Some 380 years ago, people started trading tulips quite frenetically. A variety of tulips, with exotic names, were introduced during this period. They were considered exotic flowers and became a desired item due to their novelty.
There was a fundamental rarity inherent in tulips, which triggered the initial demand and led to a spike in prices. But, at some point, this transformed into a mania as people continued trading tulips even at sky-high prices. Initially, this was done informally and then in the formal futures market making the bubble bigger. And then it burst.
The tulip mania between Nov 1636 and May 1637 is a textbook example of the making of a bubble. And something similar seems to be happening in the bitcoin market. There’s no denying that the concept behind bitcoin—block chain—is a valuable one. Block chains can be used in various ways including as currency for transactions, as a store of value similar to gold and for recording a contract.
Mainly because of serving as a record keeper of contracts, the block chain technology is highly valuable. But this doesn’t necessarily translate into a value for bitcoins. It is similar to saying that artificial intelligence or virtual reality technology is valuable.
How the tulip bubble burst
Speculation drove tulip prices to unsustainable levels, leading to a crash.
Some refer bitcoins as a currency, some call it cryptocurrency and pitch it as an alternative to traditional currencies like the dollar, the rupee, the pound, etc. In the case of bitcoins, there is no central bank issuing them, instead it is the entire bitcoin community that issues and verifies the bitcoin. So, governments cannot play with bitcoin and try to manipulate it.
For some people, intellectually, this makes bitcoin a more authentic currency. Also, there is a limit to how many bitcoins can be issued. It is capped at 21 million. This imposes rarity and is designed to mimic the relatively rare supply of gold. The bitcoin is supposed to be the store of value similar to gold and is being touted as ‘digital gold’.
However, there is a catch. There can be any number of cryptocurrencies that can be issued and currently there are more than 1,300 such currencies. The latest mania globally is the initial coin offerings (ICO) mania. These are offerings for currencies other than bitcoins—ethereum, litecoin, monero, etc. And this is where the Ponzi nature of such schemes becomes stark.
You too can go ahead and start a new cryptocurrency, if you have advanced coding skills, or if you can partner with an expert programmer. So the supply of cryptocurrencies can be unlimited, although, within each currency there can be self-imposed limits on how many units will be issued, as is the case with bitcoin. During the initial phase of a new currency, the miners can mine a lot of new coins. The rate of coin issuance decreases as more coins are created. That is why there is an initial frenzy to be among the early miners.
The game of a new currency issuance works as follows:
1. Find a coder and issue new currency
2. Popularise the new currency before the ICO