An interesting thing to note about financial bubbles is that they often precede revolutionary changes in society.
The tulip mania that gripped people in Holland in the 17th century preceded the Dutch domination of the flower market. Dutch flowers, and tulips in particular, are sold in flower shops all over Europe. It is a big industry.
The South Sea bubble of the 18th century preceded the rapid expansion in world trade.
The .com bubble of the 1990s preceded the rapid adaption of the internet as a universal communication and information platform, and the Bitcoin bubble of today is no doubt heralding a revolution in banking and transactions.
There is in other words a general sense of revolution that fuel these bubbles. People are excited about something new. They can sense that something monumental is about to happen, and they want to get in on the action.
However, the revolution is only beginning, and few people are able to fully comprehend what is going on. There is a lot of room for wild speculations and little in the way of sober reflection. Things get blown out of proportion.
Tulips are flowers. The South Sea Company was a shipping company. Internet is a communication platform, and crypto-currencies are alternatives to the SWIFT system for international transactions.
All of this is pretty mundane stuff, yet people were for a while prepared to pay huge premiums for a piece of the action.
The fact that Isaac Newton, the worlds smartest man, managed to loose a fortune on the South Sea bubble illustrates that it was not just idiots that lost their sense of proportion. A lot of very smart people were gripped by the mania.
In retrospect, it's easy to chuckle at the insanity of it all. Why should the average guy in the street be invested in tulips, international trade, internet, or inter-banking transactions?
Sure, at sane prices, all of the above industries may be excellent investment objects. But at the peak of each of these bubbles, there was no rational way to explain the price.
I have heard relatively smart people argue that Bitcoin could go to a billion dollars a piece. Scarcity will drive up the price, they say. But "Toys R Us" shares are also limited in number. That doesn't make them valuable. Scarcity has no value in itself. Things have to be both scarce and useful to be valuable. But Bitcoin is not very useful, and will for technical reasons never become very useful either.
What eventually pops a bubble is reality. Once people understand more fully what the big deal is all about, there is a return to sanity, and the inflated prices quickly collapse.
Once people understood that tulips are in fact nothing more than flowers, despite their wonderful qualities, prices went down. Once people realized that the South Sea Company was but a single one of a multitude of shipping companies, the South Sea bubble collapsed.
The .com bubble burst for the same reason, and once people realize that Bitcoin is but one of many possible alternatives to SWIFT, the current market cap of more than 120 billion dollars is sure to come down.
Most likely, Bitcoin will go the same way as the South Sea Company. The South Sea Company never had more than a few ships sailing. Bitcoin is hardly used in any cross border transactions.
What we are likely to see in the near future is a revolution in banking and money technology. However, just like the South Sea Company never became a part of the revolution in world trade, Bitcoin will not be a part of the coming revolution in banking.
What is coming will be quite different, and in the end, quite mundane. Everyone will shake their heads and wonder why people all over the world suddenly wanted to be part owner of an international transaction system that had quite obvious flaws in its implementation.
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