A couple of weeks ago I spoke with the Chief Privacy Officer at Google, and he remarked “I see no better evidence of a bubble than a company like Snapchat being valued 10 billion dollars”. I was like “preach it brother”.

I bring up Snapchat because it has quickly become the symbol of the tech bubble 2.0: a fast-rising tech company with awful fundamentals, propelled by irrational exuberance over its “coolness”. I mean, everyone is on Snapchat right? Yet, Snapchat, just like many social media and consumer software companies has built its growththrough eyeballs (valley speak for “engaged users”), but monetizing eyeballs has proven a challenge for all. Facebook pulled it off by investing aggressively in highly sophisticated analytics, Twitter is trying to do the same thing with some success albeit not reflected in its stock price.

Snapchat however is a whole different ball game, and I wish them good luck and all. This post however is not about Snapchat as much as about the bubble: the phenomenon where the price of an asset or company keeps skyrocketing to become 10x if not 100x the actual value of the company, for not legitimate reason, until it inevitably and suddenly crashes. It happened with the Dutch tulips during the Dutch Golden Age, with Pets.com shit in the late 90’s, and most recently with mortages during the most recent financial crisis.

Bubbles are crazy because everyone goes wild as everything seems to be going up: a never ending rollercoaster. Then they crash, people are left without jobs, and they realize its going to take years for them to pick up the pieces. Some of the greatest investors of all time have either made fortunes betting against them (John Paulson made $4.9 billion shorting the mortage bubble), or lost fortunes (the great George Soros got OWNED by tech bubble in the 2000s). I believe we are in another bubble, and this one is more insidious.

The first tech bubble was clear: tons of dumb website and companies with aweful fundamentals kept going public, and their IPO documentations eventuall revealed just how nonsensical these business models were. A few of them crashed, and brought the entire sector down with them. Not all tech companies failed, because some greate technology companies were built and survived the crash: the vast majority didn’t. In this reiteration however the tech sector has learned its lesson, and tech startups are going public much later than they used to and never all at once.

That’s why the real cause of bubbles isn’t the assets or the companies themselves, but their investors and shareholders that push the valuations higher and higher. VC’s behavior is thus the driver of the future of the tech bubble.

On one hand, because of low interest rates thanks to quantitative easing, venture capital is at all time high as LPs (limited partners IE the VCs of VCs IE the people who give money to VCs to invest) looking for the highest risk-adjusted returns possible thus pour money into risky venture capital since bonds don’t pay up that much. As one fellow from Lightspeed Ventures put in our conversation about a month ago, “I mean, we have raised a lot of money and it’s there to be invested so we have to put it somewhere”. This creates the first trend, which is VCs doing larger rounds and even more frequent seed investments in order to gain higher returns for their investors.

The second trend is competion. Sequoia enjoys the brand of “20% of the NASDAQ” because back in the day there really weren’t that many VC firms, so they got to back pretty much all of the greatest companies of all time. Were they to start now it would be much more difficult without such a legacy, because since the supply of money to invest is high it’s hard for VC firms to win deals with high quality companies. What’s fascinating is that, unlike traditional finance, venture capital is not a 0-sum game. Just like Game Theory predicts, rational actors in competion will tend to create carterls because oligopolies maximize expected return and lower risk for the members. Essentially, this accounts for why multiple VC firms participate in the same round, both early and late, just to get a piece of the pie, thus they throw money at a company which drives the valuations up.

Low interest rates increase the capital VCs have at their disposal to invest, and competition makes the funding rounds larger because more firms participate to get a piece of the pie. However VCs, more often than not the real decision makers, have been very smart about how to handle this situation: they go hard driving up valuations, but they make sensible and calculated plans when to take companies public in order to solidify their portofolio companies. That’s why tech startups are not going public one at the same time, because as long as the vast majority of these crazy evaluations remains in the private sector, the stock market has no reason to freak out. In the alternative, if a company like Snapchat filed for an IPO Wall Street would take it to the sheds.

Thus a few questions arise: when is the bubble going to pop? Which companies will be affected? Does this mean we need to back off of tech?

The best way to answer the first question is by figuring out “what” is going to pop the bubble. A shift in interest rates that would make bonds and regular equity more appealing to LPs, thereby undermining the resources of VCs? Hackers from Russia and China humiliating tech companies demonstrating just how vulnerable they are? The Apple Watch, a new platform that undermines the traditional user behavior that social media companies are built around? I honestly have not made up my mind yet.

The easiest way to answer the second question is by figuring which companies are strong enough to sustain a crash. The best standard to evaluate such strength is the legitimacy of the fundamentals: price to earnigns ratio, cash to R&D proportions, revenue projections compared to market trajectory. Facebook and Uber are here to stay under those standards. Yield and Groupon are going to get smashed. Twitter I am a big believer in, but then again, I also believe in Yahoo…

The last question is very easy to answer in an unwarranted way. Tech will survive, and great companies will march forward into the new decade just like they did last time. Peter Thiel however makes very intelligent remarks that innovation is slowing down, as technological advancement is not happening in energy, healthcare and biotech are not advancing nearly as quickly as software. I am optimistic, but that’s also because I am still a teenager so my time horizon is much longer than most investors since I am looking into what the future will look like in 2 or 3 decades.

In conclusion, the real problem of this tech bubble is the same problem as with every other bubble: irrational exuberance IE individuals that don’t understand the real value of technology and investors that don’t know what they are doing getting excited for no real reason. Most VCs, IE ones without real talent, just drown startups with unnecessary cash without really contemplating an exit strategy to be able to liquidate their position.

My prediction is that around the end of this decade a whole lot if not most VC firms will be stuck with hot potatoes and toxic assets. Unlike Wall Street banks however, VC firms are not too big to fail…