Zeitgeist: Why (or Why Not) Cryptos, Part 2
A Probable Historical Parallel and the Possible Future
The “Zeitgeist” series aims to take apart a phenomenon that has captured public interest. Thus, the analysis would cover a phenomenon still in progress. While Part 1 covered the history of the U.S. dollar, Part 2 uncovers a fascinating historical phenomenon as well as the status quo on cryptos.
The introduction of tulips to Europe is (allegedly apocryphally) attributed to Ogier Ghislain de Busbecq, the ambassador of Ferdinand I, Holy Roman Emperor, to the Sultan of Turkey, who sent the first tulip bulbs and seeds to Vienna in 1554 from the Ottoman Empire. When tulips arrived in the United Provinces (now the Netherlands), it was observed by botanist Carolus Clusius - a professor at the University of Leiden who established the hortus academicus - that that they were able to tolerate the harsher conditions of the Low Countries. Clusius also started a nursery for tulips, in part with seeds gifted to him by Busbecq in 1573 who had received them from Constantinople.
Newly independent from the yoke of the Spanish Empire, with the highest per capita income in the world from about 1600 to 1720, extensively invested into trade in the “Indies”, the birthplace of the first modern formal stock exchange and market, the Dutch Republic was in the midst of its Golden Age.
Fascination with flowers wasn’t a particularly Dutch trait, although a fair share of liefhebbers were Dutch. It is, however, estimated that the Dutch fascination with “exotica” might have led to the national captivation with the flower that went on to become the country’s national flower to this day. However, the wide variety within tulips was a point of fascination for botanists and liefhebbers alike. Great merchants, bankers and princely houses hosted extensive gardens in a riot of colours in which the tulips stood out. In an interesting case of “reverse export”, when the United Provinces sent its first great embassy to Turkey in 1612, one of the many gifts taken along by the envoy, Cornelis Haga, was “200 bulbs of the best tulips”, which found enormous admiration from the Turkish elite.
It is estimated that in these hallowed houses lay the seeds of “Tulip mania”, a time in Dutch history - roughly from around 1630 or thereabouts till February 1637 - when contract prices for both the bulbs of tulips as well as tulips themselves reached extraordinary levels followed by a dramatic collapse. Prime among the post-event chronicles was Scottish (or as I refer to them: British) *ugh* journalist’s1 1841 book “Extraordinary Popular Delusions and the Madness of Crowds” who wrote that at one point 5 hectares (12 acres) of land were offered for a Semper Augustus tulip bulb. Also, according to Mackay, “the population, even to its lowest dregs, embarked in the tulip trade". By 1635, a sale of 40 bulbs for 100,000 florins (also known as Dutch guilders) was recorded. By way of comparison, a "tun" (930 kg or 2,050 lb) of butter cost around 100 florins, a skilled laborer might earn 150–350 florins a year, and "eight fat swine" cost 240 florins.” Mackay also goes on to claim that tulip price deflation led to a widespread economic recession throughout the Netherlands for decades afterwards.
Incidentally, tulips went on to become even more important in Turkish culture. Under Sultan Ibrahim (1640–1648), the first chief florist was appointed, and in the following reign a council of florists was set up to regulate the quality of tulips and their sale. In 1725, a decision was made to fix prices as Turkish fashion resulted in wildly rising prices for tulips, with one early-eighteenth-century tulip bearing the name of Sahipkıran, or “bankrupter.”
Modern skeptics, however, have largely punctured this claim of Mackay, et al. Mackay’s work was derived from the 1797 book “A History of Inventions, Discoveries, and Origins” by Johann Beckmann - a German author who also coined the word “technology” - which, in turn, was primarily derived from three anonymous pamphlets published by the “anti-speculative” movement ( which decried the rise of stock markets and financial instruments) in 1637. American economist Peter Garber’s work “Famous First Bubbles” (2000) could only find data on the sales of 161 bulbs of 39 varieties between 1633 and 1637, with 53 sourced from the anti-speculative pamphlets “Dialogues between Gaergoedt and Warmondt” printed (and likely written) by Adriaen Roman in Haarlem between February and May, 1637 (“Waermondt” translates to “True Mouth” and “Gaergoedt” to “Greedy Goods”; in the pamphlets, the latter is a weaver who had mortgaged his house and sold his loom to buy tulip bulbs, who explains his actions “a madness”. The former is the voice of reason.)
American historian Anne Goldgar’s 2007 book on Tulipmania reached a conclusion that coincided with Garber’s conclusions of the event. Amidst the backdrop of Tulipmania was:
The bubonic plague ravaging the Netherlands, with about a fifth of the population in both Amsterdam and Haarlem dying in 1635-1636
The defeat of the Swedes in 1634 in the course of events of the Thirty Years War between Catholic Spain and the Protestant North driving more military resources to be directed against the Dutch
Both Garber and Goldgar also contend that almost all transactions were held in “colleges”, i.e. specific rooms within Dutch taverns among parties either directly representing or indirectly dealing with the mercantile/princely cognoscenti of Europe. Goldgar’s research found fewer than half a dozen people who experienced financial troubles in the time period, with almost no case being directly attributable to tulips. This isn’t altogether surprising. Although prices had risen, money frequently didn’t change hands between buyers and sellers. Garber concluded that phenomena such as “tulipmania” are bubbles that fall outside of rational market behaviour, i.e. actions taken in light of economic data available and prevailing conditions.
It was thus concluded by the ilk of Garber, Goldgar, et al, that tulipmania was merely the product of fatalistic risk-taking behaviour of the wealthy in Dutch taverns borne of the stress of plague, war, etc. with little economic consequence to the Dutch Republic or Europe.
American economist Earl A. Thompson poked an interesting hole in Garber’s conclusion in his 2007 paper with Jonathan Treussard titled “Tulipmania: Fact or Artifact”: while the rise in tulip prices might or might not have been driven by the cognoscenti’s preferences, Garber’s conclusion didn’t account for the fact that while the annualized rate of price decline for tulip bulb contract prices was 99.999% (huh what), it was only 40% for other flowers. This led to another explanation for the fall in tulips.
In February 24, 1637, the association of Dutch florists - in an act ratified by the Dutch Parliament - amended all futures contracts written after November 30, 1636 to be interpreted as options contracts instead. They did this by simply relieving the futures buyers of the obligation to buy the future tulips, forcing them merely to compensate the sellers with a small fixed percentage of the contract price.
Before this decree, the purchaser of the futures contract was obligated to buy the bulbs at the specified price. Thompson concluded that the prices of tulips seen until the fall were a reflection of the both the “intrinsic value” of the tulips (as seen by the cognoscenti) as well as the buyers' awareness of what was coming. Using data about the specific payoffs present in the futures and options contracts, Thompson argued: "Tulip contract prices before, during, and after the ‘tulipmania’ appear to provide a remarkable illustration of efficient market prices.”
Are Cryptos Millennial Tulips, Sensei?
That’s an interesting question, dear reader. To give depth to the answer, lets understand who trades the most in cryptos. Lets try and make an extrapolation of sorts with Bitcoin (BTC).2
Statista concluded an ambition survey in January 2021 to determine “BTC trading volume across various exchanges in 2020”. Here are the results (in million U.S. dollars):
There are a couple of issues with this data, evident simply by examining the list of top countries: Europe can’t be lower than Russia and Nigeria in terms of volumes: secondary accounts indicate that the crypto scene is poppin’ in Europe. Plus, it’s a survey: (a) people lie and (b) surveys can’t be used as an indicator of actual trends unless done in a very large scale. So lets try and interlace this with actual numbers, courtesy Korea-based Coinhills - which provides “user friendly access with all sorts of prices including Bitcoin and all other cryptocurrencies.”
Week-on-week, here is the representation of fiat-to-crypto (or vice versa) transactions as a percentage of all transactions as recorded by Coinhills, :
Now this makes more sense. The U.S., the E.U., South Korea, Japan and the U.K. are all “knowledge economies” and, as we had seen in Part 1, current leading “knowledge economies” (particularly the U.S.) have issues.
Let’s now lay a parallel with the Dutch Golden Age vis-a-vis the U.S.. The U.S.:
has a sophisticated financial and economic system
is invested in resource-draining wars or war-building efforts
is deeply seeped in fatalistic behaviour on account of runaway loss in purchasing power
It should come as no surprise that all of the five top countries/groups listed have a pretty strident anti-speculative sentiment. The internet-common refrain “The markets are rigged!” isn’t necessarily an anti-capitalistic screed. Despite high levels of college education in these countries, there is a definite lack of economic/market literacy (which often cannot be summarized as an easily-digestible/explainable capsule) which leads to such a conflation.
It should come as no surprise that folks looking to shore up their portfolio values seek refuge in the arms of cryptos. But is it really the common man driving up crypto values?
Who Are the Hypebeasts?
As per the 2020 Crypto Hedge Fund Report published by PriceWaterhouseCoopers and Elwood Capital Management, research concluded at the end of Q1 2020 revealed many interesting facets.
When it comes to new funds and investor types:
New crypto hedge funds arrive at a rate comparable to the rise and fall of BTC
Most common investors are “family offices” and “high net worth individuals”.
In terms of investment allocation and strategies:
Large hedge funds got larger and attracted more investors
Most strategies are “quantitative”, i.e. involve strategies based on market volatility, as opposed to the common-man “Iron Hand” strategy seen in cryptos.
In terms of choice of networks:
The likes of Bitcoin and Ethereum rein supreme in terms of chosen markets.
In terms of team composition, there is an interesting skew downwards:
Crypto hedge funds have roughly remained the same size year-on-year
Crypto hedge fund talent has gotten younger (which means a lot of exits)
Crypto hedge funds have increased reliance on proprietary valuation models
This puts paid to any assumption that the crypto space is a “common man’s haven”. Punters move to where the action is and the young bucks among them have been making a killing in a market dominated by hype. “Hype” also explains the predominance of “quantitative” strategies. If cryptos were a safe haven with enshrined value protection, “discretionary long-only” would be the leading strategy.
Prominent tech firms are not above chicanery to extol the virtues of cryptos to the unsuspecting “common man”. For example, on January 21, 2020, Square’s crypto-dedicated development team, Square Crypto, unveiled its first product: a development kit for integrating the controversial Lightning Network. Square Crypto’s website and Twitter account have recently been propagating a claim in a very twee and irksome patois, under the guise of energy conservation, that BTC can process over 10,000X as many transactions as they are today with the same total energy consumption. Dave Mullen-Muhr – Partner at Unbounded Capital, the first venture/hedge fund investing in the BSV ecosystem – argues that this is impossible; given BTC’s constraints on transactions which can be processed in each 10-minute interval, even a 10X increase in transactions for the same energy consumption is unlikely. This could only mean an endorsement of Square’s endorsement of the controversial Lightning Network. Additionally, since each hub on the Lightning Network require separate infrastructure to comply with stringent record-keeping as licensed Money Transmitter Businesses (as per US law), their energy consumption would likely mirror that of existing transaction processing infrastructure plus the cost of the periodic referencing of the BTC network.
To process this much capacity at “Layer 1” with reduced energy consumption, Mullen-Muhr goes on, the only viable option from Bitcoin-forked networks would be BSV3.
There is no better example of the “quantitatively”-driven nature of the crypto market than in the events since this past Wednesday - when the market took a tumble ostensibly on account of Elon Musk’s Tesla parting ways with BTC by no longer allowing purchases of vehicles using the cryptocurrency. Currency trajectories since then (now a meme, for crying out loud!) show a remarkable degree of correlation.
So, to summarize, while the rise of cryptos as a viable investment vehicle for the common man might have been a “bubble” as hypothesized as postulated by Garber, et al, the contraction and fall is actually an example of effective market action, as postulated by Thompson, et al. Caveat emptor, dear reader, especially when it comes to hypebeasts.
Is Crypto Useless?
While the high cost of remitting money abroad in countries such as Nigeria, Vietnam and Philippines have led to some tacit State approval of cryptocurrency usage, major countries face relatively lower costs in such matters and remain more interested in oversight of currency flows.
To that end, the rise of distributed ledger technology (DLT) - the underlying technology behind the recording of crypto transactions - offers promise in creating the framework for effective and transparent recordkeeping. Many countries - and their central banks - are now working towards developing a Central Bank Digital Currency (CBDC) that uses the DLT for a secure, quick and cost-effective digital payment system that identifies both counterparties of a transaction and ensures oversight to prevent criminal/money laundering activities.
It also bears noting that the high volatility of cryptocurrencies have not served to be a convenient means of payment or preservation of the “common man” investor’s value.
Nonetheless, coins tied to the value of a fiat currency - known as “stablecoins” - have emerged as a new way to make payments. Stablecoins are designed to enhance speed up settlement flows and reduce end-user costs. As of 2020, out of the total cryptocurrency market capitalization estimated at about $824 billion (of which 85% was pure BTC), 3% (or $27 billion) was attributed to stablecoin transaction. This is the likely future of “fiat currencies”.
While the idea of a borderless currency beyond the reach of central bank/government interference is an ideal that is to be cherished by an idealist such as you, dear reader, do remember that ideals are merely buzzwords for modern-day hypebeasts serving their own interests.
The future may very well hold a viable cryptocurrency with true and equitable global reach popping up but it won’t be too far-out to say that the current crop of cryptos wouldn’t be that currency. By all means, play the HODL game and show off your “Iron Hands”. But remember, the last one HODL-ing would likely be the worst-hit when the crypto crumbles.
This is a “flag”. Nothing good comes from a journalist who decides to talk economics.
This would also relieve me of some “mendou” (めんどう), dear reader.
It’s unsurprising that Jack Dorsey’s company would resort to chicanery. That man is a right bounder!