Small-time investors already have fled, their grubstakes or life savings decimated. Well-heeled venture capitalists, badly burned by each successive bust-up, will wash their hands and move on to the next shiny object. The side-hustling crypto-ambassadors (insert any big name from professional sports here, please) will slip back backstage. And regulators, as is their wont, will finally issue their overdue rules, long after the damage is done.
There’s a critical difference with crypto, though, compared with past bubbles: It had virtually no intrinsic merit.
Before and after their bubble burst in the mid-1600s, tulips were still pretty flowers. American railroads begot massive (and positive) change well before the Panic of 1873 and are still vital almost 150 years later. The promise of email in the 1990s — and its dot-com derivatives — was real and epochal. Even badly abused subprime mortgages were a lamentable innovation on hard-to-get loans for home purchasers — a market that survived the financial crisis of 2008.
“Crypto,” a still poorly understood catchall phrase for digital currencies and other securities not controlled by a government, won’t be able to make the same claim. Crypto was supposed to be a haven in inflationary times, the way hard-metal commodities such as gold often are. Yet confections like bitcoin and ethereum have plummeted as inflation has skyrocketed. They promised a way to store value. Clearly, they do not.
More egregiously, crypto was supposed to have all sorts of other uses, from easy cross-border remittance to pegging a value for newly created forms of digital art. None of this has come true at any scale worth bragging about.
In our system, entrepreneurs, and the investors who back them, provide a valuable service by taking risks on unproven ideas. Without them, we wouldn’t have Apple or Google — or Post-it notes. But we now know the crop of swaggering financiers who dreamed up the new category of investments casually known as web3 have been kidding themselves.
A common justification for these investments has been that they captured the fascination of software coders and entrepreneurs, leading to the dreamy conclusion that a real market for digital assets of all kinds was emerging.
What emerged instead is another example of one of the worst ills that afflicts Sand Hill Road, the heart of Silicon Valley’s venture-capital industry: confirmation bias. The enthusiasm the VCs mistook for an investment thesis was often just the result of too much cash chasing too few truly good ideas.
Nerds aren’t stupid: If someone offers them oodles of money to chase a fad, they’ll start coding. Hence, crypto.
The past 15 years or so of venture-capital investing can be in many ways explained by the low-interest-rate environment in which it exploded. With endowments and pension funds (and many an ordinary multimillionaire) unable to earn safe returns in bonds for more than a decade, their money managers opted instead to place riskier bets.
Consider the Ontario Teachers’ Pension Plan, Canada’s third-largest. Three years ago, it set up a special fund to make venture-capital-stage investments. It invested $95 million in FTX, a leading crypto trading platform. On Thursday, it noted that “not all of the investments in this early-stage asset class perform to expectations.” It added that its FTX investment — presumably none of which it will ever see again — represents a tiny percentage of overall investments.
For years now, the folly of such investment strategies translated, essentially, into free money for entrepreneurs. It didn’t take a genius to spin up a company when the cost of capital was next to zero.
Now, that era is over. Higher interest rates will allow pension funds such as the one in Ontario to seek safer investments. As a result, the flow of funds to VCs and start-ups will slow. Only the best companies and VCs will emerge on the other side.