“The bitcoin is a mania like tulip bulbs in the 1600s and Beanie Babies in the 1990s.” – Wall Street Journal
“Bitcoins are the tulips of modern times.” – Financial Times
“Central Banker On Bitcoin, At Least With Tulipmania You Got a Tulip At The End.” – Forbes
Both saw a dramatic rise in price, and critics say that bitcoin necessitates a collapse similar to the one tulips suffered in the 17th century. There are two huge problems with the comparison, though. Bitcoin has almost nothing in common with the tulip and tulip mania had more to do with disruptions in the trading climate than actual tulips.
Previously, Bitcoin Magazine released a detailed piece attempting to explain why tulip mania doesn’t apply to bitcoin, but it falls short in comparing tulips and bitcoins in relation to the properties of good money. It is true that tulip bulbs are not a good money, but they did not try to be a money; they were a commodity. Unfortunately, in order to understand how the tulip bubble developed, a brief history lesson is necessary.
The tulip was first imported to the Netherlands in 1593 and quickly grew in popularity as the most beautiful flower that could withstand the harsh climate. The Netherlands was entering a Golden Age, where the country quickly grew wealthy due to productive trade with the East Indies. The fortunes of merchants grew, resulting in more disposable income and more demand for luxury goods. The bubonic plague, which saw a resurgence in the early 1600s, may have also been a factor, with plague hitting Spain, England, Italy, and, later, the Netherlands. The threat of a repeat of the 14th century Black Death and the ongoing Thirty Years’ War may have contributed to reduced risk aversion.
Another interesting factor was the Tulip-breaking virus, which was not common, but very important. The virus caused individual petals to split into multiple colors, a beautiful effect which drove the prices of infected “Admiral” tulips upward. The virus was also responsible for limiting the flower’s reproductive capacity. Considering that regular tulips already take 7-12 years to grow (and the tulip bubble only lasted about 4 years), Admiral tulips were scarce and had a slowly responding supply.
Though these factors suggest a tulip bubble, it doesn’t quite explain the extreme price of $30,000 for a tulip. Shouldn’t investors have realized how fragile and useless a tulip is once they had it in their hands? The answer is that they did not have the tulips in their hands. Much of tulip mania took place in taverns across the Netherlands, where speculators met to trade the first ever futures contracts. As a result, more people could get involved in tulip speculation because it did not require the handling and maintenance of any plants. Many speculators never even held physical tulips and it is arguable as to whether or not the price of physical tulips kept pace with the price of tulips contracts.
The tulip price had its first hiccup in November 1636, which caused a scare among Dutch elites invested in tulips. Remember, tulip trading was not mainstream, but it was popular among some royalty. The Dutch authorities responded by converting all futures contracts into options contracts, protecting buyers from terms they agreed to and greatly reducing the cost of speculation. Previously if you overestimated the future price of a tulip (in a futures contract), you still had to buy the tulip at that price. With the new legislation, you were on the hook for only a fraction of the contract price (around 3%). All of a sudden, it was much easier to profit from speculation and less profitable to grow the flowers. It was this step that spurred furious trading activity and price movement, peaking at 20 times the November 1636 level only 3 months later.
I mentioned that these futures and options contracts were the first of their kind. Short sales, however, were not yet invented. The result was upward price pressure in the derivatives market without the possibility of short sales to temper it.
This all peaked in February 1637 when, with the price at its peak, no buyers showed up to a tulip auction in Haarlem. There was no more demand for tulips, only for profitable tulip contracts made too easy to profit from by government decree. Within days, the price plummeted across the Netherlands and we had our first financial bubble in history.
So what does this have to do with Bitcoin?
Nothing at all.
The tulip bubble saw wild price runups, like Bitcoin, but little else is comparable. Bitcoin has almost no derivatives market, with ICBIT and Predictious being the only two exchanges I’m aware of to offer derivatives trading. In fact, some economists blame bitcoin’s volatility on the lack of derivatives trading, since it is difficult to bet against bitcoin.
There is one shared characteristic of tulips and bitcoins, though. Both have unresponsive supply. Tulips take years to grow and that played a role in the tulip bubble. As demand skyrocketed, supply couldn’t keep pace, exacerbating the price explosion. Bitcoin’s supply is entirely fixed, which has likely played a similar role in bitcoin’s three bubbles, raising the price to higher than expected heights and dramatic plummets. Unlike tulips, bitcoin has reached its current price without any derivatives market and the introduction of one is likely to dampen price volatility.
Basically, wild derivatives speculation caused the tulip bubble and bitcoin doesn’t have a derivatives market. If you’re looking to compare something to tulips, I think I may have found something: The global derivatives market is at least 10 times the world GDP.
