In 1995 plush toy maker Ty Warner had a problem. His Chinese supplier could no longer make his top-selling stuffed animal, a lamb named Lovie. Warner was worried that when customers found out they could no longer buy this popular item, they would be upset.
He came up with a solution that would make him a billionaire.
Instead of telling his retailers about his manufacturing woes, Warner decided to announce the discontinuation of Lovie as a planned "retirement."1
Soon customers were calling their local gift shops to find and buy up the remaining stock of the little stuffed animal. It wasn't long before a few entrepreneurial people discovered that they could get two to four times the retail price for Lovie. And a secondary market was born.
Seizing this opportunity, Warner began to retire other stuffed animals, usually at the same time he was introducing new models. Customers responded with frenzied buying of the "limited stock," launching an unprecedented speculation bubble.
You probably already know the identity of these sought-after plush toys: Beanie Babies.
It's estimated that by the late 1990s they accounted for 10% of all sales on the massive online auction site eBay.com. Around that time a USA Weekend Poll found that 64% of Americans owned at least one Beanie Baby.
But the bubble soon burst. And most of the people who had invested in the toys were left holding the bag. Or more literally, bags. Thousands of them full of the nearly worthless plush animals. One soap opera star bought $100,000 worth of Beanie Babies, planning to use the profits to pay for his kids' college. He ended up storing all 20,000 of the little plush animals at his house, hoping their value would go back up.
In hindsight it's easy to see that the Beanie Baby craze couldn't last. While they had some utility as children's toys, their outrageous values were solely dependent on a widespread belief that their prices would continue to rise. Once this belief dissipated, so did the market.
A similar phenomenon has been fueling the value of cryptocurrency. While the concept of a distributed ledger (a way for all currency holders to see all transactions) is clever, it doesn't create intrinsic value.
Ask yourself this question: what is the intrinsic value [not the current price] of a crypto currency? Unlike other asset classes such as stocks, bonds or even government-issued currency, bitcoin has no independent intrinsic value that’s backed by the “full faith and credit” of anybody or anything.
Along with the sizeable risks of extreme volatility, the ease with which they can be lost or stolen, and the massive power consumption required to "mine" new coins, is the problem of fraud.
Sohale Mortazavi, writes in Jacobin Magazine that the reason the cryptocurrency industry doesn't want regulation is that they survive only by misleading the public. "They understand that fraud is the engine driving their interests and fueling their profits—and that is perhaps the most damning indictment of private cryptocurrencies and the industry surrounding them."2
In both Beanie Babies and bitcoin, a few have gotten rich at the expense of the majority of speculators. On the other hand, the prudent investor will follow a long-term plan that doesn't require dramatic short-term gains and their associated risks to lead them toward successful outcomes.