Bitcoin is almost 10-years-old. For a long time, the value of the cryptocurrency was too low to draw much attention. Bitcoin was just some obscure techno-geek fad to which no one paid much attention. But no more. With the value of bitcoin now set at north of $16,000, its obscurity is a thing of the past. In less than 18 months, there has been an over 6,000 percent increase in value. Yes, that is not a typo. But, is the current bitcoin streak just a bubble waiting to burst? No one really knows. Perhaps a look at some famous financial bubbles of the past can help. They might provide some signs to watch for while the bitcoin wild ride rages on.
A “bubble,” according to Investopedia, is “an economic cycle characterized by rapid escalation of asset prices followed by a contraction.” In other words, what goes up must come down. And, often the faster and farther something goes up, the harder it comes crashing down. Consequently, these crashes have been the source of financial ruin for many over the years.
Dutch Tulip Bulb Bubble
The first tulip bulbs to hit Europe were sent from the Sultan of Turkey to the Holy Roman Emperor in Vienna in 1554. From there, the bulbs were distributed to other areas of Europe. By the 1590s, they had arrived in Amsterdam. During that time, according to FocusEconomics, the Netherlands “had become the richest country in Europe mostly through trade.” Plus, a labor shortage resulting from “a recent epidemic of bubonic plague had killed thousands,” according to APS Journals. That increased the wages of the survivors. This meant that many people were quite flush with cash and possibly ready to spend money.
What we know now was “the result of a virus that had infected them,” a phenomenon referred to as “tulip breaking” began. Tulip breaking “induces in the petals of its host tulips beautiful variegated color patterns that break the solid color of the uninfected tulips.” These broken tulips were quite rare and, for that reason, quite expensive. Consequently, when the Dutch tulip bulb craze started in the early 1630s, these broken tulips were at the heart of the madness.
While the mania started early in the decade, the actual tulip bulb bubble period lasted from 1636 to 1637. During that time, the price of tulips went from approximately one guilder on November 1, 1636, up to 200 guilders on February 3, 1637. Then the bubble burst and price went all the way back down to one guilder on May 1 of the same year. The increase in value of the tulips was 200 percent during this time. Substantially lower than the current percentage increase in bitcoin value.
But, why did this happen? Here is how APS Journals describes it.
“In 1637, many tulipomaniacs realized that the madness could not last. Demand for broken tulips dissipated, selling escalated, prices plummeted, and speculators defaulted on their promissory notes. The bubble burst and left widespread bankruptcy in its wake.”
South Sea Bubble
The South Sea bubble relates to the movement of stock in the South Sea Company from 1719 to 1721. The South Sea Company was originally set up to conduct trade with the Spanish colonies in South America. The South Sea Company, as part of its agreement with the British government, sold shares of its stock in exchange for part of Britain’s national debt. The British government had enormous debts to pay and this was a way to relieve some of the pressure behind that debt. Initially, in January 1720, the shares of stock in the South Sea Company were valued at 128 British pounds. However, according to the Harvard Business School, “in an effort to stir up popular interest in the company’s stock, the directors circulated false claims of success and fanciful tales of South Sea riches.” This sent the price of the stock skyrocketing to 330 pounds by end of March of that year. Then, by May it was at 550 pounds. By June, the price peaked at 1,050 pounds. This was an increase of over 700 percent before the crash. The collapse in September 1720 brought the price down to 175 pounds. The result? Devastation to “institutions and individuals alike.”
The Mississippi bubble is another tale of government debt gone awry. This time the French government, in 1715, was “essentially insolvent,” according to Investopedia. As part of an effort to get back in the black, the French government allowed the Mississippi Company, under the direction of a man named John Law, to have a “monopoly over trading with French Louisiana.” Later, that expanded to include “tax collection and all trade outside of Europe.” Shares in the Mississippi Company were sold for cash and bonds from the French government. These bonds held a low interest rate, “which helped French finances while promising the company a more secure cash flow,” according to Mississippi History Now.
As the activities expanded, “the value of the shares of the Mississippi Company rose dramatically,” mostly due to increased interest in the company. Shares, which had been at 500 livres (the French currency used before the franc) in January of 1719, reached 10,000 livres by December of that year, “an increase of 1,900 percent in just under a year.” However, the bubble popped in January 1720. This was when investors sold shares “to turn capital gains into gold coin.” John Law would only allow 100 livre of the payment in gold and investors were nervous.
The price started back down. And, “by September 1721 share prices had dropped to 500 livres,” the same price they had started at. The result? Again, it was devastation and “many of the new millionaires were financially destroyed.”
Future of Bitcoin
According to economist Hyman P. Minsky, there are five stages to a bubble: displacement (getting smitten with a new “thing”), boom, euphoria, profit-taking, and panic. For now, it appears that bitcoin is in the euphoria stage, but for how long?
No one is sure where the price of bitcoin is headed. The cryptocurrency, which was created as a potential solution to needing banks for financial transactions, has certainly skyrocketed in value. But, will that value hold? According to a recent article in The Guardian, “economists have compared bitcoin’s meteoric rise with past bubbles.” Add to that the recent comment by the head of JP Morgan, Jamie Dimon, that “bitcoin is a fraud that will ultimately blow up,” and it is hard to predict. What we do know is that with all this activity and publicity, bitcoin will never again be an obscure cryptocurrency.