THE great Sir Isaac Newton may have revolutionised our knowledge of the world but he still had his blind spots. He was sucked into the great mania of his day, the South Sea Bubble (pictured) and lost a lot of money. “I can calculate the motion of heavenly bodies but not the madness of people,” he ruefully reflected. In retrospect, he should have pondered the popular saying that was used to define his law of gravity: “What goes up, must come down.”
Investors in Bitcoin are learning this old truth. The price of the cryptocurrency peaked last month at somewhere over $19,000 (there is a very wide spread, a problem in itself) but, at the time of writing (around 11am GMT), some exchanges now show a price below $10,000.
Perhaps the best way of understanding Bitcoin is through a model of how bubbles operate. The classic model, developed by Hyman Minsky and elaborated by Charles Kindleberger, a historian who studied bubbles, has five stages: displacement, boom, euphoria, financial distress and revulsion. The displacement is some technological development that can be used to justify a “new era”—railways, canals, the internet or blockchain. A boom then occurs and drags in more and more investors; at some stage, we reach euphoria, where the boom is widely known to the public and there is talk about those who made millions from the trade. This stage had been reached in November, when there were adverts for cryptocurrencies on the train and discussions on popular radio programmes.
In the euphoria stage, people buy because others are buying and because they anticipate being able to sell quickly at a higher price. For a while, this trend is self-reinforcing. At some stage, however, doubts set in; some people decide to take their profits while they can. Bad news occurs; with Bitcoin, it seems to be reports that authorities in South Korea (where trading has been particularly active) are going to crack down.