For those of us with long memories and some sense of history, Bitcoin’s recent meteoric rise is both thrilling and terrifying. It has all the earmarks of a bubble.
Bitcoin Bubble. The accidental alliteration makes it more attractive, but no more or less true. It’s all the similarities with previous economic bubbles going back more than a century that convinces us: This can’t last.
In the space of a few short days, the cryptocurrency, which people mine on their powerful computers, has gained thousands of dollars of fresh value. A year-long Bitcoin value chart is the extreme version of a hockey stick curve.
Bitcoin’s historic run has an inevitable side effect—people wondering if they need to get in on this craze before it’s too late or too expensive (it is).
But before you convert your life savings, consider the Beanie Baby Bubble, Tulip Mania, the Dot-Com Bubble, and even the more recent Housing Bubble, and how all of them shared certain attributes:
Everyone is talking about it.
People make critical life decisions based on it.
There are extreme predictions for its future.
Skeptics of its potential are shouted down.
When I wrote my “How to talk to Mom and Dad about Bitcoin this Thanksgiving,” it was in direct response to the increasing volume of questions I was getting from people who had no interest in technology, alternative monetary exchanges, or cryptocurrency, but had been confronted by this seemingly important and possibly financial-future-altering term: Bitcoin.
Mainstream newscasts are now covering Bitcoin, and there are more and more stories about people doing strange things to mine their own Bitcoin.
I fully expect that Bitcoin promoters will angrily decry the contents of this article.
Tale as old as time
Aside from these benchmarks, Bitcoin feels familiar and not in a good way.
The fact that we’re probably inside a bubble and yet fail to recognize it is more galling because we’ve been talking about this kind of irrational exuberance for well over 150 years.
“We find that whole communities suddenly fix their minds upon one subject and go mad in its pursuit; that millions of people become simultaneously impressed with one delusion and run after it, till their attention is caught by some new folly more captivating than the first,” wrote Charles Mackay in Memoirs of Extraordinary Popular Delusions and the Madness of Crowds. The Scottish journalist identified a pattern of irrational behavior in 1841, a sort of mass hysteria that can seize a community (real or virtual) at any time.
‘We find that whole communities suddenly fix their minds upon one subject and go mad in its pursuit.’
In that book, Mackay wrote about the most notable case, Tulipmania, which occurred almost 400 years ago. Just as Bitcoins value skyrocketed over a few weeks this fall, so did the price of tulips in Holland in the Fall of 1636.
As with Bitcoin, the tulip trade was very real and arguably even better than Bitcoin. At least with Tulips, you have a tangible object to obsess over. People made considerable sums in those first months of tulip mania. The tulip boom lasted long enough to generate new jobs around the industry, change the wealth of former paupers, and give rise to a new set of codes and laws for the tulip trade. However, once the entire enterprise became about speculation (buying and selling for a quick profit), Mackay wrote, the confidence in the Tulip market faltered, which resulted in a sudden drop in tulip value.
People who grew tulips with a promise of a certain price at sale found that suddenly no one wanted to pay that price, since the value of these flowers changed from the time they started growing the colorful flowers. Ultimately, the tulip bubble burst and many of those who were made rich by the enterprise lost it all.
Even those who avoided the mania were hurt by the ensuing economic depression.
Babies and nets
In more recent years, regular people have lost their minds over seemingly valueless objects, like Beanie Babies.
Writing in Slate in 2015, Mark Joseph Stern, described the mid-1990s rise and catastrophic collapse of these plush toys:
“…in the latter part of the 1990s, Beanie Babies were so much more than a fad: They were a mania, an obsession that ensnared not just gullible children but also otherwise responsible adults who lost all sense of perspective over these plush playthings. People sold—and bought—some rare Beanie Babies for $5,000 each and expected others to skyrocket in value within a decade.”
‘The pattern is biological in its regularity. A panic is likely and then a crash may follow.’
There was, for a time, a “mass delusion” that $5 stuffed animals could somehow accrue thousands of dollars in value. For those like Stern who have a closet full of nearly worthless stuffed animals, that speculation did not pan out.
Obviously, a Beanie Babies isn’t a perfect analogy. People are putting in more money per Bitcoin, especially as the value rises, and the system is more programmatically controlled. That $11,000 value is tied to demand that the system is measuring in real time.
On the other hand, what is that demand based on? The world of retail and trade has yet to catch up with Bitcoin to let you use it in all the places you can spend hard cash. As a result, Bitcoin is currently a place you park your money and hope for it to accrue disproportionate value, which does sound a little more like Beanie Babies.
The dot-com bubble, which happened to coincide with Beanie Baby mania, has more in common with Bitcoin. Certainly, people believed that all those online businesses could attract customers and build wealth for all their investors. On the other hand, people invested and poured millions into many of these online businesses based on the misguided belief that the burn-rate (how much cash they ate each month) would eventually be matched by revenues and massive profit. No one took a go-slow or cautious approach, even as worries increased.
Eventually, like all good bubbles, the dot-com boom simply collapsed in on itself and took with it most than three-quarters of the value of the NASDAQ and countless web businesses, big and small. What may be encouraging for Bitcoin watchers is that, as you surely know, online business did get its act together, rising out of the ashes to grow into the vibrant Internet we know today. It did not grow into another bubble… thought some argue the large, private tech companies that have accrued massive valuations are their own bubble.
So much for wisdom of the crowd
As Stern pointed out: “The thrill of the chase then muffles our ability to rationally evaluate the actual worth of the object, and others’ willingness to go along with our fantasy reinforces our suspension of logic.”
Right now, no one knows how much a Bitcoin should be worth. Unlike a dollar, there are no factors signals that act directly upon it. It’s tied to no state or country. Bitcoins are not part of any stock exchange (at least not yet) and, while they are theoretically limited in number, the end of bitcoin mining is years away, and who says that we’ll stop mining?
Right now, no one knows how much a Bitcoin should be worth.
Even if Bitcoin isn’t a classic bubble like housing, Beanie babies, Tulips or Dot-Com, it’s a financial instrument on a wild ride. These things do tend to follow a prescribed sequence of events, one that financial experts Charles P. Kindleberger and Robert Z. Aliber described in their book Manias, Panics and Crashes: A History of Financial Crises.
The authors wrote that some shock usually triggers the expansion (the unexpected result of a Presidential election?) and then economic boom. This leads to euphoria, which pushes asset prices higher, “much more rapidly than GDP or some other income measure.” Things go south when a few investors react to even the briefest pause in that expansion (though I think euphoria might still reign) and basically park some of their earnings outside the asset bubble. As soon as others follow suit, the decline accelerates.
“The pattern is biological in its regularity. A panic is likely and then a crash may follow,” they wrote.
Bitcoin is clearly in the euphoria/mania stage. How long this can last is anyone’s guess, but Bitcoin and its adherents can’t outrun history. This bubble may grow, but the burst is coming, it’s only a question of when.
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