Don’t let your friends get caught up in the Bitcoin bubble. They’ll lose big when it bursts.
What does a flower and a coin have in common? At one point in history, their prices have both artificially skyrocketed due to frenzied trading, with many people buying into ‘get-rich-quick’ schemes.
The Bitcoin bubble may not have burst yet, but many of these get-rich-quick seem suspect for good reason. Unlike an investment in a company, where a valuation is at least in part based on current or potential future earnings, the price of these crypto currencies is determined by speculation, and market forces that most crypto-investors don’t understand! Many financial experts are drawing comparisons between this current cryptocurrency craze and the Dutch Tulip Bubble, and warning of a similarly dramatic crash.
1630’s Dutch Tulip Mania is the first documented speculative bubble in history. The exponential rise of prices and the hype surrounding the commodity culminated in a catastrophic collapse. So, the next time your crypto-crazed friends try to rope you into investing on Bitcoin, send a bouquet of tulips their way to pre-emptively burst their bubble before they end up losing big.
The Bitcoin Bonanza
The soaring price of Bitcoin has been the subject of much interest and speculation in the past few years. While a lot of people have been quick to invest and join the bandwagon, the meteoric rise of Bitcoin’s value along with its volatility has warned investors of the Bitcoin bubble—drawing parallels with the current sharp up and down movements of the asset to the Tulipmania bubble of the 1630s.
As of January 26, 2018, Bitcoin is worth $11,451. At its peak, its value surged at nearly $20,000 last year from $2 in 2011. Its meteoric rise in 2017 took the financial world by storm, with various analysts and financial institutions closely documenting developments in the market. However, financial gurus Warren Buffett and Joseph Stiglitz believe this is just another bubble waiting to pop.
Goldman Sachs was quick to warn investors about the Bitcoin bubble which their analysts say is likely bigger than the dot-com boom and the Dutch Tulipmania. In both instances, the surrounding buzz and wave of enthusiasm caused a boom in valuation followed by a crash when the bubble eventually burst. Due to its volatility, Bert Ely, principal of consulting firm Ely & Company Inc., compared the Bitcoin craze to gambling. The Monetary Authority of Singapore (MAS) has also issued two warnings about investing in cryptocurrencies because susceptible investors could suffer significant losses from these highly speculative instruments.
Cryptocurreny, Bitcoin, and Blockchain
Cryptocurrencies have no physical form and are not regulated by any government or institution unlike the usual coins or paper money. These digital currencies can be used to pay for goods and services for certain merchants willing to accept this mode of payment. There are currently thousands of cryptocurrencies worldwide, including Bitcoin, Ripple and Ether.
Bitcoin was first introduced in the market back in 2009 as an open-source technology developed by a mysterious and still anonymous individual who goes by the pseudonym Satoshi Nakamoto. Nakamoto invented a decentralised system of creating cryptocurrencies and keeping financial records using a shared financial infrastructure called the blockchain which is maintained by a network of computers (nodes).
The risk and unpredictability of Bitcoin is not only down to the fluctuating prices. It has been associated with unlawful activities since the lack of regulation makes identity easier to conceal. Bitcoin’s security has also been called to question as incidents of Bitcoin phishing and hacks become ever more widespread as cryptocurrency’s popularity starts reaching fever pitch.
Winners and Losers
Early adopters managed to rack in a lot of profit from taking a risk early on. Rapper 50 Cent gained an estimated $8 million after accepting Bitcoin for his album “Animal Ambition” back in 2014. Back then, a Bitcoin was valued at $662. However, the trading frenzy over Bitcoin has also resulted in major losses for people who joined the fray late in the game.
To put Bitcoin’s volatility in perspective, entrepreneurs Cameron and Tyler Winklevoss, otherwise known as the Winklevoss twins who famously sued Mark Zuckerberg for allegedly stealing their idea for Facebook, have lost nearly $1 billion from the Bitcoin crash. Granted, they still remain Bitcoin billionaires on paper, it does make Bitcoin a highly risky investment for the average investor.
The same kind of excitement happened in The Netherlands back in the 1630s. However, according to Elliott Prechter of The Elliott Wave Theorist, this Bitcoin craze will likely surpass the Dutch Tulipmania which is considered the first recorded speculative bubble in history.
Tulipmania: A Lesson in History
A bubble occurs when the price of a commodity rises dramatically, far beyond its intrinsic value, and then suddenly collapses. During the Dutch Golden Age of the 17th century, rich merchants and traders in The Netherlands flaunted their wealth by surrounding their mansions with tulips—considered to be exotic blooms in Europe at the time. By the 1630s, tulip bulbs have become so popular that the price of a single bulb became outrageously expensive due to the extraordinary demand. At its peak, a single bulb of a rare breed of tulip managed to sell for over ten times the annual income of a skilled craftsman.
Many people participated in the nationwide craze, even trading or selling off possessions to get in on the action. The mania finally ended when people suddenly realised they were paying obscene amounts for a bulb that was not that valuable. The demand dropped dramatically causing the bubble to collapse in 1637. Bulbs were sold off or traded for a fraction of what they initially paid which left a lot of people in financial ruin.
The Parallels Between the Bitcoin Boom and Tulipmania
Many scholars and analysts have drawn parallels between the Dutch Tulipmania and today’s Bitcoin boom. Technology actually facilitated the spread of crypto-craze and the rapid acceleration of value from just last year alone. For this reason, the Bitcoin bubble has surpassed Tulipmania in size and scale which means the risk of an even bigger bust is imminent—the biggest in recent history.
Below is a comparison of the prices for both tulips and bitcoins which shows a clear similarity in trajectory, with Bitcoin poised for a major bust following its current meteoric rise which has already exceeded Tulipmania.
While the Bitcoin boom could end in a bust, there is significant interest in the blockchain technology behind it. This open-source ledger technology behind cryptocurrencies effectively eliminates middlemen and makes transactions nearly impossible to forge, hence various financial institutions envision the blockchain to be one of the biggest trends of the future.
“We think the concept of a digital currency that leverages the blockchain technology is viable given the benefits it could provide: ease of execution globally, lower transaction costs, reduction of correction since all transactions could be traced, safety of ownership, and so on,” Goldman wrote. “But Bitcoin does not provide any of these qualities.”
In this Bitcoin bubble that we’re living in, tulips not only symbolise elegance and romance, they can also serve as a valuable lesson in history and a reminder about the perils of getting caught up in the hype. In times of uncertainty, it pays to look back in the past for some wisdom and guidance.
The risks certainly outweigh the benefits when it comes to the Bitcoin boom. So before you think about taking out a loan or dipping on your funds to get yourself in the game, better think again. At least where the Tulipmania is concerned, buyers were left with the tulip bulbs from whence beautiful flowers can bloom.