tag:theconversation.com,2011:/africa/topics/financial-bubbles-13331/articlesFinancial bubbles – The Conversation2022-01-13T01:33:24Ztag:theconversation.com,2011:article/1744622022-01-13T01:33:24Z2022-01-13T01:33:24ZNFTs, an overblown speculative bubble inflated by pop culture and crypto mania<figure><img src="https://images.theconversation.com/files/439935/original/file-20220110-26-xvs5yd.jpg?ixlib=rb-1.1.0&rect=0%2C720%2C4500%2C2270&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><span class="source">Shutterstock</span></span></figcaption></figure><p>Comedian Robin Williams once called cocaine “God’s way of telling you you are making too much money”. This role may now have been overtaken by non-fungible tokens, the blockchain-based means to claim unique ownership of easily copied digital assets.</p>
<p>The latest NFT mania involves fantastic amounts of money being paid for “Bored Apes”, 10,000 avatars featuring variants of a bored-looking cartoon ape. Last month rapper Eminem (real name Marshall Mathers) <a href="https://fortune.com/2022/01/03/eminem-nft-bored-ape-yacht-club/">paid about US$450,000</a> in Ethereum cryptocurrency to acquire Bored Ape No. 9055 – nicknamed EminApe, because its khaki and gold chain resembles what Eminem wears. It purportedly joins <a href="https://news.bitcoin.com/eminem-purchases-bored-ape-yacht-club-9055-for-452k-shadys-portfolio-holds-166-nfts/">more than 160 other NFTs</a> in the rapper’s collection. </p>
<p>The Bored Ape character seems derivative of the drawings of <a href="https://www.theguardian.com/music/gallery/2017/nov/07/gorillaz-oxfam-and-a-tarot-fool-art-by-jamie-hewlett-in-pictures">Jamie Hewlett</a>, the artist who drew Tank Girl and virtual band <a href="https://www.officialcharts.com/artist/9975/gorillaz/">Gorillaz</a>. According to the creators, each variant is “generated from over 170 possible traits, including expression, headwear, clothing, and more”. They say every ape is unique “<a href="https://boredapeyachtclub.com">but some are rarer than others</a>”.</p>
<p>So what does Eminem now own? He has an electronic version of an image, which he is using for his <a href="https://twitter.com/Eminem?ref_src=twsrc%5Egoogle%7Ctwcamp%5Eserp%7Ctwgr%5Eauthor">Twitter profile</a>. But then so does anyone who copies it from the internet. The only difference is that he has a record in a blockchain that shows he bought it. He also gets to be a member of the “<a href="https://boredapeyachtclub.com/#/">Bored Ape Yacht Club</a>” a members-only online space whose benefits and purpose beyond being a marketing gimmick are unclear.</p>
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<figure class="align-center ">
<img alt="Eminem's Bored Ape avatar on his Twitter profile." src="https://images.theconversation.com/files/440389/original/file-20220112-21-4mllrq.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/440389/original/file-20220112-21-4mllrq.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=398&fit=crop&dpr=1 600w, https://images.theconversation.com/files/440389/original/file-20220112-21-4mllrq.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=398&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/440389/original/file-20220112-21-4mllrq.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=398&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/440389/original/file-20220112-21-4mllrq.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=501&fit=crop&dpr=1 754w, https://images.theconversation.com/files/440389/original/file-20220112-21-4mllrq.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=501&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/440389/original/file-20220112-21-4mllrq.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=501&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="caption">Eminem’s ‘Bored Ape’ avatar on his Twitter profile.</span>
<span class="attribution"><span class="source">Twitter</span>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span>
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<p>That’s about it. The intellectual property (such as it is) remains with the creators. He is not entitled to any share of merchandising revenue from the character. He can only profit from his purchase if he can find a “<a href="https://www.scienceabc.com/social-science/greater-fool-theory-bitcoin-definition-examples.html">greater fool</a>” willing to pay even more for the NFT. </p>
<p>Which is unlikely. While publicity given to the rapper’s purchase certainly seems to have boosted demand, the average price paid for Bored Ape NFTs so far in 2022 is about <a href="https://opensea.io/collection/boredapeyachtclub?tab=activity">83 Ether</a> (currently about US$280,000). Eminem may have been prepared to pay much more for the one that looked more like him; but would anyone else?</p>
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<a href="https://images.theconversation.com/files/440564/original/file-20220113-27-1oyr3wc.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="'Bored Ape' sales activity from NFT marketplace OpenSea. Prices are in 'ether', the currency unit of the Ethereum blockchain platfrom." src="https://images.theconversation.com/files/440564/original/file-20220113-27-1oyr3wc.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/440564/original/file-20220113-27-1oyr3wc.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=286&fit=crop&dpr=1 600w, https://images.theconversation.com/files/440564/original/file-20220113-27-1oyr3wc.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=286&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/440564/original/file-20220113-27-1oyr3wc.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=286&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/440564/original/file-20220113-27-1oyr3wc.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=360&fit=crop&dpr=1 754w, https://images.theconversation.com/files/440564/original/file-20220113-27-1oyr3wc.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=360&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/440564/original/file-20220113-27-1oyr3wc.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=360&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">‘Bored Ape’ sales activity from NFT marketplace OpenSea. Prices are in ‘ether’, the currency unit of the Ethereum blockchain platfrom.</span>
<span class="attribution"><a class="source" href="https://opensea.io/collection/boredapeyachtclub">OpenSea</a>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span>
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<p>NFTs are a highly speculative purchase. The basis of the market is proof of unique ownership, which only really matters for bragging rights and the prospect of selling the NFT in the future. NFT mania arguably combines the most tawdry and avaricious aspects of collectibles and blockchain markets with celebrity culture. </p>
<h2>The rise of the celebrity influencer</h2>
<p>Eminem’s monster payment in particular has lent credibility to the idea these NFTs have value. But he is not the only celebrity who has helped attract attention to the Bored Ape NFTs. </p>
<p>Others to <a href="https://nftnow.com/lists/celebrities-who-have-bored-ape-yacht-club-nfts/">buy into the hype</a> include basketball stars Shaquille O’Neal and Stephen Curry, billionaire Mark Cuban, electronic dance music DJ Steve Aoki, YouTuber Logan Paul and late-night television host Jimmy Fallon.</p>
<figure class="align-right zoomable">
<a href="https://images.theconversation.com/files/440568/original/file-20220113-25-dgvi0t.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Jimmy Fallon's tweet about his Bored Ape purchase." src="https://images.theconversation.com/files/440568/original/file-20220113-25-dgvi0t.png?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/440568/original/file-20220113-25-dgvi0t.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=762&fit=crop&dpr=1 600w, https://images.theconversation.com/files/440568/original/file-20220113-25-dgvi0t.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=762&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/440568/original/file-20220113-25-dgvi0t.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=762&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/440568/original/file-20220113-25-dgvi0t.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=958&fit=crop&dpr=1 754w, https://images.theconversation.com/files/440568/original/file-20220113-25-dgvi0t.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=958&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/440568/original/file-20220113-25-dgvi0t.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=958&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">Jimmy Fallon’s tweet about his Bored Ape purchase.</span>
<span class="attribution"><a class="source" href="https://twitter.com/jimmyfallon/status/1459164143626424321?lang=en">Twitter</a>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span>
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<p>These well-publicised purchasers effectively act as a form of celebrity endorsement – a tried and true marketing tactic. It is a graphic example of the power of media culture to stoke “irrational exuberance” in financial markets.</p>
<p>There has been a shift away from traditional investments and sources of investment advice. With prices disconnected from any future cash flows, there is less interest in forecasts from technical experts. Instead people turn to social media and “doing their own research”. </p>
<p>One <a href="https://www.fool.com/research/gen-z-millennial-investors-tools/">survey</a> in mid-2021 (polling 1,400 investors aged 18 to 40) suggested about a third of Gen Z investors regard <a href="https://www.tiktok.com/@cannolicrypto/video/6844644996675554566?u_code=d2h683mke5abmh&preview_pb=0&language=en&_d=dd5ggij5mh8mi8&share_item_id=6844644996675554566&timestamp=1594017582&utm_campaign=client_share&app=musically&utm_medium=ios&user_id=6612763001102696454&tt_from=sms&utm_source=sms&source=h5_m">TikTok videos</a> as a source of trustworthy investment advice. </p>
<p>This has opened up the field for celebrity influencers. </p>
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<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/fintok-and-finfluencers-are-on-the-rise-3-tips-to-assess-if-their-advice-has-value-161406">FinTok and 'finfluencers' are on the rise: 3 tips to assess if their advice has value</a>
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</p>
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<h2>A lot like Ponzi schemes</h2>
<p>While not illegal, many NFT marketing ventures have some <a href="https://www.ft.com/content/83a14261-598d-4601-87fc-5dde528b33d0">similarities</a> with <a href="https://moneysmart.gov.au/investment-warnings/ponzi-schemes">Ponzi schemes</a>, such as that operated by <a href="https://www.theguardian.com/us-news/2021/apr/14/bernie-madoff-dies-prison-ponzi-scheme">Bernie Madoff</a> (who sustained his fraud for decades by paying high “dividends” from the deposits of new investors). </p>
<p>Cryptocurrency markets work in essentially the same manner. For existing investors to profit, <a href="https://www.ft.com/content/26283f09-c3df-4c7e-814c-65083b063d8a">new buyers</a> have to be drawn into the market. So too NFTs, with something illusory attached to the digital assets.</p>
<p>Some light on the worth of this attachment compared to the economics of NFTs themselves may come from the interesting (and also highly profitable) experiment by the (now not so) “young British artist” Damien Hirst – himself a <a href="https://theconversation.com/the-art-market-not-a-pretty-picture-41822">master self-promoter</a>.</p>
<p>Hirst’s well-publicised “The Currency” project has involved selling NFTs for 10,000 similar but unique dot paintings. The twist is that at the end of a 12-month period those who have bought the NFT must decide if they want the digital token or the physical artwork. If they keep the NFT the artwork will be destroyed.</p>
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<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/418368/original/file-20210830-31-1nz5tu6.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/418368/original/file-20210830-31-1nz5tu6.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/418368/original/file-20210830-31-1nz5tu6.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=215&fit=crop&dpr=1 600w, https://images.theconversation.com/files/418368/original/file-20210830-31-1nz5tu6.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=215&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/418368/original/file-20210830-31-1nz5tu6.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=215&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/418368/original/file-20210830-31-1nz5tu6.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=270&fit=crop&dpr=1 754w, https://images.theconversation.com/files/418368/original/file-20210830-31-1nz5tu6.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=270&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/418368/original/file-20210830-31-1nz5tu6.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=270&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">These two Damien Hirst ‘Currency’ works sold within a hour of each other. ‘5083. Yeah, come on for a ride’, left, sold for US$45,966. ‘6307. We shall bring our own children’, right, sold for US$26,285.</span>
<span class="attribution"><a class="source" href="https://currency.nft.heni.com/stats">HENI</a></span>
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<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/damien-hirsts-dotty-currency-art-makes-as-much-sense-as-bitcoin-166958">Damien Hirst's dotty 'currency' art makes as much sense as Bitcoin</a>
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</em>
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<h2>No fundamental value</h2>
<p>There’s virtually nothing humans can’t turn into a market. But increasingly there are speculative bubbles in things with absolutely no fundamental value. NFTs have joined Bitcoin and celebrity meme-based cryptocurrencies such as <a href="https://theconversation.com/after-gamestop-the-rise-of-dogecoin-shows-us-how-memes-can-move-markets-154470">Dogecoin</a> and <a href="https://www.fxempire.com/education/article/what-is-shiba-inu-the-meme-coin-designed-to-kill-dogecoin-804989">Shiba Inu</a> as examples of tokens with no intrinsic worth, which speculators just buy in the hope the price will keep rising. </p>
<p>Even <a href="https://theconversation.com/after-gamestop-the-rise-of-dogecoin-shows-us-how-memes-can-move-markets-154470">Dogecoin</a>, started as a satire on these excesses, is now valued at <a href="https://coinmarketcap.com/currencies/dogecoin/">US$20 billion</a> and promoted in <a href="https://www.ft.com/content/025ea33f-7351-4d86-a1ca-b6c268f5b042">Ponzi-like ways</a>.</p>
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<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/what-is-bitcoins-fundamental-value-thats-a-good-question-171387">What is Bitcoin's fundamental value? That's a good question</a>
</strong>
</em>
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<p>Some studies have suggested <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2782236">tweets</a> or <a href="https://reader.elsevier.com/reader/sd/pii/S1544612318301326?token=59D9447B0D87B50CD42DB7D10454D35453B594ED7F6B115547A4424AD48FF2CB1603C8F7A408882E39EE81B837C6AE47&originRegion=us-east-1&originCreation=20220106032009">Facebook posts</a> can now drive stock prices. <a href="https://www.vox.com/recode/2021/5/18/22441831/elon-musk-bitcoin-dogecoin-crypto-prices-tesla">Elon Musk’s tweets</a> certainly seem to have a large impact on cryptocurrency prices. </p>
<p>We now appear to be in the monster of all speculative bubbles. The creators of assets like NFTs will do well. It is not so clear about the holders.</p>
<p>Nor will the impact of NFT crashes be restricted just to the NFT market. Speculators, particularly if they have borrowed heavily, may need to liquidate other assets as well. This is all likely to make all financial markets more volatile. </p>
<p>The larger the bubble becomes, the wider the contagion when it bursts.</p><img src="https://counter.theconversation.com/content/174462/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>This article is part of a series on financial and economic literacy funded by Ecstra Foundation.</span></em></p>The craze among celebrities for Bored Ape NFTs suggests speculation has become completely detached from any idea of fundamental value.John Hawkins, Senior Lecturer, Canberra School of Politics, Economics and Society, University of CanberraLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1584062021-04-30T12:15:56Z2021-04-30T12:15:56ZFrom tulips and scrips to bitcoin and meme stocks – how the act of speculating became a financial mania<figure><img src="https://images.theconversation.com/files/397946/original/file-20210429-18-16ru4p9.jpg?ixlib=rb-1.1.0&rect=76%2C30%2C5016%2C3145&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Financial bubbles are frequently depicted as manias. </span> <span class="attribution"><a class="source" href="https://www.gettyimages.com/detail/news-photo/wall-street-bubbles-always-the-same-j-pierpont-morgan-news-photo/646470006">Photo12/Universal Images Group via Getty Images</a></span></figcaption></figure><p>In the late 1990s, America experienced a <a href="http://pages.stern.nyu.edu/%7Eeofek/DotComMania_JF_Final.pdf">dot-com mania</a>. In the 2000s, the <a href="https://www.federalreservehistory.org/essays/subprime-mortgage-crisis">housing</a> market went wild. </p>
<p>Today, there are manias in everything from <a href="https://www.cnbc.com/2021/03/24/blockchain-com-rides-bitcoin-mania-to-a-5-2-billion-valuation.html">bitcoin</a> and <a href="https://www.nytimes.com/2021/03/11/arts/design/nft-auction-christies-beeple.html">nonfungible tokens</a> to <a href="https://seekingalpha.com/article/4418535-reits-jump-into-spac-mania">SPACs</a> and <a href="https://www.bloomberg.com/news/articles/2021-04-03/as-meme-stock-mania-fizzles-wall-street-sees-big-reckoning">meme stocks</a> – obscure corners of the market that are getting increased attention. Whether these are the next bubbles to burst remains to be seen. </p>
<p>The sudden rise of all these relatively new <a href="https://www.investopedia.com/terms/a/assetclasses.asp">asset classes</a> – or the <a href="https://www.nytimes.com/2021/03/13/technology/crypto-art-NFTs-trading-cards-investment-manias.html">astronomical heights they’ve reached</a> – may seem irrational or even enchanted. Describing them as speculative manias implies that individuals are lost in forces beyond their control and needn’t take responsibility for the actions of the crowd. </p>
<p>But, as I learned while researching my book “<a href="http://cup.columbia.edu/book/speculation/9780231200219">Speculation: A Cultural History from Aristotle to AI</a>,” which will be published in June 2021, financial speculation hasn’t always been understood as a widespread craze – or even outside of individual choice. </p>
<h2>Adam Smith and the rise of financial speculation</h2>
<p>From ancient times until the late 1700s, the term “speculation” was used mainly by philosophers, scientists and authors to describe conjectures about the future. When speaking of traders who manipulated the prices of an asset to make an outsize profit, <a href="https://fee.org/articles/speculators-adam-smith-revisited/">financial writers</a> instead used terms like “engrossing” or “cornering” the market. </p>
<figure class="align-right zoomable">
<a href="https://images.theconversation.com/files/397876/original/file-20210429-21-8os759.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="An illustration of Gen. George Washington on a horse holding his hat as he leads his men in a battle in 1777" src="https://images.theconversation.com/files/397876/original/file-20210429-21-8os759.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/397876/original/file-20210429-21-8os759.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=726&fit=crop&dpr=1 600w, https://images.theconversation.com/files/397876/original/file-20210429-21-8os759.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=726&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/397876/original/file-20210429-21-8os759.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=726&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/397876/original/file-20210429-21-8os759.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=913&fit=crop&dpr=1 754w, https://images.theconversation.com/files/397876/original/file-20210429-21-8os759.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=913&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/397876/original/file-20210429-21-8os759.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=913&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">George Washington thought financial speculators would ruin the country.</span>
<span class="attribution"><a class="source" href="https://newsroom.ap.org/detail/WashingtonBattleOfPrinceton1777/f5c9512737be4401b4d57eec415bd9af/photo?Query=George%20AND%20washington&mediaType=photo&sortBy=arrivaldatetime:asc&dateRange=Anytime&totalCount=20709&currentItemNo=2">AP Photo</a></span>
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</figure>
<p>After a <a href="https://www.jstor.org/stable/2598492?seq=1">series of international credit scandals</a> in the 1770s, though, “speculation” became the favored descriptor for high-risk financial gambling. Political economist Adam Smith used the term extensively in “<a href="https://archive.org/details/in.ernet.dli.2015.207956">Wealth of Nations</a>,” published in 1776, after seeing it used to describe lotteries and smuggling. He saw in it a perfect term for how traders were trying to capitalize exponentially on the inherent risks and unknowns of the future. </p>
<p><a href="https://founders.archives.gov/documents/Washington/03-20-02-0631">George Washington even warned in 1779 that speculators</a> “are putting the rights & liberties of this Country into the most eminent danger.” </p>
<p>Yet Smith, Washington and others still saw speculators of all types as individuals making calculated decisions, not as part of some maniacal collective or epidemic contagion. </p>
<h2>Alexander Hamilton’s ‘scripomania’ takes hold</h2>
<p>That began to change thanks largely to the early American physician and thinker Benjamin Rush. </p>
<p>As surgeon general of the Continental Army and a prolific publisher of studies of mental illness, Rush <a href="https://books.google.com/books?id=KQf4CAAAQBAJ&newbks=1&newbks_redir=0&printsec=frontcover#v=onepage&q&f=false">penned a widely circulated article</a> in 1787, “On the Different Species of Mania.” In it, he characterized speculative gambling alongside 25 other types of “manias” that he wrote had become pronounced in American life, including “land mania,” “horse mania,” “machine mania” and “monarchical mania.” </p>
<p>For Rush, speculation was a disease of the mind that spread from one to many and threatened the health of a young democracy that relied on rational decision-making by voters and politicians. The “spirit of speculation,” he foresaw, was not a good-hearted “spirit” of nation building, but rather could “destroy patriotism and friendship in many people.” </p>
<p>Rush’s terminology and his way of thinking caught on quickly. In the summer of 1791, <a href="https://globalfinancialdata.com/the-panic-of-1792">“Scripomania” took hold</a> as Alexander Hamilton sold the rights to buy shares – known as scrips for “subscriptions” – in the newfound Bank of the United States to shore up the nation’s finances following the Revolutionary War. Demand for the scrips soared; the <a href="https://www.loc.gov/item/sn83025889">Philadelphia General Advertiser declared</a> that “an inveterate madness for speculation seems to possess this country!”</p>
<figure class="align-center ">
<img alt="In an illustration, cats are representing humans and buying tulips on display" src="https://images.theconversation.com/files/397879/original/file-20210429-22-19tt2zz.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/397879/original/file-20210429-22-19tt2zz.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=491&fit=crop&dpr=1 600w, https://images.theconversation.com/files/397879/original/file-20210429-22-19tt2zz.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=491&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/397879/original/file-20210429-22-19tt2zz.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=491&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/397879/original/file-20210429-22-19tt2zz.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=617&fit=crop&dpr=1 754w, https://images.theconversation.com/files/397879/original/file-20210429-22-19tt2zz.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=617&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/397879/original/file-20210429-22-19tt2zz.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=617&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">A satire of the Dutch tulip ‘mania,’ which didn’t get that label until many years later.</span>
<span class="attribution"><a class="source" href="https://www.gettyimages.com/detail/news-photo/satire-of-the-folly-of-the-tulip-mania-news-photo/157370637">Art Images/Hulton Fine Art Collection via Getty Images</a></span>
</figcaption>
</figure>
<h2>Calculated risk – minus the calculation</h2>
<p>After that, the tie between “speculation” and “mania” spread and became inextricable – and it hasn’t been severed since. The Scottish journalist <a href="https://archive.org/details/memoirsofextraor01mack">Charles Mackay sealed this connection</a> in 1841 with his influential “Extraordinary Popular Delusions and the Madness of Crowds.” Since then, virtually every bubble, every rush in commodities and every market panic that has ensued has been called a “mania.” </p>
<p>The term has even been used retrospectively to refer to the behaviors that led to speculative bubbles in the distant past. The famous <a href="https://theconversation.com/tulip-mania-the-classic-story-of-a-dutch-financial-bubble-is-mostly-wrong-91413">Dutch tulip bubble</a> of 1637, for instance, was seen in its day as foolish and dangerous, but only after Mackay’s book was it labeled a “mania.”</p>
<p>The trouble with talking about wild financial events in this way is that society begins to confuse and distort the responsibility and nature of bubbles that inevitably crash, leaving ruin in their wake. </p>
<p>To speculate, at its core, is to make a bet about the future based on individual calculations of the risks of tomorrow. There’s nothing inherently contagious or mad about it. In fact, computers <a href="https://mitsloan.mit.edu/ideas-made-to-matter/does-statistical-trading-make-markets-less-or-more-efficient">are often speculating</a> now in place of human minds.</p>
<p>What we call a “mania” is just shorthand for saying that a lot of people – and machines – made the same bet, as happened in January when <a href="https://theconversation.com/robinhood-app-makes-wall-street-feel-like-a-game-to-win-instead-of-a-place-where-you-can-lose-your-life-savings-in-a-new-york-minute-156013">day traders</a> – many of them inexperienced – drove up the price of GameStop. Maybe they were all acting rationally and in concert. Maybe they were duped by insiders or weren’t fully calculating those risks.</p>
<p>Whatever the explanation, using the term “mania” tells us only a small and potentially misleading part of the story. </p>
<p>[<em>Over 104,000 readers rely on The Conversation’s newsletter to understand the world.</em> <a href="https://theconversation.com/us/newsletters/the-daily-3?utm_source=TCUS&utm_medium=inline-link&utm_campaign=newsletter-text&utm_content=100Ksignup">Sign up today</a>.]</p><img src="https://counter.theconversation.com/content/158406/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Gayle Rogers does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Until the late 1800s, moments of widespread high-risk financial gambling weren’t considered manias but the results of individual actors, who bore responsibility for the disastrous results.Gayle Rogers, Professor and chair of English, University of PittsburghLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1438612020-08-20T12:54:38Z2020-08-20T12:54:38Z300 years since the South Sea Bubble: the real story behind the iconic financial crash<figure><img src="https://images.theconversation.com/files/353835/original/file-20200820-16-55fmv8.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Painting of South Sea Bubble speculators by Edward Matthew Ward, Tate Gallery.</span> <span class="attribution"><a class="source" href="https://en.wikipedia.org/wiki/South_Sea_Company#/media/File:South_Sea_Bubble.jpg">Wikimedia</a></span></figcaption></figure><p>Coronavirus has caused a great deal of stock market turbulence and, somewhat inevitably, comparisons <a href="https://www.dailymail.co.uk/news/article-8220401/London-markets-fall-hours-Rishi-Sunaks-dire-warning-economy.html">have been</a> <a href="https://www.scmp.com/economy/global-economy/article/3075057/coronavirus-global-economy-faces-historical-challenge">made</a> to the volatility caused by the South Sea Bubble 300 years ago. This was the moment when, in 1720, share prices in London boomed and then fell sharply. It is thought of as a major economic disaster and huge scandal. </p>
<p>In reality, it was a scandal but not much of a disaster. While some investors lost out from the speculation, it did not make much of a dent in the wider economy, unlike the more recent crashes of 1929 and 2008 – and what the long-term economic effects will be from COVID-19. </p>
<p>The episode shows how a perceived crisis can be the subject of intense public outcry and moral panic, even when people do not understand what has happened. It shows how the narrative told to the public can easily diverge from the truth: fake news, if you will. </p>
<h2>What actually happened</h2>
<p>The real reasons behind the bubble <a href="https://www.cambridge.org/core/journals/financial-history-review/article/helen-j-paul-the-south-sea-bubble-an-economic-history-of-its-origins-and-consequences-new-york-routledge-2011-176-pp-9000/65E4800467F5090A9C7BDCB4DD177D95">are complex</a>. The South Sea Company, which gave its name to the event, helped the government manage its debt and also traded enslaved Africans to the Spanish colonies of the Americas. The government struggled to pay holders of its debt on time and investors had difficulty selling on their debt to others due to legal difficulties. </p>
<p>So debt holders were encouraged to hand their debt instruments to the South Sea Company in exchange for shares. The company would collect an annual interest payment from the government, instead of the government paying out interest to a large number of debt-holders. The company would then pass on the interest payment in the form of dividends, along with profits from its trading arm. Shareholders could easily sell on their shares or simply collect dividends. </p>
<p>The debt management and slaving aspects of the company’s history have often been misunderstood or downplayed. Older accounts state that the company did not actually trade at all. It did. The South Sea Company shipped thousands of people across the Atlantic as slaves, working with an established slave trading company called the Royal African Company. It also received convoy protection from the Royal Navy. Shareholders were interested in the South Sea Company because it was strongly backed by the British state. </p>
<p>By the summer of 1720, South Sea Company shares became overvalued and other companies also saw their share prices increase. This was partly because new investors came into the market and got carried away. In addition, money came in from France. The French economy had undergone a huge set of reforms under the control of a Scottish economist called John Law. </p>
<p>Law’s ideas were ahead of his time, but he moved too quickly. His attempts to modernise France’s economy did not work, partly because the rigid social system remained unchanged. The French stock market boomed and then crashed. Investors took their money out of the Paris market – some moved it to London, helping push up share prices there. </p>
<figure class="align-right zoomable">
<a href="https://images.theconversation.com/files/353845/original/file-20200820-22-1reo578.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Graph showing rapid spike and sharp fall in South Sea Company shares." src="https://images.theconversation.com/files/353845/original/file-20200820-22-1reo578.png?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/353845/original/file-20200820-22-1reo578.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=725&fit=crop&dpr=1 600w, https://images.theconversation.com/files/353845/original/file-20200820-22-1reo578.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=725&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/353845/original/file-20200820-22-1reo578.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=725&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/353845/original/file-20200820-22-1reo578.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=911&fit=crop&dpr=1 754w, https://images.theconversation.com/files/353845/original/file-20200820-22-1reo578.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=911&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/353845/original/file-20200820-22-1reo578.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=911&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">The rapid rise and fall of South Sea Company shares.</span>
<span class="attribution"><a class="source" href="https://upload.wikimedia.org/wikipedia/commons/e/ef/South-sea-bubble-chart.png">Wikimedia</a></span>
</figcaption>
</figure>
<p>Once the South Sea Bubble had started to inflate, it attracted more naive investors and those who would prey upon them. While it was clear that the high prices were unsustainable, canny speculators bought in hoping to sell out in time. This pushed up prices even more, in the short term. The stock price went up from £100 in 1719 to more than £1,000 by August 1720. The inevitable crash back down to £100 per share by the end of the year came as a shock to those who thought they could make their fortunes overnight. </p>
<h2>The backlash</h2>
<p>The crash provoked huge public outcry. Politicians demanded an inquiry. South Sea Company directors were accused of treason and fraud. Poems, plays and satirical prints criticised the market and those in it. The chancellor of the exchequer was briefly locked up in the Tower of London. The company’s directors were forced to appear in front of parliament. </p>
<p>The amount of noise generated by these reactions helped make the South Sea Bubble famous. From then on in, it became a byword for financial scandal. Yet many people could not really explain what had happened. Perhaps surprisingly, economic historians can find little evidence <a href="https://discovery.ucl.ac.uk/id/eprint/12397/">of a prolonged economic recession</a>. The bubble burst but without the major effects of later financial crises. </p>
<figure class="align-center ">
<img alt="Black and white print by William Hogarth caricaturing the South Sea Bubble." src="https://images.theconversation.com/files/353848/original/file-20200820-22-1mkf6yh.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/353848/original/file-20200820-22-1mkf6yh.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=500&fit=crop&dpr=1 600w, https://images.theconversation.com/files/353848/original/file-20200820-22-1mkf6yh.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=500&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/353848/original/file-20200820-22-1mkf6yh.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=500&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/353848/original/file-20200820-22-1mkf6yh.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=628&fit=crop&dpr=1 754w, https://images.theconversation.com/files/353848/original/file-20200820-22-1mkf6yh.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=628&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/353848/original/file-20200820-22-1mkf6yh.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=628&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">William Hogarth’s caricature of the bubble.</span>
<span class="attribution"><a class="source" href="https://en.wikipedia.org/wiki/Emblematical_Print_on_the_South_Sea_Scheme">Wikimedia</a></span>
</figcaption>
</figure>
<p>So why all the fuss? First, the crash happened in the early days of the stock market. There was no body of financial theory or financial journalism which could help explain it to laypeople. They turned instead to conspiracy theories or strange ideas about people becoming gambling mad. </p>
<p>Second, there was talk of people being given their money back. This gave losers every incentive to talk up their losses. It is human nature to complain, even about a small loss. The popular perception is that great fortunes were destroyed, but there is little evidence of this beyond one or two cases. </p>
<p>Third, this was a glorious opportunity for schadenfreude and various sorts of prejudice to be expressed. Female investors were <a href="https://theconversation.com/women-were-to-blame-for-the-south-sea-bubble-according-to-men-72439">lampooned by misogynists</a>. Foreigners and various religious groups were the subject of racist commentary. There was no expert analysis available and commentators, with no real understanding of finance, provided scandal and scapegoating instead of accurate reporting. </p>
<p>The South Sea Bubble has been a symbol of financial crisis for 300 years. But like other more modern crises, its public image diverges from the reality. The same probably can’t be said for the COVID-19 pandemic, which will have a much more deep and lasting effect on the world economy.</p><img src="https://counter.theconversation.com/content/143861/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Helen Paul has received funding from EHRC, the Economic History Society, the AHRC and the University of Southampton.</span></em></p>The real story of the South Sea Bubble and what happened when it burst 300 years ago.Helen Paul, Lecturer in Economics and Economic History, University of SouthamptonLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1094682019-01-11T16:36:43Z2019-01-11T16:36:43ZWhy 2019 could be the year of another tech bubble crash<figure><img src="https://images.theconversation.com/files/253375/original/file-20190111-43532-nouw1u.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-vector/hand-pushing-needle-pop-balloon-business-462221455?src=hK7GDW-jlmXaED9mWL20hQ-1-1">Sira Anamwong / Shutterstock</a></span></figcaption></figure><p>When the dot-com bubble burst in 2000 it sent significant numbers of businesses <a href="https://www.investopedia.com/terms/d/dotcom-bubble.aspt">to the wall</a>. Investment banks had been encouraging enormous investment in dot-com ventures by launching Initial Public Offers (IPOs) allowing investors and entrepreneurs to cash in on vast fortunes by selling off shares in their companies. </p>
<p>Most of the dot-coms which listed on stock exchanges had done little more than consume vast amounts of investor cash and showed little prospect of achieving a profit. Traditional metrics of performance were overlooked and big spending was seen as a sign of rapid progress. </p>
<p>The cash burn was to build branding and create network effects – where something gains more value the more people use it. These are the main driver of platform businesses. With Amazon, for example, the more suppliers the greater benefit to potential customers and vice versa. Together, this would build the foundation for future profits on the assumption that the underlying business case was sound. Most were not – and yet almost any idea attracted large amounts of funding. </p>
<p>Fast forward 19 years and, following a similar “app” boom, investment banks are bringing forward IPOs as they foresee volatile market conditions arriving later in the year. Ride-hailing apps Uber and Lyft, respectively valued by investment banks at US$120 billion and US$15 billion, are to be placed in early 2019 to beat the collapse. Both are loss makers – with Uber’s losses <a href="http://fortune.com/2018/03/06/how-much-money-uber-spent/">approaching US$4 billion in 2018</a> after a US$4.5 billion <a href="https://www.theguardian.com/technology/2018/oct/16/uber-targets-120bn-valuation-2019-flotation-report">loss in 2017</a>. Traditional metrics have been ignored and user growth taken as a proxy for future profitability. But this requires an enormous leap of faith. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/253376/original/file-20190111-43517-z76rmd.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/253376/original/file-20190111-43517-z76rmd.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/253376/original/file-20190111-43517-z76rmd.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=332&fit=crop&dpr=1 600w, https://images.theconversation.com/files/253376/original/file-20190111-43517-z76rmd.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=332&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/253376/original/file-20190111-43517-z76rmd.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=332&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/253376/original/file-20190111-43517-z76rmd.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=418&fit=crop&dpr=1 754w, https://images.theconversation.com/files/253376/original/file-20190111-43517-z76rmd.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=418&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/253376/original/file-20190111-43517-z76rmd.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=418&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">The NASDAQ Composite index from 1994 to 2005, showing the peak in early 2000 that coincides with the dot-com bust.</span>
<span class="attribution"><a class="source" href="https://commons.wikimedia.org/w/index.php?curid=3189816">Lalala666 via Wikimedia Commons</a></span>
</figcaption>
</figure>
<p>Uber, like many, has been able to tap readily available funds and has raised <a href="https://www.investopedia.com/insights/ubers-top-investors/">more than US$22 billion from investors</a> so far. The problem with being able to raise funds so readily is that it discourages focus and efficiency. Uber is not only developing the ride hailing model but also bike sharing, takeaway food delivery and autonomous vehicles. The latter is also being developed by most of the major car manufacturers, as well as Google. </p>
<p>Snap Inc, owner of social media app Snapchat, is also on the rocks, as it is rapidly running out of funds – despite its <a href="https://www.cnbc.com/2017/03/01/snapchat-ipo-pricing.html">US$24 billion listing</a> in 2017. The shareholders are powerless to intervene, as only founder shares have voting rights. LinkedIn is still losing money after its <a href="https://www.theguardian.com/technology/2016/jun/13/linkedin-bought-by-microsoft-for-262bn-in-cash">US$26 billion purchase by Microsoft</a>. Twitter has <a href="https://www.theguardian.com/technology/2018/feb/08/twitter-makes-first-quarterly-profit-history">just made a small profit</a> for the first time, following adoption as US president Donald Trump’s main channel for US policy announcements. </p>
<p>The investment bank belief is that network effects will build scale economies and create “winner-takes-all” markets that emulate Facebook, Google and Amazon. But the reality is far from the truth, as most differ in several important aspects. </p>
<h2>Two types of app</h2>
<p>Most apps fall into two categories. There are those that use content to attract users in anticipation that these users can be monetised – typically by selling advertising or collecting subscriptions. These include the likes of LinkedIn, Twitter, Snapchat, Facebook. Then there are those that provide a service or goods, such as Uber, Lyft, Deliveroo, Amazon. </p>
<p>Apps using content have found that content can be enormously expensive to keep new and that monetising users is difficult in terms of attracting advertising or subscriptions. Investor funds are used to develop content in the hope of creating enough users to pay for it and eventually show a profit. The reality is that users tend to move onto the next fad before they can be monetised. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/253443/original/file-20190111-43544-1w5yyly.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/253443/original/file-20190111-43544-1w5yyly.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/253443/original/file-20190111-43544-1w5yyly.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=221&fit=crop&dpr=1 600w, https://images.theconversation.com/files/253443/original/file-20190111-43544-1w5yyly.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=221&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/253443/original/file-20190111-43544-1w5yyly.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=221&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/253443/original/file-20190111-43544-1w5yyly.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=277&fit=crop&dpr=1 754w, https://images.theconversation.com/files/253443/original/file-20190111-43544-1w5yyly.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=277&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/253443/original/file-20190111-43544-1w5yyly.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=277&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">The NASDAQ Composite index from 1992 to today.</span>
<span class="attribution"><a class="source" href="https://www.nasdaq.com/symbol/ixic/stock-chart?intraday=off&timeframe=10y&splits=off&earnings=off&movingaverage=None&lowerstudy=volume&comparison=off&index=&drilldown=off">NASDAQ</a></span>
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<p>Where goods and services are concerned, investor funds are used to prime the market through advertising and subsidising prices to both suppliers and customers. In effect they are trying to create network effects, which are anticipated to persist once the low price incentives are withdrawn. </p>
<p>But this is the equivalent of paying suppliers more than the market rate and then selling to customers at less than the market rate. In markets with low switching costs such as ride hailing apps and food delivery, users will simply revert to the most competitive offering once the incentives are withdrawn. </p>
<p>In the case of Uber, despite an impending IPO, it has been unable to withdraw costly incentives <a href="http://fortune.com/2018/11/14/uber-billion-dollar-loss-slow-growth/">due to user growth collapsing</a>. Scale economies are also rather limited, as Uber is finding when trying to withdraw driver incentives which has <a href="https://www.timeslive.co.za/news/south-africa/2018-07-03-uber-promises-incentives-to-offset-fuel-price-increases-as-drivers-strike/">resulted</a> in <a href="https://tech.economictimes.indiatimes.com/news/internet/ola-uber-strike-in-mumbai-set-to-end-80-of-drivers-demands-met/66419890">strikes</a>. In effect the model only works with incentives, which investors are needed to fund.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/253377/original/file-20190111-43544-p1k9pm.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/253377/original/file-20190111-43544-p1k9pm.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=399&fit=crop&dpr=1 600w, https://images.theconversation.com/files/253377/original/file-20190111-43544-p1k9pm.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=399&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/253377/original/file-20190111-43544-p1k9pm.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=399&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/253377/original/file-20190111-43544-p1k9pm.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=502&fit=crop&dpr=1 754w, https://images.theconversation.com/files/253377/original/file-20190111-43544-p1k9pm.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=502&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/253377/original/file-20190111-43544-p1k9pm.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=502&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="caption">Uber is driven by subsidies to pay drivers and keep rides cheap.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/jyvaskyla-finland-december-7-2017-uber-774391564?src=82QlziyQ71_pFB5YbQu33A-1-1">Tero Vesalainen / Shutterstock.com</a></span>
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<p>The big difference with Facebook, Amazon, and Google is that they were among the very first to build network effects. Uber has faced sustained competition and staunch resistance around the world, resulting in enormous battles of attrition funded by investors. Snapchat have found Instagram and WhatsApp (both owned by Facebook) waiting for them, making the competition for users very difficult. </p>
<p>It’s only a matter of time before the app bubble bursts. Big tech companies such as <a href="https://www.marketwatch.com/investing/stock/aapl">Apple</a> and <a href="https://www.marketwatch.com/investing/stock/fb">Facebook</a>’s shares have fallen almost 40% in the past few weeks – which is indicative of markets losing faith in even the established tech businesses to achieve their forecasts. This does not bode well for the apps which have not yet listed. When it comes to investment markets, history does repeat itself again and again and again.</p><img src="https://counter.theconversation.com/content/109468/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>John Colley does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>There are a lot of similarities between the state of tech companies today and when the 2000 dot-com bubble burst.John Colley, Professor of Practice, Associate Dean, Warwick Business School, University of WarwickLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1075962018-12-10T03:33:53Z2018-12-10T03:33:53ZHow low will Bitcoin now go? The history of price bubbles provides some clues<figure><img src="https://images.theconversation.com/files/249575/original/file-20181210-76983-1spzyf1.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">The Bitcoin bubble is perhaps the most extreme speculative bubble since the late 19th century.</span> <span class="attribution"><span class="source">Shutterstock</span></span></figcaption></figure><p>Nearly 170 years before the invention of Bitcoin, the journalist Charles Mackay noted the way whole communities could “fix their minds upon one object and go mad in its pursuit”. Millions of people, he wrote, “become simultaneously impressed with one delusion, and run after it, till their attention is caught by some new folly more captivating than the first”.</p>
<p>His book <a href="https://en.wikipedia.org/wiki/Extraordinary_Popular_Delusions_and_the_Madness_of_Crowds#Influence_and_modern_responses">Extraordinary Popular Delusions and the Madness of Crowds</a>, published in 1841, identifies a series of speculative bubbles – where people bought and sold objects for increasingly steep prices until suddenly they didn’t. The best-known example he cites is the tulip mania that gripped the Netherlands in the early 17th century. Tulip bulbs soared in value to sell for up to 25,000 florins each (close to A$45,000 in today’s money) before their price collapsed. </p>
<p>The Bitcoin bubble <a href="https://www.bloomberg.com/news/articles/2018-11-21/how-bitcoin-s-crash-compares-to-history-s-biggest-bubbles-chart">surpasses this and all</a> other cases identified by Mackay. It is perhaps the most extreme bubble since the late 19th century. In four years its price surged almost 2,800%, reaching a peak of US$19,783 in December 2017. It has since fallen by 80%. A month ago it was trading at more than US$6,000; it is now down to US$3,500.</p>
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Read more:
<a href="https://theconversation.com/bitcoin-turns-ten-heres-how-it-all-started-and-what-the-future-might-hold-105782">Bitcoin turns ten – here's how it all started and what the future might hold</a>
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<p>That’s still a fantastic gain for anyone who bought Bitcoin before May 2017, when it was worth less than US$2,000, or before May 2016, when it was worth less than $500. </p>
<p>But will it simply keep dropping? What makes Bitcoin worth anything?</p>
<p>To begin to answer this question, we need to understand what creates the values that drive speculative price bubbles, and then what causes prices to plunge.</p>
<iframe id="datawrapper-chart-9UH3k" src="https://datawrapper.dwcdn.net/9UH3k/1/" scrolling="no" frameborder="0" style="width: 0; min-width: 100% !important;" height="400" width="100%"></iframe>
<p>The above chart shows the magnitude of the Bitcoin bubble compared with the price movement of Japanese property and dot-com bubble from four years prior to their peak until four years after.</p>
<h2>When asset values diverge</h2>
<p>We typically think about bubbles in financial assets such as stocks or bonds, but they can also occur with physical assets (such as property) or commodities (like tulip bulbs). </p>
<p>A bubble begins when the price people are willing to pay for something deviates significantly from its “intrinsic value”. </p>
<p>The intrinsic value of an asset is theoretical, based its “fundamental” value. Fundamental value includes: the ability to generate cash flow (e.g. interest or rental income); scarcity or rarity value (e.g. gold or diamonds); and potential use (e.g. silver and platinum are used in both jewellery and industrial operations). </p>
<p>A house may have fundamental value owing to the scarcity of land, its use as a home, or its ability to generate rental income. A tulip (or Bitcoin) has none of those things; even the presumed scarcity does not exist when you consider all of the alternative flowers (or cryptocurrencies) available. </p>
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<img alt="" src="https://images.theconversation.com/files/248965/original/file-20181205-186073-1en7evi.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/248965/original/file-20181205-186073-1en7evi.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=384&fit=crop&dpr=1 600w, https://images.theconversation.com/files/248965/original/file-20181205-186073-1en7evi.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=384&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/248965/original/file-20181205-186073-1en7evi.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=384&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/248965/original/file-20181205-186073-1en7evi.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=482&fit=crop&dpr=1 754w, https://images.theconversation.com/files/248965/original/file-20181205-186073-1en7evi.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=482&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/248965/original/file-20181205-186073-1en7evi.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=482&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="caption">Flemish painter Jan Brueghel the Younger portrayed tulip speculators as monkey in his ‘Satire on Tulip Mania’ dated to circa 1840.</span>
<span class="attribution"><a class="source" href="https://commons.wikimedia.org/wiki/File:Jan_Brueghel_the_Younger,_Satire_on_Tulip_Mania,_c._1640.jpg">Jan Brueghel the Younger / Wikimedia Commons</a>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span>
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<h2>Price bubble preconditions</h2>
<p>A bubble tends to occur after a sustained period of economic growth, when investors get used to the price of an asset always increasing and credit is easily accessible.</p>
<p>To these conditions something more must be added for a bubble to form. That is typically a major disruption or innovation, such as the development of a new technology. Think of railways in the 19th century, electricity in the early 20th century, and the internet at the end of the 20th century. </p>
<p>Initially most investors tend to be cautious and “rational” about a new technology. For instance, early investment in railways took advantage of limited competition and focusing on profitable routes only. It was gradual and commercially successful.</p>
<p>This creates higher growth and profitability, leading to positive feedbacks (from greater investment, higher dividend payouts, and increased consumer spending), which raises confidence further. </p>
<p>If conditions allow, this develops into a period the economic historian <a href="https://www.hetwebsite.net/het/profiles/kindleberger.htm">Charles Kindleberger</a> described as “<a href="https://www.economist.com/finance-and-economics/2003/07/17/of-manias-panics-and-crashes">euphoric</a>”: investors become fixated on the ability to make a profit by selling the asset to a “greater fool” at an even higher price. </p>
<p>That is, they are attracted not by “fundamental” motives – the benefits from potential cash-flows such as dividend or rental income – but by “speculative” motives – the pursuit of short-term capital gains. </p>
<p>Higher prices attract a greater number of speculators, pushing prices higher still. Uncertainty around the significance of the new technology allows extreme valuations to be rationalised, although the justifications seem weaker as prices rise further. </p>
<p>The virtuous cycle of ever-rising prices continues, often fuelled by credit, until there is an event that leads to a pause in price rises. Kindleberger suggests this can be a change in government policy or an unexplained failure of a firm. </p>
<p>When asset prices stop rising, investors who have borrowed to finance their purchases realise the cost of interest payments on their debt will not be offset by the capital gain to be made by holding onto the asset. So they cut their losses and start to sell the asset. Once the price starts falling, more investors decide to sell.</p>
<h2>Bitcoin’s bubble</h2>
<p>Observers of the cryptocurrency market will find this story familiar. Bitcoin emerged following one of the <a href="https://www.bloomberg.com/news/articles/2018-05-01/as-u-s-expansion-hits-endurance-milestone-here-s-what-s-next">longest economic expansions</a> in history, with easily accessible credit, and global interest rates at their lowest levels in <a href="https://www.abc.net.au/news/2018-07-06/interest-rates-over-5000-years/9947802">5,000 years of civilisation</a>. </p>
<p>The surge in price attracted speculators into the Bitcoin market, helped by intense media attention. There are cases of individuals paying for Bitcoin by using credit cards or by <a href="http://fortune.com/2017/12/12/bitcoin-investors-mortgages/">re-mortgaging their homes</a>. The rationale for higher prices became more fantastical, with claims the price could rise to $100,000, despite <a href="https://www.cnbc.com/2018/05/01/warren-buffett-bitcoin-isnt-an-investment.html">more sober warnings</a>.</p>
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Read more:
<a href="https://theconversation.com/a-history-of-bitcoin-told-through-the-five-different-groups-who-bought-it-98359">A history of Bitcoin – told through the five different groups who bought it</a>
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<p>The possible triggers for a pause in Bitcoin price rises included concerns about increased government regulation of crypto-assets and the possibile introduction of central bank digital currencies, as well as the large theft of assets and collapse of exchanges that have <a href="https://www.businesstoday.in/exclusive/rebrain-or-rot/bitcoin-disasters-virtual-currency-cryptocurrency-invest-in-bitcoin/story/265555.html">dogged Bitcoin’s short history</a>.</p>
<h2>Going down</h2>
<p>In liquid markets such as stocks (where it is inexpensive to buy and sell assets in large values) the price decline can be steep. In illiquid markets, where assets cannot easily be sold for cash, the fall can be brutal. Examples include the mortgage-backed securities (MBS) and collateralised debt obligations (CDOs) that led to the Global Financial Crisis.</p>
<p>Bitcoin is <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3204237">particularly illiquid</a>. This is due to a large number of different Bitcoin exchanges competing; often substantial transaction costs, and <a href="https://theconversation.com/think-carefully-before-buying-bitcoin-and-dont-buy-the-safe-haven-claims-99134">constraints on the capacity</a> of the Blockchain to record transactions. </p>
<h2>The aftermath</h2>
<p>The aftermath of a bursting bubble can be brutal. The stock market crash of 1929 was a prelude to the Great Depression of the 1930s. The collapse in Japanese asset values after 1989 heralded a decade of low growth and deflation. The dot-com crash of 2000-01 destroyed US$8 trillion of wealth. </p>
<p>The effect of a crash depends the size, ownership and importance of the asset involved. The effect of the tulip crash was limited because tulip speculations involved a relatively small number of people. But sharp declines in property values during 2007 led to the worst financial crisis since the Great Depression.</p>
<p>Bitcoin is more like tulips. The entire market valuation was about US$300 billion at the peak. To put this into context, the US stock and housing markets are currently valued more than US$30 trillion each (the equivalent Australian markets are valued at A$2 trillion and A$6.9 trillion respectively). Relatively few investors own the majority – it is estimated that <a href="https://www.businessinsider.com.au/bitcoin-97-are-held-by-4-of-addresses-2018-1?r=UK&IR=T">97% of all Bitcoin are owned by just 4% of users</a>. This suggests the effects on the wider economy of the Bitcoin crash should be contained.</p>
<h2>Estimating Bitcoin’s intrinsic value</h2>
<p>The true value of cryptocurrencies is widely debated. Bitcoin entrepreneurs suggest a much higher price is justified. Others, such as Eugene Fama (a Nobel Prize winner) and Warren Buffett believe it is close to worthless. The <a href="https://www.bis.org/press/p180206.htm">Bank of International Settlements</a> has described it as “a combination of a bubble, a Ponzi scheme and an environmental disaster”. </p>
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Read more:
<a href="https://theconversation.com/what-is-the-real-value-of-a-bitcoin-96386">What is the real value of a bitcoin?</a>
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<p>Obtaining a realistic estimate of Bitcoin’s intrinsic value is tricky because it is not an asset that generates a periodic cash flow, such as interest or rental income. </p>
<p>For such an asset, value ultimately depends on what others are willing to pay for it. This often relates to scarcity. </p>
<p>This does not provide a positive story for Bitcoin. Though the total number of Bitcoins is limited, there are many competing, virtually indistinguishable cryptocurrencies (such as Ehtereum and Ripple). </p>
<p>Bitcoin also <a href="https://bankunderground.co.uk/2018/11/13/the-seven-deadly-paradoxes-of-cryptocurrency/">fails to meet the criteria of a currency</a>. Its the price movements are too volatile to be a unit of account. The transaction capacity of the Blockchain is too limited for it to be a medium of exchange. Nor does it appear to be a good store of value. </p>
<p>Since it produces no income, has limited scarcity value, and few people are willing to use Bitcoin as currency, it is even possible that Bitcoin has <em>no</em> intrinsic value.</p><img src="https://counter.theconversation.com/content/107596/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Lee Smales does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>From a peak of US$19,783, Bitcoin’s value has fallen by 80%. What makes Bitcoin worth anything?Lee Smales, Associate Professor, Finance, The University of Western AustraliaLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/914092018-02-08T10:06:31Z2018-02-08T10:06:31ZWhy stock markets crash – lessons from recent history<figure><img src="https://images.theconversation.com/files/205355/original/file-20180207-74512-8vgyt8.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">In the red.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-illustration/stock-market-arrow-aiming-down-on-103610648?src=n3KXAhmJQnXZh8cF-zGxSQ-1-4">shutterstock.com</a></span></figcaption></figure><p>Stock markets around the world suffered sudden, heavy losses on February 5 and 6. Following a 4.6% drop in the Dow Jones on the Monday, the Japanese Nikkei index fell by 4.6%, and European markets followed suit, with the FTSE 100 down around <a href="http://www.bbc.co.uk/news/business-42957834">2% in the first hour of trading on Tuesday</a>. There was a rebound on February 7, but things remain turbulent. The phrase “when the US sneezes, the rest of the world catches a cold” comes to mind. </p>
<p>The main culprit seemed to be <a href="https://www.theguardian.com/business/2018/feb/05/why-are-global-stock-markets-falling">fears of inflation hikes in the US</a>. If inflation is up, the government may soon <a href="https://www.ft.com/content/9d5e441e-0b02-11e8-8eb7-42f857ea9f09">start raising interest rates</a> to contain it. And when interest rates increase, this reduces the return investors get on stocks, making them less desirable – hence the sell-off. This means that, historically, when interest rates rise, <a href="http://onlinelibrary.wiley.com/doi/10.1111/j.1540-6261.2005.00760.x/full">stock prices tend to decrease</a>.</p>
<p>But markets do not only follow economic reasoning. They also follow human emotions and out-of-control algorithms. Here are some of the lessons from recent history’s big crashes.</p>
<h2>Flash crash, October 2016</h2>
<p>If a crash is unrelated to the economic fundamentals, it will quickly be corrected. This was the case of the flash crash in <a href="https://www.theguardian.com/business/2017/jan/13/pound-flash-crash-traders-sterling-dollar">October 2016</a> when the pound plunged by 6% against the dollar in a mere two minutes of trading. </p>
<p><div data-react-class="Tweet" data-react-props="{"tweetId":"784264540225544192"}"></div></p>
<p>This phenomenon can occur because of large sell orders from computer program trading, which may lead to sudden drops in liquidity. A lack of buyers to match the large sell orders pushes the price down, making the market illiquid.</p>
<p>In this type of crash, the market mistakenly believes that the sell orders are driven by new information on fundamentals, while it may be due to a wrong algorithm in a computer program. Once the market understands that the sell orders did not originate from genuinely bad news, stock prices should rebound.</p>
<h2>Black Monday, October 1987</h2>
<p>The biggest and most famous stock market crash is known as Black Monday, and took place on October 19, 1987. Stock markets around the world were hit, with the Dow plummeting 22.6% – still its largest one-day percentage decline.</p>
<p>The Black Monday crash has been attributed in part to a large number of “stop loss orders” – orders that are in place to sell a security once it falls below a certain limit (to stop your losses). Computer programs, being used for large-scale trading, were relatively new to Wall Street at the time and they began to liquidate stocks as soon as loss targets were hit. A domino effect took place – when many investors submit stop loss orders simultaneously, this drags the price of stocks down, resulting in a crash. </p>
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<img alt="" src="https://images.theconversation.com/files/205321/original/file-20180207-74509-zupsos.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/205321/original/file-20180207-74509-zupsos.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=490&fit=crop&dpr=1 600w, https://images.theconversation.com/files/205321/original/file-20180207-74509-zupsos.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=490&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/205321/original/file-20180207-74509-zupsos.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=490&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/205321/original/file-20180207-74509-zupsos.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=615&fit=crop&dpr=1 754w, https://images.theconversation.com/files/205321/original/file-20180207-74509-zupsos.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=615&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/205321/original/file-20180207-74509-zupsos.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=615&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="caption">Things got more complicated when computers were introduced.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-illustration/stock-traders-on-floor-new-york-242289160?src=PMF0QxbX1ZwHs4xcsu19XQ-1-1">shutterstock.com</a></span>
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<p>This alone <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=982615">does not explain the extent of the crash</a>. New regulatory restrictions may also have caused a lack of liquidity in the market, pushing down the price of stocks.</p>
<p>Unlike with the 2016 flash crash, the market did not rebound immediately after the Black Monday crash. This suggests that it also reflected the fundamentals at play. Similar to the recent crash, the Black Monday crash was accompanied by expectations of interest rate hikes. </p>
<h2>Bursting bubbles</h2>
<p>If stocks keep rising in price, but their fundamental values do not also rise, then they are overvalued and a bubble forms. This could be a result of speculation or technical traders who focus more on the price history of the stock and what the market is doing. </p>
<p>The key here is that while many market participants may agree that stocks are overvalued, they may think that others are unaware of this and they can capitalise on it. But sooner or later there will be a correction, when stock prices fall in line with their fundamental value. </p>
<p>This bursting is often preceded by a sharp increase in prices. The sudden drop occurs when the market suddenly realises that they have been mispriced, thanks to some new piece of information – the straw that breaks the camel’s back. </p>
<p>There is also the effect of <a href="https://www.investopedia.com/university/behavioral_finance/behavioral8.asp">herd behaviour</a> at play. Just as traders can buy stocks because everyone else is, traders can also follow the herd and sell, if they see everybody else doing so. This leads to a race to the bottom. </p>
<p>This happened with the <a href="http://onlinelibrary.wiley.com/doi/10.1111/1540-6261.00560/full">dot-com bubble in the late 1990s</a>, which involved stocks of high-tech companies. Optimistic individual investors are thought to have created the bubble, based on unrealistic expectations on the future performance of dot-com stocks. But the bubble burst once large institutional investors started selling off their dot-com stocks, making individual investors quickly change their mind and leading to large sell-offs. </p>
<p>When bubbles burst, stock prices will not rise to the previous level until the fundamentals improve again. There will be no immediate rebound, as the drop is a correction of a previous mispricing.</p>
<p>The latest tumble in global stock markets does not appear to be a full on crash – yet. Following the volatility of February 5, stocks did rebound, but it is hard to say whether the trouble is over.</p><img src="https://counter.theconversation.com/content/91409/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Enrico Onali has received funding from the Deutsche Bundesbank and the European Commission.</span></em></p>Markets follow a mix of economic reasoning, human emotion and out-of-control algorithms.Enrico Onali, Reader in Finance, Aston UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/894692017-12-28T10:53:18Z2017-12-28T10:53:18ZThree things that will shape the economy in 2018<figure><img src="https://images.theconversation.com/files/200223/original/file-20171220-5004-z5n8vv.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Future gazing.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-vector/businessman-telescope-explorating-future-eps8-rgb-662264896?src=tgjtA9u3plSx5HBMLlfDnQ-1-0">shutterstock.com</a></span></figcaption></figure><p>Whether you follow opinion polls, experts, the media, or soothsayers, a few common themes have emerged regarding the economy in 2018 and beyond. </p>
<p>These are Brexit, the rise of the robots and a continued obsession with bitcoin and cryptocurrencies. Here’s a primer on how to better understand these three stories that will dominate the news.</p>
<h2>1. Brexit</h2>
<p>Someone <a href="https://twitter.com/jimmfelton/status/920627894027776000?lang=en">claimed</a> to have asked their iPhone: “Siri, what’s a good metaphor for Brexit?” Siri replied with the news story of someone trying to kill a spider with a blowtorch, <a href="http://www.independent.co.uk/news/world/americas/man-burn-spider-house-down-blowtorch-tuscon-arizona-a8005991.html">and burning his house down</a>. It nicely captures Britain’s approach to the EU.</p>
<p>Few would deny there are problems with the EU; some of which may be as annoying as having an unwanted spider in one’s house. But there are different ways of approaching these issues, some of which may prove more drastic and costly than others. While moving the European Parliament between Brussels and Strasbourg may be a costly waste of resources, and the euro project <a href="https://www.theguardian.com/business/2016/aug/10/joseph-stiglitz-the-problem-with-europe-is-the-euro">never made economic sense</a>, it is quite another thing for a country to voluntarily give up access to its key export markets – as was recently <a href="http://www.kellogg.ox.ac.uk/discover/news/the-brexit-sword-hanging-over-our-universities/">made clear</a> by the founder of Cobra beer, Lord Bilimoria.</p>
<p>Even if the UK negotiates a favourable trade deal in 2018, what the impact will be on UK industry is unknown and unknowable. Hence the importance of developing <a href="https://theconversation.com/timid-industrial-strategy-means-britain-could-still-end-up-with-a-soft-brexit-71585">an effective industrial strategy</a>, to maximise the chance of UK industry being able to continue to sell to Europe, even if faced with tariff and other restrictions. It’s important for industries to compete on the basis of high quality and innovation. Such industrial success will also be key for finding new markets, which may prove vital if European ones are blocked.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/200358/original/file-20171221-17720-rd90qw.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/200358/original/file-20171221-17720-rd90qw.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=399&fit=crop&dpr=1 600w, https://images.theconversation.com/files/200358/original/file-20171221-17720-rd90qw.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=399&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/200358/original/file-20171221-17720-rd90qw.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=399&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/200358/original/file-20171221-17720-rd90qw.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=501&fit=crop&dpr=1 754w, https://images.theconversation.com/files/200358/original/file-20171221-17720-rd90qw.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=501&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/200358/original/file-20171221-17720-rd90qw.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=501&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Brexit trade negotiations will start in 2018.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/negotiation-great-britain-european-union-brexit-463766687?src=djZnlpwV7Hox-FcT7s3x9w-1-5">shutterstock.com</a></span>
</figcaption>
</figure>
<p>The industrial strategy looks good as far as it goes, in identifying potential growth areas, and setting out the sort of investments which will be required to stay at the forefront of new product and process developments. But it’s hard to get too excited when a number of its predecessors sunk without trace. </p>
<p>A big reason is that for over a century British industry has been locked in a <a href="https://theconversation.com/how-to-drive-britains-new-industrial-strategy-80770">trap of “short-termism”</a>, with managers focusing on the next quarter’s share price and dividend payout, for fear that if these dip their company may be prey to takeover. And behind this industrial weakness lies the dominance of finance and the City of London, which has always been more interested in global deal-making than domestic investment.</p>
<p>The unveiling of the latest industrial strategy <a href="https://www.inclusivegrowth.co.uk/new-industrial-strategy-can-support-left-behind-places/">left many asking</a> who is responsible for monitoring its performance and ensuring its success? It is unlikely to succeed unless such a commitment is made – along with delivering long-term industrial investment; greater corporate diversity; a revolution in Britain’s education, training, and skills base; the creation and implementation of regional policy; tackling inequality of income, wealth, and opportunity; boosting Research and Development and innovation; and ensuring environmental sustainability. </p>
<h2>2. Robots and jobs</h2>
<p>While the industrial strategy has focused on new technology sectors such as robotics, these have also been depicted as threatening to wipe out swathes of jobs over the next ten years. That may be, but we need to recall that the same was <a href="http://www.nationalarchives.gov.uk/education/politics/g3/">said by the Luddites</a> 200 years ago – and <a href="http://www.peoplescapitalism.org">many times since</a>. </p>
<p>There are two crucial aspects to why technology will not render us all jobless. First, although new technology replaces some jobs, <a href="https://theconversation.com/five-new-jobs-for-humans-if-robots-take-over-the-world-74277">it creates others</a>. And given that technological innovation usually helps promote economic growth, the outcome has generally been more jobs rather than fewer. </p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/200359/original/file-20171221-17709-qqml25.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/200359/original/file-20171221-17709-qqml25.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=359&fit=crop&dpr=1 600w, https://images.theconversation.com/files/200359/original/file-20171221-17709-qqml25.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=359&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/200359/original/file-20171221-17709-qqml25.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=359&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/200359/original/file-20171221-17709-qqml25.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=452&fit=crop&dpr=1 754w, https://images.theconversation.com/files/200359/original/file-20171221-17709-qqml25.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=452&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/200359/original/file-20171221-17709-qqml25.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=452&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">No need to look so worried.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-vector/job-applicant-sitting-line-human-research-530764171?src=_OpHrb_ntkPY9fTpot3a8Q-1-1">shutterstock.com</a></span>
</figcaption>
</figure>
<p>Second, if the number of jobs – or rather, the total amount of employment – were to decline, this should be a good thing, as the work could be shared out. This would give more time for leisure, with less intensive, stressful work. That has long been the promise, <a href="http://www.econ.yale.edu/smith/econ116a/keynes1.pdf">though rarely the reality</a>.</p>
<p>To reduce employment (either the number of jobs, or the amount each of us had to do, if a reduced amount of employment enabled greater leisure time for all) means increasing the amount produced per person (or per person hour). In other words, higher productivity. This is not occurring in Britain. Indeed, over the past ten years the UK has witnessed <a href="https://theconversation.com/debunking-the-uks-productivity-problem-88042">the exact opposite</a>, with the rate of productivity growth declining rather than increasing. So, don’t plan for your three-day week just yet.</p>
<h2>Bitcoin, blockchain and bubbles</h2>
<p>Much of the above – stagnant productivity growth, the need for an industrial strategy, even the vote for Brexit – might be laid at the door of the 2007-08 global financial crisis and the <a href="https://www.ft.com/content/b31c06a2-5a7a-11de-8c14-00144feabdc0">subsequent global recession in 2009</a> – the first time the world’s output and income had fallen since the 1930s.</p>
<p>Another thing to be wary of into 2018 is the fact that the danger of a repeat performance of this crash remains. International governments prevented the global recession slipping into a 1930s-style global depression by boosting government spending. But as soon as the immediate danger had passed the UK government – and several others – reverted to type, imposing austerity policies that <a href="https://theconversation.com/fact-check-has-austerity-held-back-economic-growth-40578">held back the already fragile recovery</a>.</p>
<p>So, another shock to the global system could create a further financial crisis and recession. Last time the trigger was <a href="https://theconversation.com/i-predicted-the-last-financial-crisis-now-soaring-global-debt-levels-pose-risk-of-another-84136">home-loan defaults</a>; what might trigger the next one? Defaults on the <a href="https://theconversation.com/are-we-facing-a-car-loan-credit-crunch-here-are-the-facts-83471">growing car-loan debts</a>? International conflict and even war? Or perhaps the bursting of the <a href="https://theconversation.com/the-bitcoin-bubble-how-we-know-it-will-burst-88511">bitcoin bubble</a>? </p>
<p><a href="https://theconversation.com/uk/topics/blockchain-11427">Blockchain</a> technology will be used increasingly for a range of activities – from the accreditation of global online learning to the creation of cryptocurrencies such as <a href="https://theconversation.com/uk/topics/bitcoin-1358">bitcoin</a>, which are basically IOUs in digital form. </p>
<p>So the answer to the question whether the bitcoin bubble will burst, or whether bitcoin becomes mainstream, is “both”. <a href="https://theconversation.com/uk/topics/cryptocurrency-8321">Cryptocurrencies</a> will replace some of what current banking and monetary systems do. But the extent may be limited by concerns over their use for illegal activities, their <a href="https://theconversation.com/bitcoins-energy-use-is-out-of-control-but-maybe-thats-the-point-89133">heavy resource use</a> in an era when we need to be making less use of energy, and their susceptibility to speculative bubbles and crashes, which always carries the threat of more general crises and recessions.</p>
<p>Happy 2018!</p><img src="https://counter.theconversation.com/content/89469/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Jonathan Michie does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Brexit, bots and jobs and bitcoin are set to dominate economics news in 2018.Jonathan Michie, Professor of Innovation & Knowledge Exchange, University of OxfordLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/885112017-12-06T13:51:08Z2017-12-06T13:51:08ZThe Bitcoin bubble – how we know it will burst<figure><img src="https://images.theconversation.com/files/197931/original/file-20171206-933-mrs2fs.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Ready to pop?</span> <span class="attribution"><a class="source" href="https://www.flickr.com/photos/dachis/9720357616/in/photolist-fNXnEG-8dUyK9-qArLkv-f2mRTy-ruWmjN-qAeKhU-f2mRmJ-rx8QCJ-9yLQ7q-rfDKZJ-edijNS-oZyttd-qAeT9A-cPbRrN-EEP9D7-dhkf3J-Re5h3Q-wJNeum-arbxSe-5rFAfp-5rKVFb-kZirBD-5rFB6V-Qi3sKM-8TkC8T-8TkBAa-8TkB2c-8TkFSa-8bSyUz-iUv7cD-aiDT5h-dMp4kh-aiB95e-cC6hbY-96wSTr-iUxdWL-8dUyKd-9ztRVj-fNXnxw-cweAAW-2hPsv-6AeoaZ-HUvQfx-GneHex-9exQRt-W4yiiZ-YQbegi-8S8zAi-8SbHxL-dRsLkh">Adam Dachis/flickr</a>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span></figcaption></figure><p>In the last year, the <a href="https://coinmarketcap.com/currencies/bitcoin/#charts">price of Bitcoin</a> has increased from less than US$800 to more than US$12,000. This huge spike in value has many asking if it is a bubble or if the high price today is here to stay.</p>
<p>Finance defines a bubble as a situation where the price of an asset diverges systematically from its fundamentals. Investment mogul <a href="https://www.bloomberg.com/news/articles/2017-11-28/vanguard-founder-jack-bogle-says-avoid-bitcoin-like-the-plague">Jack Bogle</a> says there is nothing to support Bitcoin, and the head of JP MorganChase, <a href="https://www.cnbc.com/2017/09/12/jpmorgan-ceo-jamie-dimon-raises-flag-on-trading-revenue-sees-20-percent-fall-for-the-third-quarter.html">Jamie Dimon</a> has called it a fraud “worse than tulip bulbs”. </p>
<p>Like any asset, Bitcoin has some fundamental value, even if only a hope value, or a value arising from scarcity. So there are reasons to hold it. But <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3079712">our research</a> does show that it is experiencing a bubble right now. </p>
<p>Together with <a href="http://business.dcu.ie/our-people/Dr-Shaen-Corbet">Shaen Corbet</a> at Dublin City University, we took as the fundamentals of Bitcoin elements of the technology that underpins it (and other cryptocurrencies). We looked at measures, which represent the key theoretical and computational components of how cyrptocurrencies are priced. </p>
<p>New Bitcoin is created by a <a href="https://www.investopedia.com/tech/how-does-bitcoin-mining-work/">process of mining</a> units called blocks. Bitcoin is built on blockchain technology – a digital ledger of transactions – which enables the currency to be traded independently from any central banking system, without risk of fake or duplicate Bitcoins being used. Instead of having a bank verify pending transactions (a “block”), miners check them and, if approved, the block is cryptographically added to the ever-expanding ledger.</p>
<p>So the first measure we examined relates to mining difficulty. It calculates how difficult it is to find a new block relative to the past. As per the <a href="https://www.investopedia.com/news/what-happens-bitcoin-after-all-21-million-are-mined/">Bitcoin Protocol</a>, the number of Bitcoin is capped at 21m (there are currently <a href="http://www.bitcoinblockhalf.com/">16.7m in circulation</a>). This means that as more people mine for Bitcoin and more blocks are created, each block is, all things being equal, worth less than the previous block. </p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/197937/original/file-20171206-933-1sdb7tk.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/197937/original/file-20171206-933-1sdb7tk.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/197937/original/file-20171206-933-1sdb7tk.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/197937/original/file-20171206-933-1sdb7tk.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/197937/original/file-20171206-933-1sdb7tk.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/197937/original/file-20171206-933-1sdb7tk.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/197937/original/file-20171206-933-1sdb7tk.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Bitcoin mining affects the cryptocurrency’s values.</span>
<span class="attribution"><span class="source">shutterstock.com</span></span>
</figcaption>
</figure>
<p>The second measure we looked at relates to the “hash rate”. This is the speed at which a computer operates when mining. To successfully mine Bitcoin, you must come up with a 64-digit hexadecimal number (called a “hash”), which is less than or equal to the target hash. The faster you can do this, the better chance you have of finding the next block and receiving payment. </p>
<p>The third measurement was “block size”. This relates to how large the chain is at any given time, with larger chains taking longer to mine than shorter ones. </p>
<p>And lastly we looked at the volume of transactions conducted. Any asset, in particular any currency, which is more widely used will be more valuable than one which is used less frequently. </p>
<p>In our study, we examined data from Bitcoin’s early days – from July 2010 to November 2017. The price of one Bitcoin did not rise above US$1 until April 16, 2011, then to US$10 on June 3, 2011 and US$100 on April 2, 2013. Since then the price rise has clearly been exceptional. </p>
<iframe src="https://datawrapper.dwcdn.net/mygLM/1/" scrolling="no" frameborder="0" allowtransparency="true" allowfullscreen="allowfullscreen" webkitallowfullscreen="webkitallowfullscreen" mozallowfullscreen="mozallowfullscreen" oallowfullscreen="oallowfullscreen" msallowfullscreen="msallowfullscreen" width="100%" height="450"></iframe>
<p>We then applied an accepted method that is used to detect and date stamp bubbles after they burst. In essence, this involves identifying the existence of an explosive component in a series. As the series, here the price of bitcoin, “explodes”, it runs the risk, like any explosion, of flying apart. </p>
<p>A possibly counter-intuitive result of this approach is that if a fundamental driver and the price of an asset both show an explosive component, we might not conclude a bubble is present. A bubble is when something deviates from its fundamental value. If the fundamental value is itself growing explosively then the price would also. </p>
<p>Think of dividends on a stock. If, somehow, these were to grow at an explosive rate we might expect to see the price do the same. While unsustainable, this is not technically a bubble. To overcome this, we then date stamp a bubble as being present when the price shows an explosive component and the underlying fundamentals do not. </p>
<p>Here are the results of the analysis:</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/197566/original/file-20171204-4062-195jztn.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/197566/original/file-20171204-4062-195jztn.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/197566/original/file-20171204-4062-195jztn.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=447&fit=crop&dpr=1 600w, https://images.theconversation.com/files/197566/original/file-20171204-4062-195jztn.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=447&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/197566/original/file-20171204-4062-195jztn.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=447&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/197566/original/file-20171204-4062-195jztn.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=561&fit=crop&dpr=1 754w, https://images.theconversation.com/files/197566/original/file-20171204-4062-195jztn.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=561&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/197566/original/file-20171204-4062-195jztn.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=561&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">The Bitcoin Bubbles.</span>
<span class="attribution"><span class="source">Authors own calculations</span></span>
</figcaption>
</figure>
<p>The orange lines denote when the price is showing explosive behaviour. We also see a period where the hash rate was growing explosively – the blue columns in late 2013 and early 2014. This is also an indication of a price bubble, which went on to burst.</p>
<p>So there are clear points where bubbles are visible – including now. The price of Bitcoin at present shows explosive behaviour in the absence of anything similar in its fundamentals. We see the price moving upwards in a manner that is not related to the technical underpinnings. It is a clear bubble. </p>
<p>A weakness of these tests and indeed all bubble identification tests is that they take place after the bubble has burst. Even this test, which can be redone as swiftly as new data arrives, is such. Bubbles by their nature grow in a compound manner – so even a day or two delay in addressing the situation can make a bubble significantly worse. </p>
<p>What is not yet available is an accurate advanced warning bubble indicator. In its absence, this approach may be the best. Unfortunately, we cannot use this approach to determine the extent of the bubble. There is no well-accepted model that suggests a “fair” value for Bitcoin. But whatever that level is, it is almost certain that, at present, it is well below where we are now.</p><img src="https://counter.theconversation.com/content/88511/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>An analysis of Bitcoin’s fundamentals shows how much of a bubble its price has inflated to.Larisa Yarovaya, Lecturer in Accounting and Finance, Anglia Ruskin UniversityBrian Lucey, Professor of International Finance and Commodities, Trinity College DublinLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/886562017-12-06T11:22:50Z2017-12-06T11:22:50ZBitcoin isn’t a currency – and unless it becomes one it could be worthless<figure><img src="https://images.theconversation.com/files/197837/original/file-20171205-22967-13ldzf4.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><span class="source">Shutterstock</span></span></figcaption></figure><p>Bitcoin is in decline. Not its price, which has <a href="https://www.coindesk.com/price/">increased 900% this year</a> and (at the time of writing) stands at over US$12,000 per unit, but its actual use as a currency. And this makes its rapid appreciation all the more puzzling. </p>
<p>A few years ago, enthusiasts triumphantly shared announcements from businesses that had <a href="http://www.telegraph.co.uk/technology/news/10562976/Major-US-retailer-starts-accepting-Bitcoin-payments.html">started accepting Bitcoin</a>. Over the last couple of years, such announcements have become scarce. Instead, businesses that once accepted the currency have begun to drop it.</p>
<p>The BBC contacted ten businesses in London that once advertised accepting Bitcoin. Four no longer accepted it, and two that did said they <a href="http://www.bbc.com/capital/story/20170906-what-you-need-to-know-about-the-latest-bitcoin-boom">hardly ever received payments in Bitcoin</a>. The same is even true online. The Wall Street Journal, citing a report by Morgan Stanley, recently reported that Bitcoin is now accepted by <a href="https://www.wsj.com/articles/bitcoin-is-the-worlds-hottest-currency-but-no-ones-using-it-1512142187">just three of the top 500 global online merchants</a>, down from five last year.</p>
<p>If growing adoption as a currency can’t justify Bitcoin’s rapid appreciation, what can? Many enthusiasts have started to promote the idea of <a href="https://www.wsj.com/articles/bitcoin-can-be-a-competitive-store-of-value-1505231277">Bitcoin as a store of value</a>. In economics, this is usually defined along the lines of <a href="https://books.google.co.uk/books?id=sSY9AAAAQBAJ&lpg=PP1&dq=Essentials%20of%20Economics%20(6th%20ed.).%20Mason%2C%20OH%3A%20Cengage%20Learning.&pg=PA437#v=onepage&q&f=false">“an item that people can use to transfer purchasing power from the present to the future”</a>. In simple terms, it’s somewhere safe to invest your wealth that won’t lose its worth over time.</p>
<p>Apples can be used to barter services from a neighbour while they’re still fresh, but their purchasing power will disappear as they rot. The purchasing power can be retained into the future by exchanging the apples for money, gold, government bonds or some other store of value.</p>
<p>Some items have <a href="https://books.google.co.uk/books?id=nYyJAwAAQBAJ&lpg=PP1&dq=virtual%20economies&pg=PA184#v=onepage&q&f=false">attributes that make them better stores of value</a> than others, whether we are talking about physical items or digital objects. Gold is a good store of value because it’s durable. Electronic bond certificates are also durable as long as banks’ systems don’t fail, and have the added benefit of being easier to secure than physical valuables. Money, both physical currency and digital bank money, has the advantage of being very liquid, so it’s easy to convert into a purchase when needed.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/197922/original/file-20171206-910-jenxyf.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/197922/original/file-20171206-910-jenxyf.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=300&fit=crop&dpr=1 600w, https://images.theconversation.com/files/197922/original/file-20171206-910-jenxyf.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=300&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/197922/original/file-20171206-910-jenxyf.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=300&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/197922/original/file-20171206-910-jenxyf.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=377&fit=crop&dpr=1 754w, https://images.theconversation.com/files/197922/original/file-20171206-910-jenxyf.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=377&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/197922/original/file-20171206-910-jenxyf.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=377&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Only one way to go from here?</span>
<span class="attribution"><a class="source" href="https://www.coindesk.com/price/">Coindesk</a></span>
</figcaption>
</figure>
<p>Bitcoin does share many of these attributes of a good store of value. It also offers potentially high levels of financial privacy, somewhat <a href="http://uk.businessinsider.com/cryptocurrency-value-explained-by-crypto-hedge-fund-cio-ari-paul-2017-11?r=US&IR=T">similarly to the offshore banking system</a>. This is an important attribute of a store of value for some people, although it also creates a lack of accountability and the potential for tax evasion.</p>
<p>But the most important attribute of a store of value is that it’s valuable. Gold is valuable because it has many industrial and decorative uses. Its price can fluctuate because of speculation on financial markets, but it can never fall to zero. There will always be someone willing to accept gold because it’s a useful commodity.</p>
<p>Similarly, US government bonds are ultimately valuable because they entitle the owner to a relatively secure flow of interest payments. Dollars and euros are valuable because they are widely accepted as a means of payment, and will continue to be so in the foreseeable future. In contrast, the future acceptability of the Venezuelan bolivar is in doubt, so people are desperately trying to exchange it to better stores of value.</p>
<p>Is Bitcoin valuable? It has no industrial or decorative uses, and it doesn’t entitle the holder to receive interest. It was intended to be valuable as a currency that is accepted the world over, but that doesn’t seem to be happening. The only major value that Bitcoin has now is its exchange value. Many people are willing to pay a lot of money today to get hold of some Bitcoin.</p>
<p>But what they are getting for their money is simply the hope that another buyer down the line will pay even more money for the coins. Once the music stops, there is no fundamental value to prevent the coins’ price from falling close to zero, save for their tenuous position as the currency of choice in the <a href="https://www.economist.com/news/international/21702176-drug-trade-moving-street-online-cryptomarkets-forced-compete">online drug trade</a> and <a href="http://www.vocativ.com/news/321790/the-weird-maybe-illegal-world-of-bitcoin-gambling/index.html">grey-area gambling</a>.</p>
<h2>Beanie Babies lessons</h2>
<p>The idea that Bitcoin is valuable because it’s a store of value is upside down. In reality, something becomes a store of value because it’s valuable. In the 1990s, people started to trade Beanie Babies on eBay. Prices of these limited-edition plush toys rose to thousands of dollars, and by 1997 they made up <a href="https://books.google.co.uk/books?id=daY0AQAAQBAJ&lpg=PP1&dq=the%20perfect%20store&pg=PT23#v=onepage&q&f=false">6.6% of the entire site’s</a> transaction volume.</p>
<p>Some people <a href="http://abcnews.go.com/Business/beanie-babies-mania-ends-bankruptcy/story?id=19785126">invested their life savings</a> into Beanie Babies, fully expecting their value to be preserved and more. But eventually people came to their senses and the market bombed. Beanie Babies are useful as toys and collectables, but that doesn’t justify thousand-dollar valuations.</p>
<p>My advice to individuals and institutions tempted by the headlines is to keep their savings away from Bitcoin and other cryptocurrencies and “initial coin offerings” (ICOs). I know serious <a href="https://www.oii.ox.ac.uk/blog/the-blockchain-paradox-why-distributed-ledger-technologies-may-do-little-to-transform-the-economy/">blockchain developers</a> won’t mind me saying this, because they see speculative bubbles and bursts as a distraction. For Bitcoin to truly function as a store of value, it first has to gain acceptance as a currency.</p><img src="https://counter.theconversation.com/content/88656/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Vili Lehdonvirta is the Principal Investigator of the research project "Distributed Ledger Technologies and Structural Change in Financial and Cultural Services", funded by the Alan Turing Institute, Infosys Finacle and DACS.</span></em></p>If you can’t use Bitcoin to buy anything then it has no intrinsic value.Vili Lehdonvirta, Associate Professor and Senior Research Fellow, Oxford Internet Institute, University of OxfordLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/815722017-07-27T13:34:26Z2017-07-27T13:34:26ZSilicon Valley firms are over-valued – here’s why a correction is coming<figure><img src="https://images.theconversation.com/files/180004/original/file-20170727-8533-bypmnr.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="https://www.flickr.com/photos/manoftaste-de/9483452871/in/photolist-fs2b98-dgWV3R-mX3Xx3-6xiuGW-aaLcXm-7X4Zjj-wWuE8S-o5BTeY-axYa2o-wiHi9L-7VcHft-9ZdBc4-abetZ3-7mD4zj-7Ud1Lr-hfFRBb-asjYVj-6fYqJS-9xzoiS-dLd5kE-9HwDdB-bWvRyG-bsJvdf-iSbzHw-95VPKh-3Pft6B-bsJv7y-6hhQvg-agvuX9-GqM5CE-bFDozT-bsJvFh-a7bdks-bFDmZk-bFDnyv-e8Linq-bsJuD7-bFDmVa-bFDnNi-bFDo96-bsJxUm-HLu4Wo-bsJuiy-bsJu4m-HLu4ES-w97DVN-o9Zzhw-DERbat-PaXbLb-a1RwYP">Christian Schnettelker</a>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span></figcaption></figure><p>As Facebook’s shares hit a record high, CEO Mark Zuckerburg will be patting himself on the back for bucking the trend and outperforming financial projections <a href="http://www.cio.com/article/3194866/it-industry/facebook-nears-2-billion-users-warns-ad-growth-will-slow.html">for eight consecutive quarters</a>. Meanwhile, many of his competitors are worried – and they should be. </p>
<p>While Evan Spiegel, 27-year-old CEO of Snapchat, enjoyed a yachting break, his company’s shares <a href="http://pagesix.com/2017/07/20/evan-spiegel-to-keep-sailing-with-bros-amid-snapchat-stock-dive/">sunk below their launch price</a>. The market is losing faith in the social sharing app’s ability to find features that Facebook cannot instantly copy. </p>
<p>Similarly, Travis Kalanick, ex-CEO of Uber, is also enjoying his <a href="https://theconversation.com/uber-gets-a-backseat-driver-as-kalanick-exits-top-job-79854">enforced break</a> as concerns grow around Uber’s business model and <a href="https://www.ft.com/content/09278d4e-579a-11e7-80b6-9bfa4c1f83d2">whether it can ever generate profit</a>. </p>
<p>Yet both businesses have been enormously effective in raising funds from investors. Uber has <a href="https://www.recode.net/2017/5/25/15686886/ride-hail-valuation-investment-uber-didi-lyft">raised around US$12 billion</a> and Snap <a href="https://www.forbes.com/forbes/welcome/?toURL=https://www.forbes.com/sites/alexkonrad/2017/02/02/snap-ipo-means-big-windfall-for-early-snapchat-investors/&refURL=https://www.google.co.uk/&referrer=https://www.google.co.uk/">around US$6 billion</a> (if you include <a href="http://www.firstpost.com/tech/news-analysis/snap-inc-raises-3-4-billion-in-its-ipo-shares-will-start-trading-on-nyse-today-3698657.html">proceeds from its float</a>).</p>
<p>Other Silicon Valley perennial under-performers <a href="https://theconversation.com/livening-things-up-can-twitter-stay-afloat-through-new-innovations-54579">Twitter</a> and <a href="https://theconversation.com/whats-going-on-at-yahoo-54121">Yahoo</a> have similarly raised significant sums from investors but failed to provide any sort of return. Too many tech companies seem to be better at raising funds from investors than generating profits from their operations. This speaks to a fundamental issue with the tech market and the level of investment that is being poured into it.</p>
<h2>The search for returns</h2>
<p>Since the 2007-08 financial crisis, <a href="http://www.global-rates.com/interest-rates/central-banks/central-banks.aspx">interest rates have approached zero</a>, forcing businesses and investors with cash to find other means of generating returns. The stock market is the obvious place, as returns from private equity and hedge funds <a href="http://fortune.com/private-equity-investors-effect/">have also been declining</a>. </p>
<p>The sheer weight of money looking for opportunities forces investment into more marginal opportunities that yield lower returns. Conversely, this same weight of money has been pushing share prices <a href="https://www.theguardian.com/business/2017/may/16/global-stock-markets-whats-driving-the-rise-and-will-it-continue">ever higher</a>, despite the uncertainties of <a href="https://theconversation.com/what-the-stock-market-tells-us-about-the-british-economy-post-brexit-63981">Brexit</a> and <a href="https://theconversation.com/why-markets-have-bounced-back-after-the-election-of-donald-trump-68636">Trump</a>. </p>
<p>Nowhere is the problem of finding destinations for cash more evident than in Silicon Valley. Enormous amounts are channelled into almost any opportunity in the hope of hitting the next Facebook, Google, or Amazon jackpot, and riding the share price surge. In turn, some of the money being thrown off by these mega corporates is dribbling down through the acquisition of other tech businesses at sky high valuations. </p>
<p>Start-ups that are valued at over US$1 billion have become so common they have a name: unicorns. But investors should start to question their value following the stock market launches of companies like <a href="https://techcrunch.com/2017/07/10/snap-falls-below-its-ipo-price-for-the-first-time/">Snapchat</a> and recipe and ingredients service <a href="https://techcrunch.com/2017/07/05/blue-apron-falls-9-on-fourth-day-as-a-public-company/">Blue Apron</a>, which have both rapidly fallen below their float price. </p>
<p><div data-react-class="Tweet" data-react-props="{"tweetId":"837309480111058951"}"></div></p>
<p>Valuations of US$24 billion for Snapchat made Spiegel worth US$5 billion. But there is no way of connecting this valuation <a href="http://uk.businessinsider.com/analyst-snapchats-valuation-numbers-dont-add-up-2017-3">with any hard statistics</a>, financial or otherwise from Snapchat’s books. And the banks which supported the float are becoming <a href="https://www.bloomberg.com/gadfly/articles/2017-07-13/snapchat-hasn-t-changed-but-investors-feelings-have">more sanguine</a> on the company’s outlook.</p>
<p>Uber has not yet listed, but is valued at <a href="https://techcrunch.com/2017/06/22/as-ubers-value-slips-on-the-secondary-market-lyfts-is-rising/">around US$50 billion</a> (down from US$68 billion a year ago), and backers have invested US$12 billion which is principally being used to fund incentives to drivers and customers. Uber is being launched amid significant incentives around the world, whatever the nature of the local competition. In effect, this consists of cheaper fares to passengers and subsidised pay to encourage recruitment of self-employed taxi drivers. </p>
<p>This is risky business. The unregulated taxicab industry is one that is traditionally viewed as unattractive to investors as profits have never done much more than cover drivers’ wages and car running costs due to the plentiful supply of drivers. </p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/180008/original/file-20170727-8516-13pj4gi.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/180008/original/file-20170727-8516-13pj4gi.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/180008/original/file-20170727-8516-13pj4gi.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/180008/original/file-20170727-8516-13pj4gi.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/180008/original/file-20170727-8516-13pj4gi.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=502&fit=crop&dpr=1 754w, https://images.theconversation.com/files/180008/original/file-20170727-8516-13pj4gi.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=502&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/180008/original/file-20170727-8516-13pj4gi.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=502&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Uber risky?</span>
<span class="attribution"><span class="source">shutterstock.com</span></span>
</figcaption>
</figure>
<p>Customers are fickle in that they will take the cheapest and most responsive taxi, and will have more than one taxi app. There is no patentable technology and most taxi businesses have their own apps. So once the Uber incentives cease, what is to stop the original taxicab companies claiming back market share? In short, app or no app, competition is fierce in this industry and there is little to guarantee Uber’s success.</p>
<h2>Sheer volumes of cash</h2>
<p>Silicon Valley firms are also awash with cash and the idea of giving it back to shareholders is apparently unappealing. Instead, much of it is spent on acquisitions which are partly intended to ensure competitor technologies do not reach a dangerous size. This is facilitated by the US Department of Justice, which has <a href="https://theconversation.com/are-us-antitrust-regulators-giving-silicon-valleys-free-apps-a-free-pass-63974">still not decided</a> whether normal competition law should apply in Silicon Valley. </p>
<p>Similarly, there is still a pursuit of the next big thing. Microsoft, for example, has spent almost US$60 billion on acquisitions such as <a href="https://www.wsj.com/articles/microsoft-to-acquire-linkedin-in-deal-valued-at-26-2-billion-1465821523">LinkedIn at US$26.2 billion</a>, and <a href="https://www.theverge.com/2016/5/25/11766540/microsoft-nokia-acquisition-costs">Nokia at US$7.2 billion</a>, along with more than a hundred others. It is not clear that any are delivering returns. Indeed, Microsoft tried to buy Yahoo for <a href="https://techcrunch.com/2008/02/01/wow-microsoft-offers-446-billion-to-acquire-yahoo/">US$45 billion</a> but luckily for them, the bid was rejected. Yahoo was eventually sold to Verizon this year – <a href="https://techcrunch.com/2017/06/13/verizon-closes-4-5b-acquisition-of-yahoo-marissa-mayer-resigns-memo/">for US$5 billion</a>. </p>
<p>It is likely that Microsoft’s attitude to risk is influenced by the <a href="https://seekingalpha.com/article/3586136-microsoft-earnings-preview-100-billion-cash-95-billion-held-overseas">US$100 billion of cash</a> it is sitting on. Google has bought more than 200 businesses, spending around US$24.5 billion on the ten biggest, including Motorola at US$12.5 billion. Facebook has been more prudent and successful, buying WhatsApp at US$19 billion in 2014 after paying US$1 billion for Instagram in 2012, then a 13 person operation. </p>
<p>Overall, the sheer volume of cash looking for a home is driving behaviour which in more “normal” times would be viewed as profligate and high risk. Indeed, investor behaviour has some <a href="https://www.wsj.com/articles/startups-spend-with-abandon-flush-with-capital-1412549853">similarities to the dot.com era</a> when it was seen as a good thing to burn through shareholder capital. </p>
<p>The canny investor may well be wise to let their cash rot in the bank rather than become involved in this casino, which runs the risk of coming to a sad end. <a href="https://www.theguardian.com/technology/2017/jul/02/is-it-time-to-rein-in-the-power-of-the-internet-regulation">Regulation is growing</a> and starting to catch up with technology, certainly outside the US. Sky high valuations bear little resemblance to future earnings capabilities and result from too much surplus cash and a wish to prevent competition growing up. A correction is coming.</p><img src="https://counter.theconversation.com/content/81572/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>John Colley does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>It hasn’t been a good round of earnings for Silicon Valley’s big names.John Colley, Professor of Practice, Associate Dean, Warwick Business School, University of WarwickLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/793502017-06-19T20:01:29Z2017-06-19T20:01:29ZPrice hikes in Ether and Bitcoin aren’t the signs of a bubble<p>When there is a rapid growth in any of the crypto-currencies and assets such as Bitcoin, Ether, Zcash and others, many will call it out as a <a href="https://techcrunch.com/2017/06/07/what-the-hell-is-happening-to-cryptocurrency-valuations/">bubble</a>. Indeed, on a relatively short time scale it clearly looks like a <a href="http://www.coindesk.com/25-billion-30-days-cryptocurrencies-bubble/">bubble</a>.</p>
<p>The entire <a href="https://coinmarketcap.com/">crypto-currency market capitalisation</a> currently stands at around US$100 billion; it was US$60 billion one month ago. But Bitcoin was worth 1/100 of a US cent in June of 2009, 7 cents in June 2010, and US$7 in June of 2012. </p>
<p>Recently all eyes were on Ether. Over a 90 day period, Ether appreciated twice as quickly as Bitcoin did in late 2013, when Bitcoin crashed to around 35% of it’s highest value. Aside from the 2013 crash, Bitcoin has experienced smaller crashes many times since, but is now worth double its 2013 high. </p>
<p>In the longer term, these are fluctuations around a strong growth trend. Crashes will cause some to abandon the field. But signals of longer term growth in these crypto-currencies and assets point to a possible emergence of a new type of market, through the building of a new economic infrastructure. </p>
<p>Ether is the token of the <a href="https://www.ethereum.org/">Ethereum</a> <a href="https://theconversation.com/au/topics/blockchain-11427">blockchain</a>, a platform that runs “smart contracts” through a distributed online ledger that records transactions. It’s second only to the crypto-currency Bitcoin in price. Some believe it will one day overtake Bitcoin (a process dubbed “<a href="http://www.coindesk.com/flippening-will-ether-pass-bitcoin-will-mean/">The Flippening</a>”).</p>
<h2>Price hikes not the sign of a bubble</h2>
<p>Fundamental aspects of the technology that underpins crypto-currencies and assets are causing people to re-imagine, and then enact, new ways of creating and exchanging value online. </p>
<p>The key difference between Bitcoin and Ethereum is that you can use Bitcoin for payments, but you can use Ether to automate any number of processes using <a href="https://theconversation.com/au/topics/smart-contract-23131">smart contracts</a>. </p>
<p>While many use cases for Ethereum are still at the proof-of-concept stage, it is now attracting the attention of major banks, businesses and <a href="http://www.data61.csiro.au/en/Our-expertise/Expertise-Strategic-insight/Blockchain">governments</a>, all interested in the potential of the technology to provide greater efficiency and transparency in transactions. That normalisation has collapsed the implicit risk premium attached to this technology. </p>
<p>Venture capitalist Albert Wenger describes the current activity in crypto-currencies and assets as “<a href="http://www.usv.com/blog/fat-protocols">fat protocol investing</a>”. To explain what this is, take the example of the underlying internet and web protocols (TCPI/IP and HTTP), used to build and run websites. These are not able to store value - therefore they are “thin protocols” in Wenger’s terminology. So instead, people invest in companies that make software (applications) and hardware that rely on these protocols.</p>
<p>Companies such as Google and Facebook made a fortune by collecting and storing data generated by users through their online interactions. Meanwhile, users, and the developers who created internet and web protocol, received nothing in return. Blockchain is a “fat protocol” because it can be monetised, including incentives for developers but also for users. For example, the creator of JavaScript and co-founder of Mozilla <a href="https://en.wikipedia.org/wiki/Brendan_Eich">Brendan Eich</a>, recently released an Ethereum-based web browser through which users can be paid for the attention they give to advertisements. </p>
<p>What is making crypto-assets and currencies appear bubbly is the way in which many of these new platforms and applications have raised money through what are called <a href="https://blockgeeks.com/guides/what-is-an-initial-coin-offering/">initial coin offerings</a>. An initial coin offering (a word play on ‘initial public offering’) is a mechanism by which developers sell the tokens associated with their platform to the public. Depending on the structure of the offering, buyers can usually then trade the tokens, creating secondary markets. As the founder of Ethereum, Vitalik Buterin, has noted, no-one has figured out the <a href="http://vitalik.ca/general/2017/06/09/sales.html">right model for these offerings</a>. </p>
<p>This could be due to the immaturity of the Ethereum platform and ecosystem (which started development in 2013 and went live only in 2015). What we’re observing here is a new economic infrastructure being built and coming online. In tweets on Tuesday, Buterin <a href="https://twitter.com/VitalikButerin/status/874521946079232000">distanced</a> himself from initial coin offerings, stating he would no longer agree to be an advisor. </p>
<p><div data-react-class="Tweet" data-react-props="{"tweetId":"874521946079232000"}"></div></p>
<p>So while the current speculation in crypto-assets should make us pause, this is not speculative <a href="https://theconversation.com/what-economics-has-to-say-about-housing-bubbles-74925?sr=1">like tulips, or gold mining stocks</a>. It is speculative like building a new city, in that infrastructure needs to be developed first before you get to see who moves there. </p>
<p>A further point to note is that investment bubbles are actually <a href="https://www.cis.org.au/app/uploads/2015/04/images/stories/policy-magazine/2007-summer/2007-23-4-jason-potts-b.pdf">useful and important mechanisms</a> for building new technologies because of the way they concentrate speculative resources on a new technology to facilitate exploration.</p>
<p>There is an enormous effort proceeding to building new crypto businesses and infrastructure on the Ethereum platform. If this platform does indeed begin to carry large parts of the global economy as predicted by <a href="https://www2.deloitte.com/au/en/pages/technology/articles/distributed-ledgers.html">Deloitte</a>, a business consultancy, then it’s still massively undervalued.</p>
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<p><em>These comments should not be construed as offering personal financial advice.</em></p><img src="https://counter.theconversation.com/content/79350/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Jason Potts has received funding from the Australian Research Council. </span></em></p><p class="fine-print"><em><span>Ellie Rennie has invested in blockchain technology. She receives funding from the Australian Research Council and Telstra. She is a Director of the Community Broadcasting Foundation. </span></em></p>While the current speculation in crypto-currency and assets should make us pause, this is not a speculative driven bubble like tulips, or gold mining stocks.Jason Potts, Professor of Economics, RMIT UniversityEllie Rennie, Principal Research Fellow, RMIT UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/420842015-05-27T10:18:56Z2015-05-27T10:18:56ZBeware of bullish bankers, their bubbles and the inevitable burst<figure><img src="https://images.theconversation.com/files/82683/original/image-20150522-32583-dnv5fw.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Bulls dominate Wall Street but behind them always lurks a big bear. </span> <span class="attribution"><span class="source">Wall St bull via www.shutterstock.com</span></span></figcaption></figure><p>Something happens between the bubbles, bailouts, boom and bust cycles that we can’t afford to ignore, and it’s happening right now in the US and Europe. It’s a kind of collective amnesia that lulls investors into forgetting exactly what and who caused the last financial crisis. </p>
<p>The collapse of Lehman Brothers, the mortgage crisis and the Great Recession of 2008 are already ancient history in the minds of investors, bankers and regulators. A few short years of low default rates and good loan growth creates that heady atmosphere of irrational exuberance that transforms staid bankers into high-wire risk takers.</p>
<p>With their hubris restored, bankers once again have convinced themselves - and everyone else - that they are the smartest players on the street with superhero risk-management skills. Regulators are beginning to <a href="http://dealbook.nytimes.com/2014/10/22/u-s-loosens-reins-but-mortgage-lenders-want-more-slack/?_r=0">loosen</a> their reins; investors fund bankers’ <a href="http://www.bloomberg.com/news/articles/2015-05-22/wall-street-flouts-fed-standards-to-fund-high-risk-loans">risky investments</a>; and credit rating agencies assign really high credit ratings to the securities banks issue. </p>
<p>Everybody has again become incredibly bullish about banking, which inspires a lot of risk-taking and more financial leverage. This can happen even in an environment of weak fundamentals, so when these fundamentals eventually manifest themselves in a negative shock, it rocks the markets. The boom dissolves into a financial crisis. </p>
<h2>Boom foreshadows doom</h2>
<p>Understanding the psychological bias (known as the availability heuristic, a sort-of mental shortcut that relies on using only the most readily available information, such as the most recent past, to arrive at inferences about the current and future state of affairs) that drives this kind of behavior is important. </p>
<p><a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2587168">My research</a> into the conditions and causes of the last two major financial crises reveals that the longer a lending boom lasts, the more trouble it foreshadows. More generally, during booms, any aspects of risk management in financial institutions <a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2565499">get corrupted</a> by a kind of overconfidence in the skills of bankers. </p>
<p>The recent <a href="http://www.bloomberg.com/news/articles/2015-05-20/six-banks-pay-5-8-billion-five-plead-guilty-to-market-rigging">foreign exchange scandal</a> in which many global banks were assessed billions of dollars in fines for rate-rigging is an example of the kind of reckless behavior that occurs when things have been going well. </p>
<p>While that may seem counterintuitive and almost paradoxical, it’s true. Research into the conditions that existed prior to the major financial crises that have occurred over the past eight centuries shows that virtually every crisis <a href="http://www.nber.org/papers/w13761.pdf">was preceded</a> by an asset price bubble in the economy and high leverage on the balance sheets of banks, conditions that suggest an environment tolerant of high risk. </p>
<p>And that’s exactly the environment we have now, as six years of ultra-low interest rates across the world have led to ever-rising debt loads in most countries and have created incentives for increased risk-taking in the pursuit of high yields, putting the financial system at risk of another collapse if regulators don’t act soon. </p>
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<figcaption><span class="caption">How boom turns to crisis.</span></figcaption>
</figure>
<h2>Stemming the cycle</h2>
<p>To prevent the boom-bust cycle, US and EU banking regulators need to adopt and enforce a policy that requires capital requirements that are strongly counter-cyclical. That means during good times, banks should be required to increasingly hold more and more capital, because the more capital banks have, the more circumspect they’ll be in terms of how much risk they take. </p>
<p>So, during good times, requiring banks to keep more capital is going to start putting the brakes on the rate at which bank lending grows. It’s not the only policy available, but it is one relatively easy fix that regulators could put in place now to mitigate or prevent the next crisis. </p>
<p>Unfortunately, the tendency is toward the exact opposite. The longer the boom goes on, the more relaxed regulators and banks’ internal risk controls become. </p>
<h2>How far will regulators go?</h2>
<p>Changing that would seem to be natural goal of <a href="http://www.bis.org/bcbs/basel3.htm">Basel III</a>, a voluntary, global regulatory framework on bank capital adequacy, stress-testing and market liquidity risk. The issue is: how far are regulators willing to go? How high are they willing to set capital requirements? </p>
<p>Existing capital requirements being contemplated under Basel III set the leverage ratio (a measure of how much capital a bank has) at 3%, but in the US, regulators have set it at 5%. We need to aim much higher. We <a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2341835">should be talking</a> about 10% or even 15% capital requirements (possibly depending on some assessment of overall portfolio risk via, say, stress tests). In the US we are moving in this direction with capital buffers determined by regulators based on stress tests.</p>
<p>I’m not suggesting that we do this overnight, but I think when the economy is doing well, when banks are doing well, when they’ve got high profits, it’s relatively easy to build up capital. By slowing down dividends paid to shareholders and retaining more earnings, banks can build up capital levels over three to five years. And perhaps in this process, we can think of ways in which we can lighten the regulatory burden on banks in areas that have little to do with prudential regulation and also reduce regulatory complexity, so that the costs of regulatory compliance for banks, which are quite substantial, are reduced.</p>
<p>The goal should be to get to that 10% to 15% watermark in terms of capital (along with less regulatory complexity), so that when the next crisis hits, we have the necessary shock absorption capacity within the banking system. Now, some bankers may complain that this will reduce their return on equity, but as I have pointed out in my earlier research, this is not necessarily detrimental to shareholder value. In fact, higher bank capital levels are associated with <a href="http://www.newyorkfed.org/research/staff_reports/sr390.pdf">higher bank values</a>. Moreover, over time, investors and analysts will recalibrate their expectations about return on equity in banking when they see a sounder and safer banking system. A lower return on equity is acceptable if the bank is sounder and more capable of absorbing risk.</p>
<h2>Meandering risk</h2>
<p>Meanwhile, regulators should be cognizant of the fact that when they restrict banking activities to control systemic risk and increase the costs of regulatory compliance for banks, many of the risky activities migrate to less heavily regulated parts of the financial services industry. </p>
<p>Currently, this is happening as broker-dealers and private equity firms pick up services that used to be performed by banks. In other words, the next financial crisis may not originate in banking, but that does not mean it will be any less damaging than the last one.</p>
<p>Regulators can only do so much to keep these firms from taking excessive risks. What they can do is ensure banks have enough capital and regulatory costs imposed on banks are not excessive, helping contain the next crisis and preventing the near-collapse we experienced in 2008.</p><img src="https://counter.theconversation.com/content/42084/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Anjan V. Thakor does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Bankers are back to their old ways, putting the global economy at risk just six years after standing at the brink of another Great Depression.Anjan V. Thakor, Professor of Finance, Washington University in St. LouisLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/337972014-11-05T06:13:30Z2014-11-05T06:13:30ZScientific research can be prone to bubbles too – neuroscience risks being the next one<figure><img src="https://images.theconversation.com/files/63613/original/9sc22j3b-1415102723.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Too late!</span> <span class="attribution"><a class="source" href="https://www.flickr.com/photos/vivaviena/15506124798">vivaviena</a>, <a class="license" href="http://creativecommons.org/licenses/by-nc-sa/4.0/">CC BY-NC-SA</a></span></figcaption></figure><p>Science, like any other field that attracts investment, is prone to bubbles. Overly optimistic investments in scientific fields, research methods and technologies generate episodes comparable to those experienced by financial markets prior to crashing.</p>
<p>Assessing the toxic intellectual debt that builds up when too much liquidity is concentrated on too few assets is an important task if research funders want to avoid going short on overvalued research.</p>
<p>The cause of the meltdown of the financial market is obvious: leveraged trading in financial instruments that bear no relation to the things they are supposed to be secured against. Science, too, is a market in which the value of research is ultimately secured against objects in the world. If the world is not as it appears in a research paper, does the research have value? </p>
<p>A paper that claims that smoking causes cancer or that terrorism is caused by poverty is valuable only if it turns out to be a good explanation of cancer or terrorism. As recently <a href="http://www.timeshighereducation.co.uk/407277.article">noted</a> by Philip Gerrans at the University of Adelaide, “[It] is why an original and true explanation is the gold standard of academic markets.”</p>
<h2>Hunting for bubbles</h2>
<p>Consider the recent investments in neuroscience. No one with an interest in scientific trends and science policy will have failed to notice that cognitive neuroscience is the next big thing. This narrative has been around for at least a decade, but now it is getting serious. </p>
<p>Take the <a href="http://www.wired.com/2013/05/neurologist-markam-human-brain/all/">recent award</a> by the European Commission of €1 billion (US$1.3 billion) to the Human Brain Project to build a “supercomputer replica of the human brain” or the US$1 billion Brain Activity Map project – “the largest and most ambitious effort in fundamental biology since the Human Genome Project” – <a href="http://www.nature.com/doifinder/10.1038/495019a">endorsed</a> by the US president, Barack Obama, in January 2013.</p>
<p>As with a leveraged investment in mortgage bonds, most bureaucrats have little or no competence in determining how these massive projects will turn out. Whether or not the expectations will be realised, research funding is framed with expectations that neuroscience will translate into jobs and growth. Neurotechnology – brain-based devices, drugs and diagnostics – is <a href="http://somatosphere.net/2010/11/privatization-of-neuroscience.html">projected</a> to be a US$145 billion industry by 2025.</p>
<p>It should be little surprise then to see newly emerging fields that attach “neuro” to some human trait – neuroeconomics, neuromarketing, neuropsychiatry, neuroethics – with the expectation that the techniques of neuroscience will explain the relevant human behaviour and practice.</p>
<h2>Impending neurobubble?</h2>
<p>The generous provision of funding for projects in neuroscience creates the first precondition for a science bubble. Add to this a second precondition: the presence of speculators. Both researchers and directors of research institutes hedge their bets by supporting research strategies that follow the current fashions, publication channels and funding streams. Consider for instance the vision of a <a href="http://www.neuroesthetics.org/statement-on-neuroesthetics.php">statement</a> from the prominent experimental neuroscientist Semir Zeki:</p>
<blockquote>
<p>It is only by understanding the neural laws that dictate human activity in all spheres – in law, morality, religion and even economics and politics, no less than in art – that we can ever hope to achieve a more proper understanding of the nature of man.</p>
</blockquote>
<p>And this tremendous <a href="http://www.wired.com/2013/05/neurologist-markam-human-brain/all/">claim</a> from a recent interview with the principal investigator of the Human Brain Project, Henry Markram:</p>
<blockquote>
<p>Once you have built a [a supercomputer replica of the human] brain, anything is possible. You could take it apart to figure out the causes of brain diseases. You could rig it to robotics and develop a whole new range of intelligent technologies. You could strap on a pair of virtual reality glasses and experience a brain other than your own.</p>
</blockquote>
<p>Combine these promises with a <a href="http://www.ncbi.nlm.nih.gov/pmc/articles/PMC2778755/">series of results from social psychology</a> suggesting that peer reviewers, students and lay citizens are likely to find explanations of psychological phenomena more convincing when they contain neuroscientific information – even in situations when the neuroscientific information is irrelevant to the explanation.</p>
<p>This situation resembles a number of well-documented phenomena in social psychology and behavioural economics called “<a href="http://www.springer.com/medicine/book/978-3-319-03831-5">pluralistic ignorance</a>” (a situation in which a majority of members in a group reject a norm, but incorrectly assume that most others accept it and therefore go along with it) and “<a href="http://onlinelibrary.wiley.com/doi/10.1111/meta.12028/abstract">bystander effects</a>” (where the greater the number of bystanders, the less likely it is that any one of them will help a victim). So, in other words, everyone can see something is wrong but everyone expects someone else to do something about it. These have been shown to have significant impact on processing information and making judgements.</p>
<p>Overly optimistic research programs and claims of future scientific impacts crowd out more modest and pluralist research strategies pursued by scientists in search for novel explanations and solid evidence building. And that is what science is all about, not only mainlining what may turn out to be a <a href="http://link.springer.com/article/10.1007%2Fs13347-013-0142-7">science bubble</a>.</p><img src="https://counter.theconversation.com/content/33797/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Vincent F Hendricks does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Science, like any other field that attracts investment, is prone to bubbles. Overly optimistic investments in scientific fields, research methods and technologies generate episodes comparable to those…Vincent F Hendricks, Professor of Formal Philosophy, University of CopenhagenLicensed as Creative Commons – attribution, no derivatives.