Let’s Clear The Air: Is Crypto A Market Bubble?

Since the very beginning, people have called cryptocurrencies bubble-like assets. The reasons they gave were: one, cryptocurrencies could not be used to purchase daily things, two, cryptocurrencies were isolated in coder communities, and three, no one could invest in them. Therefore, people early on came to the conclusion that they had no value.

However, once Bitcoin and Ethereum became more mainstream, particularly in 2020, the market for cryptocurrencies grew and investors started to pile in. This was because the real economy was experiencing poor fundamentals, rising prices, and inflation, which were all caused by the pandemic and subsequent policy responses. In addition, retail and institutional investors alike slowly realized the technology and innovative potential behind blockchain-supported and “inflation-proof” cryptocurrencies. As a result, their valuations soared and many first-time investors came into the space, which further boosted prices.

Has The Crypto Bubble Burst?

The rapid ascent of cryptocurrencies created a problem. These new assets that many investors didn’t thoroughly understand were surpassing the market caps of Fortune 500 companies and notching thousand percentage point gains. This happened in multiple instances. For example, in the early days by December 2017, Bitcoin hit the price of $19,000 and reached a market cap of over $300 billion, and by April 2021, Bitcoin hit $60,000 (an ATH) and reached the $1 trillion dollar market cap milestone. As a result of these overly high valuations in such short timespans, the markets reversed ruthlessly and the crypto bubbles popped.

However, when the crypto market crashed in early 2018 it was purely speculative, and when it crashed in spring 2021 it was due to downward policy pressures and over-leverage. Both of these were severe instances of what happens when market bubbles and crypto market bubbles pop.

What Is A Market Bubble?

A market bubble is an investment or economic cycle where asset prices escalate rapidly beyond healthy market values, and because of exuberant market behavior, subsequently decrease in value, often by double-digit percentage points.

There are many historical examples of market bubbles that investors and economists should study. For example, the Japanese “bubble economy” in the 1980s, the dot-com stock market bubble in the late 1990s, the US housing bubble in 2009, and the 2015 Chinese stock market bubble. But right now, the most widely discussed potential future market bubbles include the US stock market, the Chinese housing market, and the cryptocurrency market.

Because market bubbles have such drastic first-order effects and unpredictable second and third-order outcomes, it is important that investors put in the effort to understand what is a market bubble and be able to point out red-flashing market bubble indicators.

Crypto Bubbles vs Stock Bubbles

A crypto bubble is similar to a stock market bubble, where asset prices and market valuations rise extravagantly and fall dramatically. Because the cryptocurrency markets are by reputation volatile, there have been multiple instances of crypto bubble crashes (featured in the table below).

Is Crypto A Bubble [UPDATED 2021]?

Supporters and investors in Bitcoin point to Bitcoin’s utility as a currency, a corporate cash parking place, an inflation hedge, and as a store of value that’s better than gold. These four value propositions are well-grounded as an investment thesis.

But what justifies the price of Bitcoin, and is it showing signals of crashing? A crypto bubble is when the price of a cryptocurrency surpasses its fair market value. However, as the real economy continues to decline and inflation soars, Bitcoin’s value remains relevant and has even strengthened.

But still, Bitcoin is still not on many companies’ balance sheets, it is not used to buy and sell everyday consumer items, and it is not a transaction mechanism (because of cost). Some even argue that it will never be a medium of exchange, and nor is it a real hedge against inflation.

This is the current status of the debate around cryptocurrencies and whether they are bound to be the next bubble. It is a debate around the true value of cryptocurrencies, for example, Bitcoin.

However, in March 2020, when the stock market crashed 35%, Bitcoin dropped 55%, and since the stock market recovery, Bitcoin’s price outpaced the stock market by leaps and bounds. If consumers keep spending, interest rates stay low, and earnings stay strong, then Bitcoin will rise. But if interest rates increase, if peak profits are reached, and the economy cools down, then there may be a correction. But the fundamentals don’t show a massive crypto bubble is going to occur in the near future.

Conclusion

Bitcoin and other cryptocurrencies are not going to disappear out of the blue. This is especially because Bitcoin has cemented itself as a popular investment mechanism for retail and institutional investors alike. Moreover, with the rise of DeFi, other cryptocurrencies such as Ethereum and Solana have opened the door to decentralized finance, which has risen to be a $100 billion dollar market, with industries like NFT art, gaming, metaverse, insurance, lending, asset management, and payments. Market bubbles are rarely isolated events, so if a bubble were to pop in the stock market or the cryptocurrency market, it would spill over to other parts of the economy.