Lest crypto go the Dutch tulip way

This is not a coincidence but by design as markets are nothing but an aggregation of individual households each deciding independently at the same time.

Published: 03rd July 2022 12:00 AM  |   Last Updated: 03rd July 2022 12:00 AM   |  A+A-

There are several interesting economic developments that merit a column. Each of which might help demystify some of the developments that are impacting households the world over. But equally important is to discuss an event in the not-so-distant past.

To be precise, we are talking about the Dutch Tulip Mania which started in 1634 and ended in February 1637. The Dutch Tulip Mania is one of this author’s favourite bubble stories and not so because it is considered as the first recorded speculative bubble story, but more so because it pertained to a perishable commodity such as the Tulip becoming a speculative instrument.

The introduction of tulips to Europe occurred sometime in the 16th century. Netherlands saw the tulips become immensely popular and it began to be widely cultivated. The saturated petal colour added to its charm as it quickly became a status symbol. With the ordinary tulip becoming a luxury item, its prices increased substantially. Their popularity also pushed professional growers to pay higher amounts to get tulip bulbs. The increasing demand for tulips from France resulted in speculators entering the market leading to the creation of a futures market. With a steady increase in prices, the bubble peaked sometime between 1636 and early 1637. By February 1637, tulip bulb prices had collapsed abruptly and, therefore, the tulip trade came to a halt.

Many regarded tulips and their bulbs as an investment instrument as they argued that it had value because of limited supplies – or because someone was willing to buy them in exchange for some money. In that sense, yes, tulips did attain some speculative value for a brief period. However, several investors had mistakenly attributed the speculative value to the intrinsic value of the asset. Consequently, when liquidity constraints or market participation dipped, the speculative value was the first casualty. With the dip in speculative value, there was a frenzy and the bubble burst leading to widespread destruction of fortune.

Some may say that the similarities between cryptocurrencies and the Dutch Tulip Mania are overstated. Some may even find them to be a coincidence. There have been several events in the recent past where we have noticed that commodities and instruments see a wide divergence between their intrinsic value and the value that a speculator ascribes to them. It is useful to remember that such divergence may last for a couple of years, sometimes even for a decade. Ultimately, the markets will eventually be able to price assets appropriately.

This is not a coincidence but by design as markets are nothing but an aggregation of individual households each deciding independently at the same time. Therefore, the behaviour boils down in most cases to greed and fear. It is a combination of these individual decisions that creates bubbles and bursts them from time to time. Easy money policies do play a role in the process, but fundamentally it boils down to human behaviour. This behaviour was responsible for attributing a far higher value to Tulip Bulbs in the past and more recently in attributing value to cryptocurrencies that have little to no intrinsic value.

The arguments presented over the last few years – one of which is that cryptocurrencies are assets and not currencies – are very similar to the use of Tulip bulbs for speculation purposes. The recent correction in prices of cryptocurrencies should therefore not come as a surprise. The Tulip Mania story is an important reminder of how any commodity could be turned into a speculative instrument.                                                                                

(Author is New York-based economist)



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