As American historian Ira Berlin observed in the first of three Nathan I. Huggins Lectures at Harvard University, “History is not about the past; it is about arguments we have about the past”. What is true of his reflections on the fierce debates about slavery in North America also applies to the use of historical metaphors for financial bubbles, including the recent spectacular rise of bitcoin and other crypto-currencies.
Commentators at no less than The Financial Times and The Economist have rushed to compare this recent development with the 17th century Dutch Tulipmania, replete with warnings that people have begun to mortgage their houses to buy into the craze, just as they reputedly did in the 1630s. In fact, the actual historical reality of Tulipmania bears little resemblance to the legends about it, which first appeared in Dutch Calvinist dialogues used by the authorities against the Mennonite tulip growers and were later promoted by the Whig journalist Charles MacKay as his first example in Extraordinary Popular Delusions and the Madness of Crowds. The tulip analogy is simply a cautionary tale about fantastic objects imbued with magical powers to defy the laws of market gravity. There is little to be learned from this sort of ranting, beyond the maxim that shrewd speculators know when to get out, leaving the “devil to take the hindmost”. (By far the most entertaining modern account can be found in Edward Chancellor’s eponymous 1998 book by the same name.)
The better historical analogy for crypto-currencies is the European-wide bubble of 1719-1720, most often associated with John Law’s Mississippi Scheme and the even more famous South Sea Bubble. Unfortunately, financial journalists appear to have a limited number of metaphors. As a result, these serve as set-pieces, usually rolled out for other purposes: in the case of Law, to decry “easy money” or to warn readers that asset-price bubbles never end well. Such analyses miss the most important interpretative fuel, however, for understanding the rise of crypto-currencies and the most likely short- and long-term consequences of the recent speculative fury.
First, what are crypto-currencies? Bitcoin, though the most famous, is by no means the only one. Its competitors are commonly referred to as “altcoins”. Various precursors (most famously “Bit Gold”) date from the late 1990s, but bitcoin in its current incarnation dates from 2009. The name derives from the use of cryptography to create secure, decentralised ledgers (known as the blockchain), which are used to make transactions both anonymous and transparent, and to permit a very gradual increase in the number of coins in circulation. The latter “mining” process is very energy intensive, with consequent concerns about its enormous carbon footprint.
The aim of bitcoin is to create a token currency that is free of central bank influence, hence the European Union’s concern to regulate cryptocurrencies to prevent money laundering and their use by organised criminal gangs and terrorists. Modern states do not like bearer instruments, and bitcoin is the 21st century equivalent of a bearer bond, that staple of 20th century spy novels.
Modern states have both good and bad reasons for wanting to know the identity of the account holder. Crypto-currencies threaten anti-fraud measures, even as they offer libertarian sceptics a protection against their much-feared spectres of capital controls, inflationary devaluations, and unconventional monetary policy. Authorities are rushing to adopt rules to require the identity of account holders on exchanges (secondary markets for trading these currencies). Bitcoin futures trading and options dealing appear to have “gone mainstream” with this week’s debut on the CBOE in Chicago. At the same time, major investment banks are seeking regulatory approval to use Ethereum blockchain technology (a competitor to bitcoin) to automate their reporting requirements for counter-parties, in a move that would improve both security and transparency.
And this is where the analogy to the South Sea Bubble is most cogent. This bubble is not just about bitcoin. There are nearly two dozen alternative crypto-currencies, each with slightly different features, some of which are pegged in some way to the price of bitcoin. Interested parties can read their white papers online, and make judgements about which, if any, represent the future of blockchain technology.
Likewise in 1719-1721, there were a whole host of schemes launched in London that offered opportunities to invest in the New World of South Sea trade. Some of these schemes, like the York Building Company, invested the money they raised in South Sea Company shares, effectively pegging the value of their shares to South Sea stock. Likewise, London Assurance and the Royal Exchange Assurance invested much of their treasury capital in South Sea Company shares, even doing so as a hedge against their insurance liabilities.
The bubble, however, was not limited to South Sea Company shares. At one point, the South Sea Company’s directors got very nervous that alternative schemes were mopping up liquidity that could be poured into their own subscription shares (these allowed small investors to pay on instalment or sell the security on to someone else). The South Sea directors began lobbying for the Bubble Act, to outlaw public trading in shares of firms that were unable to secure a royal or parliamentary charter. Their lobbying efforts occurred at the height of the bubble, and the crash was soon to follow.
That narrative should give us pause. What will happen, you ask? Historians have no great powers of foresight. Still, it is not beyond the realm of possibility that bitcoin will climb further, crash, and then settle back around $200 as it continues to be used in growing but fairly narrow range of transactions. More environmentally-friendly blockchain technology will see widespread adoption, but with concomitant regulatory requirements and rent-seeking lobbying. Money will change hands, but much as with the with the South Sea Bubble of 1720, the quality offerings (South Sea Company, London Assurance, Royal Exchange Assurance) will be around for centuries to come.
The South Sea Company was wrapped up in the 1850s, not the 1720s, along with the East India Company. This story won’t end in 2018, and may even enjoy a poetic denouement in 2018-2020, but decentralised ledgers are here to stay. The challenge will be to make them environmentally sustainable and pro-social in regulatory terms.
D’Maris Coffman is a Senior Lecturer (Associate Professor) of Economics and Finance of the Built Environment at UCL Bartlett. She has co-edited a four-volume History of Financial Crises with Professor Larry Neal. In the interest of full disclosure, she holds a small portfolio of crypto-currencies, primarily stellar lumens (XLM).