A Modern Tulip Mania
“Bitcoin is the tulip of modern times,” stated the Financial Times. “It is a mania like tulip bulbs in the 1600s and Beanie Babies in the 1990s,” heralded the Wall Street Journal. So are tulips and Bitcoins really comparable?
The History Lesson
Why the tulip bubble? The tulip bulbs were imported to the Netherlands in 1593 and produced “the most beautiful flower that could withstand the harsh climate”. As the country became richer, merchants traded contracts on the future price of the blooms. A hiccup came in 1636 and the government converted futures into options. With futures if your price is wrong you are committed, buy or sell.
An options contract costs less and, as today, is an option, not a commitment. Merchants found it easier to profit from speculation and less profitable to grow tulips. The demand was for the contracts, not the bulbs. When the price collapsed that was the first financial bubble in modern history.
Miners Striking it Rich
Bitcoin was invented in 2009 by Satoshi Nakamoto as an antidote to the instability of traditional currencies. Nakamoto, who is in hiding somewhere, devised an unalterable computer algorithm that produces or ‘mines’ Bitcoins at a steady rate. Once there are 21 million, new production will cease. For a small Bitcoin fee, ‘miners’ verify transactions by tracking digital codes to prevent fraud.
The value of the digital currency has been on a wild ride – a year after launch and it was worth less than 1p, now that it is gaining recognition as a legitimate means of payment, it has touched highs and lows ranging from $200 to $1,200. That is clearly not an antidote to instability.
Steady Growth Vs Rollercoaster Prices
Both tulips and Bitcoin have an unresponsive supply. Tulips take years to grow and that played a role in the price explosion when supply could not keep up with demand. The supply of Bitcoins is fixed, which may contribute similarly to the sharp fluctuations in value. The number of Bitcoins will grow at 0.6% a year over the next century, making its expansion much slower than traditional currencies, another reason for the price rise.
So What?
Paradoxically, the sharp fluctuations in the value makes Bitcoin unsuitable as a means of exchange. Someone who expects the currency to be worth more tomorrow will be unwilling to spend it today. There are currently around 13 million Bitcoins in circulation and predictions suggest that each one could be worth $2,000 by the end of the year.
The mania is not yet over, but the longer it lasts, the greater chance investors are likely to be burned. Truly, not a sensible currency for the cautious investor.