2021 has seen significant gains in the prices of several cryptocurrencies. New trends also took off such as non-fungible tokens, or NFTs, and the metaverse. As cryptocurrency prices skyrocketed in the past few months, NFTs and the metaverse attracted more people to the overall cryptocurrency and blockchain space, increasing the market capitalization of the cryptocurrency space by a couple of billion dollars. However, the start of the new year has seen a dramatic downfall in cryptocurrency prices. This could be due to several factors such as governments clamping down on cryptocurrencies - introducing tighter regulation, or people cashing out their cryptocurrency gains, and in so doing, causing a wave of panic selling in the market. Some skeptics go as far as to say that the cryptocurrency bubble is finally popping. In this article, we will take a look at what a bubble is, and whether or not the entire cryptocurrency space is in fact a big bubble waiting to pop.
What is a Bubble?
The term “bubble” used in an economic context usually refers to a situation where the price of something - like an individual stock, financial asset, or an entire sector, market, or asset class - exceeds its fundamental value by a fairly large margin. This is because speculative demand inflates the price of the item beyond its intrinsic value. Eventually, the bubble inevitably pops and panic selling of the item causes its price to decline. This decline is often dramatic. In most cases, a speculative bubble is followed by a crash in the items in question.
The impact of a bubble bursting is dependent on which economic sectors are involved and also whether the extent of participation is widespread or localized. An example of a dramatic bubble bust is when the equity and real estate bubbles in Japan burst between 1989-1992. This burst was followed by prolonged periods of stagnation for the Japanese economy, resulting in the 1990s being referred to as the Lost Decade. Other notable bubble bursts include the dot-com bubble in the United States in 2000 and the residential real estate bubble in 2008. Both of these bursts led to severe recessions.
Types of Asset Bubbles
In theory, there are an infinite number of asset bubbles since a speculative frenzy can arise over pretty much anything. This can include meme stocks, housing prices or even tulip bulbs. These are just some of the real-world examples of bubbles that have already burst. However, asset bubbles can be categorized into four basic categories: stock market bubbles, asset market bubbles, credit bubbles, and commodity bubbles.
Stock Market Bubbles
These types of bubbles relate to equities whose prices rapidly rise - often out of proportion to the companies’ fundamental value. These bubbles can include the overall stock market, exchange-traded funds, or equities that belong to a specific field or market sector.
Asset Market Bubbles
These bubbles involve other industries or sections of the economy that are outside of the equities market. A classic example is Real Estate. Other examples can include price rises in either traditional currencies like the U.S. dollar or euro, or digital currencies like Bitcoin or Litecoin.
These bubbles occur when there is a sudden surge in consumer or business loans, debt instruments, and other forms of credit. Specific examples include corporate bonds, government bonds, student loans, or mortgages.
These involve an increase in the price of traded commodities such as gold, oil, industrial metals, or agricultural crops.
Now that you know what a bubble is in the context of the financial markets, and that we have taken a look at the four main types of bubbles, let’s now see whether or not the cryptocurrency market is a bubble.
Is There a Crypto Bubble?
Before we take a look at whether or not the cryptocurrency market is a bubble waiting to pop, let’s first revise what a bubble is. The premise of a bubble is that the speculation around a financial instrument, commodity, item, etc. causes the price of the item or asset in question to be inflated beyond what its intrinsic value is. The calculation used to determine an asset’s or item’s intrinsic value involves complex financial models and various factors. When looking at the intrinsic value of the cryptocurrency space, the utility of blockchain technology is a major determining factor. The more ways blockchain technology can be used, the more value can be created using blockchain. This increases the amount of value in the blockchain space and closes any gap that exists between the speculation around blockchain technology and its true intrinsic value.
As mentioned earlier in the article, other trends in the cryptocurrency and blockchain space experienced significant gains in market traction. These trends are the metaverse and non-fungible tokens. In a nutshell, a metaverse is a virtual world built on top of a blockchain that includes some sort of gameplay and the ability to earn cryptocurrency for taking part in the gameplay. Non-fungible tokens, or NFTs, are blockchain-based tokens that represent both real-world or digital assets or items. These tokens are not interchangeable and are unique representations of the item or asset that they represent.
Both the metaverse and non-fungible tokens have attracted cryptocurrency newcomers to the market. In the beginning, it was because people had the fear of missing out on the latest, hyped trend in the cryptocurrency space. However, there might be more to the underlying value that these two main trends bring to the space, both adding more utility to blockchain technology. Let’s take a look.
As mentioned, the metaverse is a virtual world built on top of a blockchain. In these worlds, players can interact with other players, purchase in-game assets, and take part in the metaverse’s native gameplay. Metaverses grew in popularity mainly because people across the globe were left isolated due to the Covid-19 pandemic and were unable to interact with others until they discovered the metaverse. However, as the popularity of metaverses surged, so too did their potential. Now, not only is a metaverse a place where people can play and interact with other players, it is also a place where people can earn. This ability to earn is perhaps one of the greatest utilities of a metaverse because people across the globe have lost their jobs due to Covid. This, coupled with the constant rise of living costs, makes a metaverse a very valuable concept - contributing to the intrinsic value of the general cryptocurrency space.
NFTs make it possible to trade and exchange in-game assets in a metaverse since the asset is no longer just an intangible item, but rather a digital representation of an item that can be transacted with on a blockchain. Furthermore, NFTs expanded the blockchain space into the collector’s and speculator’s market when the technology made it possible for artists to sell digital versions, or rights to the real versions, of their artworks on a blockchain. This gives NFT technology a fair amount of utility.
Both NFTs and metaverses would not be possible without blockchain technology. Blockchain technology provides a distributed, decentralized digital ledger that can secure and prove ownership of any form of digital value, whether it be a digital artwork, an in-game asset, or a digital currency.
Crypto Bubble: Conclusion
With all of the above discussed and all of the utility that blockchain has enabled through technologies such as non-fungible tokens and virtual worlds where people can take part in native gameplay and earn money for doing so, the gap between the speculative value around the blockchain space and its true value begins to narrow. There is also the utility of enabling fast, low-cost borderless transactions, as well as censorship-resistant applications, strengthened user privacy, and the ability to make microloans that add to the true value of the cryptocurrency and blockchain space. It’s important to remember that the technology is still in its infancy, and there are still a lot of undiscovered uses for blockchain and cryptocurrencies that are yet to be explored. Prices in this new and innovative space are fairly inflated, but that’s mostly driven by people who believe in blockchain’s potential and want to see what’s next for the technology.
A bubble in the financial market refers to financial instruments or assets with inflated prices. The inflation in prices is a result of the speculation around the asset or instrument in question causing people to value it at a higher price than what it is actually worth. When the market realizes that the price of a financial instrument or asset is higher than what it should be, they will sell the asset to either cash out their initial investment and any realized profits or limit the loss on their investments. This flood of selling pressure often results in dramatic declines in prices as the rest of the market panics sales to limit their losses. The question is, is the cryptocurrency space a bubble waiting to pop? As the number of use cases for the technology rises, the gaps between what prices in the market should be and what they are will begin to close. Technology has made it possible to do things that once before were considered impossible. However, there is still a small gap between the cryptocurrency space’s intrinsic value and its speculative value.
More Articles on Investing
If you'd like to read more articles on Investing and how to grow your wealth, simply follow the link below!