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Bitcoin & The Tulip Bubble

Introduction

Since Bitcoin’s inception, it has often drawn comparisons to tulips, a reference to the Tulip Mania in Amsterdam between 1634 and 1637. At this time, the price of contracts for tulip bulbs reached an extraordinarily high level and then suffered a catastrophic collapse, the whole episode taking place within a few short years. 

The analogy is famous because Bitcoin, especially in its early years, has seen similarly massive surges in value, often followed by a steep collapse. However, to the chagrin of its critics, Bitcoin has shown much greater strength in its price action. The ‘bubble’ has lasted 15 years instead of the three years for the tulips. Although the price reductions in Bitcoin have often been dramatic, they never seem to fall far below previous highs, and within a few short years, the price regularly begins to rise again. Far from being a repeat of the Tulip Bubble, Bitcoin, as seen just through its price action, is an entirely different entity.

Tulip Bubble
Tulip Bubble
Bitcoin Bubble
Bitcoin Bubble

Why would this be?

To understand this, we need to understand history, the law, and, in particular, the history of money and the legal structures surrounding it.

In my previous newsletter, Bitcoin & Politics, I explain how the governments of our countries govern the rules that we live by. This point may seem obvious, but many need help understanding our societal structures and how and why they came into being. Many live their lives by taking these things for granted without giving them much further thought, but then they wonder why life seems so frustrating and why it seems so difficult to change. 

To understand how a car works it helps to comprehend its engine. To understand how society works, it helps to know that it has an ‘engine’ and to study how this works, too. Our government rules have managed society’s engine for the last 300-plus years, and fiat money fuels that mechanism. How different would life be if it were possible to change that fuel? You would likely need a new engine!

Historical Context

The word ‘contracts’ is the key to understanding the difference between Bitcoin now and the Tulip Bubble of the 1600s. In one of my previous newsletters, Bitcoin and the Joint Stock Company, I explained how the Central Bank of Amsterdam was set up to manage the joint ventures of merchants collaborating to fund voyages to explore the new world. Thus, the idea behind ‘contracts’ in the 1600s to manage financial agreements was a new concept. The notion of a joint stock company facilitated so many new transactions that it exploded the velocity of money, directly impacting the Gross Domestic Product of a country, as demonstrated by the graph below. 

GDP and World Population
GDP & World Population

This administration of money created opportunities for securities/shares and speculative trading. For example, a merchant could make a contract not just for the price of a tulip bulb but also for the price of a tulip bulb in the future. It was using these mechanisms that the cost of tulips climbed so high. Only when the individuals engaging in these trades decided that they believed the contracts for the bulbs cost too much did the tulip bubble collapse.

Contract for Tulip Bulbs
Exchanging Contracts for Tulip Bulbs

Recognising that the goal and ability to eliminate corruption are relatively new phenomena for humanity is essential. In the 1600s and 1700s, corruption was rife, as I demonstrated in Bitcoin & The Southsea Bubble, so the moment enterprising individuals introduced an innovation, it opened a window of opportunity to be immediately exploited. The invention of contracts associated with business ventures at the time made more corruption possible. Financial contracts and speculative trading were very new concepts. Society had yet to discover the harm that such agreements could wreak.

The Tulip Bubble in Amsterdam was the first such consequence. Although historians will argue that the subsequent adverse effects were limited to the wealthiest in society, in many ways, it highlighted to those with resources and poor intentions just how practical such schemes could be for extracting wealth from a naive populace.

Dutch Tulips
Dutch Tulips

The bubble ended when buyers of tulip bulb contracts refused to fulfil the agreed future contract prices, and new buyers rapidly disappeared. The Dutch government facilitated the refusal to meet the contract prices for the bulbs by allowing the conversion of the contracts to ‘options contracts’, meaning that the merchants could complete the original agreements for only a proportion of their cost. In anticipation of this change in the law, these tulip contracts were seen as attractive as this potential change in the law to ‘those in the know’ reduced the risk of their purchase. Savvy merchants could purchase the contracts for valuable bulbs, but there was a chance that they would never need to pay the full price, essentially making their purchases risk-free. A speculative bubble ensued as the merchants caught on and sought out the contracts. The ‘bubble’ collapsed when the Dutch government enforced the new law, and the tulip contracts lost their paper value.

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The Bank of England & The Southsea Bubble

Interestingly, in a few short decades following this episode, a Dutch prince – William of Orange, was established on the throne of England in a bloodless coup. The Bank of England was established as part of the deal in 1694, with Parliament using the legal structure of a Joint Stock Company. 

Keen investors provided the king with a £1.2 million loan through this bank to support his wars with France. The contract stated that the British people would repay the loan and interest at 8%. In a few short years, this loan had exploded to £16 million, along with an unaccounted-for spending spree by the government to the tune of a further £9 million by 1711. 

Although the responsibility for repaying the loan had been committed to the British people through the contract with the Bank of England, the tax laws as they exist today had yet to be invented. So, to manage the debt, the British Government approved the creation of The Southsea Company to trade in the South Americas as the Scottish William Patterson recommended. Williams’s Scottish friend John Law then hightailed it to France to copy the scheme in Paris, leading to the establishment of the Mississippi Company. I relate the tale in my previous newsletter, Bitcoin & The Southsea Bubble

As the newsletter title reflects, both of these schemes also led to financial bubbles, the outcome of which led to both winners and losers. 

The British Government managed the Southsea Company’s losses by dividing the subsequent debt between the Bank of England and the East India Company. In contrast, the French government could not manage the end of the Mississipi Bubble in the same way as John Law had set up both the Bank of France and the Mississipi Company as enmeshed entities, meaning the problem here was impossible to overcome. 

John Law fled to Venice, where he died a pauper. The French currency was so devastated that the French government was left to try several experiments with paper currency schemes in an effort to solve the problem. The Mississippi Bubble damaged the currency of France so severely that it eventually led to the French Revolution.

The Bubble Act 1720

The creation of Joint Stock companies was so helpful to the elite that they banned their formation without a royal charter in 1720 to avoid competition while the Southsea Company attempted to meet its objectives. The Bubble Act was not overturned for another 100 years, almost as though the population had demonstrated that it could not handle such a tool, now seen as a weapon of mass financial destruction. 

Isaac Newton’s strict management of the national currency, as Warden of the Royal Mint shortly after establishing the Bank of England in 1694, created the foundation for Britain’s first and second industrial revolutions in the 1700s and 1800s.

Isaac Newton as Warden of The Royal Mint
Isaac Newton: As Warden of The Royal Mint

Although the British government hid its additional debt behind the scenes, it did not prevent Britain’s progress. The British Government successfully created an illusion of trust with the Bank of England, securing the strength of its currency, facilitating business transactions, and ensuring its success for the time being. 

Counterfeiting currency was a capital offence in Britain during these years, again established by Isaac Newton. Anyone caught counterfeiting money could be sentenced to death by the gallows. Such strong punishments created a powerful incentive to keep the cash honest on the streets, albeit far from honest behind the scenes.

Building on this illusion of honesty, the Bank of England eventually gained a monopoly on printing currency, even though many banks had that privilege when the government initially established the Bank of England. With power over a dominant currency, the government was eventually at liberty to pass several laws to develop the formation of joint stock companies, as I outline in my newsletter Bitcoin & The Joint Stock Company.  

With each new law, more companies were established, creating a new explosion of wealth, and the rules under which the Bank of England was allowed to operate were gradually modified.

Fiat Currency: Money By Decree

Joint stock companies multiply the dysfunction of fiat currencies. In Bitcoin, we often discuss how central banks have corrupted the money. Still, another layer to the argument is that governments have been responsible for managing fiat currencies by creating and manipulating laws for centuries. 

Their creation relied on the existence of joint stock companies and the rules and regulations that govern their means of operation. Over time, these business structures have adjusted as circumstances demanded. For instance, the Bank of England was nationalised following World War II to manage the nation’s war funding. Nevertheless, it was in the sixteenth century that the concept of executing transactions for groups of people rather than just individuals was born, leading to the Bank of England’s establishment.

Joint stock companies and our modern corporations have significant consequences because companies are managed and held to account differently from individuals. They also operate using different laws and tax laws, which, in many circumstances, gives them numerous unfair advantages, as explained in my book Truth Decay: How Bitcoin Fixes This.

Truth Decay How Bitcoin Fixes This
Truth Decay - How Bitcoin Fixes This

In my book, I discuss how the difference in interest rates available to corporations compared to individuals and small businesses creates disadvantages even today—exposing the more prominent and hidden sources of current wealth inequality.

Bitcoin Analysis

However, the situation with Bitcoin is different. Bitcoin’s rules are encoded on the Blockchain and can only be changed with great difficulty now. Bitcoin’s software protocol creates a firm foundation for the value of a money. Its rules are no longer at the whim of governments colluding with central banks to hold or lose its value. 

Bitcoin trades on exchanges using futures contracts and exchange-traded funds, and as such, has the potential to exacerbate bubbles in its price, similar to the first fiat bubble involving tulips. The difference now is that governments do not have the power to change Bitcoin’s code and, thus, no power to change the ‘laws’ under which Bitcoin operates.

Irresistible Force Meets Immovable Object
Irresistible Force Meets Immovable Object

They can try to restrict Bitcoin’s usage for a while, but as access to Bitcoin’s protocol is now global, each government’s power now has limitations when managing Bitcoin as a form of money. As people increasingly realise this, the other powers of governments will also be affected as their ability to pay for any tyranny becomes prohibitive.

Conclusion

So, while there may be intermittent ‘bubbles’ in the price of Bitcoin, it is an asset with incredible usefulness. As such, it has the potential to be immensely valuable over a long period. So bear this in mind next time someone wants to refer to Bitcoin as ‘tulips’ and remember that even though we are now well on our way to fixing ‘money’, this is only one piece of the puzzle. The legal and value structure of joint stock companies, which have evolved into modern corporations, will be the next money monster we need to address.

Until next time, enthusiasts!

Victoria

Play Video about Bitcoin & Tulips

Bitcoin & Tulips

Explore the intriguing connections between historical financial bubbles and the rise of Bitcoin in our latest video, which is perfect for anyone fascinated by economic history and the future of money.

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