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1855, theater slang for "a failure," by 1862 acquired the general sense of any dismal flop, on or off the stage. Via French phrase fiare fiasco "turn out a failure" (19c.), from Italian far fiasco "suffer a complete breakdown in performance," literally "make a bottle," from fiasco "bottle," from Late Latin flasco, flasconem (see flask).
The reason for all this is utterly obscure today, but "the usual range of fanciful theories has been advanced" [Ayto]. Weekley finds it utterly mysterious and compares French ramasser un pelle "to come a cropper (in bicycling), literally to pick up a shovel." OED makes nebulous reference to "alleged incidents in Italian theatrical history." Klein suggests Venetian glass-crafters tossing aside imperfect pieces to be made later into common flasks. But according to an Italian dictionary, fare il fiasco used to mean "to play a game so that the one that loses will pay the fiasco," in other words, he will buy the next bottle (of wine). That plausibly connects the word with the notion of "a costly mistake."