By guest post William Quinn
In 2020, John Turner and I published a history of financial bubbles: Boom and Bust: A Global History of Financial Bubbles (Cambridge University Press, 2020). At the end we wrote about the 2017 crypto bubble and thought it had run its course…but a few months later, it bubbled back up harder than before.
At first people wanted to know if it was really a bubble, and I usually replied that it was somewhere between a bubble and a scam. The early stages of the boom phase looked very artificial – not much retail interest, but lots of tethers being issued. The word “bubble” refers to something more organic.
Now that the 2021–22 crypto bubble is bursting, people want to know if it’s anything like what we’ve seen before. So let’s go through the candidates…
Tulipmania is a sore spot for financial historians. The famous story is based on a story by Charles Mackay Unusually popular mazesBut many of the details are wrong — partly because of that McKay mistook Dutch satire for real news.
A brief description of Tulipmania:
- The price of bulbs rose in 1636 when rare and beautiful flower forms were discovered, and later that year these bulbs were propagated and became more common (this pattern repeated itself in the 18th and 19th centuries when new forms were discovered).
- The second can be explained by the ascension and bust A legal change freed merchants who agreed to buy bulbs from the obligation to comply.
It is not a complete removal. It seems, though difficult to prove, that tulips became temporarily fashionable and rare bulbs became an object of speculation. If so, there is some truth to the popular story.
But that still makes it pretty sensible as bubbles go. Rare tulips are a potentially valuable commodity, and you can make valid arguments to justify the high prices. People generally don’t buy tulips with borrowed money, and there are no confirmed cases of anyone going bankrupt due to tulip losses. Participation seems very small. After that there was no economic and financial crisis.
Tulipmania made the most sense to compare it to the crypto bubble.
The South Sea Bubble of 1720
Known as the South Sea Project, the bubble was the result of a comprehensive government plan to reduce the national debt by convincing the public to trade their lucrative government bonds for South Sea Company shares. Economic historian Brad DeLong He recently compared it to the crypto bubble.
The South Sea bubble was created on purpose, and the methods were similar to those used by crypto exchanges in 2020-21. The UK government created liquidity, gave generous leverage to investors and heavily promoted the scheme. Promotional materials often use bogus complexity to hide the downright bad nature of the investment.
But the South Sea bubble is a Basically a political event. Its purpose was to resolve a policy issue, and it went through a long process of approval by Parliament. Investors were drawn almost entirely from the moneyed elite, and the Bubble Act was enacted to prevent speculation from spilling over into other investments. The bursting of the bubble brought down the government, and the new government made up some of the losses.
There were some similarities, but it was a completely different type of bubble.
Mississippi Bubble 1718-20
It was the French precursor to the South Sea bubble – much larger and more economically damaging.
The whole episode was mind boggling John Law, a brilliant financial wizard who escapes from a Scottish prison to Europe. As with the South Sea Project, the most notable feature was the conversion of outstanding government debt into Mississippi Company stock.
If I had to pick a historical precedent for the crypto bubble, it would be this one. That is the common denominator The market was deliberately created with the intention of causing a bubble.
We describe the conditions under which bubbles occur using Bubble triangle: Plenty of marketability and liquidity, plenty of money and credit, and plenty of speculation. In 2021, crypto exchanges made all of this easier: they provided liquidity, used stablecoins to create a new flexible money supply, extended margin loans to traders, and conducted speculative trading.
This level of centralized control over the bubble is unusual. It’s hard to find a precedent for stablecoins: creating an entirely new form of money under the control of exchanges that allowed them to create their own monetary incentives. But this is similar to what John Law did when he introduced bank notes into the currency-based French economy during the Mississippi Bubble.
On the other hand, it was one of the most economically meaningful bubbles in history. The Mississippi Company controlled a large share of French trade. It was highly valued, but it generated significant positive cash flows. The project’s collapse had significant economic consequences.
In this sense they are quite different: one of the distinguishing features of the crypto bubble is how disconnected it is from the real economy. We can never completely rule it out—the contagion mechanisms are complex—but it is almost inconceivable that its outbreak would cause an economic or financial crisis.
The dot-com bubble
An exciting new technology entered the mainstream during a time of low interest rates. Early adopters, mostly young people, became overnight millionaires. Investment in the sector has been lavish, with prices rising amid a wave of initial IPOs. Things got somewhat out of hand, but the core technology was valuable, and the companies started during the bubble changed the world.
This is a very flattering comparison, and is often used as a pro-crypto argument. The problem is that crypto and blockchain, unlike the Internet, Not very useful. For more details, I highly recommend the rest of David’s blog and his two books — they are very good.
We can rule out any housing bubbles. These are usually slow-burning political events, with heavy banking involvement and severe economic consequences.
The US stock market bubble of 1928-29 bears some similarities. The summer of 1929 is like the winter of 2021 – Many ordinary people became highly profitable day traders, and most of them lost money. But buying in September 1929 would not have been an issue, as US stocks have historically been a very good investment. Total Disaster until you endure depression.
The Beanie Baby Bubble was very similar to the NFT craze, especially how the early stages of the boom were Astroturf. This is not a good comparison for crypto as a whole.
What if there is no predecessor?
Most of the features of the crypto bubble have been seen somewhere before, but its most important feature is fundamentally new. Bitcoin:
- There is no use-value regardless of the willingness of others to accept it.
- Does not generate cash flows and is not even identified as potentially generating cash flows.
- This results in mining costs that can only be paid in fiat, making the investment environment negative-sum.
Not all major cryptocurrencies are exactly like this, but most are close. These are unique terrific characteristics for an investment. Every bubble I’ve encountered involves a commodity, collectible, or asset with associated cash flows.
Why hasn’t there been a bubble in an asset like this before? Because, historically, producing a financial asset with no cash flows and marketing it as an investment would have been considered fraud. And a scam and a bubble are two different things.
But Bitcoin is not a scam because a scam needs a criminal. Coined as Bitcoin An honest – and somewhat unhinged – political project, and operates independently of its creator. It’s a bad investment just like a scam is a bad investment, but it’s not a scam.
In a twisted way, it’s actually quite innovative. JP Koning sees Bitcoin not as a bubble, but as a concept An improvement on the traditional Ponzi scheme (Or, as Preston Byrne called it, A Nakamoto Project) cash flows are identical—then investors pay the initial investors. But in a traditional Ponzi scheme, the operator either absconds with everyone’s money or the authorities shut it down. This is theoretically not a problem with Bitcoin.
Of course, in practice most people use exchanges and therefore face the same two risks. Still, with a gun to my head, I’d rather invest in Bitcoin than invest in a regular Ponzi.
So we have two possibilities:
- Crypto is a dumber bubble than the previous bubble
- Crypto was a smarter Ponzi than the previous Ponzi
And the truth is probably somewhere in the middle.