Crypto Carnage and the Tulip Mania

In the past few years, crypto suddenly became the buzzword in India. The vested parties started pushing this agenda through paid-up articles and advertisements. Newspapers and media were ablaze with such pieces showcasing the glamour and wealth involved with crypto. It was the perfect trap. No wonder the millennials and the Gen-Z got attracted to this latest fad. Bitcoin became the talk of the town, and Blockchain was the language of the street. Everyone was thrilled and excited. Euphoria started building around these words. Speaking about crypto, Bitcoin and Blockchain was the latest fashion. Owning crypto became a status symbol. One who did not have crypto was looked down as an ignorant fool. The tulip mania was booming. The herding bias was flourishing.

The writing on the wall was clear. Whatever goes up so fast has to fall down miserably. That’s what happened few weeks ago.

One of the largest and supposedly reputable crypto trading platforms FTX filed for bankruptcy. More than $1 Billion (Rs. 8,000 Crores) of funds are missing from the exchange. It is alleged that the founders have misused the funds. In recent funding round, FTX was valued at $32 billion however today it is worth a big zero. The native cryptocurrency, FTT lost more than 90% of its value. Investors are running for the cover. There is no respite anywhere. The money has gone forever. There is absolutely no possibility of any recovery. It is the end of the game for all those who blindly invested in crypto. Sad but true.

In Aug 2021, in my article “Should Retail Investors Invest in Crypto?” I had warned against investing in crypto. At that time, I received many calls from young professionals and students seeking my advice about investing in crypto. Even the parents asked me whether they should allow their children to invest in crypto. The temptation, greed, and peer pressure were at the nadir.

At that time, I counseled them and convinced them that they must not even look at crypto as an investment asset. Today, when I look back, I feel proud that I did my job honestly. I am happy that those who took my advice seriously are having a good night’s sleep. All others who are invested in crypto are doomed.

It may be noted that this scenario is not new. This is not unheard of. We have seen such things happening many times in the past. However, we hardly want to learn from history. History is replete with such examples. The saga of “Tulip mania” is reiterated many times in behavioral finance. Tulip mania is now used as a metaphor for a financial bubble. Way back in the year 1841, Charles Mackay in his famous book “Memoirs of Extraordinary Popular Delusions and the Madness of Crowds” tells the story of Tulip mania in great detail.

This happened in Holland in the year 1634. This was the golden era in Holland. The economy was at its peak. The new rich community was flourishing. People have surplus cash in hand. The situation was very similar to what we see in India today. At that time, having a Tulip at home was considered a status symbol. In a short period, the popularity of Tulips skyrocketed. Everyone wanted to have tulips. This increased the demand for Tulips and created a shortfall. The speculators took advantage of this situation. People now started trading tulip contracts. Those who did not own Tulip by then felt the fear of missing out (FOMO). This made them buy Tulips at any price. This further escalated the cost of Tulips. People started leveraging to buy Tulips. The speculation reached its peak. In today’s currency, one Tulip bulb was sold anywhere between $20,000 to $ 100,000. Due to such insane pricing, people could not honor the traded contracts. The bubble finally burst. However, the damage was already done. Many Tulip lovers lost their life savings.

In behavioral finance, this is called herding bias. In herding bias, the investors make investment decisions based on others’ opinions or information. They do not make rational decisions. They are tempted to follow what others are doing. They imitate others’ behavior. Such herding behavior invariably leads to financial disaster. This is the precise reason why we educate investors on investing behavior.

Tulip mania happened more than three centuries ago. Since then, the world has experienced many such bubbles. The Indian stock market has also seen many such ups and downs. The present carnage in cryptocurrency is certainly not the last. This will keep repeating till the human race is alive. Greed and fear will continue to haunt us.

Next time whenever you see such herd behavior, immediately make a U-turn and start walking on your own path. Worldly wisdom lies in behaving equinomously in every situation. Remember, your behavior will decide your destiny.

Charlie Munger was generous when he said, “Mimicking the herd invites regression to the mean.”

In this situation it is a “complete disaster” rather than “mean regression.”