A financial bubble refers to an economic phase marked by a swift escalation in asset prices, reaching levels that are ultimately unsustainable, generally fueled by overly optimistic market conduct. This euphoric sentiment ultimately culminates in a bubble burst, causing the asset to suddenly decline in value. Note that, within a bubble, assets tend to be traded at prices or within price ranges that significantly surpass their intrinsic value.
With that said, cryptocurrencies, being a relatively new asset class, are even more prone to this financial bubble and burst phenomenon. In this article, we will explore what a crypto bubble is, how to detect if a bubble is forming, and how to adapt your trading approach during a crypto bubble.
What is a crypto bubble?
A cryptocurrency bubble emerges when countless individuals rush to acquire a specific digital currency driven by the belief that its value will skyrocket, allowing them to amass substantial wealth.
However, as is frequently the case, the price ultimately escalates beyond reason only to undergo a downward spiral. Fear ensues and prompts a mass exodus of investors who sell off the cryptocurrency, thereby exacerbating the decline.
With each subsequent drop, more individuals succumb to panic, triggering a relentless cycle of crashing prices and continuous selling until the coin’s worth shrinks to near insignificance.
Experts typically attribute 5 stages to a crypto bubble, which are:
The first phase, displacement, occurs when investors become captivated by fresh investment prospects, like a ground-breaking technology, an alteration in policies, or a shift in the relevant economy. In the case of a crypto bubble, the emergence of some extraordinary blockchain technology, a substantial advancement in the cryptocurrency sector, or sudden hype about some digital coin would fall under displacement.
During the boom phase, prices initially experience a gradual ascent before gathering steam and soaring to unprecedented levels.
As the upward trajectory persists, an influx of investors flocks to the market, fuelling a self-perpetuating cycle of purchasing and escalating prices. The apprehension of not wanting to miss out on a potentially extraordinary chance propels further speculation, attracting a growing multitude of investors and traders into the realm.
In this period, restraint is abandoned as asset prices soar uncontrollably. Investor zeal reaches its pinnacle, and the market succumbs to a state of irrational euphoria. Participants harbor the conviction that prices will surge endlessly, typically neglecting the fundamental realities.
During the profit-realization stage, investors who got into the market early and made big profits begin speculating that the bubble burst might be close to rupturing. They decide to forfeit their assets to lock in their gains amid apprehension of losing their profits if they wait too long.
But it is not easy to predict exactly when a bubble is about to burst because markets can behave irrationally for a long time. Moreover, this phase can mix with other stages and show different levels of intensity and duration depending on market conditions and how investors feel.
In the final stage, also known as panic, asset prices swiftly reverse their upward trajectory and descend due to an excessive supply rather than demand.
Fear and anxiety grip the market as prices decline, triggering a frenzied rush to sell assets. Investors and speculators, confronted with the rapid devaluation of their holdings and signs of the bubble burst, seek to get out of the market at any price.
How to identify that a crypto bubble is forming?
While it is impossible to accurately pinpoint a crypto bubble formation, some factors can always hint at a bubble’s emergence. Some of them are:
- If a digital currency undergoes an abnormally swift and unsustainable price surge within a brief timeframe, it may suggest the presence of a speculative bubble. Sharp price gains disconnected from the fundamental aspects of the project frequently serve as an alert. In such circumstances, it is prudent to closely monitor the coin’s price. If it substantially rises without any significant news or technological advancements supporting the increase, a bubble might be forming.
- Social media has become so prevalent nowadays that a mere few shares or retweets can propel a coin into the spotlight as “the next biggest opportunity.” If the predominant topics in mainstream media, social platforms, and investor conversations revolve around fast and explosive profits with some tinge of FOMO, it could indicate the emergence of a bubble. Essentially, it is crucial to exercise caution when the emphasis shifts from technology and utility to purely imaginative elements.
- When trading volume and market activity surge, it may also be an indication of a crypto bubble. The escalation in trading volumes, fueled by short-term traders chasing rapid gains rather than long-term investors, could potentially perpetuate an unsustainable market environment.
- When individuals invest in cryptocurrencies solely based on the herd mentality, lacking comprehension of the underlying technology or long-term value potential, it hints at an unreal frenzy. In essence, if prices notably surpass what can be reasonably justified by the project’s fundamental merits, it could be an indication of a bubble.
A look into some past cryptocurrency bubbles
Bitcoin Bubble of 2017:
During the eventful year of 2017, Bitcoin embarked on a captivating journey, soaring to near the $20,000 mark in December. This remarkable surge represented an astounding leap from its modest beginnings earlier in the year when it traded at around $1,000.
The swift and meteoric rise of Bitcoin commanded the attention of the media, investors, and the wider populace, igniting their fascination. However, as the euphoria reached its peak by December 2017, the Bitcoin bubble ultimately ruptured. In the subsequent year, 2018, the price of Bitcoin experienced a steep and rapid decline, dropping to nearly $3,000 by the close of the year.
This profound bubble burst dealt significant blows to those investors who had entered the market at its extreme, serving as a reminder of the inherent risks within this volatile domain.
The Altcoins Bubble of 2013-2014
Following Bitcoin’s initial rise, a tidal wave of alternative cryptocurrencies, known as “altcoins,” surfaced and gained traction during 2013-2014. Numerous altcoins registered massive price surges during this period. Similar to the Bitcoin Bubble, altcoin prices spiked as a result of speculative purchasing and the aspiration to mimic Bitcoin’s success.
Nonetheless, the altcoin bubble eventually burst, leading to substantial devaluation of many of these coins. Novacoin and Feathercoin are some of the coins that became a victim of this bubble burst, turning worthless after an initial surge.
How should you handle a crypto bubble cycle?
A crypto bubble is an intricate phenomenon that must be dealt with prudently.
Firstly, you should strive to gain a deeper understanding of the cryptocurrency dynamics, market forces, and the myriad factors that propel the value of these assets. Keep yourself in tune with the latest news and breakthroughs, both specific to the cryptocurrency you hold and the broader market landscape.
Moreover, you may mitigate potential losses by strategically parting ways with a fraction of your crypto assets when a particular coin skyrockets in popularity. Such a move not only curbs your exposure to excessive risk but also opens up the possibility of reaping reasonable gains.
Additionally, you can enlist the guidance of seasoned professionals and digital currency experts to navigate the enthralling crypto market.
Also, never forget to harness the power of discipline. Resist the lure of impulsive decisions driven by the broader hype or the weight of fear. Stay steadfast in your investment judgment and shield yourself from the tides of herd mentality and presumptive frenzy.
Ultimately, craft a clear-cut investment strategy before diving into the crypto waters, and stick to it. Carve out your investment goals with precision, account for your risk tolerance, and cultivate a mindset that embraces the long-term horizon to achieve sustainable prosperity.