If you’re anything of a long-term investor, someone who’s studied economics, or simply a fan of finance, you’ve probably looked on with disdain as the electronic currency known as Bitcoins has exploded from just $20 per fictitious token to a high of $266 in less than two months.
Source: Casascius, wikimedia.commons
The currency, if it can even be called that, was described in good detail by my colleague Alex Planes earlier this week. Its value is derived not from any sort of monetary backing — no government or monetary body recognizes a Bitcoin as an acceptable form of currency — but from the acceptance of other retailers and individuals who are willing to assign a monetary value to a Bitcoin and use that figure to exchange goods and services. Its value is also derived from its designed scarcity — there are only a fixed amount of bitcoins to go around.
As you might have assumed, as someone with a penchant for thinking long-term and having studied economics in college, I think there’s a clear and present danger investing in something that essentially doesn’t exist beyond cyberspace. However, the truly scary part of Bitcoins isn’t that they aren’t backed by a government entity, but is ingrained in the fact that it’s spawning a new generation of emotional and irrational investors who will get the completely wrong impression of how “investing” works.
History tends to repeat itself
You may have come across the phrase that history tends to repeat itself; I believe this is a perfect case in point to describe the trading action in Bitcoins over the past six months.
In 1999 you could throw a dart at the newspaper, purchase the stock your dart landed on, and probably have come out a winner. Earnings, cash flow, and valuation were all placed on the back burner as the emergence of the Internet as a commerce medium was putting all of those “archaic” investment tools back in the box. The technology-driven NASDAQ Composite (INDEXNASDAQ:.IXIC) would eventually cross 5,000, and both Cisco Systems, Inc. (NASDAQ:CSCO) and Microsoft Corporation (NASDAQ:MSFT) would top $500 billion in market value. Near their peaks, Cisco Systems, Inc. (NASDAQ:CSCO) traded for around 120 times earnings, while Microsoft Corporation (NASDAQ:MSFT) was valued at a multiple of 55. It was truly a time of emotional and irrational investing, and Wall Street encouraged it just as much as speculative traders promoted it.
This week, I came across an article from the Silicon Valley Business Journal dated March 19, 2000, just nine days after the Nasdaq’s all-time record close. In that article, it’s stated that 37 investment banks at the time had “strong buy” or “buy” rating on Cisco Systems, Inc. (NASDAQ:CSCO) without a single “sell” or even “hold” rating. Furthermore, George Kelly, a Wall Street analyst who was working for Morgan Stanley Dean Witter at the time and was a player in bringing Cisco Systems, Inc. (NASDAQ:CSCO) public in 1990, was quoted as saying in his defense of Cisco’s enormous P/E multiple: “A low P/E usually signals investors are uncomfortable.” Imagine that! Paul Weinstein, a founding partner of Azure Capital Partners and an analyst with Credit Suisse First Boston at the time, would make the bold claim that “Cisco Systems, Inc. (NASDAQ:CSCO) could be the first trillion-dollar market cap company … within two to three years.”
Needless to say, most predictions fizzled out, with Cisco Systems, Inc. (NASDAQ:CSCO)’s $557 billion market cap now being worth about $115 billion, Microsoft Corporation (NASDAQ:MSFT) down to just $241 billion, and the NASDAQ Composite (INDEXNASDAQ:.IXIC) still more than 1,700 points from an all-time high.
This week, we witnessed the complete collapse of Bitcoin euphoria as well, with the cyber-currency falling from its $266 peak to as low as $54 as of this writing.
