Blockchain : Internet :: Bitcoin : ?

Younger readers might not recognize the format of this piece’s title, but those of a certain age will recognize it as all too familiar. The SAT removed the analogy section of the verbal test in 2005, but the logic lives on for many of us who prepped those questions. The question is this: blockchain is to internet what bitcoin is to ________. The question may sound frivolous, but roughly $1 trillion – the market capitalization of bitcoin — hinges upon the answer. 

Regardless of your opinion about cryptocurrencies, I believe that the analogy between blockchain and the internet is apt. Blockchain is a distributed, immutable ledger. Its initial application was to keep track of bitcoin transactions, but creative minds are devising a wide range of potential applications from financial innovation to supply chains management and much more. Consider the internet in its earliest days. It was a means to allow messaging between disparate computers in the defense department. Just as the internet has evolved from a means of exchanging crude emails to something indispensable to billions of people in a multitude of unimagined applications (such as, ahem, internet stock trading), blockchain could find itself embedded into a wide range of functions that most of us haven’t yet considered.

As of now, however, the primary use case for blockchain continues to be cryptocurrencies. And as a market strategist (not a futurist), it is upon that use case that I need to focus on. With bitcoin, the most visible cryptocurrency – the OG, as it were – on the rise from $30,000 to $50,000, it seems to be another opportune time to consider how bitcoin fits into the broader context of blockchain and what the parallels may be to the internet stock craze at the end of the last century. Let’s take a look at some charts. First is a 1-year chart of bitcoin with its 50, 100, and 200-day moving averages. I chose to focus on longer-term moving averages in order to put the recent bounce into a longer-term context, bearing in mind that longer-term averages define trends.

(Click on image to enlarge)

Source: Bloomberg

We see that the 50-day average has begun pointing steadily higher after bitcoin completed its successful test of $30,000 support. The 100-day is still pointing down, but the 200-day is peeking ever so slightly higher. These trends are decidedly mixed, making the technical viewpoint uncertain. If we see the rally stall and decline from current levels, I would expect to see no shortage of pundits saying that they see the onset of the dreaded head-and-shoulders top. Let me be clear that for now, such calls are highly premature.

Now let’s look at a 2-year chart of bitcoin against 2 of its crypto peers, Ethereum and Dogecoin. The former is considered by many to be a superior form of cryptocurrency to bitcoin because it has a more robust, faster infrastructure. The latter was literally created as a joke, yet has become a favorite of speculators because, well, um, important people like Mark Cuban and Elon Musk say it’s fun.

(Click on image to enlarge)

Source: Bloomberg

While we see that Ethereum has outperformed Bitcoin over the past 2 years, the use cases of both seem to be outweighed by the fun factor of Dogecoin. This, and the clear correlation between the 3 cryptos, tells me that the current wave of cryptocurrency movements is more about the ebb and flow of speculative fervor than a careful differentiation of the relative merits of the systems and benefits that underlie each currency.

This brings me to my final chart, a reminder of the internet bubble. The late 1990s was a period when, as now, a new technology was being adapted by the public at large and a wide range of companies. As now, monetary policy was accommodative, particularly in late 1999 when the Fed was pumping money into the system to avert a Y2K crisis that never materialized. Also, as now, individual investing was undergoing a wave of accessibility (web-based trading then, zero commissions and fractional shares now). All that led to a speculative frenzy. The mere notion that a company was creating a website was enough to jolt its stock price higher, just as the news that a visible company now may begin accepting crypto for payment. The result was this:

Daily Chart, 1996-2002, NASDAQ 100 (NDX, white, right axis 1), S&P 500 (SPX, blue, left axis), Cisco Systems (CSCO, red, right axis 2), Amazon (AMZN, purple, right axis 2)

(Click on image to enlarge)

Source: Bloomberg

We can see dramatic outperformance and later underperformance by NDX over SPX during that period.NDX rallied about fivefold in four years, only to give back nearly all its gains over the subsequent 2.Over that time SPX roughly doubled but finished somewhat higher than when it started. We see that AMZN and CSCO both moved much higher, with AMZN outpacing CSCO for a while, but they moved generally in tandem. 

It was a clearly excessive period in hindsight, and to be fair it did seem excessive to many at the time. The peak was reached early in 2000 when the Fed began withdrawing the excess Y2K money from the system. Now we have a period where SPX doubled in a shorter timeframe and the Fed is considering when to slow monetary growth, if not withdraw support more fully. There certainly could be parallels to that period.

This brings us back to our initial question. Many of the high-flying internet stocks were consigned to the dustbin of history, others were slow to recover, like CSCO, while others, like AMZN, thrived. That doesn’t even consider an internet upstart like Google (GOOG, GOOGL) or companies like Facebook (FB) that didn’t yet exist. Which of these best represents Bitcoin vis-à-vis the early days of the internet?

1. Pets.com
2. Netscape
3. Cisco
4. Amazon
5. None of the Above

I have to confess, I don’t know the answer. My gut says C, Cisco, because blockchain wouldn’t exist without bitcoin, and the internet would be much less robust without CSCO. Will the cryptocurrency suffer a similar outcome? Time will tell. (And don’t be shy about letting me know your answers to that question).