The Surprising Similarities Between Cryptocurrencies & Tulips
Disclaimer: First of all, let’s get things straight. Despite what you are about read, the purpose of this article is not to:
- convince you to buy or sell crypto assets
- spread FUD (fear, uncertainty, and doubt) or hype regarding cryptocurrencies
- diminish the importance of blockchain technology as a whole
The purpose of this article is to:
- help you start asking the right questions before you decide to invest your hard-earned money
- shed some light on the less talked-about aspects of cryptocurrency
- explain my investment strategy of value over hype
With that in mind, what do cryptographic hashes representing digital cash and tulips from The Dutch Golden Age have in common? The answer is price speculation.
Abstract: In this article I will briefly touch on the history of price speculation, how price speculation plays a role in today's cryptocurrency market, and some factors & historical comparisons to look into when evaluating the timing of changes in price speculation.
The History of Price Speculation: Tulipmania
At the peak of the Dutch Republic (which at that time was the leading economic and financial power of the 17th century), the first speculative bubble that was believed to be recorded had occurred. It was February 1637 and the price for a bulb of this fashionable tulip had reached extraordinarily high levels. Then the price crashed suddenly.
According to Scottish Journalist Charles Mackay, the growing popularity of tulips in the early 17th century caught the attention of the entire nation: “the population, even to its lowest dregs, embarked in the tulip trade”. By 1635, a sale of 40 bulbs for 100,000 florins was recorded. By way of comparison, a ton of butter cost around 100 florins, a skilled laborer might earn 150–350 florins a year, and according to the International Institute of Social History, one florin in 1637 had the purchasing power of €11.51 in 2016.
By 1636, tulips were traded on the newly minted exchanges and futures markets in numerous Dutch towns and cities. This encouraged trading in tulips by all members of society; Mackay recounted people selling or trading their other possessions in order to speculate in the tulip market, such as an offer of 12 acres of land for one of two existing Semper Augustus bulbs.
As mentioned, Tulipmania was the first speculative bubble recorded and it is very interesting to compare and contrast the idea of price speculation in our current “Bitcoin Craze”.
Cryptocurrency Price Speculation
Legendary investors and Nobel Prize winning economists such as Warren Buffett, Ray Dalio, Jamie Dimon, Robert Shiller and Joseph Stiglitz have all declared that cryptocurrencies are a bubble.
Whether or not we are in a bubble is not the focus of this article. Instead I want to help build an understanding of the time we are in today by defining certain characteristics of previous eras of price speculation and drawing upon similar characteristics that we are seeing today.
What is a bubble?
A bubble occurs when an asset’s price exceeds its intrinsic value. Because it is often difficult to observe intrinsic values in real-life markets, bubbles are often conclusively identified only in retrospect, once a sudden drop in prices has occurred, which is known commonly as a crash.
When modeling the value of new technologies, people have regarded this effort to be very difficult with heavy speculation on incoming cash flows. As with blockchain technology, most cryptocurrencies don’t even have a product in the market, making it even more difficult to model out cash flows and to properly value the new crypto-company. With no cash flows to ground investors, people speculate on the valuation of these companies without a proper basis. With hype and a fear of missing out on the table, this leads the average Joe to invest their capital into anything that has the word “blockchain” or “decentralized” in it, creating a virtuous cycle. As the price increases and the “social contagion” effect described by Schiller begins to take place:
“News of price increase enriches the early investors, creating word-of-mouth stories about their successes, which stir envy and interest. The excitement then lures more and more people into the market, which causes prices to increase further, attracting yet more people and fueling “new era” stories, and so on, in successive feedback loops as the bubble grows.”
With today’s easy access to social networking and social interactions, it is quite easy to see how the likes of Twitter and Facebook play a role in this “contagion”. With price speculation building, it only begs the question: when will this end?
How Much Longer Until The Bubble Bursts?
When we compare our current situation with previous price speculations, we see that many of the technological building blocks that have thrust us forward in society have been on the backbone of overly speculative pricing, such as the railways and in the Internet in the 2000’s . With over-investment, there is enough capital in the industry that it actually helps to enable those who are well fit to create the future building blocks of the technology and our future. For instance, Google, Amazon, Adobe, and CISCO were all able to recover from the tech market bubble in the 2000’s and have helped to build what is now regarded as a revolutionary technology.
If we compare today’s crypto-craze with the dotcom bubble, it is interesting to note that it took the tech market 17 years to recover from the crash of 2000. In an article posted in 2017, it read:
“The dot-com bubble was 17 years ago, and after that many years, the S&P 500 information technology index finally recovered from the implosion.
The index SPLRCT of over 60 of the U.S. largest technology companies rose 0.6 percent to close at a record high of 992.29, edging above its previous peak of 988.49, set on March 27, 2000. What this means, technology stocks is now higher than during the dotcom boom.”
Looking at the companies that made it through shows a similar story. For instance below we see the recovering price of Microsoft, which took 17 years to climb back to the valuation they had at the time of the bubble.
While Microsoft made it back and exceeded their valuation, there were some that far exceeded their 2000 valuation, such as the much hyped Amazon.
and others that failed to do, such as CISCO.
If there is real value in the underlying technology (of the company), then the industry and valuations of these companies will be justified in time. However, in the dotcom bubble, the vast majority of companies did not see their valuations return to their peak levels.
Since it is very difficult to set a value for these different crypto projects and many of them are being valued for what they could do, the question arises as to the timing of a market correction. Aka, in the scenario that these cryptocurrencies are overvalued, when will there be a market correction? In the case of the dotcom bubble, the market cap at the time of the crash was at $3 trillion — where it was largely led by North American investors.
On the other hand, the current market cap of all cryptocurrencies is at $570 billion. Where the dotcom bubble was funded primarily by North American traders, the crypto-market has been very actively watched and financed by the Global community, with large financing and influence coming from South Korea, China, Russia, etc. With a far greater reach and financial influence, it leads to the possibility of a larger market cap at the time of disruption, meaning an even greater speculative bubble. While there are many other factors that affect the situation, such as the amount time taken to reach the peak market cap and differences in social influence mechanisms, it is impossible to set a date or potential market cap of a burst.
Takeaways
- While it is unclear as to whether or not we are in a bubble, it is clear that there is a lot of price speculation when it comes to crypto-projects in the market.
- It is also clear that if you were to invest, it would be savvy to invest in projects that have an underlying value that can have an impact that will be felt in the next 5–15 years.
- Investing in this market is difficult, especially when having to evaluate these projects from a non-technical perspective.
- As a final conclusion I would warn all would-be investors to understand the risks apparent with investing and that it is very difficult to actually value the current projects underway, as the technology is nowhere close to maturity.
