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  Image source: EMIL LENDOF/THE WALL STREET JOURNALThe market value of Dogecoin, which was born as a joke, once reached $54 billion. Does this indicate that the entire cryptocurrency market is in an excessively crazy stage?Before explaining, let’s start with the joke that gave birth to Dogecoin. Almost every serious person who mentioned Dogecoin would say it was a joke, when there were dozens of new cryptocurrencies being created. This is true but should not be a hindrance. If something is useful, its originator's intentions should not make us averse to it. The first woman elected to public office in the United States was elected as a result of being nominated by a prank. Facebook Inc. (FB) grew out of Mark Zuckerberg's drunken idea of FaceMash, originally designed to let his classmates at Harvard rate female students' attractiveness. And if the creator's intentions mattered, Bitcoin would be viewed as a complete failure because it was created to enable small online payments but is now being hoarded or used for speculation. To the extent that Dogecoin has found a use as a way to reward Reddit users for their hilarious or informative social media posts, Dogecoin is in principle a very good cryptocurrency from a cryptocurrency perspective.  This is not an endorsement of Dogecoin’s value. It is mostly dominated by people who are joking and putting money into it, while others are betting on the outcome of this cryptocurrency, a situation that has led to big gains and big losses. Dogecoin is no more likely to replace the U.S. dollar than Kentucky Derby betting slips. The fact that the price of Dogecoin tripled in two days last week was a sure sign of excessive madness. But that doesn't prove that stocks or bonds are grossly overvalued: things are almost always going to be wildly over the top, because that's how markets work. Part of the brilliance of public markets is that they tap into the human desire to gamble in order to provide liquidity. This means that when long-term investors need to invest more money or cash out, there will always be someone willing to sell or buy as a counterparty. The side effect of this is that gambling often determines prices in the form of bubbles and hoarding, which makes prices far away from their true value.  Dogecoin, and the broader craze for cryptocurrencies, is a bubble, but that conclusion doesn’t necessarily apply to the rest of the market. Mini-bubbles often pop up in the stock market when traders jump into a new fad without a second thought: 3D printing briefly gained popularity in 2013, with shares of bellwether 3D Systems nearly tripling, while rare earth metals stocks more than quadrupled before crashing in 2011. Neither signals a blanket glut in the market, and the same may be true for Dogecoin. Now we come to the serious warning. Dogecoin is not unique. It's clearly part of a broader wave of excess that has spread across a bunch of different speculative assets over the past year. I don't believe this overheating will cause trouble for the rest of the market, but it is definitely a risk. Like other cryptocurrencies, Dogecoin is highly susceptible to speculation, with minimal regulation and no fundamentals to limit price and wild swings. The gambling instinct can only drive stock prices higher for so long, because eventually the fundamentals of the business will emerge and provide a basis for valuation.  Last year saw huge gains in stocks with weaker fundamentals and more reliance on hard-to-disprove future thesis. Profit is the foundation of a stock, but theme stocks can soar on the wings of imagination for a long time before being pulled back to the ground by cold business reality. Of course, there may also be a few companies that prove to be outstanding. The driving force behind Dogecoin is a combination of speculators looking to get rich overnight and traders who gather on Reddit forums with a "you only live once" philosophy, a combination similar to the hype surrounding GameStop Co. (GME). GameStop initially rallied on new business model thesis, then went higher on a short squeeze, and then was led by nihilistic investors on Reddit forums.  The hottest theme stock of the last decade was electric car maker Tesla Inc. (TSLA). Fans believed that there was a huge untapped market for self-driving electric vehicles and clean energy, and that these two technologies would eventually be used and bring high profits. Many of Tesla's would-be competitors became the subject of hype last year, sending their shares jumping, along with clean energy stocks, special purpose acquisition companies, cryptocurrency-related stocks and marijuana stocks. These stocks hit new highs, but the gains mostly faded in January and February. Overall, these don't pose a problem for people who don't bet on speculative booms. There's a valid argument to be made that the traditional stocks that most investors focus on are now well-supported by fundamentals, including a strengthening U.S. economy and low bond yields, even as the prices of these stocks are now at historically high levels. Of course, if these fundamentals deteriorate, as they have with the global economic outlook due to the recent surge in COVID-19 cases in many countries, then stock prices should pull back. The danger now is that the obvious overshooting of Dogecoin is no longer limited to theme stocks, but has spread to mainstream investment varieties. When the bubble finally bursts, the enthusiasm in other areas of the market will suddenly cool down. If that happened, it wouldn't be funny. James Mackintosh Note: The copyright of this article belongs to Dow Jones & Company and may not be translated or reproduced without permission.  Further reading: |
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