By definition, a market bubble can’t be recognized before it pops, but given the similar track records of some of the most famous bubbles in history, Tulip Mania, the US housing bubble, and the roaring twenties, we can identify clear patterns throughout their courses that serve as indicators to predict if we too, are currently in a bubble.
Cryptocurrency is a new form of digital currency that is traded and stored in a digital ‘wallet’, that doesn’t rely on a middleman and is not backed by the government or a bank. This new method of decentralized finance allows transactions to be performed in seconds and provides cryptocurrency access to everyone. Currencies, such as Bitcoin, are ‘mined’, meaning that they are collected through highly complex computer algorithms and stored in blockchain, a database divided into ‘blocks’ that are eventually filled with information, closed, and linked to a successive block. Bitcoin is a coin, something you own and something you can spend. Tokens, on the other hand are premined or computer generated, and are convertible into real money once liquidated.
There are a couple differences between investing in stocks and investing in crypto. There are numerous indicators that one can use when choosing what stocks to invest in, the leadership of the company, the company’s history, the annual financial report that public companies are required to publish, and graphs that depict the volatility and growth of the stock throughout the years. When comparing a graph of the S&P 500’s growth to those of the major cryptocurrencies, the S&P is flat while the cryptos paint an alpine skyline illustrative of their extremely high volatility. Due to this volatility, their investors are engaging in speculative trading. Speculative trading – when investors trade based on price fluctuations rather than long term profit, motivated by the possibility of making large profits quickly while subjecting themselves to the more likely possibility of losses – can be likened to gambling.
These large price fluctuations also make it risky for people to begin accepting cryptocurrencies such as Bitcoin as paychecks rather than fiat money. Recently New York City mayor Eric Adams announced he would accept his first paychecks in Bitcoin, and El Salvador is now accepting it as legal tender. This gives rise to the risk that the currency could drop significantly in value before they have a chance to liquidate it. Bitcoin, alongside Ethereum, is the leading cryptocurrency and is now beginning to gain purchasing power. Other cryptocurrencies are working towards gaining this same reputability and value, but until they reach it, they have virtually no intrinsic value.
Now let’s draw a parallel between cryptocurrency and a market bubble from this century: the dot com bubble. The internet boom of the early 2000s was when millions of people began investing in new technology stocks that had just hit the markets. Any company ending with a .com was a potential new gold mine.This was the first step of the boom, a new paradigm that sparked investors’ interests while also creating some hesitations due to its novelty. In this case, blockchain technology, new currency and its decentralization, are the new innovations that caused a hype.
The next step in a market bubble is the boom. During the dot com bubble, a whopping 457 companies conducted IPOs, and investors flocked to invest in any company ending in .com. Between 2021 and 2022 alone, the number of cryptocurrencies doubled- we now have more than 12,000 of them, with the amount increasing by nearly 1000 a month. Contributing to the boom are the hype people: people who spread the word about the benefits of investing in these new stocks, or in this case, currencies. We have a myriad of youtube videos, articles, and social media promoters taking over the internet with their propositions. Some of these, such as in the case of the SquidCoin, are pump and dump schemes where scammers boost the value of the currency with false claims, then sell once it’s inflated. 2021 was a breakthrough year for cryptocurrency, with the total market capitalization growing 187.5%, and funding from blockchain and crypto companies rising by nearly $20 billion.
Currently, we’re in the third phase of the boom: euphoria. The hype around crypto is higher than ever, as demonstrated by its integration into our lives and by the amount of new currencies being created on the daily.The market capitalizations of cryptos is rising rapidly, there are over 80 cryptos with market caps of over $1 billion. This overvaluation in relation to intrinsic value is the essence of a bubble. Another element contributes to the bubble theory, are the short lived hype coins. Hype coins are coins that are not mined with the same computer algorithms used for Bitcoin, but are coins that can be minted in innumerable quantities, condemning them to low values. These coins are hyped up until they reach values far greater than their intrinsic worths (which is virtually nothing since they have no purchasing power), then they have the rug pulled out from under them when the hype men begin selling, causing a panic that crashes the currency altogether. The life cycle of these now ‘dead’ coins are accelerated displays of a bubble. This practice of selling once the asset has grown in price is known as profit taking: the fourth phase of a market bubble.
Panic selling is the final phase of the bubble. Investors notice a decline in price due to the profit taking or the reassessment of the value of the asset, and panic sell, knowing that their investments are decreasing in value, and as everyone sells, the price markedly drops. In May 2021, Bitcoin, the most recognized form of cryptocurrency, dropped 37%. This drop partially due to Elon Musk tweeting that Tesla would no longer continue to accept Bitcoin as a form of payment, and partially due to China’s ban on crypto, showing that companies can back out at any second due to its considerable volatility causing major consequences for anyone involved.
Although this isn’t indicative of a panic sell or that we have reached the pop of the bubble, this large drop may be a foreboding of the future of the other, less established cryptocurrencies. Likening the progression of the rise of crypto to a market bubble is only a speculation into its course, for it has also created large profits for investors and the growth of decentralized finance is only at its beginning.