Many members of the crypto community believe that the high rates of development of the crypto industry over the past year can signal the beginning of mass adoption of the digital economy. This is evidenced by the growing market capitalization of cryptocurrencies, which is more than $289 billion today. And also the high popularity of ICOs as the main way of crowdfunding of new projects. If 210 projects raised about $3.9 billion in 2017, only the first half year of 2018 brought more than $9.6 billion of investments to 390 projects.
The stock market of the 20s and the current trends in the development of the crypto industry have much in common. As such, market players should extract a couple of valuable lessons from the crash of 1929, which brought about the beginning of the Great Depression in the United States.
Stormy, Roaring Twenties
The Roaring Twenties is the era of the 1920s in the US, which began with a return to a peaceful life after the First World War and was marked by large-scale scientific, social, and cultural breakthroughs. At the same time, the US achieved a dominance in the sphere of finance, which positively affected the high dynamics of the securities market growth.
In many respects, the famous American banker Charles E. Mitchell, the president of bank National City Bank, which is now known as Citibank, promoted this phenomenon. In the early 20s, he was one of the first to offer the securities of companies to a broad market of investors, who were mainly offered state bonds before that. Consumer loans also became popular under the control of Mitchell, which allowed the banking network to expand to 100 offices, and have offices in 23 countries outside the US. This step also contributed to the development of the speculative stock fever, which preceded the collapse of 1929.
According to the scientific article "A Brief History of the 1930s Securities Laws in the United States – And the Potential Lesson for Today," published in the Californian University of Pepperdine, U.S. economic growth has also led to the fact that from 1925 to 1929, the securities market experienced a prolonged bullish rise and the stock index of the market grew almost three times during the same period. In many respects, it was promoted by development and mass popularization of a new means of mass media, the radio.
These factors became key to the growth of speculative activity among players in the stock market, which led to cases of massive manipulation of securities prices. This was said by many high-ranking officials in the US government, who repeatedly warned investors about the high level of speculative activity and risks of trading in the stock market. Before the stock market crash of 1929, however, no concrete steps were taken by the authorities of the time.
Moreover, many companies saw their future in the centralization of their resources in order to remove incompetent managers from management positions. In connection with this, holding companies started appearing on the market far too often, and they played the role of centralized management structures. At the same time, various shops, businesses, and entertainment establishments began to be integrated into corporate networks. As for banks, they were also extremely interested in the participation of bank holding companies in the process of centralizing their services.
At that time, the stock market did not obey the federal laws governing trade in securities. This involved local financial authorities, which issued laws at the level of their states. And the secondary securities market was in a complete state of self-management, where the main role was assigned to the stock exchanges.
Shortly before the collapse of 1929, companies were actively issuing shares that brokers enthusiastically offered to investors, promising high returns in the shortest time periods. These promises, however, were not always based on the actual state of things within the companies themselves, and often the information was exaggerated, or completely fabricated. Nevertheless, thousands of investors invested their money in inflated stocks in the hope of earning a quick profit, which led to the formation of an economic bubble. At the same time, many investors used to borrow funds at interest rates to buy shares.
The bubble burst on October 24, 1929, and a panic selloff began, which led to a drop in the Dow Jones industrial index by 11% in the first day of the market collapse. Within a week, stock market capitalization fell by 40%, and investors lost about $30 billion, or more than the US government spent throughout the entire time of the First World War.
The Crypto Market Today
It is impossible to compare the state of the stock market in the 1920s and the current development of the crypto market without noting several similar trends. Of course, unlike centralization, today the main theme is the absolutely opposite idea of decentralization.
The development of such tools as blockchain networks, smart contracts, DAOs (decentralized autonomous organizations), and cryptocurrencies, in many respects, is similar to the development of the stock market instruments of the early 20th century. At the same time, many participants in the crypto community believe that the current laws aimed at centralizing economic power are a barrier rather than a protection of their interests.
As for the ICOs, then, the development of this instrument of the crypto market is in many ways similar to the actions of large companies and corporations on the stock market of the 20s. In particular, this concerns projects that issue utility tokens (tokens that give investors the right to services of the issuing company), either disclose incomplete information or provide false information and to attract potential investors, as indicated by numerous investigations of the financial regulators in US.
Moreover, the secondary market of trade in utility tokens in most cases is self-regulated by cryptocurrency exchange sites, just as the securities market of the 20s was regulated only by the stock exchanges.
Secondary Market of Trade, a Comparison of Traditional and Crypto Assets
The purpose of any exchange is to provide an open and fair platform for the exchange of assets, where the relationship between supply and demand is not regulated or manipulated by third parties. Nevertheless, as the investigation of the collapse of 1929 showed, the stock exchanges manipulated the rates of securities in order to control prices on the stock market. Today, many accusations can be heard on the crypto market against pump and dump schemes.
The Exchange Pool in the 20s
In most cases, the exchange pool consisted of several players in the stock market, which artificially raised stock rates. To do this, pool members bought shares of one company, often at a low price, through option contracts, or directly from the company, its managers or from a large shareholder. Further, the shares received were sold inside the pool, thereby increasing the stock rates, and the participants of the fraudulent scheme spread information (not always reliable) about the company's prospects with the aim of attracting the attention of foreign investors. As soon as third-party investors started buying the shares, the pool members sold theirs.
During the investigation of the stock market crash of 1929, it turned out that in many cases, the employees of large brokerage firms, as well as the executives of companies whose shares were bought by the pools, were the participants of such pools. This scheme of manipulation is called a pump and dump, and at that time it was an absolutely legal practice of the stock market.
Crypto Pools Today
Due to the lack of regulation on the crypto market, many traders participate in pump and dump groups, which, like stock exchanges, are engaged in manipulating the prices of cryptocurrencies. This is evidenced by numerous reports of state regulators, as well as by market participants themselves, who faced such cases of fraud.
The implementation of pump and dump schemes on the crypto market involves organizers, promoters, and investors. In this case, the first two groups of traders are well aware of the upcoming scheme of manipulation, and their main goal is to attract the latter to the scam. The organizers of the scheme choose an altcoin, which their group will pump up, after which the so-called “pre-pump” starts, when the organizers of the pump buy the altcoins in small portions for some time, so its price does not increase dramatically, and so they could get the most coins at the lowest price.
Then, a signal is emitted in the closed groups about the beginning of the first wave of pumps and the promoters of these groups start buying the chosen altcoin, thus raising its rates. Then they disseminate information about the "promising" altcoin, thus trying to attract investors. The official reason for the unexpected growth of the coin rate can be both reliable information or absolutely fictitious information. Together with the information attack, the organizers of the pump establish a support line on the exchange, preventing the asset from falling in value against the intended goal. Fake orders are created with the help of bots, which provoke growth in price rates.
If the campaign is successful, then third-party investors start buying the altcoin, thereby increasing its rates even higher, and the organizers and participants of the closed groups gradually start selling their coins. After the growth rate of the altcoin has completely stopped, however, the pump turns into a dump, and the remaining coins are sold. At the same time, the investors end up with coins, whose price is rapidly falling for a reason they do not understand.
The Lessons of the 20s
Thus, it turns out that the development of the stock market in the United States of the 1920s and the current crypto market largely overlap with the current trends in the development of the crypto industry. In this connection, all players should heed the following lessons, so as not to repeat the mistakes of the past:
Exchanges cannot be responsible for self-regulation: in the 20s, stock exchanges were regulated, relying on the leadership of internal committees, which consisted of employees of the largest brokerage firms. And they, in turn, often participated in the activities of exchange pools. This conflict of interest became one of the key reasons why stock exchanges did not take serious steps to prevent the collapse of 1929. As for crypto instruments, there have not been any serious attempts to prevent the manipulation of asset rates. It was so that in November of last year, the popular Bittrex site just sent letters to its users, warning that the accounts of participants in pump and dump schemes will be blocked. At the same time, other platforms, such as Kraken, do not see the need to protect users from cases of market manipulation. The reason for this can be the fact that the implementation of such schemes requires the use of crypto exchange sites that do not want to lose users. According to Nirav Gala, another reason may be that the sites themselves can participate in manipulations, acting as the organizers of such schemes, since this practice is not illegal on the crypto market.
Under the right conditions, most people will cheat: many cases of insider trading and participation in pump and dump schemes suggest that even the most honest people will cheat in pursuit of profits. This is especially true when it comes to trading stocks or cryptocurrencies, which are often not perceived as "real" money. Moreover, as of yet, there are no rules or laws capable of stopping such manipulation on the unregulated market of digital assets, which means that such actions on the part of market participants will not entail any serious consequences.
Power corrupts, absolute power corrupts absolutely: trading platforms have huge power over assets, as they provide liquidity to previously illiquid assets. Unlimited power can lead to the fact that the crypto exchanges will abuse their winning positions. For example, according to Business Insider, some sites charge huge commissions (up to $1 million) for listing new tokens. Moreover, the criteria by which certain tokens are added to the listing are not standardized and can be different for each site.
Exchanges cannot completely control the market: certainly, exchanges can and should take steps to prevent the actions of manipulators and illegal traders. They cannot, however, influence the policies of other sites and larger market participants. In this connection, exchanges should not be considered as regulators or instances that resolve disputable issues on the crypto market.
The mass adoption of the crypto market will prove the ineffectiveness of self-regulation: the closer the moment of mass adoption and the introduction of the cryptocurrency market into traditional financial structures, the more obvious is the fact that self-regulation cannot serve as a reliable system that protects the interests of all parties. As such, the market should develop a system for regulating trade in cryptocurrencies, where the actions of dishonest players will have consequences that the industry as a whole will not suffer from.