The rise of cryptocurrencies is one of 2017’s most captivating market stories.

A lot of market watchers have been left scratching their heads, not sure what to make of it. There’s strange new jargon to absorb—words like “blockchain.” Mystical, faceless founders, known only by Internet alias.

One thing that isn’t confusing is the price action. It seems overnight millionaires are regularly being minted. Bitcoin has soared over 1,500%, while some of its peers have done even better.

Yet for all the excitement surrounding bitcoin mania, there is also a dimension with a familiar arc.

What dooms most investment booms is a wall of new supply. That wall is quietly forming in the realm of digital currencies. Brick by brick, it grows bigger by the day, with each new coin being issued.

Yes—I’m pretty sure I’ve seen this story before, in different forms.

Here are a few examples, starting with my first “investment”.

Case Study #1: Baseball Cards

When I was 8 years old, I diligently saved up $100 from my allowance and birthday money, then parked it all in baseball cards. Specifically, I purchased a 1983 Topps complete set.

It seemed like a wise decision at the time. I studied monthly Beckett price guides religiously back then, and felt well-attuned to “the market.” Baseball cards were popular and steadily increasing in value.

Alas, it turned out to be a very bad investment.

For starters, my dog ate a third of the cards right after I bought them!

Even if I still had all the cards in mint condition though, I’d be lucky to get $40 for them today.

The baseball card market boomed throughout most of the 1980s, attracting an influx of hobbyists and speculators. I was one of those speculators, although I had no idea what the word meant at the time.

Baseball cards stopped increasing in value in the late ‘80s when the leading card issuer, Topps, saw an influx of competition. New companies like Score and Upper Deck jumped in the ring, joining fringe competitors like Fleer and Donruss.

For me, it became annoying tracking all the brands. How many 1989 Jose Canseco cards does a collector really need?

I stopped buying as many cards, and so did others. Price momentum stalled, which further dampened enthusiasm. The market became engulfed in a negative feedback loop it’s never recovered from.

Case Study #2: Tech

If you were a stock investor in and around 2000, you likely remember the tech frenzy. Any equity ticker representing a company with a .com at the end of its name was in very high demand.

In a free society, capital flows to where it's treated best. When a category is under-served and booming, new capital formation scrambles at a ferocious pace to catch up and cash in. Venture capitalists and investment bankers help make this happen by bringing new securities to market.

However, supply always overshoots at some point. That’s when booms go bust.

For instance, in 1999 over $50 billion of equity capital was raised via initial public offerings—a record. Over half of the total IPOs that year were technology related.

Around this time, the market became oversaturated with tech shares. The long bull run in tech stocks began grinding to a halt. Over the next two years, the tech-heavy Nasdaq Index lost 78% of its value.

Case Study #3: Real Estate

There was a time in the last decade when many people believed real estate prices only went up. Starting around 2006, many of those same people began to experience a rude awakening.

The housing collapse was precipitated by a period of ultra-easy lending standards, which increased the buyer pool. Higher demand nudged housing prices higher. Eager homebuilders then sought to capitalize by expanding the rate of housing starts beyond cyclical norms.

(Data source: HiddenLevers)

 

Eventually, housing supply became extended beyond a rational level. When demand conditions normalized, a price correction was imminent.

Each of the preceding examples illustrates the same investing lesson. That is: too much of a good thing—in any market—can be hazardous.

Will Cryptos Be the Next Case Study?

Financial blogger, Josh Brown, has been a bitcoin bull most of this year. He’s profited nicely from that stance. However, he recently wrote an insightful post articulating a budding concern.

 “So I asked… the following rhetorical question: There are only three coins on the (Coinbase) platform. If there were five or ten, isn’t it more likely that they would all individually be worth less per coin, because Coinbase retail people would have more places to spread their bets?”

In my view, Josh is wise to worry about this. All cryptocurrency enthusiasts should be monitoring the threat imposed by rising competition for investment dollars via new tokens.

Bitcoin bulls point to limited supply as an attractive trait of the new ‘currency.’ Unlike the U.S. monetary base—which the Federal Reserve has perennially expanded since the U.S. ditched the gold standard—bitcoin supply caps at 21 million coins in 2040.

If the rules don’t change, supply limits appear to make bitcoin a better store of value than fiat currency.

However, there’s one big caveat: bitcoin isn’t the only digital currency game in town. And that could potentially become a very big deal.

Coinbase is presently the main exchange for trading digital assets, serving 13 million customers in 33 countries.  Bitcoin (BTC), Ethereum (ETH) and Litecoin (LTC) are listed on the platform, and all have skyrocketed in 2017.

Litecoin (LTC), founded by a former Google engineer Charlie Lee, is said to be faster to mine than bitcoin. Perhaps that explains why it’s up 75-fold in the last 12 months?

By the way, Mr. Lee sold every one of his tokens this month.

Next month, a fourth option will become available on Coinbase in the form of Bitcoin Cash (not to be confused with the other bitcoin—BTC).

Ripple (XRP)—released in 2012, already has a market capitalization over $18 billion.  How long until that one appears on Coinbase, and gains wider adoption? Will it be at the expense of rivals?

There are many other competitors to consider as well, like Dash, Monero, and NEM.

This army of second-generation cryptos will keep growing and nipping at bitcoin’s heels, just like all those sports card companies came after Topps.

To be clear, there are many things I do not profess to know about how digital currencies will perform from here.

• I don’t know where bitcoin will be trading ten years from now
• I don’t know if government regulation will upend the market
• I don’t know which digital coin is the best bet for 2018

Here’s what I do know: the fact we’re seeing all these new tokens emerge means we’re at the beginning of the end. Not necessarily the end of the cryptocurrency story in its entirety, but of this chapter—a parabolic ascent phase that caught most people by surprise.

 

Originally published by Forbes. Reprinted with permission. 

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