How history repeated itself in crypto’s fall

Computing all their cost and trouble,

Directors’ promises but wind,

South Sea at best a mighty bubble.

— Jonathan Swift, The Bubble.

The crypto bubble ran out of steam during the course of this year. While it was inflating, those who benefitted made it look like the next big thing for the human kind. But now that it has burst, like is the case with every bubble that bursts, this time wasn’t any different.

The word ‘bubble’ in this day and age is used to describe a situation in which the price of an asset, financial or otherwise—like say real estate—is off the charts and doesn’t reflect the fundamental factors as they prevail. Interestingly, the word didn’t always mean what it currently does. William Quinn and John Turner make this point in Boom and Bust—A Global History of Financial Bubbles: “The word ‘bubble’, in its present spelling, appears to have originated with William Shakespeare at the beginning of the 17th century. In the famous ‘All the world’s a stage’ speech from his comedy As You Like It, he uses the word bubble as an adjective meaning fragile, empty or worthless, just like a soap bubble.”

This was followed with the word being used as a verb, meaning ‘to deceive’. The current meaning of the word came into the picture only in the early 18th century. As Quinn and Turner write: “The application of the term to financial markets began in 1719 with writers such as Daniel Defoe and Jonathan Swift, who viewed many of the new companies being incorporated as not only worthless and empty, but deceptive.”

In fact, Defoe was perhaps the world’s first investigative financial journalist and is said to have reported extensively on the South Sea bubble of 1720.

Structurally, there is a lot in common between the South Sea bubble and the crypto bubble. In this piece, we will try and see what the two bubbles had in common. And why, even if history doesn’t really repeat itself, it does rhyme.

The South Sea bubble

The South Sea Company was established in 1711 through an Act of the British Parliament. The company’s name came from the fact that it had monopoly of trade to the South Seas, the geographic region which lay to the South of Panama—the Spanish colonies of South America. The company talked about the immense riches of South America.

Everybody knew about the gold and silver mines in the continent, but the question was why would Spain allow an English company to exploit these resources? The company tried negotiating with the Spaniards to get them to share the riches, but nothing much came of it. Nearly a decade after being in existence, the company made, what in current terminology, would be called a pivot. It offered to buy out the entire debt of the British government. This proposal was introduced in the British Parliament and cleared in April 1720. The company then decided to raise money by selling shares and use that money to buy out government debt.

To drive up its stock price, the company also started to provide loans against its shares to allow investors to use the loaned money to buy the new shares being issued by the company. This worked in two ways. One, it drove up the demand for the stock. And two, it reduced supply because the stocks that were mortgaged to raise a loan were pulled out of the market.

As the stock price kept going up, the company issued more shares. In fact, as Edward Chancellor points out in Devil Take the Hindmost—A History of Financial Speculation, as the money through the issue came in, it was lent out so that interested investors could buy more stock.

By the time the company came around to its fourth issue of shares, in August 1720, it had already issued shares with a market value of more than £75 million and lent over £12 million against its own shares. If ever there was an example of making hay while the sun shines, this was it. In fact, seeing the success of the South Sea Company, a whole host of other copycat companies entered the market and sold their shares.

There was someone wanting to make deal boards out of saw dust and wanted to raise money for the same. Someone else wanted to make a wheel of perpetual motion. One proposal sought to raise money to develop an air pump for the brain. There were several other proposals—a business trading in human hair; hospitals to take care of illegitimate children of the London elite; yet another one for furnishing funerals in various parts of the country. (And you thought techno-solutionism is a modern phenomenon?) But there was one proposal which took the cake. It was ‘a company for carrying on an undertaking of great advantage, but nobody to know what it is’.

None of these businesses, like the South Sea Company, had any business model in place. They were just raising money from investors who were in the market to make a quick buck. They had no idea of how they would utilize that money to build a business. Or, they had no intention to build a business.

Initially, what gave the South Sea Company credibility was the fact that its proposal to buyout government debt was presented in the Parliament by the British Chancellor of the Exchequer (the finance minister that is). Post this, the South Sea Company had been driving up its stock price through rumour-mongering. One rumour going around was that Spain would allow free trade between all her colonies and England. There were also whispers about the rich produce from the silver mines in Potosi (in modern day Bolivia) being brought to England, until silver was as common as iron.

As Darren Tseng, Stephen Diehl and Jan Akalin write in Popping the Crypto bubble – Market Manias, Phony-Populism, Techno-Solutionism: “The [South Sea] company was effectively a non-economic enterprise… Nevertheless, the company’s stock price rose due to speculation in the enterprise detached from its underlying business fundamentals.”

So, the investors were attracted by the potential of the company due to the rumours spread. And later, they came in just because of the fear of missing out (FOMO).

Of course, in the early 18th century, it wasn’t very easy to keep the hype around anything going, simply because communicating with the world at large and getting the message across, wasn’t as easy as it is now. As the year 1720 progressed, investors figured out that the South Sea Company was just hype and nothing more. As Chancellor writes: “By the end of September, the share price was below 200, a fall of around 75% in four weeks.”

And that’s how the story of the South Sea Company more or less ended.

In an anonymous tract titled, The Secret History of the South Sea Scheme, it was said: “That the advancing by all means of the price of stock, was the only way to promote the good of the Company [originally italicized].”

The modern day story of bitcoin and the crypto bubble is very much in line with that of the South Sea Company bubble. As Tseng, Diehl and Akalin write: “The South Sea bubble presents the most explicit historical parallel to the cryptocurrency bubble.”

Bitcoin and the copycats

Bitcoin was the first crypto. It was first mined in early 2009, as a response to the financial crisis of 2008, which had seen politicians and central banks abuse the global financial system as it had existed up until then. It was originally supposed to be a peer-to-peer payment mechanism, which would avoid using the conventional financial system of central banks, commercial banks and other financial intermediaries. Also, unlike the conventional paper money, which central banks could keep creating out of thin air, there was a limit to the total number of bitcoin that could be created (21 million).

As Quinn and Turner point out: “To its advocates, bitcoin was the money of the future: it could not be devalued through inflation by a central bank, you could spend it on anything without having to worry about government interference or taxes, and it cut out the middleman, namely commercial banks.”

Hence, bitcoin was this new medium of exchange which was supposed to end up replacing the conventional financial system—at least that’s what the true believers had hoped (and some still hope).

Nothing of that sort happened. As Chancellor writes in The Price of Time: “Transactions on Bitcoin’s network were agonizingly slow and consumed vast amounts of energy. Amazon wouldn’t accept bitcoin for retail transactions, nor would the US government accept it for the payment of taxes. Its market price was too volatile to serve as a store of value, a key function of money.”

The world was just happy to continue using paper and digital money created by the conventional financial system to keep carrying out its economic transactions. Only illicit transactions moved to bitcoin and later, to other cryptos like Monero.

It soon turned into a successful object of speculation, like the South Sea Company had. And when that happened, the copycats, as was the case with the South Sea Company, started to come in.

Entrepreneurs started launching initial coin offerings, or ICOs. Like initial public offerings, ICOs were a way of raising money to launch new crypto projects by selling a new cryptocurrency (like companies sell shares). The hope was that the price of these new cryptos will keep going up.

The ICOs were unregulated and a whole lot of money was raised. While the first ICO was launched in 2013, they really came into their own post 2016. As Quinn and Turner point out: “In August 2016, bitcoin was trading at $555; in the next 16 months, its price rose by almost 3,400% to a peak of $19,783. This was accompanied by a promotion boom, as a mix of cryptocurrency enthusiasts and opportunistic charlatans issued… initial coin offerings…They…attracted $6.2 billion of money from investors in 2017 and a further $7.9 billion in 2018.”

The authors of Popping the Cryptobubble quote the US regulators as saying that the total amount of money raised through ICOs stood at $22.5 billion.

Further, as Robert Shiller writes in Narrative Economics—How Stories Go Viral & Drive Major Economic Events: “The ICOs brought a flood of new narratives, each tied to a particular coin [a new crypto] identified with some line of business…In 2017 alone, there were over nine hundred initial coin offerings for crowdfunded business startups that wanted to raise money for some new venture. Almost half of them failed within a year, but new ICOs kept coming.”

The trouble was that the intention in most cases wasn’t to raise money for new projects, but to just take money and disappear. Like was the case with copycat companies which followed the South Sea Company, wild claims about future prospects were made and this was used to drive up prices of these new cryptos. Financial influencers, and everyone from actors to stand-up comedians, were used to promote the new cryptos.

As Tseng, Diehl and Akalin point out: “The simple fact remains that no company that raised funds under an ICO has taken any profitable product to market… The companies that raised [money] successfully under [the] ICO funding model fall into three categories: blatant scams, self-aware scams, and outright naivety.”

Of course, this worked for a while, until it didn’t. Most newer investors kept coming in only because the price of bitcoin and other cryptos kept going up (Remember FOMO?). When that stopped happening, during the course of 2022, the interest in investing in bitcoin and other cryptos dropped as well.

To conclude, as Charles Mackay wrote in the Extraordinary Popular Delusions and the Madness of Crowds: “Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one.”

That’s what happened in the early 18th century. That’s what is happening in the 21st century as well. Oh, but recover they do—only to become victims of the next bubble.

Vivek Kaul is an economic commentator and a writer.