Tulips and Bitcoin

Financial bubbles from the Dutch Golden Age and now

2018.07

Tulips and Bitcoin: Financial bubbles from the Dutch Golden Age and now (Blockchain Series I)
Tulips and Bitcoin
리스트 보기
인사이트
토론질문
영상/기사
국문보기
영문보기

I. The spice trade, Age of Discovery, and rise of the Netherlands

The spread of Islam to Europe and the consequent spice trade brought on the Age of Discovery starting from the 15th century.

  • Europeans began to regularly use spices after Rome conquered Egypt in 30 BC. The major spices at the time were pepper and cinnamon from India. The trade route crossed the Indian Ocean by trade winds, went north through the Red Sea to reach Egypt.
  • The Ottoman Empire was at its prime from 1453, when it conquered Constantinople (formerly Byzantium, later Istanbul), to 1699, when it hit a lull in territorial expansion. During this period of conquest, the Ottoman Empire seized control over the whole of North Africa and parts of Eastern Europe, enjoying economic prosperity by using its strong navy to act as an intermediary between Europe and Asia.
  • When the Ottoman Empire conquered Constantinople, Europe became unable to procure spices without going through Arab merchants. Clove and nutmeg, the most popular spices at the time, were speciality items of the Maluku Islands and could only be imported by a dangerous long-distance voyage. In addition to the high cost of transport, caliphs and sultans imposed high taxes on spices traded exclusively by Arab merchants, increasing prices even more. On top of that, Venetian merchants traveling through the Mediterranean Sea, transporting the spices to Venetia, and selling them to various parts of Europe also upped the value of spices; spices like pepper were even distributed like currency at the price of silver.
  • Because Europe lacked convenient modes of transport and refrigeration, the staple food was either salted meat or salted, dried fish from the North Sea. Given that these foods were unpalatable without the addition of spices, Europeans could not reduce their spice consumption even as the price of spices increased. Moreover, due to the low medical standards at the time, spices were also used as medicine and aphrodisiacs, proving how pervasive spices had become in European culture.
  • Ultimately, Portugal and Spain started developing new routes to overthrow the Islamic monopoly over the spice trade. After analyzing nautical data and the size of the Earth, Portugal chose a new route that went around Africa to India, successfully monopolizing that trade bloc. Christopher Columbus, who believed that the Earth was round and that he’d reach India if he kept going west, “discovered” a “new” continent, after which Europe entered the Age of Discovery.
  • Portugal, having “discovered” Brazil and a sea route to India, accumulated immense wealth through maritime trade. However, Portuguese national power weakened due to the concentration of wealth in the royal family and nobility, as well as their wasteful extravagance and failed economic policies; Portugal gradually lost its political influence to England and the Netherlands. The Netherlands, which had been growing in strength amidst the competition between Spain and Portugal, ultimately occupied the West Indies (a strategic point for trade) and monopolized the spice trade from the early 17th century onward.

While dominating the spice trade, the Netherlands developed various trade/finance techniques still widely used for smooth transactions today.

  • Dutch merchants could get high returns selling spices imported from India and Indonesian regions through the newly developed route. However, this route was so dangerous that only one or two out of ten ships could return without incident, requiring also years at sea. Few individuals and organizations could bear such big risks and investment costs upfront, impeding the development of trade.
  • In order to compensate for this problem, the Netherlands raised capital through public participation and created a corporate system that distributes trade profits. The first stock companies—the British East India Company and the Dutch East India Company—were established in the early 1600s, making it possible to pursue large-scale businesses by combining the upper class’ capital with the public’s idle capital. Investors were no longer investing in a particular trading ship, but in a company that owns many ships; they were only liable for their original investments, receiving a proportional cut of the profit and being able to somewhat 1)hedge the high risks of maritime trade in particular.
  • This stock company system popularized investments in maritime trade. Dutch authorities established the Amsterdam Stock Exchange to further encourage investments and enabled the stable trading of the Dutch East India Company’s stocks and bonds.
  • The Netherlands, the birthplace of the world’s first stock company and exchange, saw the emergence of a wide variety of stock-related commodities and finance techniques that are still widely used in today’s financial market, such as spot and (2)futures trading, stocks, bonds, foreign exchange transactions, deposit systems, and leverage.


II. Tulips and the South Sea Company: The start of the “bubble”

Overspeculation in the 17th-century Dutch tulip market was the most infamous financial bubble in history and the first case of capitalist speculation.

  • Tulips were introduced from Turkey to Europe in the late 16th century and became a luxury item enjoyed by the wealthy (including nobles and merchants) in the early 17th century. Tulips were originally a perennial bulb that blooms five years after planting—but as demand grew and prices rose, Dutch merchants began to cultivate tulips in a way that blooming became possible within six months through splitting the bulbs.
  • In the early 17th century, tulip trading was still limited to horticulturalists and a small number of wealthy aficionados. It was a difficult product to attract speculation because trade involved real products and the supply couldn’t be limited (because tulips always grow after some time, however difficult it was to grow them).
  • However, continuous development from the early 17th century resulted in the creation of unique tulip varieties. Particularly rare variants of cultivated tulips grew extremely popular among the upper class due to its scarcity. Even though the supply of general tulips could be increased, the supply of specialty tulips was limited because those were determined by probability.
  • However, financial speculation requires both limited supply and widespread participation (i.e., high demand and easy accessibility). Speculations began with the emergence of tulip futures trading in the Netherlands, which had the most advanced finance techniques coming out of the Age of Exploration and spice trade. Instead of selling real tulips in person, merchants started making and dealing contracts that detailed how many tulip bulbs of a particular variety would be delivered when.
  • Unlike spot trading, futures trading requires only a small deposit at the time of the contract and the terms of the contract to be fulfilled upon maturity. More people started making big profits by buying contracts with small deposits, selling the contract once the price of tulips rose, and earning a premium. In doing so, Dutch people across social class flocked to futures trading, resulting in tulips prices hitting record highs daily.
  • With the introduction of speculation that allowed people to earn much more money if a tulip bulb produced a rare bloom, every Dutch household planted tulip bulbs and participated in futures trading, forming a massive financial bubble. Ultimately, this created a tulip market bigger than the combined worth of the Dutch East India Company (which was, at the time, the goose that laid golden eggs) and every Dutch bank. People jumped in and tried to earn big money by creating new varieties, even attempting to produce black tulips. Though true black tulips could not possibly exist in nature (because black is not a pigment, rather the absorption of all visible light waves), the bubble at the time still strived to produce it to the point of irrationality.
  • Everyone felt anxious about the tulip market that was not driven by actual production, knowing that that bubble would one day burst. But everyone joined in on Tulipmania and played (3)hot potato with the market, thinking, “as long it doesn’t burst on me.” This bubble reached its climax with second-, third-hand contracts in 1636. Tulip prices finally plummeted on February 5, 1637, when everyone dumped their contracts at once and caused a massive economic crisis. The price of tulips fell by 90% in a matter of a few days, and futures contracts were reduced to mere pieces of paper.
  • As society descended further into chaos with tulip-related bankruptcies as well as violent crimes and lawsuits, the Dutch government got involved, nullifying all contracts before a certain date, and deeming all contracts after that to be paid only 5-10% of the original price.

Wild speculation in tulip futures spread in England amidst the government’s bad policies and failure to take action.

  • The House of Habsburg was one of the most influential and distinguished royal houses of Europe, but developed various hereditary diseases after inbreeding, due to their obsession with pure bloodlines and arranged marriages for political power; their prognathism known as the “Habsburg lip” is especially well-known. Many royals from the Habsburg bloodline, including Charles V, Philip II, Carlos II, and Mary Antoinette, had difficulty eating due to this hereditary disease and also suffered from severe malocclusion, imprecise pronunciation, and chronic gastrointestinal disorders.
  • After Maria Theresia’s son died from the Habsburg lip and her stepbrother Carlos II died without an heir, war broke out for the Spanish throne in 1701, between Louis XIV of France and Anne, the Queen of Great Britain.
  • After a decade, France and Britain ended the war with a series of peace treaties, but found themselves in piles of debt. In 1711, the British government established the South Sea Company, a joint-stock company, with the private sector to resolve the country’s financial difficulties. Instead of handing its debt over to the South Sea Company however, the government gave the company the right to trade enslaved people between the African-Spanish West Indies, which was acquired from France after the war. Britain sought to reduce excessive debt by utilizing trade profits, but the South Sea Company’s trade was repeatedly disrupted by accidents at sea and disputes with Spain.
  • In 1718, the struggling South Sea Company suddenly transformed into a successful financial institution after the state lottery it operated to resolve the financial crisis finally turned a large enough profit. The British government granted the right to issue shares (at face value) equal to the amount of bond exchange to people who acquired large sums of bonds. Following this policy, the South Sea Company implemented a program to exchange stocks for government bonds.
  • For example, in the case that the South Sea Company stocks were £100 at face value and £200 at market value, the company would circulate £200 worth of stocks at face value for a single £200 government bond and exchange £100 at face value (£200 market value), which is worth half of the issued stock, for £200 in government bonds. Accordingly, £100 face value (£200 market value) worth of stocks would be left after the exchange, and the South Sea Company would sell this on the market and make £200 in profit. As the company’s profits increased, so did its stock prices; given that the difference between market value and face value increased as much as stock prices increased, the South Sea Company was able to sell more remaining shares and make profit.
  • Ultimately, a deformed business structure took shape—one that created profit through vague expectations that the South Sea Company would become the next British East India Company and that the corporation would not be a business, but a government guarantee; large-scale stock issuances, and constant production of rumors that the stock would rise further.
  • Though its main trading business was slow, thanks to the success of its debt acquisition program, the South Sea Company’s stocks skyrocketed over tenfold in a matter of a couple months. Accordingly, people of all social classes, and even those who lacked all knowledge in stocks, got swept up in the speculative fad.
  • The South Sea Company abused the fact that the British government had not yet completed a detailed system to regulate stock companies, and also that it needed the South Sea Company to decrease its debts. By bribing numerous politicians with company stocks, the South Sea Company maintained the system that permitted the unregulated release of stocks with identical face and market values. However, once unlicensed corporations crowded the market with speculation and even black market stocks grew popular, the British government started issuing regulations and sanctions on bubble companies, causing stock prices to crash unprecedentedly.
  • In a matter of couple months, the South Sea Company stocks returned to their prices before the bubble, and many people killed themselves after going bankrupt. Isaac Newton lost £20,000 on his South Sea Company investments, and the composer George Frideric Handel profited from his investments, establishing the Royal Academy of Music—which goes to show people of all trades participated in the South Sea Company investments.
  • Though it’s true that many illegitimate companies solely out for investment money cropped up during this time, the surge in investments made revolutionary products and technological developments possible. The South Sea Company incident also became the reason for the creation of various bills and regulations regarding corporations.


III. Bitcoin: investment or speculation?

Bitcoin, a virtual currency based on blockchain technology, has entered the market after the accumulation of virtual currency concepts and technology.

  • Bitcoin is both a form of virtual currency and the method by which this currency works. Bitcoin is the first and successful case of using blockchain technology for virtual currency that makes exchange of value and trade possible even without a money-issuing institution like a central bank, trust institutions like commercial banks, or brokers.
  • Blockchain technology is a distributed data storage system that puts data in blocks and connects them in a chain, then simultaneously copies and saves the chain on a participant’s computer. It is unique in that it does not save data on a central server, shares the transaction history and participant information to all parties involved, and can prevent hacking/forgery through a verification process.
  • Bitcoin was created through a mining process that solves mathematical problems using a high-performance computer. The mining difficulty of Bitcoins increases as time goes on, thus increasing the mining time and cost. There are only 21 million Bitcoins that can be mined in total. (That said, a bitcoin can be divided up to eight decimal places, allowing you to increase your mining volume as desired.)
  • Bitcoin was first introduced to the world when the domain “bitcoin.org” was registered in August 2008 under the name Satoshi Nakamoto. Satoshi presented a paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System” in November 2008 and created Bitcoin, a cryptocurrency using blockchain technology based on open-source software, on January 3, 2009.
  • Bitcoin’s technological structure and system mechanism are the results of comprehensively synthesizing years of cryptocurrency-related research. Bitcoin is based on the principles of Nick Szabo’s digital currency BitGold, the usage of B-money created through hashcash (a proof-of-work system), and the ideas of Wei Dai, who sought to develop an anonymous, distributed electronic cash system.
  • After concentrating on developing various Internet electronic commerce protocols, Nick Szabo proposed BitGold, a form of digital currency, in 1998 and found success in 2005. As the digital implementation of the gold standard in currency, BitGold was structured so that participants could dedicate their computer power to solving cryptographic puzzles and earn BitGold if they did, and the network would put a timestamp after confirmation. However, BitGold was different from Bitcoin in that it relied on a centralized trust.
  • Hashcash, a technology that started from a proof-of-work system, is the basis of the Bitcoin mining algorithm. This technology started from a paper about system algorithm to eradicate spam mail, co-authored by Cynthia Dwork (a computer scientist and professor at the Harvard Paulson School of Engineering) and Moni Naor (an Israeli computer scientist and professor at the Weizmann Institute of Science) and evolved, through British cryptographer Adam Back’s work, into a proof-of-work system used to limit spam mail. This was set up so that users had to pay an adequate amount of hashcash to send email, making it time-consuming and expensive to send thousands of spam emails.
  • Wei Dai, the developer of the Crypto++ library, suggested B-money, an anonymous, distributed electronic cash system, in 1998. A proof-of-work system based on hashcash was used in the creation of B-money, and later Satoshi Nakamoto developed Bitcoin using the same method.
  • In 2009, Bitcoin software was released on SourceForge.net (an open-source software site for developers). The first person to mine Bitcoin and trade with Satoshi Nakamoto was Hal Finney, a pioneering developer of console games.
  • With computer scientist Phil Zimmermann, Hal Finney co-developed PGP (Pretty Good Privacy), an email security system based on the RSA algorithm, a standard of public-key cryptography. Hal Finney interacted with Wei Dai, Nick Szabo, and other scholars who developed core technologies later used in the creation of Bitcoin and also interacted with cypherpunk groups that had led the privacy protection movement at the time.
  • Various technologies developed through these interactions (e.g., malleability and hashcash) became the foundation for the development of Bitcoin. Meanwhile, Finney developed the algorithm called RPOW (reusable proof of work) and developed and released e-money similar to Bitcoin in 2004, demonstrating his vested interest in virtual currency.
  • Around the time of Bitcoin’s creation, Hal Finney was living in the same city as Satoshi Nakamoto, and there were reports that they had corresponded by email. There is also a conspiracy that Hal Finney is Satoshi Nakamoto, given that Hal Finney’s retirement and death due to Lou Gehrig’s disease matches with the disappearance of Satoshi Nakamoto. To this day, the real identity of Satoshi Nakamoto has not been revealed, and there are various theories regarding the pseudonym, including one that Satoshi is actually an anonymous group based in Silicon Valley.

Concerns were raised about a jump in prices and the creation of a bubble as investors and speculators flocked to Bitcoin, which hadn’t received much attention following its initial release.

  • Bitcoin, first released in 2009, did not capture the attention of the ordinary public until 2013. Blockchain technology applicable in a variety of fields and safe virtual currency made with blockchain technology were certainly attractive items, but only drew the attention of a few developers—to the point where Bitcoin was hardly worth $1 in the beginning.
  • However, when the value of the euro plummeted due to the Cyprus financial crisis in March 2013, some global investment funds looked for replacement investments and trickled into Bitcoin, causing the price of Bitcoin to shoot up. As relevant media coverage increased, the price of Bitcoin continued to soar. Then, just one month after, Bitcoin prices plummeted and trades were even temporarily suspended; prices remained at the $100-200 range through the end of the year as negative news reports about its stability persisted.
  • Then came news reports about people who’d invested in Bitcoin at the end of 2013, forgot about it, then struck rich in a couple of years. There was more news coverage after Ben Shalom Bernanke, the former Chairman of the Federal Reserve, evaluated Bitcoin to have criminal potential. However, he also said that it could become a fast, safe, and efficient payment system in the long run. After that, investment demand grew and Bitcoin prices soared again.
  • As less than 1% of the money traded on the stock exchange, Bitcoin is not all that usable in real life. Even so, the demand for Bitcoin investment continues to steadily rise because users can escape from governmental meddling and Bitcoin has the potential to become an alternative to the existing currency system.
  • The price of Bitcoin has repeatedly risen and fallen according to national forecasts and policies on Bitcoin by financial authorities, news of hacking, the opening and bankruptcy of the stock exchange, etc. However, continued news of individual investors earning massive profits from Bitcoin has rapidly encouraged the speculative fad. With the fall of gold prices and the weakening of the U.S. dollar, even the economic situation is changing favorably for Bitcoin; the price of Bitcoin on November 19 rose 7500% from last year.
  • The price of Bitcoin, which had risen up to $2,000 in May 2017, reached $8,000 in November and $19,000 in December. After its sudden rise following various issues, it is being traded for around $6,000 as of July 2018.
  • Stocks have various monitoring organizations, including the Financial Supervisory Service, stock firms, and the Ministry of Justice, and are operating within legal and institutional frameworks. Blockchain-based coins including Bitcoin, however, do not have such monitoring organization or system. Consequently, there have been constant controversies including hackings, price manipulations, and investment fraud. Recently, it was revealed that there were two price manipulating robots behind the 566% price jump in 2013, and there have been constant suspicions that there are forces influencing speculations.


IV. Implications

There are three lessons we can learn through “Tulips and Bitcoins.”


Lesson #1: Financial bubbles unsupported by substantial production will burst without exception.

  • A variety of financial bubbles (e.g., the development of Dutch trade, the establishment and expansion of British corporate systems, the emergence of the Internet, the popularization of cryptocurrency) have been created at turning points for changing paradigms of industry. Rather than emerging naturally, bubbles tend to have behind-the-scenes powers fabricating or controlling the early market before the general public (4)follows suit.
  • A continuous stream of new funds can perpetuate speculation, and prices will keep rising during this period because participants either gain real profits or expectations about profits. There will come a time, however, when the inflow dwindles for whatever reason, causing prices to spiral and the speculation bubble to abruptly burst.

Lesson #2: Scarcity and replaceability determine the value of a product or service.

  • There is a price to every product or service. The price is determined by scarcity and replaceability, separate from the product’s usefulness to society. Buying a scarce product is an investment, but it becomes speculation as investors mistakenly think, “This must have some sort of value because its price is rising.”
  • Bitcoin is useful in that it allows you to exchange money without regulation. However, what determines its price is not this sort of usefulness, but its scarcity and replaceability. Bitcoin could be seen as scarce because its output is limited, but its amount in circulation can actually be expanded almost infinitely because a bitcoin can be divided down to 8 decimal places.
  • Bitcoin isn’t being replaced by another form of virtual currency due to its scarcity and network, but also perhaps due to the same reason why other social platforms cannot easily replace Facebook or Instagram. It is difficult to replace simply because the majority of people are using Bitcoin, which brings people to the conclusion that it is the most scarce among all the various virtual currencies.
  • Bitcoin is expected to live on for the time being because it’s both a useful and scarce resource.

Lesson #3: We must focus on the legacy that Bitcoin will leave to society.

  • Tulipmania has taught us about the dangers of speculation and the market’s irrationality, even as the South Sea Company incident brought on the betterment of corporate systems. At the same time, massive funds poured into different businesses during the bubble expedited the development of new technology and products. The Internet bubble also brought on numerous revolutionary venture companies, which then led to the growth of bioindustry.
  • Due to Bitcoin’s rising popularity, Bitcoin and blockchain technology have become more popular knowledge, and much human talent and investment funds have been funneled into related fields. Blockchain technology is projected to have great influence over legislation, real estate, intellectual property rights, finance, and other fields related to trade and credit.
  • At this point, it is impossible to know whether Bitcoin will go down in history as another Tulipmania, coexist with the existing monetary system, or take root as a new replacement system. Even so, it seems certain that Bitcoin and its massive acquisition of labor and investments will leave a meaningful legacy to the world.


Talk to your Ringle tutor about “Tulips and Bitcoins,” and also receive feedback on your English usage.

또는
이메일로 회원가입
이름 *
이메일 *
비밀번호 *
비밀번호 재입력 *
추가 정보 입력(선택)
제휴회사
추천인