The South Sea Bubble, the History of Corporations and the Cryptocraze

People who have read my blog for some time know that besides value investing, I am a big fan of historic (and current) asset bubbles.

The South Sea bubble – recap

One of the most interesting historical stock bubbles was clearly the famous “South Sea Bubble” which peaked and collapsed around 1720. Besides the fact that Sir Isaac Newton lost a ton of money in this bubble, there is another interesting aspect of this bubble which is often overlooked:

The underlying construct which enabled this bubble was the invention of the “Business Corporation” which were initially created to gather enough capital for exploiting the colonies in the Netherlands and England. 

Up until 1711 or so, only a few “Business Corporation”s were existing, most of which were very solid dividend paying enterprises such as the East India company.

With the initial success of the South Sea company, the year 1720 became known as the bubble year with a lot of new companies being created as this article lists:

As South Sea Company shares bubbled up to incredible new heights, numerous other joint-stock companies IPOd to take advantage of the booming investor demand for speculative investments. Many of these new companies made outrageous and often fraudulent claims about their business ventures for the purpose of raising capital and boosting their stock prices. Here are some examples of these companies’ business proposals (History House, 1997):

  • For supplying the town of Deal with fresh water.
  • For trading in hair.
  • For assuring of seamen’s wages.
  • For importing pitch and tar, and other naval stores, from North Britain and America.
  • For insuring of horses.
  • For improving the art of making soap.
  • For improving of gardens.
  • For insuring and increasing children’s fortunes.
  • For a wheel for perpetual motion.
  • For importing walnut-trees from Virginia.
  • For making of rape-oil.
  • For paying pensions to widows and others, at a small discount.
  • For making iron with pit coal.
  • For the transmutation of quicksilver into a malleable fine metal.

And the most outlandish (and cunningly clever!) of all:

  • For carrying on an undertaking of great advantage; but nobody to know what it is.

In the same year 1720, the British Parliament decided enough is enough and basically prohibited Business Corporations with the “Bubble Act”. 

All undertakings … presuming to act as a corporate body … raising … transferrable stock … transferring … shares in such stock …, either by Act of Parliament or any charter from the Crown, … and acting under any charter … for raising a capital stock … not intended … by such charter … and all acting … under any obsolete charter … for ever be deemed illegal and void.[4]

Of course this didn’t help the stock price of the South Sea company which collapsed shortly thereafter. For the next 100 years or so, those dangerous corporations could only established by obtaining a “royal charter” which was granted very selectively.

However what is important to understand is that the concept of a “Business Corporation” thereafter was fully established.

It is hard for today’s investors to understand how life would look like if there were no Business or Stock corporations. In the old days, people would only act als private persons or some kind of partnerships. This had, among other issues the disadvantage that an entrepreneur was always personally liable if things didn’t work out.This was not a small problem as in those times debtors actually had to go to prison until their debt was worked off. Naturally this didn’t really improve the entrepreneurial spirit when business failure might mean a life long prison sentence.

It is fair to asume that only the Corporation allowed to issue stocks or bonds and fund the industrial revolution, Back then in 1720 Government though it was a much too dangerous innovation. But as we know now, this concept could not be stopped forever and resulted in today’s economy with unstoppable corporate juggernauts like Amazon, Google or Apple being worth hundreds of billions of dollars.

How does this relate to Bitcoin & Crypto currencies ?

Many investors I know compare the Cryptocraze with the Tulip mania, This was a 1637 event where in the Netherlands tulip bulbs were traded for astronomical sums for a few months. After the dust settled, all that was left were too many tulip bulbs but not much more.

The South Sea bubble however, as I mentioned above had much more profound impacts.

In my opinion, the current Cryptocraze is much more like the South Sea bubble than the Tulip mania.

Underlying the current Crypto currency mania in my opinion is a fundamental new way how to raise capital for and create a new type of decentralized organization.

This is very similar to the fledgling Business Corporation concept which fueled the South Sea bubble.

Similar to the South Sea bubble we see the ascend of the dominating concept (Bitcoin) and hundreds or thousands of copycats who try to make a quick buck or two. (ICOs) with even more stupid concepts than those listed above.

What is so far missing is the Government stepping in big time and abolishing most of those schemes. Nevertheless I think that will come at some point in time when enough people have lost a lot of money. However this is much harder to enforce as Crypto currencies are global and virtual and single countries can not do too much against it.

I guess it is also fair to assume that the initial “scheme” like in 1720 will not be the ultimate winner.

But the big question in my opinion is the following: Will have decentralized token based systems have the same impact on business and the economy than the concept of the Corporation 300 years ago ?

I am not sure but I would be carefull especially in assuming that today’s dominating digital “network” or “platform” companies will be unstoppable for decades to come. Especially such networks and platforms can be organized very nicely with decentralized token systems and we will see how this plays out.

In any case, I really like to follow everything with crypto currencies at the moment because I think that this is “history in the making”, only on “fast forward”. Other than with the south Sea bubble, I don’t think that we need to wait 100 years for the impacts.

For that reasons you might read more about this on th blog in the coming montgs (which in itself might be one sign for the top of the bubble).

 

 

 

12 comments

  • What do you think of the thesis that Bitfinex is printing unbacked Tether (USDT) to support BTC/USD?

    See for instance:
    View story at Medium.com

  • Interesting article, thank you. I think the idea that BTC is more like South Sea than Tulips is an optical illusion. While South Sea did indeed have a major impact in creating the corporation as an entity, a development which has an impact centuries down the line, BTC doesn’t have a similar feature. Yeah – people will mumble about decentralised block chain applications blah blah, but the reality is that there is no, and I mean NO use case for BTC which doesn’t have a better alternative today other than speculating someone will pay more for it than you did. The best I’ve heard is FX remittances to geographies with working internet but without a proper banking system – this is at best a corner use case.

    A decentrlaised ledger can just as well be implemented with a database – nobody has so far been able to explain why it’s better to have control in the hands of miners rather than some central authority. People moan the Fed creates money out of thin air – guess what – BTC is only one protocol change away from infinite supply – and all that’s needed for that protocol change is for 80% of the mining hash rate to deem it worth their while. And if you think you know the incentives behind the hash rate running BTC, then you’re a fool. When you read articles about rural Chinese BTC farms it’s clear we don’t really know why so much electricity is being wasted mining BTC – I would not be surprised if in 10 years time it comes out Putin was mining BTC to try and engineer some sort of bank crisis – he’s crazy enough to do it.

    So I remain sceptical – my prediction is that in 10 years time bitcoin will be as popular as Second Life (remember that?) is in 2017 (10 years after it peaked). The path to this, however, is something I will not dare predict.

    • So, why can crypto assets have value in general?

      I see at least two prerequisites: (1) The respective asset needs to be scarce (OK, most crypto assets are) and – more importantly – (2) it needs to provide a benefit / value / utility to its users / owners.

      In case of BTC, prerequisite no (2) has vanishedi, i.e., BTC has lost its utility as a means of payment / a currency:
      (1) it has become veeeery slow due to its blockchain’s congestion (just google “unconfirmed BTC transactions”) and (2) fees have become way to high for smaller payments.

      It will be interesting to watch, when the majority of market participants will finally come to realise this and act accordingly (sell).

      Right now, there seem just too many people driving demand with either no / little technical understanding of what’s going on OR career risk (emerging crypto hedge fund managers NOT investing in the biggest asset) or just plain speculators (probably most people as of now).

      I am not touching BTC with a ten foot pole.

      Please note, this is no “speculation advice” – wouldn’t call crypto assets “investments” as of now.

    • That’s the part where I disagree strongly. Yes, I think BTC is not the winner going forward. But if you look more closely there is interesting stuff happening. Filecoin for instance looks very interesting from a conceptual point of view. This could become a competitor for AWS for instance. I also would want to avoid invetsing into trust deposit banks etc.

      But again only time will tell.

      • As my criticism was only pointed towards BTC and not towards the crypto space as such, I don’t think we disagree.

        In contrast, I also think that there will be a couple of basic layer distributed ledger protocols that will not only survive, but become very important (my best guesses as of now are Ethereum and IOTA). Many successful DAPPs are going to be built on top of the surviving basic layers.

        Filecoin is built on a different protocol (IPFS) vs. BTC, so if the bitcoin blockchain should die – that would not have any functional impact on Filecoin at all.

      • Filecoin is a perfect example of why all crypto is today just a pyramid scheme. There is nothing in Filecoin which can’t be done just as well using other technologies. Distributed hard drive space? Sure – if Dropbox discovered it was somehow cheaper to provide storage on people’s laptops than in a data centre (surprise: turns out hosting hard drives is a scale business), there’s no reason why the Dropbox app can’t handle distributed storage. Method of payment? Well, banking system works for all other payments – why not for your distributed storage app?

        IMHO until cryptocurrency/blockchain technology finds a useful usecase which can only be solved with cryptocurrency/blockchain technology they will be nothing but a speculative pyramid scheme. Effectively the only unique use case is speculating someone will pay more for it than you will…..

        I think the current run-up in BTC is a positive feedback loop – people buy BTC because BTC has gone up, which causes it to go up even more. At some point we will run out of new people and then whole thing will collapse. Only then will we start getting journo articles along the likes of “FileCoin – actually why not just use AWS?” and the “hotness” will abate. In the interim, good luck to all!

    • An article which makes one my points that might be a worthwhile read – turns out you don’t need to control that many entities to control Bitcoin because the hashrate is so concentrated – https://medium.com/@homakov/stop-calling-bitcoin-decentralized-cb703d69dc27

  • No, I would not short Bitcoin as it can go anywhere (for some time)-

    And no, I would not short any stock market index either

  • I thing Mmi likes more predictable things than a speculative rollercoasters, also when shorting. The question I would address is if Mmi and Wally are bearish, why don’t they short s&p or some indices…

  • Are you interested in shorting this thing if possible?

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