Digital Tulips: The Bitcoin Mania

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Remnant Review

In 1637, the tulip bulb investment mania peaked in Holland. It had made some people rich. Now it was about to make others poor.

Bulb prices rose steadily throughout the 1630s, as ever more speculators wedged into the market. Weavers and farmers mortgaged whatever they could to raise cash to begin trading. In 1633, a farmhouse in Hoorn changed hands for three rare bulbs. By 1636 any tulip–even bulbs recently considered garbage–could be sold off, often for hundreds of guilders. A futures market for bulbs existed, and tulip traders could be found conducting their business in hundreds of Dutch taverns. Tulip mania reached its peak during the winter of 1636-37, when some bulbs were changing hands ten times in a day. The zenith came early that winter, at an auction to benefit seven orphans whose only asset was 70 fine tulips left by their father. One, a rare Violetten Admirael van Enkhuizen bulb that was about to split in two, sold for 5,200 guilders, the all-time record. All told, the flowers brought in nearly 53,000 guilders.

Soon after, the tulip market crashed utterly, spectacularly. It began in Haarlem, at a routine bulb auction when, for the first time, the greater fool refused to show up and pay. Within days, the panic had spread across the country. Despite the efforts of traders to prop up demand, the market for tulips evaporated. Flowers that had commanded 5,000 guilders a few weeks before now fetched one-hundredth that amount.

The story is here.

What goes up comes down. Whatever offers fabulous riches for no good reason then offers fabulous losses for a very good reason: no new buyers at higher prices, and then a wave of selling.

Bitcoins that sold for $2 two years ago were selling for $1,242 on Thursday, November 29. Then they fell by a third in three days. Then there was a rally.

Volatility? Like nothing ever seen before.

Would you bet your future on Bitcoins? Would you hold 90% of your wealth in Bitcoins instead of dollars? No? Neither will anyone else. That is why Bitcoins will not replace the dollar or any other currency. An asset that traded for $50 for 10,000 units in 2009 is just too volatile. Multiply $1,242 by 10,000; that is $12,420,000. If you asked the buyer, he would say this: “Bitcoins have been very, very good to me.”

Eat your heart out, Warren Buffett! It was all so easy. Just buy and hold.

That strategy is why Bitcoins will never become a replacement currency for the masses. Felix Salmon explains why.

This is something which should worry the bitcoin faithful, if they really want to see bitcoin become a broadly-used global currency. After all, press coverage of bitcoins runs in lockstep with the bitcoin price: it’s times like this, when the price is at its fluffiest, that bitcoin gets written about the most. (If it’s not physical bitcoins, it’s hard drives in landfills.) The largely unspoken assumption behind all such stories: bitcoin is an asset class, and people should get excited about it when (and, implicitly, only when) the price is going up.

This is what I think of as the CNBC Premise: when an asset rises in price, that is necessarily a Good Thing, and when it falls in price, that is always a Bad Thing.The CNBC Premise has never made much sense with respect to currencies, however. And with respect to bitcoin in particular, its most exciting aspect is not its value, but rather its status as an all-but-frictionless international payments mechanism. If you want bitcoin to really take off with respect to payments, you actually don’t want to see crazy price spikes — such things are the best possible way of stopping people from using bitcoins for payments. After all, if your bitcoins are doubling in value every few days, why on earth would you want to spend them?


I am writing this response to a critic of my criticism of Bitcoins.

He dismisses me as if I am an economic ignoramus. He is not the first. I always have fun responding. He says of me that “his arguments diverge from Austrian economics.” This, I must admit, is a new twist. I have not faced this accusation in the past.

I must respond. If an author does not respond, some of his followers may think he cannot respond. Trust me. I can respond.

Let me say from the beginning that I have never heard of the author, John Mather. His article was introduced by Jeffrey Tucker. Mr. Tucker was wise enough to get a stand-in for this hatchet job. “Let’s you and him fight.”

North purports to base his critique of Bitcoin on Austrian economic theory. However, his arguments are so weak that he makes Austrian economics look bad, to the point that someone unfamiliar with Austrian theory could finish his article doubting the validity of Austrian theory. One reader who linked North’s article on a message board even commented that the article made him want to stop referring to himself as Austrian.

Rule: When debating seriously, save your rhetoric of condemnation for your conclusions. You may overplay your hand when you start this up front.


He begins with this.

Is Bitcoin a Ponzi Scheme?

In my article, I carefully defined how I was using the term. Here is what I wrote.

The individual who sells the Ponzi scheme makes money by siphoning off a large share of the money coming in. In other words, he does not make the investment. But Bitcoins are unique. The money was siphoned off from the beginning. Somebody owned a good percentage of the original digits. Then, by telling his story, this individual created demand for all of the digits. The dollar-value of his share of the Bitcoins appreciates with the other digits.This strategy was described a generation ago by George Goodman, who wrote under the pseudonym of Adam Smith. You can find it in his book, Supermoney. This is done with financial corporations when individuals create a new business, retain a large share of the shares, and then sell the stock to the public. In this sense, Bitcoins is not a Ponzi scheme. It is simply a supermoney scheme.

The Ponzi aspect of it comes when we look at the justification for Bitcoins. They were sold on the basis that Bitcoins will be an alternative currency. In other words, this will be the money of the future.

The coins will never be the money of the future. This is my main argument.

Mr. Mather then goes on to develop at length his argument by applying Wikipedia’s definition of a Ponzi scheme to my article. The Wikipedia article does not address my definition. Neither does Mr. Mather.

When arguing against a person’s statements, it is best to quote his statements, not quote a Wikipedia article as a substitute.

I am willing to substitute tulip mania for Ponzi scheme, in order to keep Mr. Mather happy. As I said, the heart of my criticism is this: “The coins will never be the money of the future. This is my main argument.”


Here is the heart of my article: fiat money is money “spoken” into existence. It is not money developed over centuries in market transactions.

Bitcoins are wanna-be fiat money digits. They were spoken into existence. This is the characteristic feature of fiat money. Bitcoins are not yet money.

Because of the mania, they will not become money. They lack money’s characteristic feature: predictable value.

1) North says Bitcoin is made “out of nothing.” This is a specious argument.

On the contrary, this is a specie argument. I reject fiat currencies that are not the product of long years of use in the free market.

The fact is that the Bitcoin currency and payment network is comprised of computer code. Is the web browser you’re using to read this article made out of nothing? That Bitcoin is not a physical good doesn’t mean it is made out of nothing. Billions of people, including North, assign economic value to all sorts of things which have no physical form. The most obvious example aside from the computer code of companies like Google or Apple is the vast supply of US dollars, the majority of which exist only in digital form.

My reference is to the fact that Bitcoins were created out of nothing to perform a service. This service is to replace fiat currencies with a new currency, which will replace fiat currencies in trade.

Unlike gold and silver, which became monetary units out of millennia of human action, Bitcoins were launched as a fiat currency that would become a new currency unit. My point is this: the volatility of Bitcoins’ price is an indication of why they will not replace central bank fiat currencies, which are easily used in trade, and which are — so far — stable in purchasing power. This can change, but this is sure: they are used in trade by millions of people in billions of transactions.

The market has determined that the dollar is money. It has not determined that Bitcoins are money. The crucial factor in money is predictability of purchasing power. Bitcoins lack this.

2) North writes, “Something that was valuable for its own sake, most likely gold or silver….” Nothing is valuable for its own sake. All value is assigned. This is Subjective Theory of Value 101. North doubtless knows this, but it appears he’s attempting to imply gold and silver possess some sort of intrinsic value.

Rule: when you are an unknown author, and you attack a well-known author who, ever since 1969, has been publicly defending the idea that gold does not have intrinsic value, you really do look silly if you use rhetorical arguments like this.

The man who wrote this is not a skilled debater. That is why I am cutting him some slack. My guess is that the author was not born when my first article on this was published in The Freeman. The article was titled, “The Fallacy of Intrinsic Value.”

He then adds:

It may feel good to believe (especially if you own gold and silver), but it’s just not true.

This young man thinks he is making a damaging attack on me by arguing that I in some way was arguing for the doctrine of intrinsic value, despite the fact that he writes “North doubtless knows” that value is subjective. Yes, I do. So, why go into a discussion of what I “doubtless” know? The answer: rhetoric.

Rule: when rhetoric has no supporting logic, avoid it.


The author then launches into a discussion of something he calls a “network effect.” He uses the language of programmer instead of the economist. But he makes the same point I made in 1969: gold is marketable.

Gold and silver have many uses, for example in electronics or silver in water filtration. But most of the value of gold in particular is due to its marketability, meaning, the acceptability of gold by other market participants.

Yes, yes, yes. It’s time to stop beating a dead horse. But he doesn’t.

This acceptability is a mutually reinforcing process by which people are more willing to accept gold because others are more willing to accept it. The existence of a mutually reinforcing cycle of demand is known as a network effect. Some examples of other network effect markets are cell phones, fax machines, web browsers and web servers, cars/roads/gas stations, and fiat money.The difference between network effect goods and direct use goods is that, for example, the enjoyment of a steak dinner does not depend on its acceptability or adoption by others. A direct use good directly meets an individual’s needs, while a network effect good derives a significant part of its value from the network. Most goods we use today have some combination of both.

And on and on and on.

As the Austrian economist Karl Menger argued, money itself replaced non-money as a market network effect good.

Karl Menger was Carl Menger’s son. Mr. Mather is confused here. I can assure you that Carl Menger, the founder of Austrian school economics, did not use language like this: “money itself replaced non-money as a market network effect good.” No Austrian school economist ever has. Austrian school economists do their best to communicate in something other than programmers’ professional jargon.

Network effects can come and go. An example is the adoption of fashion. A particular look can go in and out of style either very quickly or over a much longer time frame.

Now he’s getting close. The “network effects” of gold and silver go back thousands of years. The network effects of Bitcoins as an alternative currency have yet to come.

Read the rest of the article

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