What is a craze? It is defined as a mental illness characterized by great excitement, euphoria, delusions and hyperactivity. When investing, this results in investment decisions being driven by fear and greed without being tempered with analysis, reason or the balance of risk and reward outcomes. The craze usually runs parallel to the development of the product business, but the timing can sometimes be wrong.
The technology.com boom of the late 1990s and the current cryptocurrency boom are two examples of how a craze works in real time. These two events will be highlighted with each stage of this article.
The idea stage
The first stage of a craze starts with a great idea. The idea is not yet known to many people, but the profit potential is huge. This usually translates to unlimited profit as “no such thing has ever been done before”. The Internet was one such case. People who used the paper systems of the time were skeptical about “how can the Internet replace such a familiar and entrenched system?” The backbone of the idea begins to build. This translated into the modems, servers, software and websites needed to turn the idea into something tangible. Investments at the idea stage start out low-gloss and made by “known” people. In this case, it can be the visionaries and the people working on the project.
In the world of cryptocurrencies, the same question is asked: how can a piece of crypto code replace our monetary system, contract system and payment systems?
The first websites were crude, limited, slow and annoying. Skeptics would look at the words “information superhighway” that the visionaries were throwing around and say “how can this really be that useful?” The forgotten element here is that ideas start at the worst and then evolve into something better and better. This is sometimes due to better technology, more scale and cheaper costs, better applications for the product in question, or more familiarity with the product combined with great marketing. On the investment side, early adopters are coming in, but euphoria and astronomical returns are still lacking. In some cases, the investments have yielded decent returns, but not enough to entice the masses to jump on board. This is analogous to slow internet connections in the 1990s, crashing websites or incorrect information in search engines. In the world of cryptocurrencies, high mining costs for coins, slow transaction times, and account hacking or theft are seen.
The word begins to spread that this Internet and “.com” are the new things. The products and tangibility are being built, but because of the massive scale involved, the cost and time spent would be massive before everyone uses it. The investment side of the equation starts to get ahead of business development as markets discount the potential of a business with the price of the investment. The euphoria is starting to materialize, but only among early adopters. This is happening in the cryptocurrency world with the explosion of new “altcoins” and the huge media press the space is getting.
This stage is dominated by parabolic returns and the potential offered by the internet. Not much thought is given to implementation or issues because “the returns are huge and I don’t want to miss out.” The words “irrational exuberance” and “craze” are becoming commonplace as people buy out of sheer greed. Downside risks and negativity and largely ignored. Symptoms of the mania include: any company with havent.com in its name is in the red, analysis is thrown out the window in favor of optics, investment knowledge is less and less evident among new entrants, Expectations of returns of 10 or 100 bags are common and few people know how the product works or doesn’t work. This has happened in the world of cryptocurrencies with the stellar returns of late 2017 and incidents of the company’s stock jumping hundreds of percentage points using “blockchain” in its name. There are also “reverse takeover bids” where shell companies that are listed on a stock exchange but are dormant have their names changed to something involving blockchain and the shares are suddenly actively traded.
The crash and the burn
The new product business scenario is changing, but not as rapidly as the investment scenario is changing. Finally, a change of mentality appears and a great wind begins. Volatility is massive, and many “weak hands” and market wipes. Suddenly, the analysis is being used again to justify that these companies have no value or are “overvalued”. Fear spreads and prices accelerate downward. Unprofitable companies that survive on hype and future prospects get blown up. Incidents of fraud and scams are exposed as they increase to take advantage of greed, causing more fear and selling of securities. Companies with the money are quietly investing in the new product, but the pace of progress is slowed because the new product is “an ugly word” unless the benefits are convincingly demonstrated. This is starting to happen in the world of cryptocurrencies with the folding of lending schemes that use cryptocurrencies and higher incidents of coin theft. Some of the fringe coins are falling in value due to their speculative nature.
At this stage, the investment landscape is charred with stories of losses and bad experiences. Meanwhile, the big idea becomes tangible and for the companies that use it, it’s a boom. It begins to be implemented in day-to-day activities. The product begins to become the standard and visionaries are quoted as saying that the “information superhighway” is real. The average user notices an improvement in the product and mass adoption begins. Companies that had a real profit strategy take a hit during the crash and burn stage, but if they have the cash to survive, they move on to the next wave. This has yet to happen in the cryptocurrency world. The expected survivors are those with a tangible business case and corporate backing, but it remains to be seen which companies and coins they will be.
The next wave: Business catches up to the hype
At this stage, the new product is the standard and the benefits become obvious. The business case is now based on earnings and scale rather than the idea. A second wave of investment appears, starting with these survivors and extending into another early-stage craze. The next stage was characterized by social networking companies, search engines and online shopping, which are all derivatives of the original product: the Internet.
Fads work in a pattern that develops similarly over time. Once you recognize the stages and the thought process behind each one, it’s easier to understand what’s going on and investment decisions become clearer.