Is the crypto market a bubble? What history can tell us

Sir Isaac Newton was undoubtedly one of the smartest men in history. But not even he could outsmart the nature of economic bubbles.

He invested his life savings in the South Sea Bubble of 1720, and lost today’s equivalent of £4 million, causing him to quip after the crash: “I can calculate the movement of the stars, but not the madness of men”

So if not even Sir Isaac Newton can foresee a bubble and act rationally, what hope do the rest of us have?

For one thing, we have hindsight, and the knowledge of enduring human behaviours.

Taking a long view of history allows us to see that the hype and speculation surrounding cryptos today is strikingly similar to huge economic bubbles of the past, and gives us a cautious outlook for the future of this revolutionary technology.


A state of booming economic activity (as in a stock market) that often ends in a sudden collapse

Not all bubbles are created equal. Although all bubbles throughout history follow the same basic pattern, there’s a fundamental difference between bubbles that are based on pure speculation, and those that involve the development of new, disruptive technologies.

Both are still types of economic bubbles, and both inevitably pop.

Despite this, they have vastly different consequences for the post-bubble future.

The purely speculative bubble will grow, pop, and then return to somewhere near baseline. Investors will lose money, and legislation will be put in place to try and halt the bubble, or to stop more bubbles forming in the future.

But in this scenario, nothing really changes. The world isn’t any different after the bubble has burst; everyday life usually resumes.

A prime example of this type of bubble is one familiar to anyone who has spent more than 5 minutes researching crypto: the tulip mania of 1637.

Tulip Mania

Tulips were imported to the Netherlands from Turkey in the 16th century, and they instantly became a hit with the Dutch. As they were in such demand, prices for tulips and tulip bulbs started to skyrocket, causing many people to start speculating on their price, buying them up in droves, in the hope that they could be sold for a higher price in the future. This increased the scarcity of tulips and drove their price up even further, to the point that some were selling acres of land for single tulip bulbs.

Eventually, people began to see that prices for tulips were wildly inflated, and stopped showing up to tulip auctions. This small act eroded confidence, and sent the market into a panic, causing prices to plummet, and to eventually return in a few months to their pre-bubble levels.

Tulips remained popular in the Netherlands even after the crash, but nothing about Dutch life at the time was drastically altered. Tulips couldn’t improve people’s lives in any measurable way, and had no economic value once the bubble burst. Their prices skyrocketed in the 6 months of the bubble purely due to speculation — people bought tulips purely because their price was going up, in the hope of selling later to make a profit, not because of any intrinsic value.

Contrast this with the dot-com bubble of the late 1990’s, and the railroad mania of the 1840s; two famous bubbles of the past that grew from what were then new and revolutionary technologies.

Dot-Com Bubble

Let’s start with the dot-com bubble, an event still in the recent memory of most non-millennials.

At the beginning of the 1990s, The U.S had just turned a recession into an economic boom. With jobs being created, GDP growing and interest rates shrinking, investors became gradually more optimistic about the future.

The Internet had just been invented, and once it became clear that this new technology would open up completely new ways of doing business, interest began to soar.

The NASDAQ stock index started the decade slowly, beginning January of 1990 at 814 points. By the end of the 90’s, however, it had rocketed up by 740%, fuelled primarily by the explosion of new technology companies.

The number of tech companies going public each year ballooned from less than 50 in 1990 to almost 400 by the end of the boom in 1999.

Netscape released their popular web browser in October 1994, and less than a year later would IPO so successfully that shares jumped almost 300% on the first day of trading. They would go on to be acquired by AOL for $10 billion only 4 years later.

The success of Netscape’s IPO turned heads from Silicon Valley to Wall Street, and caused a seismic shift in the industry. For the first time, it was shown that even though Netscape was yet to earn its first dollar in profit, there were huge sums of money to be made from investing in Internet startups.

The incredible growth rate of internet companies was projected around the world by new forms of online media, and saw many investors and businesses behaving irrationally due to the sheer amount of money being passed around. This caused then-chairman of the Federal Reserve, Alan Greenspan, to suggest that ‘irrational exuberance’ could be to blame for the over-inflated prices of the as-yet unproven tech companies.

Bankers were also getting in on the act, encouraging companies to IPO as quickly as possible. The process of taking a company to IPO netted these bankers around 7% of the total amount raised, so it was in their best interest to take as many companies public as possible, regardless of any solid business case to do so.

Flipping stocks also became rampant, with institutional investors buying up large amounts of company stock before an IPO, waiting for the stock to rise anywhere up to 300%, and then selling it off to the public for a huge profit.

Scared of missing out on these incredible price increases, the general public then bought the stocks, not knowing that the price was being manipulated in the background. They were often left with shares in an artificially pumped up company without any real evidence of potential for future value.

Despite this, the money kept flowing and the hype kept building. Capital became increasingly easy to come by after the Taxpayer Relief Act of 1997, which cut the maximum capital gains tax from 28% to 20%. This allowed venture capital firms to pour even more money into just about every new startup that had a ‘.com’ in their name, hoping that at least one would be a success.

Due to the incredible hype in the peak years of 1998–2000, scams abounded. Venture capitalists were spread too thin and were too caught up in dot-com mania to do proper due diligence on potential investments.

Companies would frequently pop up with just a name and an idea, raise huge sums of money from these VCs and then simply disappear.

This wild ride wouldn’t last long; however, as the exuberance around these new tech companies eventually began to fade.

Nobody can pin down exactly what caused the bubble to burst in March of 2000, but it’s likely that it was a combination of a range of factors, not one specific event.

Some of the suggested reasons include:

  • The verdict of the antitrust court case against Microsoft (concluded in April 2000) eroded confidence in tech companies
  • An impending interest rate rise made investors increasingly nervous about realising returns on their investments
  • News broke at the peak of the bubble that Japan had entered a recession, causing a wide-scale sell off of technology stocks
  • Prominent news outlets began reporting that many tech companies were rapidly running out of money, further eroding investor confidence
  • Tax Day (April 15) encouraged investors to sell stocks in order to pay tax on gains realised in the previous year

The NASDAQ lost 60% of its value a year after the bubble burst, and hit the bottom of the crash 9 months later, with just under 75% of its value lost.

It’s clear that the dot-com bubble was catastrophic for those who invested in and worked for the companies involved. However, the huge amount of capital invested in the tech industry in the 1990s spurred the growth of internet infrastructure and intellectual property, that laid the foundations for the sites and services we use today.

We would not have the products of Web 2.0, such as Facebook, Google, Twitter, YouTube and Reddit if the dot-com bubble didn’t stimulate the first wave of tech companies to show the world that the internet could be used to communicate, learn and do business even better than before.

Yes, the dot-com bubble was just that — a bubble where trillions of dollars were lost. But the money raised during this time didn’t just evaporate. It was spent on marketing, advertising, promotion, hype, and brand awareness.

Buying things online was unheard of in 1995. Instant, text-based communication was refined to tech nerds and research scientists. And forget about streaming hours of video, you couldn’t even download a 3-minute MP3 file unless you didn’t need your telephone for the next 6 days.

But of course all of these activities are ubiquitous today thanks to the boom in infrastructure investment and awareness of the Internet caused by the dot-com bubble.

It’s clear to see that the dot-com and tulip bubbles were caused by fundamentally different circumstances. The tulip mania was caused by pure speculation, and blew over in 6 months and changed little about Dutch society. The dot-com bubble involved lots of speculation of course, but was precipitated by a seismic shift in technology, and went on to revolutionise society in the process.

Let’s analyse one more technology-based bubble just for good measure.

Railway Mania

You’ve probably heard enough about bubbles for a lifetime, but it’s important to discuss one more example, so I’ll keep it brief.

The railway mania of the 1840s involved huge numbers of British railway companies being formed, with promises to lay down new tracks all over the country rampant at the start of the industrial revolution.

There was massive exuberance around this new, and potentially disruptive technology, that led stocks in these new companies to be wildly over inflated throughout the peak of the bubble.

A short timeline of events is as follows:

  • The British government reduced interest rates and removed legislation (ironically repealing the Bubble Act, which was enacted to stop the South Sea bubble of 1720), which encouraged investment in railways
  • Companies heavily promoted themselves, helped by new forms of media (newspapers)
  • Aggressive self-promoting companies portrayed themselves as virtually risk-free investments
  • To entice investors, companies offered generous promotional deals
  • Investors became enthralled by the companies’ growth prospects, generating huge buzz
  • The government took a hands-off approach, and didn’t try and prevent the formation of a bubble
  • The hype was so huge that railway companies were not required to demonstrate the viability of their businesses in order to raise money
  • Insider trading meant that new businesses got approved regardless of their legitimacy
  • As shares continued to rise, fear of missing out led many middle class families to invest heavily in these railway companies, in an attempt to strike it rich
  • Huge amounts of money were given over to companies with highly-audacious, impractical or even downright fraudulent plans
  • Capital for investment eventually ran out, and the realisation dawned that these companies were nowhere near as valuable as their stock price indicated
  • Stock prices then plummeted, popping the bubble

Notice anything familiar here? Almost every single one of the events listed above occurred again, almost in exactly the same way, over 150 years later.

Why would the same events take place even though the time, the technology and the people were all completely different?

It ultimately comes down to human nature.

An economy is driven fundamentally by transactions between humans. These transactions are driven by human desires, wants and needs.

And those never change.

And unfortunately, humans don’t see things very clearly when huge sums of money are on the line.

We’re still as susceptible to greed, fear and irrationality as we were 150 and 1500 years ago.

And we’re still unable to see into the future and truly evaluate the potential of a new technology, especially if everyone around us is getting filthy rich.

Amara’s law shows us that:

We tend to overestimate the effect of a technology in the short run and underestimate the effect in the long run.

This is why the tech bubble formed, popped, and then in under 10 years, completely transformed society.

The exact same process occurred during the railway mania. People saw the transformative potential of railways, and were over exuberant in its early years, causing the bubble. But railways didn’t go away, and soon thereafter would facilitate the coming of the industrial revolution.

And exactly the same thing is happening in crypto right now.

The technology is underdeveloped, but fresh millions are being poured in every day, mostly into immature companies being run by young, inexperienced founders.

New crypto companies (ICOs) are forming every day; some are legitimate but most are scams. They are aggressively promoting themselves on social media and gaining huge followings.

Pump and dump schemes and insider trading are rampant.

Massive buzz follows anything labelled ‘crypto’ or ‘blockchain’. Company stock prices soar by just mentioning these words.

Middle-class investors are flocking to crypto with little-to-no experience in the stock market in an attempt to strike it rich, creating markets fuelled by emotion over technical fundamentals.

Many investors are relying on the greater fool theory to sell on their crypto investments before prices crash.

Something tells me we’ve been here before.

But these cycles have happened time and time again, and will continue to happen in the future.

Just take a look at some of the proposals put forward for starting new companies to trade with the New World during the South Sea Bubble of 1720 (the one where Sir Isaac Newton lost all his money):

  • For the trading in hair
  • For the insuring of horses
  • For improving the art of making soap
  • For the improving of gardens
  • For insuring and increasing children’s fortunes
  • For a wheel for perpetual motion
  • For the transmutation of quicksilver into a malleable fine metal

And the most incredible of all:

  • For carrying on an undertaking of great advantage; but nobody to know what it is.

How could you say no to that!

So crypto is a bubble. What now?

Crypto is definitely in a bubble, but it’s incredibly disingenuous to compare it with speculative bubbles like the tulip mania, even though this keeps onhappening.

The crypto bubble, like dot-com and railways before it, is based on more than just speculation. If you don’t believe that, you just haven’t studied blockchain technology enough.

The bubble currently forming is due in part to hype, but the hype is due to the excitement surrounding the disruptive nature of blockchain and distributed ledger technology.

However, despite all the bubble talk, and the outlandish and often illegal activities occurring on an almost daily basis, there should be nothing to fear.

From a long view of history, bubbles aren’t necessarily a bad thing.

Some most definitely are, such as the tulip mania of 1637 that we discussed earlier, as thousands of innocent (mostly uninformed) citizens lost a damaging amount of money, and society was no better off after the bubble than it was before.

However we saw that some bubbles — like the dot-com and railway bubbles that grow around revolutionary technologies — foster and encourage huge amounts of innovation and change.

And that’s exactly where we are with crypto in 2018.

It’s undoubted that we’re currently in a bubble, and that nobody knows when it will burst.

But focusing on the bursting of the bubble, in my view, isn’t the most important thing going on right now.

Sure, if you have lots of money tied up in crypto investments, the thought of the bubble popping would probably make you nervous.

I’d be nervous about losing money as well.

But that’s a short term view of things.

Just like in the dot-com crash, 90% of companies will crash and burn because they were unsustainable, too early, run poorly, spent too freely or myriad other reasons.

And even the ones lucky enough survive will (temporarily) lose most of their value, as the crypto castle comes crashing down around them.

But even if (or when) the bubble bursts, crypto won’t disappear along with it.

Distributed ledger technology, and the robust decentralisation, anonymity and security that it provides will still be desired by millions of users.

The physical, digital and mental infrastructure to deliver this will continue to be built on top of what the current crypto boom lays down.

The scams will disappear as the market matures and more regulation is put in place to protect consumers.

And the companies/groups/communities developing these cryptos who have their shit together and are delivering real value to users will weather the storm and continue to innovate, and change the world in the process.

In summary

The railway mania of the 1840s didn’t stop railways from being built and revolutionising transport, ushering in the industrial revolution.

The dot-com crash of the early 2000s didn’t stop the Internet from connecting over 4 billion people, and completely reshaping our lives in the process.

There is no guarantee the crypto bubble will burst and play out in exactly the same way, but history shows us that a crypto crash won’t stop distributed ledger technologies from revolutionising the way the majority of the world transacts, banks, secures their personal information, accesses healthcare and much more.

So stop reading the clickbait headlines proclaiming that “the crypto bubble has burst” (it hasn’t), “crypto is the biggest bubble in history” (it isn’t) or why “you should worry about the crypto bubble” (You shouldn’t).

If the bubble is going to pop, there’s not a thing you can do to stop it.

So stop stressing, appreciate that we live in such an incredible point in history, and that the future that cryptos will help to build is going to be incredible.

This post was originally published on Medium by Jack Dossman in September 2018.

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