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1. What are crypto bubbles?

What is crypto?

Before understanding what crypto bubbles are, it's important to first take a look at what cryptocurrency itself is. Crypto is a form of digital currency that uses cryptography for the sake of security measures. Cryptocurrencies are decentralized and usually run on blockchain technology.
All the transactions on blockchain are recorded in this huge public list. So it is hard to cheat because everything is visible to all users. Unlike banks, anybody can join and use this since it is not controlled by any person or government.

What is crypto

Why are people so interested in crypto?

There are two main major reasons why people become so interested in crypto.

First, it is overly believed that it will become a better way to make payments in the future than today's conventional systems: faster, cheaper, and more secure. Having this potential for innovation and better financial transactions is the influence of increasing interest and investment in various cryptocurrencies.
Second, many people believe cryptocurrency is a way to get rich. They want to invest in crypto today to sell later at a higher price for huge profit. Most of the investors who want to gain quickly flow in for the speculative element of the crypto.

Both these reasons create crypto bubbles. The belief in the future potential of cryptocurrencies, together with the hope for high returns, increases demand, inflating their prices. The more this climbs, the more people are interested in buying them—the fear of missing out on possible profits. This self-reinforcing cycle of increasing demand and rising price can inflate crypto bubbles. When crypto bubbles finally bursts, prices can drop dramatically, sometimes causing quite big losses relative to those who bought at the peak. The phenomena of crypto bubbles thereby go directly back to the motivations of those investing in the market.

What are crypto bubbles?

Crypto bubbles are the phenomenon where cryptocurrency prices go up very fast, not because the cryptocurrencies are actually worth more, but it is due to the fact that lots of people suddenly get excited and start buying them. This rush to buy causes prices to rise even more, creating what are known as crypto bubbles.
Crypto bubbles, or coin bubbles, happen when a cryptocurrency becomes very popular for a short time. During this period, its price increase rapidly because more people buy in, hoping to make a profit. However, this excitement usually doesn't last for long. When they lose their interests or realize the prices are too high, they stop buying, and prices can drop just as fast as they went up. This rise and fall in prices is what defines crypto bubbles.

What are crypto bubbles

Source: Adobe Stock

Crypto bubbles are quite similar to bubbles in other markets, like the housing bubble or the dot-com bubble. In both cases, prices go up too much because of speculation, and then crash as people realize the assets aren't worth as much as they thought. The difference of crypto bubbles with other types of bubbles is that they can happen much faster because of how quickly information spreads online and the volatile nature of cryptocurrencies.
Therefore, understanding crypto bubbles is important for anyone thinking about investing in cryptocurrencies. Knowing the signs of crypto bubbles can help you make better decisions and avoid losing money by buying into the hype without doing proper research.

2. Signs of crypto bubbles

Crypto bubble chart

Classic crypto bubble chart. (Source: Forbes)

There are several ways to identify potential crypto bubbles in this market:

Prices increase quickly: One of the main signs of crypto bubbles is when one coin's price increase very fast, much faster than the actual value of the cryptocurrency can justify. This quick increase usually means the market is driven by speculation, not real value.
People buy based on hype, not facts: People are buying crypto because everyone else is doing the same, not because they actually understand it. Cryptocurrency prices are often driven more by speculation trading and "animal spirits" than by rational economic factors.

Animal spirits in crypto world

Source: Medium

Crypto doesn't move along with the regular economy: Normally, the value of things goes up and down with the economy. In other words, the economy has a huge impact on crypto. However, sometimes it’s different from real-world events. Therefore, this could be an indication of crypto bubbles.
Leading investors might be manipulating the prices: Sometimes, big invertors, also known as whales, can control the price of a cryptocurrency. Their words can manipulate people into buying or selling a certain cryptocurrency. A study by Neil Gandal and others showed that there was a small number of leading investors who manipulated the 2013 Bitcoin bubble; this proved how much the cryptocurrency market is at the mercy of speculators.

Crypto bubbles can grow due to market manipulation. And here's how:

Manipulators buy large amounts of cryptocurrency: When big investors buy a lot of cryptocurrency, it can cause prices to rise quickly.
Their movements catches the attention of other investors: As prices go up, other investors notice and start buying too, pushing the price even higher.
FOMO: When cryptocurrency prices go up higer and higher, many people will get FOMO and buy without doing careful research. This pushes prices even higher and makes the cryto bubbles even bigger.

Bitcoin-USD exchange rate with periods of suspicious activity shaded

Bitcoin-USD exchange rate with periods of suspicious activity shaded. (Source: Neil Gandal and others)

By knowing these signs, you can recognize potential crypto bubbles and avoid getting caught up in the hype. This awareness can help you make better decisions and avoid losing money when prices suddenly drop.

3. Is crypto a bubble?

The cryptocurrency market has gone through huge price bubbles in the past. For example, the 2017 Bitcoin bubble is that which mostly brings comparisons to the NASDAQ Dotcom bubble in 2000. In both cases, prices skyrocketed due to speculation rather than economic fundamentals. The research evidence to date finds Bitcoin and other cryptocurrencies do experience rapid price jumps followed by serious crashes, a classic signal of a price bubble.

Dotcom bubble

Dotcom bubble. (Source: Yahoo Finance)

Crypto bubbles in Historical Price Data:

2017 Bitcoin Bubble: Bitcoin's price went from about $1,000 in early 2017 to nearly $20,000 in December 2017, then dropped to around $3,000 by December 2018. This dramatic rise and fall is a clear example of crypto bubbles.
2000 NASDAQ Dotcom Bubble: The NASDAQ Composite index soared in the late 1990s due to internet company speculation, peaked in March 2000, and then crashed significantly over the next few years. This historical comparison helps to understand the nature of crypto bubbles.

Volatility Patterns and Crypto Bubbles:

Cryptocurrencies, especially Bitcoin, show high volatility with big price swings. This is a common sign of speculative bubbles. For example, between 2021, the price of Bitcoin spanned from roughly $30,000 to as high as $65,000 within months.

Volatility Patterns and Crypto Bubbles:

During the 2017 bubble, many retail investors jumped in due to fear of missing out (FOMO), and many initial coin offerings (ICOs) were launched without solid business plans. This kind of speculative trading is a hallmark of crypto bubbles, where hype and excitement drive people to invest.
Similarly, huge investments were poured into internet companies with less consideration as to their profitability or business sustainability during the dot-com bubble. This behavior is similar to what we often see in crypto bubbles.

4. Are we in crypto bubbles?

It's hard to say for sure if we're currently in crypto bubbles, but there are several signs that suggest it might be the case:

Past Bubbles: The 2017 Bitcoin bubble has similarities to the 2000 NASDAQ Dotcom bubble.
High Volatility: One common sign of economic bubbles is sustained high volatility, particularly in some major crypto currencies such as Bitcoin (BTC), Ethereum (ETH), Tether (USDT), BNB (BNB), Solana (SOL), etc.
Switching behavior: With those positive news, money can be basked from traditional assets such as stocks and gold to Bitcoin. It can thus lead to even more speculative trade.

Crypto Bubbles

Source: Crypto Bubbles

5. How to handle crypto bubbles

Here are some general strategies that might help you to deal with a crypto bubble:

Diversification - Don't Put All Your Eggs in One Basket: Cryptocurrencies are known to swing in their prices, so you should think about diversification across assets and not putting too much into cryptocurrencies.
Risk Management - Know Your Limits: Manage your risk carefully through proper position sizing, stop loss orders, and other mechanisms of risk assessment to avoid crypto bubbles.
Focus on Economic Fundamentals - Look Beyond the Hype: Do not put your money into something because everybody is buying it. Ensure that any cryptocurrency offers utility to you and that the technology behind it is actually useful. Understand economic factors and appreciate the real values of cryptocurrencies and other digital assets, rather than relying solely on market sentiment and speculation.
Patience and Discipline - Stay calm: It's really difficult to get rich quickly with crypto, so there is no urge to chase a quick dollar by quickly realigning your portfolio in order to jump onto the next price spike. To better withstand the inevitable pops of a cryptocurrency bubble, maintain a more disciplined, long-term investment strategy.

Conclusion

Crypto bubbles occur when the prices of a certain coin go up rapidly, which is often caused by hype on social media. Crypto bubbles can lead to huge increases in market capitalization, as more people enter the market with the hope of profiting from rising prices. However, these surges are typically unsustainable. When crypto bubble bursts, it results in dramatic price crashes and significant financial losses for many investors. The high volatility and frequent price fluctuations in the crypto market make it especially susceptible to such bubbles.

The limited supply of many cryptocurrencies, like Bitcoin, can make price bubbles worse. When more people want to buy and the supply doesn't increase, prices can soar to unrealistic levels. Eventually, when the excitement fades, the market can drop sharply. Despite these risks, cryptocurrencies are now considered as a legitimate asset class within the financial system. The decentralized nature of the Bitcoin network and other crypto platforms offers unique advantages, but investors should be careful of bubbles and ready for the market's natural ups and downs.

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Crypto Bubbles: Everything You Need to Know

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