In 2008 the first cryptocurrency Bitcoin was launched. While still providing a means for exchanges and the store of value, cryptocurrencies have the distinct advantage of being decentralised as opposed to the more typical fiat currencies (e.g. the US Dollar) which rely on banks and governments to declare it legal tender and maintain its value. However, Bitcoin has the advantage of cutting out the ‘middle-man’ (i.e. banks) and ensuring autonomy and anonymity to its users. Yet despite some claiming that it is the currency of the future, it hasn’t been globally adopted and its value has fluctuated dramatically due to speculative bubbles inflating and bursting.
The very first speculative bubble (a steep rise in an asset’s price) occurred in 1637, during the Dutch Golden Age. At the time the Dutch traded goods between Asia and Europe which positioned it as one of the wealthiest nations in Europe and arguably the world. One of these goods was the tulip, more precisely the tulip bulb, which was regarded as a very exotic good and it wasn’t long before demand was high. Everyone wanted them and prices skyrocketed escalating to the peak price of $750,000 in today’s money. Individuals even went as far as paying 10 years’ worth of wages, or the value of the grandest of houses believing that they could make a profit from selling them back due to the ever-increasing prices. Such speculation led to people spending all the money they had, and even some they didn’t, in order to get in on the action. But this rising bubble suddenly burst. Everyone realised that the absurd prices were well above the intrinsic value of the tulip. Prices dropped very quickly and those who originally thought that this was the safest and most profitable market of all were left in unimaginable debt. Although there is some disagreement on the extent this crash had on the Dutch economy as a whole, it is nevertheless the first speculative bubble and referred to nowadays as ‘tulip mania’.
Despite seeming like an absurd story, speculative bubbles occur often and are almost impossible to spot before they burst due to associated widespread faith and trust in the given market. Bitcoin itself experienced this phenomenon in 2017. With the price at under $6,000 per Bitcoin on the 5th of November the market experienced a 2,800% price increase peaking at over $19,000 less than a month later on the 10th of December. This was due to investors and speculators having too much confidence in the market and everyone rushed in much like the Dutch did with tulips; a phenomenon best described by Charles Mackay (19th century journalist and author) who said that communities could “fix their minds upon one object and go mad in its pursuit” in his book Extraordinary Popular Decisions and the Madness of Crowds. When people realised the Bitcoin was completely overvalued there was a big sell-off. Prices dropped by 80% (down to around $3,200 a year later).
However, unlike tulip mania Bitcoin prices subsequently recovered back to around $10,000 in 2020. This is somewhat comparable to the Dot-com crash of the early 2000s where investors rushed to buy shares of internet-based start-up companies due to the widespread belief that these were safe and profitable acquisitions – or perhaps gambling that at least some of them would be. This bubble burst famously in the early 2000’s, but the tech industry has since recovered as winners have emerged (think Google, Amazon, Apple).
The volatility of Bitcoin is largely due to its current usage being different to its intended usage. Currently, the vast majority of daily transactions (which amount to less than half the value of Paypal’s) are not business or payment transactions as intended but simply speculative trading which only contribute to speculative bubbles. It is axiomatic that this inability to hold value deters many people and governments from using it for fear of losing large amounts of money very quickly. Such instability has continued to persist, with Bitcoin experiencing its 5th largest price drop as recently as the 19thFebruary 2020 where it lost nearly $1000 of its value in an hour. Furthermore fluctuations of hundreds of dollars are not only daily occurrences but materialise very quickly – exacerbating people’s doubts and scepticism.
Nevertheless, Bitcoin shouldn’t be ruled out, in fact it should be embraced in some places. With the almost comical levels of hyperinflation in Venezuela, many consumers have transferred their Bolivars to Bitcoin in order to salvage the value of their money. This shows that Bitcoin can work if its price is less volatile than standard fiat currencies. Therefore, if governments, companies and individuals all switched to Bitcoin it would allow for a very stable currency as the percentage of users who are trying to profit from its volatility becomes negligible. Unless that happens, Bitcoin will continue to experience dramatic rises and crashes which will prevent widespread adoption of what could be the future of money.