Tiptoe through the tulips

by Aaron Burden via StockSnap
by Aaron Burden via StockSnap

While cringing through reviews of “Tulip Fever”, released in the US last weekend, I couldn’t help but wonder why the story still captures our imagination.

The bitcoin bubble has often been likened to the tulip bulb mania of the Amsterdam markets in the 17th century. That is wrong.

While the speculative fervour may have the same underlying root (cough, sorry), namely the me-too desire to get rich quick, there the similarities end. Historical analogies make for good copy, but unless you believe history does repeat itself (and I don’t), the usefulness ends there.

First of all, in the tulip frenzy, the actual price of tulips was volatile, but not nearly as much as the futures price. People were entering into contracts to buy tulip bulbs at a certain price a few months hence. In early 1637, the Dutch authorities decided that the futures contracts would become options – the purchase contract could be “cancelled” upon payment of a small percentage. In other words, speculators were buying the right (but not the obligation) to buy tulip bulbs at certain prices – these are the ones that went through the roof, not the actual prices at which the bulbs changed hands.

Second, bitcoins are obviously not tulips (not nearly as pretty), but even the nature of the investment (or speculation) is totally different. Bitcoin actually has a practical use. It can be used to transfer value without third party control or interference. It satisfies all of the characteristics of money, except for the (dubious) requirement that it be authorised by a central authority.

Tulip bulbs, on the other hand, have the potential to make people happy, but beyond that, they’re not useful, not even as a means of exchange. They are 1) not a store of value (they perish), 2) they are not fungible (no way is a lily-flowered the same as a viridiflora), and 3) they are not limited in supply. They shot up in price because people expected them to shoot up in price. The same can be said of bitcoin, true, but the difference is in the residual value – what is the underlying use worth? With bitcoin, it is potentially worth a lot. Tulip bulbs, not so much.

(Although as a caveat I would like to stress that I do believe that the enjoyment of beautiful things, even ephemeral ones, is worth paying for – although nature so often gives them to us for free. An interesting anecdote is that the most coveted bulb during the tulip mania was the Semper Augustus – it turns out that the flower’s beautiful striations were due to a virus that eventually killed the breed off. Even nature’s accidents can have aesthetic value.)

It remains to be seen what impact the growth of the bitcoin derivatives market will have. In the case of tulips, the emergence of a liquid options market lend the market some stability – the strike prices were volatile, the actual traded prices much less so. Could bitcoin’s development follow the same path? Or will derivatives undermine the financial incentives of proof-of-work consensus? As soon as I have the time, I’ll be looking into this some more.

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