Are There Too Many Cryptocurrencies...Has The Asset Class Become Overcrowded?

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The incredible returns delivered by Bitcoin, Ethereum, Dogecoin, and the other leading cryptocurrencies that have seen their market caps swell into the billion dollar range has encouraged new tokens to come to the market each day. The ICO, or initial coin offering market has exploded, becoming a highly profitable business for those arranging token listings.

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The sheer volume in the ICO market has dwarfed the IPO business in the stock market over the past years. Ironically, the Apr. 14 listing of Coinbase (NASDAQ:COIN), the leading cryptocurrency trading platform, found its way onto the NASDAQ via an untraditional route.

COIN rejected an IPO and all the associated rules, regulations, and enormous fees. Instead, they went the direct listing route, wherein the NASDAQ listed the shares without the help of an army of investment banks. The popularity of the asset class eliminated the need for investor roadshows and other expenses traditional IPOs incur.

I remember when the number of tokens on the CoinMarketCap site broke through the 1,000 level, and it was not that long ago. I began keeping track of the rise at the end of the first quarter of 2019 when the figure stood at 2,136.

At the end of 2019, it rose to 4,986, more than doubling over the nine month period. On Dec. 31, 2020, there were 8,153 cryptos. The global pandemic likely slowed the exponential growth last year.

As of the end of Q1 2021, 9,045 tokens were in play, and on June 30, it is a safe bet the number will eclipse the 10,000 level. On May 19, the number stood at 9,945 and rising.

Speculators grease the wheels of markets as they add a consistent level of liquidity. As speculators buy and sell assets, they tighten bid-offer spreads because of their activity.

Producers, consumers, investors, arbitrageurs, traders, indeed all market participants benefit from speculative buying and selling. The speculator often gets a bad rap from the press, regulators, and legislators, but without them, liquidity would suffer.

I always find it interesting when politicians complain that speculators are pushing the prices of assets higher, causing consumers to pay more for products. The truth is that speculators are as likely to push prices lower, but we rarely hear complaints when prices are falling because of speculative participation.

Meanwhile, Bitcoins rise from pennies to over $65,500 per token, and Ethereum’s explosive move from under $1 to over $4,400—as well as many other crypto success stories within the digital token asset class—have created a speculative frenzy. When my 88-year-old mother asked me if she should buy Bitcoin, I knew the market was out of control.

The rise of the asset class’s market cap has encouraged the ICO market as an expanding addressable market of participants who are looking for the next digital coin that will turn a small investment into a significant fortune.

It's challenging to make a case for a continuation of exponential returns for 10,000 cryptocurrency tokens. In biology, “survival of the fittest” was a concept from Charles Darwin’s “On the Origin of Species,” published in 1869.

Darwin suggested that organisms best adjusted to their environment are the most successful at reproducing. For digital currencies, we are likely to see a financial version of survival of the fittest over the coming months and years.

The speculative frenzy that ignited the ICO market and pushed the addressable token market to the 10,000 level is due for a substantial culling of the herd, to reduce numbers by weeding out undesirable traits from the asset class. The bottom line is that when gravity finally hits digital currencies in a significant way, many of those 10,000 tokens will become nothing more than computer dust collectors in digital wallets.

Still, digital currencies have made some of the leading financial minds look foolish over the past years. JP Morgan’s CEO, Jamie Dimon, called cryptocurrencies a “fraud” in 2017. Today, his bank offers its high-net-worth clients a cryptocurrency fund.

Famed investor and Berkshire Hathaway (NYSE:BRKa) CEO Warren Buffet said Bitcoin was “financial rat poison squared” around the same time. While he has been quiet on the topic over the past months, his 97-year-old partner, Charlie Munger, recently doubled down, saying cryptocurrencies are “dangerous for civilization.” My mom is only nine years younger than Munger, but she remains hot to trot on the prospects of big profits from the asset class.

Digital currencies are here to stay. However, the asset class needs to mature by addressing the many issues that will increase the profile as mainstream assets and means of exchange. Custody, cybersecurity, and the carbon required for mining are all substantial issues.

Meanwhile, the most significant gap to bridge is the shift in financial ideology that rejects government control of money. Regulators and legislators will desperately seek to hold onto power, which comes from controlling and manipulating the economy’s purse strings. Current monetary and fiscal policies may be fostering the rise of cryptocurrencies, but they are tools that governments are not likely to surrender.

We should see the number of cryptocurrencies peak over the coming months. A significant reduction could come after a substantial correction in prices and the overall asset class’s market cap, a bit of which we witnessed in early May.

In trading and investing, liquidity is critical. It allows market participants to enter and exit risk positions. Buying or selling an asset with limited liquidity exposes one to a far higher risk level.

While I may throw a few bucks at some of the smaller emerging cryptos, those investments are a long shot that's not likely to pay off. I expect to lose every penny invested. However, trading is another story. I follow trends in markets as they reflect the herd mentality of a wide range of market participants.

I would only trade cryptos with market caps over the $1 billion level as of May 18, which included under 100 coins. Aggressive trading requires higher liquidity levels. Therefore, my cut-off would be markets that are worth over $10 billion. There are only 17 cryptos or 0.17% of the asset class that have that critical mass.

Think biology when approaching the cryptocurrency asset class as there are too many tokens out there in cyberspace. Most are sponges that will eat your investments without the hope of any return. The fittest will survive as the market will eventually cull the herd.

Written By: Andy Hecht