Every decade there are instances when financial markets react brainlessly to fads and swags. Investors go grazing passively from one place to another, following a leader, without scouting out the grass themselves. This is called herding. History has recorded 3 most irrational herding phenomena that is unknown to many; the Dutch Tulip mania, the Mississippi Bubble and the South Sea Bubble. The pre-modern definition of a bubble, according to Dictionary of Political Economy (1926), is “Any unsound undertaking accompanied by a high degree of speculation.”
Drawing it simplistically, a bubble is an upward price movement over an extended range which later implodes in the future. Very reasons of a bubble development are herding, irrational exuberance, self-delusion and blindness. Here, market sentiment acts as a driving force and not the mental state of an investor. An excerpt from Financial Times article will explain the perspective better. It says, “When everyone rushes in the same direction, it is hard for financial speculators to stand aside and recall the lessons of past stampedes.” Now, whether these definitions can be applied to Bitcoin is a million-dollar question.
It is imperative to look at the histories of the early bubbles to track down what they actually implied about the behaviour of the private capital in the financial markets. One such epitome of market stress occurred in 1634-1637, called The Dutch Tulip mania. Till now, it stands as the decisive example of the insanity and irrationality that materializes in the asset market. At the time of the tulip speculation, Netherlands was a highly commercialized country with innovative financial markets. Its participation in innumerable risky ventures had proven so successful that the era was considered the golden age of the Netherlands. During that time, non-professionals and novices entered the tulip trade in large numbers.
Currently the same is being witnessed in the Bitcoin market. A rising demand for tulip bulbs in France apparently drove the speculation. Soon enough, individual tulip bulb prices reached enormous levels. People from all classes hurriedly liquidated other assets to participate in the tulip market. Elite population adopted wearing tulips as a sign of affluence; elegantly stuffed on suit pockets and various hairdos. It was in their view, a kind of anarchy show, but in doing so, all the conventions and rules for virtuous and sober commercial conduct had been thrown into the wind. And just when the rising demand faded in the first week of February, 1637, the tulip speculation collapsed and the tulip bulbs could not surpass the 10% mark of their peak prices.
For example, Roi de Fleurs (Rare tulip) was sold at fl. 1000 in 1637 the peak of mania but was available at fl. 10 by 1722 (fl. is the Dutch guilder, currency of the Netherlands from 17th century until 2002). It was no longer considered as rare. If we analyse cryptocurrencies, there are so many names alternatively to Bitocin that are now available in the market, the rarity is over. If we dissect the facts further, one tulip bulb was equivalent to all of the combined: 2 bags of wheat, 4 lasts of rye, 4 well-fed oxens and pigs, 12 well-fed sheep, 4 tons of 8 guilder beer, 2 tons butter, 1000 pounds of cheese, 1 bed with accessories, 1 stack of clothes and 1 silver chalice. It’s unbelievable to accept this figure but it’s true. Today one Bitcoin can probably buy all of the above and much more.
The Bitcoin bubble has been created due to excessive demand in the market and rising prices. It has created frenzy across the world and has driven people obnoxiously greedy. Also, it’s quite legit to say that there are chances that the government will want to control the monetary policy “manually”, which gives them the power to wilfully control the wealth distribution system. No government would give away the monetary power to some tech ingenuity. However, one should know that Bitcoins use more electricity per year than the whole of Nigeria. Furthermore, the supply of bitcoins is finite, capped at 21 million, which is self-explanatory that soon enough supply will come from miners across the world. If mining cryptocurrencies makes one rich, who will not want to be? Once this happens, miners will rain the market with cryptocurrencies by whatever names called and this phenomenon has already begun in a big way. The bubble has already peaked, and people have started panic selling. Bitcoin will inevitably crash. After all, Bitcoin’s price is determined by demand v/s price.
One such similar incident (Like Bitcoin) that took place later in the early 1700s was the Mississippi and the South Sea Bubble. A monetary theorist named John Law created a system to lower down the bankruptcy rate in France during 1715. Law came out with an idea of paper currency that would expand real commerce permanently, thereby increasing the demand for the new currency sufficiently to preclude pressure on prices. Without any delay, Mr John opened up a note issuing bank called Banque General and started minting new coinages, similar to Bitcoins, that soon brought in a surge of demand. The prices of the shares of the bank rose so high that it brought France in a state of inflation. Precisely within 5 years of constructing a powerful currency generating system, Mr John failed drastically when shareholders started converting their shares to the concrete form of gold. And that was the end of it. Such was the condition of the French economy. Similar scenes were also visible in Britain around the same time of 1720s. These two incidents clearly highlight the volatility of new surging demand. The Dutch Tulip mania, the South Sea bubble in England, and the collapse of the Mississippi Company in France are three well-documented cases of speculative insanity.
It is evident that such a fate will also be met with Bitcoin, wherein when the mania subsides, the prices will fall dramatically. The biggest disruptive side of Bitcoin is the underlying Blockchain technology. The great new era of Bitcoin may not last, but it certainly will make the Blockchain technology available for quick adoption across the world. Bitcoin won’t be putting banks out of businesses. And when global investors need a safe haven of currency for their money in uncertain times, it will likely be the yellow metal, and not a digital version of it.
Up until recently, different versions of cryptocurrencies like Litecoin has been making the news after the creator, Charlie Lee sold off all his holdings. Such a factor is important to note which particularly highlights its true worth to its creator. When the promoter of a company sells off all his shares in the company in the market, it means that for the investors too that the time has come to move on. Such analogy also holds true for Bitcoin. It’s time to move on.
(By Jimeet Modi, CEO and Founder of SAMCO Securities)