Economic analysis of historical speculative frenzies reveals the fundamental differences between the value of BTC and traditional bubbles.

From the "Tulip Mania" in the Netherlands in the 1630s to the internet memes stocks like GameStop and AMC during the pandemic, history is filled with various peculiar asset price fluctuations. But what exactly makes them financial bubbles? The price of Bitcoin has currently reached about $108,000, up from $55,000 a year ago and $9,200 five years ago. Does this reflect the fundamentals? Possibly. Recent market trends suggest that even in developed economies, policy-induced inflation could shrink your savings' value by 20% or more. U.S. President Trump clearly leans towards supporting crypto assets, even discussing the establishment of a government strategic cryptocurrency reserve. Other value-preserving assets like gold can be quite tricky for the average investor to buy and sell.

Warren Buffett, the stock god, described Bitcoin as a "mirage." Jamie Dimon previously called it a "scam." Paul Krugman referred to it as "a huge bubble that will ultimately end in tragedy." Interestingly, these remarks were made in 2014, 2017, and 2018 respectively, and it seems that none of these three have fully changed their views. Therefore, if their judgments about the Bitcoin bubble from about ten years ago were correct, then it is currently a rather persistent bubble. Or perhaps, it is not a bubble at all. This is the nature of financial bubbles – it is really hard to say, and it may even be impossible to say.

1. Historical Speculative Frenzy: Post-Frenzy Does Not Equal Bubble

The peculiar fluctuations in asset prices have a long history, and to some extent, these fluctuations seem to be disconnected from the fundamentals. The earliest and most famous instance was the "Tulip Mania" in the Netherlands during the 1630s. Between November 1636 and February 1637, tulip prices skyrocketed, with the price of a single tulip even equaling that of a beautiful house. Subsequently, prices plummeted instantly, dropping to 10% of the peak. A century later, prices were only one two-hundredth of what they were at the beginning of 1637.

Throughout history, there have been many other speculative frenzies: the South Sea Company stocks in 1720, British railways in the 1840s, internet stocks in the late 1990s, American real estate in the early 2000s, and meme stocks like GameStop and AMC in 2021. In retrospect, these all seem quite crazy. However, financial economics guru and Nobel laureate Eugene Fama believes that bubbles must be detectable in advance. Or, as he told my favorite podcast host Joe Walker: "Price fluctuations are large but fundamentally unpredictable. If it's unpredictable, then it contradicts the definition of a bubble." This is not to say that financial bubbles are without problems.

II. The Dangers of Bubbles: From Local Impact to Global Crisis

Indeed, bubbles can cause significant economic turmoil. For example, the price of GameStop soared from $1 to over $80, then fell back to $10, leading to the bankruptcy of some hedge fund managers and heavy losses for some ordinary investors. However, such bubbles did not result in a wider economic spillover.

However, the real estate bubble in the United States at the beginning of the 21st century triggered the financial crisis of 2008. This crisis led to a freeze in global capital markets, a surge in unemployment rates in the United States that remained high for many years, and had ripple effects around the world. It almost triggered a second Great Depression.

People do indeed question whether the Sydney real estate market has a bubble. However, it is equally difficult to determine. The median price-to-income ratio in Sydney is 13.8, making it the second most expensive city in the world, just behind Hong Kong. This figure is higher than about 5.3 in the mid-1990s and 7.4 at the turn of the century. Would you say it's a speculative frenzy, or simply because Sydney is an excellent place to live, and interest rates are systematically (far) lower than in the 1990s?

If the bubble bursts, it could trigger a wave of liquidations, and the real economy will suffer severe impacts due to wealth loss and reduced consumption. Our major banks may even need a bailout. So, it's either completely fine or it could lead to disastrous consequences.

3. The Elusive Nature of Bubbles: Historical Controversies and Psychological Factors

Historians are even debating whether the Dutch tulip mania was really just a bubble. One author points out that the most sought-after tulips at the time—those with striped or spotted petals—were in very limited supply because these flowers were difficult to cultivate. This meant they could not be grown from seeds but only sprouted from so-called "mother bulbs." Although the price of the most expensive tulips had risen to around 5000 Dutch guilders—equivalent to the price of a nice house—there were only 37 transactions for tulips priced above 300 Dutch guilders. In the jargon of financial markets, the high-end tulip market was extremely thin. So, was the most famous bubble in financial history really a bubble? It's hard to say.

If all of this sounds unsatisfactory, well, I agree. While bubbles are difficult to detect, that doesn't mean policymakers cannot reduce the likelihood of bubble formation from the outset. The key factor in all financial bubbles is cheap money being injected into speculative assets. This is precisely the responsibility of prudential regulators such as the Australian Prudential Regulation Authority. For this reason, the market needs to establish a comprehensive regulatory framework around Crypto Assets.

But ultimately, the core of financial bubbles is public psychology—irrational prosperity and the expectation of selling assets to "greater fools" before the bubble bursts. Regulatory agencies, however, are powerless against people's psychological states.

Conclusion:

The essence of financial bubbles is their difficulty in being identified in advance. Although there have been numerous speculative frenzies throughout history, hindsight judgments do not aid us in making decisions in the present. From the Tulip Mania to Bitcoin, the definition and identification of bubbles have always been controversial. However, policymakers can still reduce the risk of bubble formation through prudent regulation, particularly concerning the influx of cheap capital into speculative assets. Ultimately, the core of financial bubbles remains the elusive psychology of the masses.