This has become the epitome of market excess and bubbles.
Tulip mania was a period during the Dutch Golden Age when the price of bulbs for tulips reached an extraordinarily high level. It was during a 3 year period, from 1634 through 1637.
The bubble is considered the first based upon speculation.
Tulips were introduced into Europe around 1550. The demand soon exceeded supply causing a run up in prices.
Introduction
The entry of tulips into Europe is often attributed to Ogier de Busbecq who sent seeds to Sultan Suleiman the Magnificent. This is believed to happened in the 1550s (the date is 1554). Popularity started in the Netherlands in 1593.
Economic advances during this period led a golden age and people having more resources. In turn, tulips became a coveted item among the affluent.
Florists, or tulip traders, signed forward contracts to buy tulips at the end of a season. Thus the Dutch, who developed many of the techniques of modern finance, created a market for tulip bulbs. Short selling was banned by an edict of 1610. Those sellers were not prosecuted under these edicts, but forward contracts were deemed unenforceable, so traders could walk from deals if faced with a loss.
Supply was constrained by the novel way the tulips that were desired grew.
Tulips grow from bulbs and can be propagated through both seeds and buds. Seeds from a tulip will form a flowering bulb after 7–12 years. When a bulb grows into the flower, the original bulb will disappear, but a clone bulb forms in its place, as do several buds. Properly cultivated, these buds will become flowering bulbs of their own, usually after a couple of years. The tulip breaking virus spreads only through buds, not seeds, and propagation is greatly slowed down by the virus.
It was the virus that get the tulips the color patterns that made them so popular.
Speculation
Like any asset that people speculate upon, limit in supply starts the process of a bubble. As demand increased, growers paid higher prices for bulbs with the virus. With demand spreading in France, speculators entered the market. This happened in 1634.
The contract price of rare bulbs continued to rise throughout 1636. By November, the price of common, "unbroken" bulbs also began to increase, so that soon any tulip bulb could fetch hundreds of guilders. Forward contracts were used to buy bulbs at the end of the season.
Tulips were not traded through exchanges. Instead, the counterparty were individuals. Tulip trading became a part of Dutch society. The entire process was exchanging contracts as opposed to tulips.
Without any deliveries, contracts were changing hands repeatedly. This caused prices to keep rising.
By 1637 the contract prices stopped rising and collapsed. Trade stopped in the tulip market ending the one of the biggest bubbles in history.