WHAT WE LEARNED FROM THE DOTCOM BUBBLE AND WHY IT MATTERS TODAY

Blockchain Coinvestors Newsletter

Vol. 4, No. 20, November 2022 

WHAT WE LEARNED FROM THE DOTCOM BUBBLE AND WHY IT MATTERS TODAY

As we approach the end of 2022, we are reminded of another year that we lived through and the investment opportunities it presented in the midst of worldwide turmoil and market chaos. That year was 2001, and while 20 years ago, we believe it is instructive for any investor to go back to review what happened, what we learned and why it matters today. 

 

Of course, we have to state up front that we are not making any investment recommendations and that past performance is no guarantee of future returns. However, it is an important thought experiment so here goes.

 

The Digitalization of Communications and Content

 

Throughout the 1990's a powerful new technology called "The Internet" was dramatically changing the way the entire world communicated and accessed and shared content. At the time, we were confused about what it was and what it eventually might do to our everyday lives: 

  • We remember CEO's of leading public companies saying that the world did not need this innovation

  • We remember lawmakers and regulators arguing that it should be banned and shut down because there was too much dark web activity, porn, chargebacks, copyright infringement and piracy, avoidance of sales tax and so on

  • We remember our own partners at a leading consulting firm refusing to allow email addresses to be added to business cards because an email was not required to do business

In retrospect, none of us appreciated the way in which the TCP/IP protocol and the technology stack built on top of it would revolutionize communications and content across every industry, every business and for every individual. 

 

Despite what became an investment bubble fueled by 'irrational exuberance', long term there was a more important narrative at work. A new innovation was changing human existence in profound ways. Now we all take that innovation for granted.

 

1990's Macro Forces

 

It is easy to start the dotcom bubble with investor 'irrational exuberance', and we will get to that in a moment, however, we prefer to start with the powerful macro-economic forces that began in the mid 1990's and which, we believe, stoked the fire of investor sentiment. 

 

To begin, our politicians and their appointed financial leaders chose to greatly reduce interest rates during the early 90's. Now to the modern eye, mid single digit Federal Fund rates do not sound low, but we remember that back in the mid 1990's it seemed that capital was available and cheap, and it was one factor in stimulating investor sentiment. 

Next to 'cheap money' the lawmakers also greatly excited the investor mindset with some very important new regulations. The US Taxpayer Relief Act of 1997 lowered capital gains tax and the 1996 US Telecommunications Act stoked excitement about how the Telecom sector was going to be the next place to find Alpha. 

 

All of a sudden, money began to flow into the new digital communications and content sector.

 

Irrational Exuberance

 

By December 1996, Alan Greenspan was attempting to talk back down stock market prices in his famous speech in which he talked of 'irrational exuberance'. But the genie was out of the bottle by then. Wall Street was channeling vast amounts of capital into late stage Telco and dotcom company shares. Late stage valuations were spiking, and the retail investor was trying to get in too - we remember the appearance of day traders at Schwab day trader desks in their offices throughout San Francisco, and the arrival of the retail focused stock pickers including Silicon Investor, Yahoo! Finance, and The Motley Fool to name just three.

 

Everyone had a tip for you, including the proverbial taxi drivers of Manhattan. Everyone wanted in on dotcom stocks and nowhere was the irrational exuberance more apparent than in late stage and pre-IPO stocks. The IPO window was open, and it seemed as if any dotcom with a business plan and eyeballs could go public, even if they had minimal revenues and enormously negative cash flow. 

 

Wall Street would find the investors for a going public dotcom and the rest was as simple as one, two and three.

 

Public Market Collapse

 

Between 1995 and the dotcom bubble bursting in March 2000, the Nasdaq public technology stocks had gone to the moon, rising 400% in that period. On March 10th 2000, the Nasdaq composite peaked at 5,048.62 - more than double its value just twelve months before. By October 2002, the index was down to 1,100 and investors had lost on average 80% of their investment value. In fact, more than $5 trillion in market capitalization was lost in that period.

 

The most dramatic losers were the most visible public dotcom's and those that had raised enormous amounts of capital at multi billion dollar late stage valuations. We remember their names. Boo.com, Geocities, Global Crossing, Pets.com, Webvan, Worldcom, and many others. However, it was not just the newcomers who suffered. If you had a business linked to the Internet hype, your public stock was hammered too. Cisco lost 80% of its value even though the Internet was built on top of its boxes and could not happen without it.

 

A generation of retail day traders were wiped out, and for a while, public investors abandoned the innovation sector for more established industries where they hoped to earn more reliable returns.

 

Private Market Turmoil

 

The public market dotcom crash reverberated back along the venture capital pipeline too. While early stage venture capital valuations had never spiked in the way the late stage valuations had, they had also doubled and tripled and now startup funding moved from a seller market in which any dotcom could write their own term sheets and get funded, to a buyers market in which venture capitalists demanded much more for their investment in terms of better teams, more thorough business plans, lower valuations, and more stringent investment terms.

 

The best builders got backed, but most new entrepreneurs did not. Furthermore, a generation of startups backed through irrational exuberance failed to raise follow-on rounds, burned through their cash, and went out of business.

 

September 11th, 2001

 

To seal the end of our period of great excitement, we got a shock in late 2001 which was to drive much of the global narrative of the 2000's that followed. On September 11th, 2001 we watched the previously unimaginable occur as two planes flew into the New York World Trade Center. In the next few months, rapid regulations were passed, the US launched its global war on terror, and it seemed as if the world would never be the same again. 

 

The world was at war.

Innovation Won Out

 

Did innovation stop? Of course not. 

 

The important point of the dotcom bubble was that the world really was digitizing all of its communications and content, and while the capital markets had gotten ahead of their skis, the innovation kept moving forward. We often show this next exhibit to make a simple point. Today, most of the world's most valuable companies are those created on top of the Internet innovation and every industry, every business, and every individual has seen their lives enormously changed.

In addition, many of those companies arrived on the scene AFTER the dotcom bubble had burst. So it was not enough to place some bets in the 90's and then leave the game. The innovation carried on, which meant that a disciplined investor also needed to invest into the next waves of innovation or risk missing out on the eventual winners. MySpace lost out to Facebook, just as Inktomi lost out to Google.

 

This was inevitable in retrospect. For investors, this investment theme (as well as the more narrowly defined FANG narrative) was to drive most of the alpha of public markets for the next two decades until recent months.

 

A Wild Ride

 

To bring this wild ride to life, let's look at one company through this period - Amazon. 

 

We had all begun to hear about the digitized book shop online in the mid 90's, but few among us were thinking as Jeff Bezos was - that books were just the preamble to everything being sold digitally.

With the help of his bankers, Jeff took Amazon public on May 15th, 1997 at $18 a share. As the table above from Motley Fool shows, in April 1999 you would have paid $105.06 per share unadjusted for three stock splits. By its low in September 2001, that would have been just $5.97 per share.

 

Both would have been great investments if you had held them until today.

If you look closely at the Motley Fool chart above, you can probably make out the Amazon share price collapse during the dotcom bubble bursting.

 

But you would miss the big picture if you let that impact your long term investment decisions.

 

Superior Investment Returns

 

Is that Amazon story just a matter of winner's bias and retrospective thinking?

 

No, because the averages prove the point very effectively too. The following exhibit shows investment returns from public equities around every recession of our lifetimes. The 'so what' is obvious. If you buy low and sell high you get superior returns. And the best time to buy low is in the two years after a downturn.

 

Conversely, the worst time to buy shares is during the peak months of 'FOMO' and irrational exuberance that precede the downturn.

This is not just the case in public equities. In private equities, the cohort returns for funds raised peak in the years following downturns. 

 

Dry powder, put to work in venture capital at lower valuations, gets superior returns.

Unfortunately, most investors get burned so badly when bubbles burst that they stay on the side lines exactly when they should be putting their capital to work.

 

A New 'Internet of Value'

 

So what does any of this have to do with today and with our investment thesis?  

 

Well simply put, digital communications and content do not equal a digital global economy.  To get to that we need digital commerce too. Which requires that we have natively digital monies, commodities, and assets. Which in turn requires that all of the world's financial infrastructure will need upgrading since it is not fit for purpose. You can't transact in real time, at negligible cost, on today's infrastructure. Not with money and certainly not as an investor since most of the world's assets are still paper based.

 

To collapse our investment thesis down into a few simple lines:

  1. Digital communications; plus

  2. Digital content; plus

  3. Digital commerce; equals

  4. Digital economy which is

  5. The future.

Ten years ago when we would discuss our investment thesis, most leaders of governments and businesses would not agree. Today they all do. The dialog has shifted to who should be able to support digital monies, commodities and assets and under what laws and regulatory framework. Just as was the case back in the mid 1990's.

 

The chart that follows shows the adoption of crypto vs the Internet. We view crypto as a sub category within digital monies and assets, but it is a useful proxy since no metrics exist for the broader category that we focus on in our own investing (we do not invest in public liquid crypto at all).

 

We are not surprised at these adoption curves, because digital commerce is coming AFTER digital communications and content. The new innovation benefits from the worldwide rollout of the former. 

 

In addition, the digital natives are now a majority of the world's population which is another powerful tailwind at work today.

 

Our Third Crypto Winter

 

Having said that, today we are living through our third crypto winter, and it feels like the broader market context of 2022 is very similar to 2001:

  • Low interest rates stimulated cheap capital and investor excitement

  • A great new innovation appeared and investors bought into its promise

  • Too much capital appeared from the great capital markets, and drove late stage valuations through the roof

  • Irrational exuberance became widespread

  • Then exogenous variables could not be denied - COVID, inflation, and the need to raise interest rates

  • In parallel the world went to war again, and energy prices spiked too

Without doubt, the innovators created some spectacular collapses, including some massive frauds, but as early stage investors we expect innovators to fail more often than they succeed.

While it is painful to observe the parallels of what can go wrong when a new-to-the-world innovation attracts too much capital especially in the public liquid crypto and late stage end of the investment horizon, we take comfort in the observation that Jeff Bezos backed Amazon, but he also backed Pets.com too.

 

So in this trying time, where fear, uncertainty, and doubt are walking within the walls of every investor's office and mind, what should we all be doing?

 

What May Happen Next?

 

Now we get to prediction, which is the dangerous part. We like Mark Twain's quote:

 

"Prediction is difficult - particularly when it involves the future" Mark Twain

 

On the other hand, as investors our very work is about having a point of view regarding the future. Here are some questions we think every investor should be asking right now:

  • Have I seen this before?

  • Are we living through the dotcom crash coming again in 2022?

  • Is Russia/Ukraine our modern day Sept 11, 2001 giving rise to the resulting war on terror?

  • Will regulators again try to bottle innovation and fail?

  • Will digital commerce win out and become ubiquitous?

  • Should I be investing into downturns and if so against what investment thesis?

For our own part, we are answering these questions as laid out in this newsletter.

 

More specifically, we are backing the best blockchain builders who are making digital monies, commodities, and assets come to reality, and who are building the future today.

 

As another great American figure said:

 

"The most reliable way to predict the future is to make it" Abraham Lincoln

 

Tailwinds for Blockchain Specialists

 

A final thought to wrap up this Investment Newsletter. 

 

We believe the tailwinds behind blockchain specialists are even more substantial today than they were at the beginning of this year:

  • Digital monies, commodities, and assets are inevitable

  • Digital natives are now in their 40’s and 30’s and are digitally reliant

  • Downturns will wash away FOMO opportunists (as in 2001, 2009)

  • Superior returns in venture are highest following downturns

  • Distressed opportunities will present themselves (selective)

  • Investors will need growth and FANG mega trend coming to an end

We hope this has given you food for thought.

Thank you for reading.

Alison Davis

Matthew Le Merle

ABOUT BLOCKCHAIN COINVESTORS

 

Launched in 2014, our vision is that digital monies, commodities and assets are inevitable and all of the world’s financial infrastructure must be upgraded. Our mission is to provide broad coverage of the emerging unicorns and fastest growth blockchain companies and crypto projects. Our investment strategy is now in its 9th year and has to date invested in more than 40 pure play blockchain venture funds in the Americas, Asia and Europe; and in a combined portfolio of 400+ blockchain and crypto projects including approximately 60% of all blockchain unicorns. Our funds rank in the top decile amongst all funds in their respective categories on both Pitchbook and Preqin. Headquartered in San Francisco with a presence in Grand Cayman, London, New York, Zug and Zurich, the alternative investment management firm was co-founded by Alison Davis and Matthew Le Merle.

FUND PERFORMANCE

 

Blockchain Coinvestors Fund III (Fund of Funds) was created to provide diverse coverage of the best blockchain pure play venture funds in the Americas, Asia, and Europe. Blockchain Coinvestors Funds I and II have already experienced significant appreciation. Fund I Net TVPI is 4.82x with an IRR of 67%. Fund II shows equally impressive early results with Net TVPI of 1.42x and an IRR of 42%. Almost all of our fund investments are performing as top quartile against the Cambridge Associates Venture Benchmark.

BLOCKCHAIN COINVESTORS FUNDS

Blockchain Coinvestors’ goals are to provide broad coverage of the emerging unicorns and fastest growth blockchain companies and to capture superior returns from investing in the leading blockchain venture partnerships. Our funds are open to investors that meet the Qualified Client definition with a minimum subscription level of $250,000 at the discretion of the Manager. 

 

  • Blockchain Coinvestors Fund III (Fund of Funds) was created to provide diverse coverage of the best blockchain pure play venture funds in the Americas, Asia, and Europe. Blockchain Coinvestors Funds I and II have already experienced significant appreciation. Fund I Net TVPI is 4.82x with an IRR of 67%. Fund II shows equally impressive early results with Net TVPI of 1.42x and an IRR of 42%. Almost all of our fund investments are performing as top quartile against the Cambridge Associates Venture Benchmark.

  • Blockchain Coinvestors Fund IV (Early Stage Token) provides direct access to promising private stage token projects accessing our relationships with many of the world’s leading blockchain investors. We leverage asymmetrical information from our 40+ VC Funds to pick the most attractive opportunities. This is a continuation of the direct token investing strategy of the Fund Manager that has included private stage investments in Acala, Filecoin, NEAR, Polkadot, Structure, and others.

  • Blockchain Coinvestors VI (Mid Stage Growth) provides direct exposure to the emerging category leaders in the blockchain and crypto ecosystem. The fund leverages our unique sustainable competitive advantage (USCA) in blockchain, web3, and fintech to create a concentrated portfolio of between 20 and 30 investments with attractive return profiles and visible paths to liquidity. The fund assesses the more than 400 blockchain and crypto projects in which we are direct and indirect investors and employs a robust investment framework to select investment opportunities into the leading mid stage growth rounds - typically Series B, C and D. This is a continuation of the mid stage investing strategy of the Fund Manager that has included investments in Bitwise, Brex, InfiniteWorld, Securitize, Uphold, Wyre, and others.

Please visit the Blockchain Coinvestors website to learn more about our offerings. You can also reach our Investor Relations team directly at ir@blockchaincoinvestors.com.

BLOCKCHAIN COINVESTORS SWISS

We are excited to announce that Blockchain Coinvestors Funds are now available through Swiss certificates for those of our non-US investors who prefer this approach. The underlying fund is the same, however, our Zurich based team at Blockchain Coinvestors Swiss, who will introduce in future weeks, can provide detailed information regarding this investment option. Email us at mlemerle@blockchaincoinvestors.com to learn more.

BLOCKCHAIN COINVESTORS ANGELLIST SYNDICATE

Continuing the theme of the democratization of investing, we have a rapidly growing Blockchain Coinvestors syndicate on AngelList providing access to selected coinvestments. Please join us and our partner Lou Kerner on AngelList.

Click here to receive the insightful weekly crypto newsletter and webinar invitations from our Blockchain Coinvestors partner Lou Kerner.

REGISTER NOW FOR UPCOMING WEBINARS AND CALLS

 

Our investment team hosts regular webinars and calls to help educate our community about the Fifth Era, fintech, blockchain and crypto. We discuss important trends, tailwinds and investment themes including what we have learned and how we are using our knowledge to inform our own investment thesis and actions. Below is a list of upcoming webinars for which you can register by clicking the links:

 

Meet the Blockchain Unicorns - Year-End 2022

- December 5th, 7:00am PT
- December 5th, 12:00pm PT

 

2022 Year-End Wrap Up

- December 19th, 7:00am PT
- December 19th, 12:00pm PT

 

Blockchain Coinvestors Investment Thesis

- January 23rd, 7:00am PT
- January 23rd, 12:00pm PT

 

Recordings of past webinars and calls can be found at www.blockchaincoinvestors.com/webinars.

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