Cryptocurrencies have been increasing in popularity since their launch. As their value rises, it has led to an economic phenomenon called crypto bubbles. These refer to the financial cycle when the price of the asset goes up incredibly.
This happens because of the hype created by investors. Soon the price touches the extreme bottom. Economic bubbles occur because of the investor’s hype and speculation. People worry that when a bubble bursts, it will cause the prices of the cryptocurrency to fall dramatically.
In this article, you will find more information about what a crypto bubble is, how it works, and how to identify it.
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An Overview of Crypto Bubbles
Usually, what happens is that when a digital asset is captured inside a bubble cycle, it witnesses three chief events. These include the following:
- Price inflation, no matter what its intrinsic worth is.
- Increase in hype and speculation.
- Less level of adoption in the real economy.
Put simply, a cryptocurrency bubble means a very quick rise in crypto prices in a short period or recent months. People think that if this bubble bursts, the prices will fall down dramatically.
But we cannot say for full certainty that this will happen.
A cryptocurrency bubble is a phenomenon where the market increasingly considers the going price of cryptocurrency assets to be inflated against their hypothetical value. The history of cryptocurrency has been marked by several speculative bubbles.
Some economists and prominent investors have expressed the view that the entire cryptocurrency market constitutes a speculative bubble. Adherents of this view include Berkshire Hathaway board member Warren Buffett and several laureates of the Nobel Memorial Prize in Economic Sciences, central bankers, and investors.
What Happens During a Crypto Bubble
According to leading economists, crypto bubbles resembled a credit cycle. They have the these stages:
- Profit taking
The displacement stage occurs when an asset fascinates investors, and they buy it. This also increases the popularity of the asset. Now, the price of the asset starts rising.
When this happens, other investors also join in. The boom phase occurs when the price increases to newer resistance levels. In the end, the asset meets the headlines sparked by the hype of the investor community.
The euphoria phase occurs when the price of the asset inflates to very high levels. At this point, only hype and FOMO prevail about the asset. No trader practices caution at this point.
The profit-taking phase arises with the rise of warnings and sells pressure signals. This comes as a disappointment to investors.
In the panic phase is marked by the fear of the high price of the crypto bubble going down. Now, the price of the asset no longer inflates. Instead, it starts declining rapidly.
Experts say that the price of the cryptocurrency cannot inflate until the next bubble comes.
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How to Recognize a Crypto Bubble
Experts identify this economic bubble by co-relating the price movements of the digital currency and its internal value. The cryptocurrency is in a bubble when the inflation in its price does not relate to its intrinsic value.
It is difficult to accurately forecast a crypto bubble. Although there are various metrics available, they don’t make the job exactly easy. Another factor in determining the market sentiment is the Fear and Greed Index.
The Mayer Multiple is a metric that a famous investor, Trace Mayer, created. The value of this metric comes from the price of the existing Bitcoin over the 200 MA or moving average. Its formula is as follows:
Mayer Multiple = The market price of Bitcoin / 200-day MA value
This metric has two levels, 1 and 2.4. If Bitcoin’s market price surpasses the 2.4 level, it denotes the beginning of an economic bubble.
It is worth mentioning that in all the previous bubbles in history, the price of Bitcoin exceeded the 2.4 thresholds. So, we can say that the Mayer Multiple is a good metric for identifying the crypto bubbles.
Are We Present in a Crypto Bubble Right Now?
It is not possible to evaluate if the worth of different cryptocurrencies is justified or whether they are overvalued because of the hype. Usually, business performance and different financial metrics influence the value of traditional investments.
In contrast, the value of cryptocurrency is mainly on things like demand, competition, and production cost. Over the years, one of the most popular cryptos, Bitcoin, has experienced various bubbles. Some of the key examples highlighting this fact are as follows:
- The price of Bitcoin went over $13,000 in December 2017 before it burst.
- Bitcoin’s value surged to over $12,000 in 2019. It increased to such a level from $3,400.
- In October 2021, Bitcoin surpassed the $61,000 mark. This happened after several dips and peaks.
Currently, the price of this digital currency is much higher than what skeptics believed it would reach when cryptos were first released. We cannot say for sure what were the reasons for these fluctuations. This is because a huge part of these values is a result of speculation.
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Are There Any Risks of Crypto Bubbles
Yes. There are definitely risks associated with a crypto bubble. Here are the major ones.
- The first risk is that the financial bubble will burst. It, in turn, will make the prices fall dramatically. Thus, investors who purchase crypto at higher prices will incur many losses.
- A second risk is that many people believe that crypto may not always be there. According to many analysts, crypto is a fad, and its value will ultimately crash. In this case, investors will end up losing a lot of money.
- Finally, there is the fraud risk. Crypto is an unregulated asset class. So, there is a great scope for fraud. That’s why it is essential for investors to be cautious while investing in these digital currency.
The Future of Digital Currencies
The cryptocurrency market is forecasted to reach $4.94 billion by 2030. Although many governments, like those in the U.S. and Hong Kong, are welcoming digital currency, many are still suspicious of its impact on the economy.
For instance, Bolivia, Bangladesh, and Nepal, among others, have banned cryptos. It’s definitely possible that cryptocurrency can serve as a good alternative investment option in the future. However, there is much uncertainty associated with it. This is especially because of the predicament over the crypto bubbles.
One cannot say for sure whether we are living in a crypto bubble right now. If we are, it is critical to invest wisely. Always purchase a currency after much research. Remain updated on the latest trends from reputed channels. With the right knowledge, you can always protect your investments.