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Are We In a Crypto Bubble?

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With recent fluctuations in cryptocurrency values, many investors wonder what the future holds. Current investors may worry about losing money if a crypto bubble bursts, while new investors may be curious if it’s a good time to put in their money.

Crypto investors of all levels should consider the current state of cryptocurrency, how crypto bubbles work and how to recognize these trends.

What Is a Crypto Bubble?

A bubble occurs in a market when an asset is priced higher than its value. Typically, investments and assets are valued based on factors such as demand, earnings, growth potential and more. In some cases, however, the value of an asset will increase more than expected.

A crypto bubble forms under the following circumstances:

  1. Excitement over a specific asset leads to a rapid price increase.
  2. Investors notice the surge in value and invest in the asset, further increasing the price.
  3. As more people invest, the asset’s price will surpass its intrinsic value.

Not all rapid price increases indicate a crypto bubble. For example, price jumps can occur during recovery periods after a recession. The main difference is that these price increases can be justified by the traditional factors used to valuate an investment.

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Are We in a Crypto Bubble?

It is difficult to assess whether the value of various cryptocurrencies are justified or if they are simply being overvalued due to excitement. Traditional investments are valued based on business performance and other financial metrics, while cryptocurrency is primarily valued based on factors such as demand, cost of production and competition.

Bitcoin, one of the most popular cryptocurrencies, has been said to have many bubbles over the years:

While Bitcoin’s current price has since fallen to its current value of $21,450.54, as of Aug. 23, 2022, this is still much higher than many skeptics had believed it would reach when cryptocurrencies were first introduced. It’s difficult to determine what caused these fluctuations in Bitcoin’s value, since much of the value is derived from speculation.

How Crypto Bubbles Work

In any market, bubbles form and pop in similar ways:

  1. Bubbles typically begin with something that causes investors to shift their perspectives on a particular investment or investment vehicle. In this case, the invention of cryptocurrency may have been a catalyst for exciting new investment opportunities.
  2. Next, investors will begin to hear about the potential gains from the investment in question.
  3. Speculators will begin taking their chances, increasing the price further and attracting even more investors. Using Bitcoin as an example, its growth period from 2017 to 2019 is indicative of this phase. 
  4. At its peak, the bubble will attract many new investors who believe there is little risk and plenty to gain. They may make unjustified investing decisions, which will drive the price even higher.
  5. Finally, a few investors may lose money, which will then cause others to sell their shares. This causes a snowball effect, and while some investors may get out with gains, those who are too late to sell can end up with significant losses, and the investment price will drop back down.

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While Bitcoin’s highest prices in 2021 were followed by sharp declines, it is unclear whether this is a true crypto bubble since the factors used to valuate cryptocurrencies are difficult to determine.

How To Recognize Bubbles

The best way to recognize a crypto bubble is to understand the market behavior outlined above. However, many investors won’t recognize a bubble until it has popped. Plus, identifying crypto bubbles is more complicated than bubbles in traditional markets.

With traditional investments, an investor may be able to predict a bubble if the price begins to rise above the investment’s actual value. Individuals can look at business performance, financial metrics and other factors to determine the actual value of the investment.

When it comes to cryptocurrency, however, these traditional factors can’t be used. An investor may be able to identify crypto bubbles by examining investor mentality. For example, if a steep price increase occurs immediately following a viral social media post, it could be that investors are excited about a new opportunity.

The Future of Cryptocurrency

The cryptocurrency market is expected to almost triple by 2030. While more governments, businesses and individuals are open to cryptocurrency, there is still a lot of skepticism surrounding the value of cryptocurrencies and how to implement balanced regulations.

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People who invest in cryptocurrency identify benefits such as easy payment management, accessibility and working more closely with other individuals rather than banks and large organizations. However, they worry about market volatility and keeping their assets secure.

Because of these factors, there are mixed feelings about larger corporations investing in cryptocurrency and having the government place regulations on the industry. Since many investors like the non-traditional system cryptocurrency uses, they are skeptical of it becoming more corporate.

Moving forward, governments, companies and individuals will need to work together to create a system that balances the need for regulation with the desire to keep the existing peer-to-peer structure of cryptocurrency.

Takeaway

It is difficult to determine whether a crypto bubble is currently building. Therefore, investors may be uncertain as to whether they want to invest in cryptocurrencies or not.

When making investment decisions, individuals should consider the reasons behind wanting to invest money. For example, if a person invests in cryptocurrency simply because they want to join the crowd, they may wish to take more time to determine whether the investment makes sense.

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Information is accurate as of Aug. 24, 2022.