What is mania? It is defined as a mental illness characterized by great excitement, euphoria, illusions and excessive activity. In investing, this translates into investment decisions driven by fear and greed, not tempered by analysis, reason, or risk-reward balance. The mania usually runs parallel to the business development of the product, but timing can sometimes interfere.
The technology.com boom of the late 90s and the cryptocurrency boom today are two examples of the mania working in real time. These two events will be highlighted with each stage in this article.
The stage of ideas
The first phase of mania begins with a big idea. The idea is not yet known to many, but the earning potential is huge. This usually translates to unlimited profits, because “something like this has never been done before”. The Internet was one such case. People who used the paper systems of the time were skeptical as “how can the internet replace such a well-known and entrenched system?” The backbone of the idea begins to be built. This translated into the modems, servers, software and websites needed to turn the idea into something tangible. Investments at the idea stage start off without a splash and by people who “know”. In that case, it can be visionaries and people working on the project.
In the world of cryptocurrencies, the same question arises: How can a piece of crypto code replace our monetary system, contract system and payment systems?
The first websites were crude, limited, slow and boring. Skeptics would look at the words “information superhighway” uttered by the visionaries and say “how can this really be so useful?” The forgotten element here is that ideas start at their worst and then evolve into something better and better. This sometimes happens because of better technology, greater scale and lower costs, better application of the product in question, or greater product knowledge combined with excellent marketing. In terms of investment, early adopters are emerging, but there is no euphoria and astronomical returns yet. In some cases, the investments made decent returns, but not enough to encourage the masses to jump in. This is analogous to slow internet connections in the 1990s, websites crashing, or information on search engines being incorrect. In the world of cryptocurrencies, this is evidenced by the high cost of mining coins, slow transaction times, and account hacking or theft.
Word is starting to spread that this internet and “.com” is a new thing. Products and tangibility are being built, but due to the sheer scale involved, the cost and time involved would be huge before everyone starts using it. The investment aspect of the equation is starting to come before business development as markets reduce business potential at the cost of investment. 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 big media press it’s getting.
This phase 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 them”. The words “irrational exuberance” and “mania” are starting to become common as people buy out of sheer greed. Negative risks and negativity are largely ignored. Symptoms of mania include: every company with .com in its name is red hot, analysis is discarded in favor of optics, investment knowledge becomes less and less visible among new entrants, expectations of 10 or 100 bag returns are commonplace and few people actually know how the product works or doesn’t work. This played out in the world of cryptocurrencies with stellar returns in late 2017 and incidents where shares of companies using “blockchain” in their name jumped hundreds of percentage points. There are also “reverse takeover offers” where fictitious listed but dormant companies are renamed to something that includes blockchain and the shares are suddenly actively traded.
The Crash and Burn
The business scene for new product is changing, but not nearly as fast as the investment scene is changing. Eventually, a shift in mindset emerges and a big sales frenzy begins. Volatility is huge, and many “weak hands” have been wiped out of the market. Suddenly, analysis is being used again to justify that these companies have no value or are “overvalued”. Fear is spreading and prices are falling rapidly. Companies that have no profits and survive on hype and future prospects have failed. Incidents of scams and scams increasing to take advantage of greed have been exposed, causing more fear and a sell-off in securities. Companies with money quietly invest in a new product, but the rate of progress slows because the new product is an “ugly word” unless profits are convincingly demonstrated. This is starting to happen in the cryptocurrency world with the decline of loan schemes that use cryptocurrencies and more frequent cases of coin theft. Some of the marginal coins fall in value due to their speculative nature.
At this stage, the investment landscape is charred with stories of losses and bad experiences. Meanwhile, a great idea becomes tangible and for the companies that use it, it’s a boom. It starts to be implemented in everyday activities. The product is starting to become the standard and visionaries are quoted as saying that the “information superhighway” is real. The average user notices improvements in the product and mass adoption begins. Companies that had a real profit strategy took a hit during the crash and burn phase, but if they have the money to survive, they make it to the next wave. This has not yet happened in the world of cryptocurrencies. The expected survivors are those with tangible business justification and corporate backing – but it remains to be seen which companies and coins those will be.
The next wave – the business catches the hype
At this stage, the new product is the standard and the profit becomes obvious. The business case is now based on earnings and scale, not the idea. A second wave of investment emerges starting with these survivors and extending into the second early phase of the mania. The next phase was characterized by social networks, search engines and online shopping, which are all derivatives of the original product – the Internet.
Manias operate in a similar pattern over time. Once the stages and thought process in each are recognized, it becomes easier to understand what is happening and investment decisions become clearer.