History Of Economic Bubbles

“It keeps going up and up, therefore it's not a bubble.”

Not the most insightful defense of bitcoin, any economist would tell you, but the most frequently used nonetheless. All bubbles go up, a long way up, sufficiently long to trap you in a false sense of security, before blowing up in your face and turning to ashes.

To quote Tyrion Lannister from George R.R. Martin's ‘A Clash of Kings', “I will hurt you for this. I don't know how yet, but give me time. A day will come when you think yourself safe and happy, and suddenly your joy will turn to ashes in your mouth.”

Legitimately valued assets generate gradual interest at a sustainable rate. Fangled assets attract frenzied speculation, for either being revolutionary or exotic. Bitcoin mania can be imputed to a combination of both.

What many bitcoin evangelists fail to understand is that a bubble does always not indicate that an asset is without merit. Internet gave rise to a bubble which, although gutted a litany of early internet companies, merely served to dissuade the irrational attribution of anything remotely pertaining to the internet as valuable.

To characterize the bitcoin bubble and what it may entail, we must delve into some economic bubbles from history for insight. Although humans adapt and evolve through time, our socio-economic instincts are eternally abiding. These instincts do not adapt to new inventions but inventions eventually adapt to old instincts.

Tulip Mania

Widely recognized as the first recorded speculative bubble, the tulip bulbs craze was a strictly exotic speculative bubble devoid of any intrinsic asset value. Tulips were newly introduced to Europe from the Ottoman empire in the late 16th century.

Being different from every other flower known to Europe at the time, it became coveted as a luxurious asset. A new market for tulip bulbs was born. Further to demand from the French, speculators entered the market and between 1634 and 1636, prices for the bulbs grew rapidly.

In 1636, At the height of the tulip mania, the Dutch created a type of formal futures market where contracts to buy bulbs at the end of the season were bought and sold. A year later in February 1637, the prices collapsed spectacularly.

South Sea Bubble

In 1711, Britain was £9,000,000 in debt and the government was dissatisfied with the services of the privately owned Bank of England. South Sea Company, thus named for its monopoly rights for trade between Britain and South America, was devised as a scheme to consolidate the debt whereby all debt holders would surrender it to the company in lieu of shares.

Several investors bought the shares in expectation of a profit. However, with Britain at war with Spain in South America and with share prices rising far beyond any trade revenue generated, the stock collapsed to its original flotation price, cutting a swathe through the national economy. Sir Isaac Newton was among those thought to have lost heavily from investing in the South Sea Company.

Japanese Asset Price Bubble

In the 1980s, any new technologically advanced product on the market was “made in Japan.” Fueled by export value of Japanese products, the Japanese economy was on top of the world. Asset prices spiraled out of control and Tokyo Stock Exchange's (TSE) Nikkei Index tripled in less than 3 years.

Bank of Japan's decision to cut short-term interests made credit easily obtainable and the government's monetary policy resulted in sharp appreciation of the yen. When the government finally sought to deflate the bubble, the stock market plummeted and real estate prices shot through the roof. The bust ushered in what economists called a “lost decade” of economic stagnation and deflation.

The Japanese asset bubble could be regarded as a precursor to the mortgage crisis in the US in late 2000s.

Dotcom Bubble

Internet was all the rage in the late 1990s. Advances in connectivity, increased awareness and new-found use cases brought Internet to the mainstream. Increasing usage predictably brought investors into the market.

The Internet frenzy was so frenetic that any company with a “.com” suffix, at any valuation, attracted investors. All caution and due process were abandoned. Nasdaq Composite stock market index rose five-fold in 5 years between 1995 and 2000. A new business economy was ushered in and companies prioritized growth over profit and were operating at significant losses.

Most of these companies were poorly conceived to merely exploit a new market and were held in wildly inflated valuations. When the bubble burst in 2002, it wiped out a $5 trillion market and most Internet companies turned to dust and had to shut down. Between 2000 and 2002, the NASDAQ Composite crashed 80%.

The boom prompted then Federal Reserve Chairman Alan Greenspan to warn about “irrational exuberance” in asset prices, widely seen as a warning about the dot.com bubble. Interestingly, Greenspan also recently warned about the “irrational” nature of Bitcoin as a currency.

Subprime Mortgage Crisis

In the late 2000s, based on ill-conceived complex financial instruments known as mortgage-backed securities (MBS) and collateralized debt obligations (CDO), meant to reduce lending risk, banks irresponsibly lent to borrowers who could not afford the mortgages they were being sold. As more individuals were able to readily obtain credit, housing prices peaked triggering a housing bubble.

When home prices declined in late 2006, borrowers were unable to refinance the loans they had acquired. As mortgage delinquency rose, securities backed by mortgages held globally by investors lost value. Investors realized the scale of bad assets in the financial markets, triggering the collapse of the banking system in 2008.

Is Bitcoin In A Bubble? Is Blockchain The New Internet?

It is often said that the Bitcoin bubble is in some respects analogous to the dotcom bubble or that Blockchain is the new Internet. The similarities begin and end with both Internet and Blockchain being seminal technological revolutions.

Blockchain has all the trappings of being the crown jewel of the Internet. While Internet allowed us to connect with each other, Blockchain allows us to transact and do a whole lot more!

Bitcoin is the first application of Blockchain but not without its demerits, power consumption to secure the network and inability to scale among them. Current interest in Bitcoin is a consequence of both its novelty and revolutionary economic proposition but the novelty will eventually wear off, cooling off interest.

History teaches us that an alarming rate of value appreciation for any asset is unfailingly followed by a devastating collapse. This is not a Bitcoin problem but a combination of socio-economic instincts and behavioral contagion.

It is a safe bet that the Bitcoin bubble will burst but it is equally safe to bet that our future socio-economic infrastructure will be founded upon the Blockchain. Blockchain as a technological revolution is inextinguishable.

Will Bitcoin rebound or will another better, advanced cryptocurrency replace it? If Bitcoin turns out to be Blockchain's Myspace, which coin will become Facebook?

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