Tulip mania is a classic example of the risks that come with speculation, and there are some key lessons Bitcoin investors can learn from it.
Bitcoin (BTC +0.23%) has no shortage of bullish and bearish investors. Although there are some people who believe it’s going to the moon and will hit more than $1 million in the future, there are others who believe that it’s destined to crash.
Michael Burry, who is best known for predicting the housing crash that occurred nearly two decades ago, belongs to the latter category. Not only is he bearish on Bitcoin, but he also compares the hype around the digital currency to what happened in Holland during the 17th century: tulip mania.
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Is Bitcoin a modern-day version of the tulip bulb mania?
The tulip mania is a classic example of what can happen when speculation runs rampant. In that bubble, demand for tulip bulbs soared out of control, before ultimately crashing and wreaking havoc on the economy.
While there may be some truth to that saga, there’s also an element of exaggerations; some historians cast doubt that it really did lead to a depression, arguing that it may not even have had a significant impact on the economy. Nonetheless, it is a widely referenced bubble when investors learn about the history of market crashes and the dangers of speculation.
It’s also a bubble that Michael Burry compares Bitcoin to, with one exception. “It’s worse than a tulip bulb, because this has enabled so much criminal activity to go deep under.” Bitcoin has been associated with many scams and has been a popular way for criminals to transfer money, but the big point Burry is making is that Bitcoin’s valuation is unsustainable and has reached absurd levels, which is why it’s comparable to the tulip mania that occurred centuries ago.
While you could certainly make the case that Bitcoin is a highly speculative asset, and thus, is similar to the speculation that took place around tulip bulbs, that’s where the similarities also end. Bitcoin, after all, has been rising for more than a decade; it’s not just a quick bubble where there’s a sudden increase and decline afterwards. The tulip bubble lasted no more than a few years, between 1634-1637.
Speculating can result in significant risk for investors
Even though Bitcoin may not be identical to the relatively shorter-lived tulip bubble, the lessons are still very relatable. In essence, speculation comes down to the greater fool theory, where the main reason for buying an asset is in the hopes that someone more foolish than you will pay more money for it in the future. It’s not based on fundamentals or any logical reason, besides perhaps a chart pattern.
The danger for investors is that can leave them with an extremely risky investment. Although some crypto enthusiasts project that Bitcoin might one day soar to more than $1 million, it’s simply based on the expectation that more investors will add it to their portfolios, even though its usefulness to investors goes back to that greater fool theory and the hope that someone will pay more for it, and thus, it will appreciate in value.
It’s a far different approach than investing in a stock based on its fundamentals, where you see a business is doing well and believe it’s going to grow and become more profitable; thus, you invest in it. That involves fundamental analysis rather than simply reading charts, and it can allow you to stay more grounded in your investments, tying valuation back to earnings or sales.
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Does Bitcoin belong in your portfolio?
Bitcoin is risky and it isn’t going to be a suitable investment for the vast majority of investors. While some people may believe it has the potential to be a good digital store of value, not unlike gold, that hasn’t proven to be the case. Bitcoin has often had wild fluctuations in value, and it can add to your overall risk, rather than reduce it.
Unless you have an extremely high risk tolerance, you’re likely better off avoiding Bitcoin. If you’re after a good growth investment, then a safer option is to simply buy a solid growth stock.