2013, 07:39:12 PM
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I'm sorry you typed all that.

The important thing is that we all now know that no one uses "websites" or "the Internet" anymore.

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April 09, 2013, 07:49:49 PM
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I'm sorry you typed all that.

The important thing is that we all now know that no one uses "websites" or "the Internet" anymore.
I think a big threat to Bitcoin is that a copycat (with better features) will become more successful.  Sure, Bitcoin has all the face time and momentum going for it now, but so did MySpace back in the day.  Technology is supplanted so quickly and easily.

It helps that Bitcoin isn't really a front-end, per say, but more of a back end.  More of the HTML to the web than anything - once everyone chooses to support and use HTML, support for it doesn't really end.  It is the de-facto web language that everything else is built upon.

OP's post is good though.  Everyone would do well to keep things in perspective and be cautious by hedging their bets and diversifying their holdings.
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April 09, 2013, 07:57:32 PM
 #5

I'm sorry you typed all that.

The important thing is that we all now know that no one uses "websites" or "the Internet" anymore.
I think a big threat to Bitcoin is that a copycat (with better features) will become more successful.  Sure, Bitcoin has all the face time and momentum going for it now, but so did MySpace back in the day.  Technology is supplanted so quickly and easily.

It's bad for Bitcoin, but it's good for us.  Just don't get caught with your pants down when the Bitcoin successor is on the rise and you have all your assets tucked away as BTC Tongue

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April 09, 2013, 08:06:15 PM
 #6

People that have never seen a bubble up close can really learn a lot by reading first hand accounts.

That said, the real question is this:  Are we in a bubble, or an adoption curve, or both?

Personally, I think both.  I think that the current exchange rates have a good chance of falling rapidly in the near-ish future, making this month a bubble of sorts.

On the other hand, it is getting harder and harder to imagine bitcoin not taking off and becoming the main settlement system of the world.  We are all over the damn newspapers, we are on TV, everyone is hearing about it now.  I'm nobody, and yet I've been contacted by a couple of reporters.

The dot com bubble was indeed a crazy time.  But it is easy to overlook that before it happened, no one knew what the internet was.  After it was all over, no one didn't know what it was.

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April 09, 2013, 08:08:56 PM
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People that have never seen a bubble up close can really learn a lot by reading first hand accounts.

That said, the real question is this:  Are we in a bubble, or an adoption curve, or both?

Personally, I think both.  I think that the current exchange rates have a good chance of falling rapidly in the near-ish future, making this month a bubble of sorts.

On the other hand, it is getting harder and harder to imagine bitcoin not taking off and becoming the main settlement system of the world.  We are all over the damn newspapers, we are on TV, everyone is hearing about it now.  I'm nobody, and yet I've been contacted by a couple of reporters.

The dot com bubble was indeed a crazy time.  But it is easy to overlook that before it happened, no one knew what the internet was.  After it was all over, no one didn't know what it was.
adoption curve

so many people are adopting and converting to the bitcoin world
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April 09, 2013, 08:15:35 PM
 #8

Thanks for sharing.

It is a fact that Bitcoin will reach it's peak at some point. As you mentioned, this will likely happen when the last bear has bought his bitcoins, and from there the price will go down. We don't know if it will come down a bit or a lot, but it almost certainly won't go to 0.

That moment is still very far away, most people still don't know what Bitcoin is. My friends, who are young, educated people, don't know what it is. So it will take years, maybe decades, until the last bears get into the action, and at that time the price might be who knows how high. At that time there will hopefully be plenty of places where one can spend bitcoins, so it will be much more than just a speculative currency.

One point to make is that the dotcom crash was mostly just the United States. Bitcoin is global, so there are much more people, many more bears, still waiting.

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April 09, 2013, 08:16:33 PM
 #9

Yet very few people actually made money on it.  Certainly not the average joe.  99% of those dot-com mania companies don't exist today.  One of the intents of my post is to say that, yes, something can be super-duper awesome, like the internet.  But that doesn't mean there will be a lot of money to be made in it.


The dot com bubble was indeed a crazy time.  But it is easy to overlook that before it happened, no one knew what the internet was.  After it was all over, no one didn't know what it was.


 
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April 09, 2013, 08:16:46 PM
 #10

On the other hand, it is getting harder and harder to imagine bitcoin not taking off and becoming the main settlement system of the world.  We are all over the damn newspapers, we are on TV, everyone is hearing about it now.  I'm nobody, and yet I've been contacted by a couple of reporters.

The dot com bubble was indeed a crazy time.  But it is easy to overlook that before it happened, no one knew what the internet was.  After it was all over, no one didn't know what it was.
The dot com bubble happened during the birth of an entire new industry, and basically excess investment caused the companies in that space to build out capacity too quickly, before the demand was ready for it. Some of the fiber that was laid in the late 1990s didn't get used for a decade. In this way the current situation resembles the dot com bubble. The adoption of Bitcoin as a currency has not kept up with the increase in the exchange rate.

On the other hand, the current situation differs from the dot com bubble in that during the last 1990s other, non-Internet, forms of communication were not in the process of collapsing. Right now the financial system of every developed country in the world is a house of cards and it's anyone's guess which domino topples first.

The possibility exists the Bitcoin bubble will never pop because before that happens there won't be anything else left.

Either way, predicting extreme turbulence between now and when the question ultimately gets resolved is a no-brainer.
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April 09, 2013, 08:21:42 PM
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+1 to Alonzo Ewing's OP. It is very insightful. Skepticism is healthy, always.

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April 09, 2013, 08:29:13 PM
 #12

I'm sorry you typed all that.

The important thing is that we all now know that no one uses "websites" or "the Internet" anymore.

It actually is possible for a bubble to increase wealth.  As the OP mentioned there were a few survivors like Amazon and Ebay that actually did make the world a better place.  And a lot of infrastructure for the internet we have today got paid for by people investing during the bubble.  So yes some good did come out of the bubble, but not nearly as much as the wealth that was transerred into the bubble.

Same thing could happen with bitcoin.  It could crash back to 10 tomorrow and the bitcoin ecosystem would be a lot more developed than it was a year ago today, but there will still be a lot of people who lost significant amounts of money getting us there.
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April 09, 2013, 08:40:18 PM
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There's a big difference between stocks and a currency like bitcoin.

Stock values are based on the idea that the underlying company will continue to grow and become more and more profitable. Eventually every company stumbles, or has a few bad quarters, and the investors flee to another stock.

Bitcoin is a completely different thing. There will eventually come a saturation point where everyone on the planet with an internet connection will be aware of bitcoin, and most will have some amount to use for buying and selling. When that happens the price will stop rising. Until then, as long as more people are becoming aware of bitcoin and using it for whatever purpose, the price will continue to rise.
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April 09, 2013, 08:45:56 PM
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thanks. that was one of the best written and informative posts regarding 'bubbles' I've read on this website as of yet

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April 09, 2013, 08:51:07 PM
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But all those dotcom crashes were things related to firms. Bitcoin is not a firm, it can never die even if the price tomorrow crashes to less than a penny.

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April 09, 2013, 08:53:23 PM
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There's a big difference between stocks and a currency like bitcoin.

Stock values are based on the idea that the underlying company will continue to grow and become more and more profitable. Eventually every company stumbles, or has a few bad quarters, and the investors flee to another stock.

Bitcoin is a completely different thing. There will eventually come a saturation point where everyone on the planet with an internet connection will be aware of bitcoin, and most will have some amount to use for buying and selling. When that happens the price will stop rising. Until then, as long as more people are becoming aware of bitcoin and using it for whatever purpose, the price will continue to rise.

I agree with this.  This time it IS different.  With stocks you have to "cash" out the unrealized gains for real gains to buy stuff.  With Bitcoin you don't have to cash out.  You can use bitcoins directly to buy goods.  Right now, you cannot use bitcoins everywhere but in the long term more and more people will accept bitcoins.  Bitcoin will naturally go through booms and busts, but the long term trends is up, up, up.
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April 09, 2013, 08:56:11 PM
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Yes, we may get a nasty crash tomorrow, and it's absolutely correct that everyone needs to be mindful of past manias and history. Good post OP.

And good points about valuation. On that note, I'd like to point out that we're NOT EVEN CLOSE to the sort of mania that happened in the .com bubble. Bitcoin's "market cap" (we really need a better term - no one likes my "Aggregate Fiat Valuation" (AFV) suggestion) is only $2B. If it achieves even niche global usage (even *just* black market), it'll need to be at least an order of magnitude larger. Likewise if it achieves safe-haven usage at 1/100th the scale of gold.

So, personally, I like to use relatively conservative (albeit really fuzzy) "fundamentals" numbers to put the parabolic chart into perspective against the process of bootstrapping the world's first global currency from zero.




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April 09, 2013, 09:14:17 PM
 #18

I think a big threat to Bitcoin is that a copycat (with better features) will become more successful.  Sure, Bitcoin has all the face time and momentum going for it now, but so did MySpace back in the day.  Technology is supplanted so quickly and easily.

This.
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April 09, 2013, 09:27:26 PM
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Yes, we may get a nasty crash tomorrow, and it's absolutely correct that everyone needs to be mindful of past manias and history. Good post OP.

And good points about valuation. On that note, I'd like to point out that we're NOT EVEN CLOSE to the sort of mania that happened in the .com bubble. Bitcoin's "market cap" (we really need a better term - no one likes my "Aggregate Fiat Valuation" (AFV) suggestion) is only $2B. If it achieves even niche global usage (even *just* black market), it'll need to be at least an order of magnitude larger. Likewise if it achieves safe-haven usage at 1/100th the scale of gold.

So, personally, I like to use relatively conservative (albeit really fuzzy) "fundamentals" numbers to put the parabolic chart into perspective against the process of bootstrapping the world's first global currency from zero.




Not even close is right.  The Dot-com bubble had $1.3T invested in the publicly traded internet companies.  So, we need another 500x rise to get there.
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April 09, 2013, 09:51:49 PM
 #20

Great post, Alonzo, and thanks for sharing your story.  Some will heed your warning, and others will not.  maybe Bitcoin is different.  Then again, maybe it's not.  Maybe this is a bubble.  Maybe it's not.

I'm personally long on Bitcoins, but your suggestion of being reasonable and cautious is a very good one.
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