• The Invisible Hand

Bitcoin mania vs Tulip mania

Updated: Feb 26, 2019

What can a crash of asset prices nearly 400 years ago teach us about a modern crash?

Two of the most famous economic bubbles in all of history are the Tulip Bubble of 1637 and the more recent Bitcoin bubble of 2017. On both occasions, assets saw dramatic increases in their price in a short space of time and eventually, those prices came crashing down. This segment of History Corner compares those two bubbles to teach you more about bubbles and their impact on the economy.

Both commodities (bitcoin and tulips) were highly talked about and their influence expanded over society and culture. Tulips were first introduced to Vienna via the Ottoman Empire in 1554 and then onwards to the Netherlands in around 1593. Bitcoin, on the other hand, is a decentralised digital currency without a central bank. However, as Economist John Quggin said in 2013 “bitcoins are the most demonstrably valueless financial asset ever created”; their value is not backed by an asset like mortgages and they are useable in a few shops. Bitcoin should not even be thought as a currency because it does not meet any of the functions of money: it is usable in very few shops and its dramatic price fluctuations mean it a very poor store of value and unit of account. Meanwhile, tulips arguably have an intrinsic value although not in proportion to the price in 1637. Tulips became a status symbol in the early 17th century and their price was pushed up more by organic demand rather than the speculation like bitcoin. Once a bubble forms an asset’s price bears little resemblance to its true value and it is that which fundamentally leads to its price collapse.

Tulip price rises truly began in 1634 with extra demand from the French. Futures contracts accelerated this increase in 1636. A futures contract meant often no actual tulips were traded and instead, it would be a certificate of ownership at a future date. This meant demand could quickly outpace supply. The tulip price peaked in February 1637 when some tulip bulbs were worth ten times the annual income of skilled craftsmen and tulips were changing hands ten times a day. Meanwhile, bitcoin’s price peaked at $19,783.06 in December 2017.

Both crashes were caused by falls in demand for the commodity either from government intervention or naturally. The key event in the tulip price fall was a failed auction in Haarlem when buyers refused to show up because of bubonic plague. Meanwhile, the bitcoin price collapse was caused by, in addition to doubt over the intrinsic value, rumours on the 12th January that South Korea could ban cryptocurrency trading; the price fell by 12%. Furthermore, a Japanese cryptocurrency OTC market was hacked. As bitcoin has no intrinsic value, its price is entirely based on expectations that it will go up which it did in 2017 by 2700%. However, once doubts were created about whether bitcoin’s price would keep rising were created, it quickly fell. In both cases, the collapse was as quick and substantial as the price rises.

A key difference, however, was the fact that tulips varied in quality and therefore demand while bitcoin is a homogeneous good. This means that the level of price increases and falls varied on each individual item. Furthermore, obviously data is unreliable and scarce from 400 years ago and most of the information we have is from the dramatised account of 19th century Scottish writer Charles Mackay who is not taken seriously by any historian. However, what we do know is that the tulip bubble was on a much smaller scale than what most people believe. While some tulips cost as much as 5,000 guilders, these were rare and only 37 people spent more than 400 guilders on flowers. Therefore, the bitcoin bubble inevitably affected far more people and is a much more obvious bubble.

Overall, the main difference between the two bubbles was the fact that the bitcoin bubble was on a much larger scale and has affected far more people. But both demonstrate the irrationality and fickleness of financial markets very well.

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