Blockchain, Cryptos and the world of Economics — Part 1💰
Lets get this straight. Blockchain and its offspring aka Cryptocurrencies are everywhere. Where you ask?
- CNBC has a show about it called the Crypto Trader.
- Familiar with Soccer moms? Well, you have Bitcoin Moms now. No seriously! Link here
- Thought, things cant get weirder? Enter :
This is the Japanese Pop group called Virtual Currency Girls whose songs are based on cryptocurrencies. They also get paid in Bitcoin. 🤑
Examples like these can be pulled like rabbits from the sweeping grasslands of Africa. So, what is the driving force behind them?
Blockchain. To be precise, Cryptocurrencies.
The advent of blockchain and the money based spin offs on the technology which we now refer to as cryptocurrencies have led to the rise of new age companies, new age groups which leverage the hype and the power of blockchain. In this series I will focus more on the economic side of things and how it has led to the creation of a parallel economy which thrives and runs on hundreds of types of cryptocurrencies.For this post though lets go back in the time machine and understand how a bubble in a financial market works and what are its implications.
Let me start with a basic question. What is money?
The answer seems simple. Merriam Webster gives the definition of money as,
Something generally accepted as a medium of exchange, a measure of value, or a means of payment.
This is the corner stone on which our world is built. So if money is so important and so widely used, then why was Bitcoin made. More importantly why was it so enthusiastically accepted by people? Bitcoin has all the hallmarks of a rebellious teenage kid.
1. It does not play by the rules of traditional/existing systems.
2. It wants to take over the world.
3. Its cool.
I cannot stress the last point enough. We as a species always get excited by new and shiny objects(Fire was probably one of the earliest examples of this behavior) and now Bitcoins serve as the latest shiny object. The coolness is what initially drove the adoption of Bitcoin. One of the first set of payments made via Bitcoin was for buying Pizza from a neighborhood Papa John’s outlet for a sum of 10,000 Bitcoins! So from there to now, the journey has been nothing but spectacular. It hovers around the 10k mark per coin and the future though shaky seems bright. Oh, it has also led to the rise of so called alt-coins.
Which brings us back to the question. How and why was it adopted so wildly in the world? For this lets go back to how the market works and how it has worked till now. I will focus on oldest bubble in recorded history.
This refers to the 450 year old Tulip bubble. This happened back in the late 1590’s when Tulips(The humble flower) was introduced in the Dutch markets. This flower quickly became a novelty and everyone around seemed to stock up on them. The flower served as the symbol of wealth and as a valuable asset. So in the first decade of 1600, the flower was a commodity which became an investment champion. Since the flower was essentially a plant which anyone could buy and cultivate, the tulip mania as its termed spread like wild fire across the Netherlands. Adding fuel to the manic fire, a new variety of tulips which were infected by a non lethal virus, gave the tulips a different pattern and colour . The bright streaks further enhanced the looks of the tulip and sellers cultivated several off shoot varieties of them. The humble tulip thus became a luxury commodity due to the relative variety and scarcity of the flower in the mainlands.
The traders started hoarding them for bigger profits, the general public jumped on the hype bandwagon and started buying more and more tulips thereby driving the price up. This led to speculative pricing and the capitalization of the tulips far exceeded their actual net worth. This is the exact definition of a BUBBLE.
This gave rise to a loosely defined futures market wherein contracts were established for trading the tulips at the end of a season. Traders established informal contracts among groups and since these were outside the purview of a typical exchange, they were unregulated. People sold their houses, took loans and sold their lifestock and hedged their bets on the tulips. On the investor side of things, tulip contracts started circulating in large numbers and many were directly or indirectly involved in one.
By 1637, the price had reached a peak and people were looking to make a quick buck by short selling the tulip bulbs. This also led to rampant contract trading which didnt have any intrinsic value since they were all hedged on emerging tulip yield. One fine day, the contract value fell(This can be attributed to speculation and at-the-time economic scenario) and the associated tulip market started going down with it.
Long story short, this led to a collapse in the prices. The nose diving prices led to panic selling which further acted as a catalyst for the colossal collapse of the tulip trade. Houses were lost, savings were reduced to pennies and panic gripped the market. Thus, the tulip mania. 🤡
You may ask now, so what? How are tulips related to bitcoins?
Whether it is 1637 or 2018, people still behave in the same manner when it comes to speculative assets. Lets do a quick related check.
1. Tulips contracts were based on future yield — Cryptocurrency value(Alt coins) are based on the development of tech products which may or may not see the light end of the day.
2. Both the tulips back in the day and the crypto coins now far exceed their intrinsic economic value.
3. Both Tulips and Cryptocurrencies traded purely on the basis of speculation and not on the basis of any sound investment principles.
4. Both have a striking similarity by the fact that, the rise in prices almost never justified their value.
While you can draw many conclusions from the above, you may think Im writing off the crypto currency hype as another tulip bubble waiting to burst.
However the reality is that, this is far from it. While many crypto currencies turn out as scams, have absolutely no future or may collapse in entirety , there are some which will weather the storm. This is because the underlying technology of blockchain can in fact solve very real problems. The domains vary from banking to insurance but the underlying technology is a strong one. This means, the prices of many of these coins are not sustainable in the long run and will face a price correction. This is needed for a frugal growth of blockchain based technologies.
In the next part I will focus on the other economic implications of the Blockchain in the financial world.
