Crypto Bubble: Is Crypto A Bubble?
Crypto Bubble
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.
Disclaimer: We want to emphasize that this is not financial advice. Cryptocurrencies operate in a volatile market, where values can drastically fluctuate in a blink of an eye. It is imperative to conduct thorough research and seek guidance from a qualified financial advisor before investing.
What is a Bubble?
The term "bubble," when employed within the economic sphere, typically denotes a scenario where the valuation of a specific entity, whether it's an individual stock, financial asset, entire sector, market, or asset class, significantly surpasses its intrinsic value. This divergence arises due to a surge in speculative demand, driving the price of the item far beyond its underlying fundamental value. Inevitably, this inflated state proves unsustainable, culminating in what's commonly referred to as the "bubble" bursting. This phase is marked by a rush of panicked selling, causing a precipitous decline in the item's price, often in a dramatically swift manner. In many instances, a consequential crash follows this collapse.
The repercussions stemming from a bubble's burst are contingent on the economic domains embroiled and the extent of participation, which can either be widespread or confined to specific areas. A poignant example resides in the collapse of Japan's equity and real estate bubbles during the years 1989 to 1992. This rupture cast a shadow of prolonged stagnation over the Japanese economy, characterizing the 1990s as the "Lost Decade." Equally notable instances include the burst of the dot-com bubble in the United States in 2000 and the residential real estate bubble in 2008. Both of these instances triggered profound recessions with far-reaching consequences.
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.
Credit Bubbles
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.
Commodity Bubbles
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 delving into whether the cryptocurrency market harbors the characteristics of a bubble on the brink of bursting, it's prudent to revisit the definition of a bubble. Fundamentally, a bubble arises when speculative fervor envelops a financial instrument, commodity, or item, driving its price to levels that surpass its inherent worth. The determination of an asset's intrinsic value involves intricate financial models and a medley of factors. When applied to the cryptocurrency realm, the utility of blockchain technology emerges as a significant determinant. The broader the scope of blockchain's applications, the greater the potential for value creation. This dynamic narrows the gap between speculative excitement and the genuine intrinsic value of blockchain technology.
Elucidated earlier in this discourse, notable trends within the cryptocurrency and blockchain sphere have gained substantial momentum. Two such trends are the metaverse and non-fungible tokens (NFTs). At its core, a metaverse embodies a virtual realm superimposed upon a blockchain, fostering interaction among players, asset acquisition, and immersive gameplay, often rewarding participants with cryptocurrency. NFTs, on the other hand, are blockchain-based tokens uniquely representing tangible or digital assets. These tokens, distinct from one another, symbolize and facilitate trade for the assets they embody.
The advent of the metaverse and NFTs has drawn newcomers into the cryptocurrency arena. Initially fueled by a fear of missing out on the latest trends, deeper examination reveals more profound values inherent to these trends. This value injection bolsters the utility of blockchain technology, broadening its spectrum.
The Metaverse
A metaverse, as highlighted earlier, isn't solely a realm of play and interaction. It morphs into an arena where not only engagement takes place but also earnings materialize. This evolution emerged as a consequence of global isolation during the draconian lockdowns. Beyond being a platform for interaction, the metaverse offers the potential to earn, a boon particularly pertinent in an era marked by job losses and escalating living expenses. This augmented utility imbues the cryptocurrency space with tangible intrinsic value.
NFTs inject practicality into trading in-game assets within a metaverse, as they evolve items into blockchain-backed digital commodities. Moreover, NFTs extend the blockchain realm into the realm of collectors and speculators, allowing artists to vend digital or real versions of their works on the blockchain. This function imparts NFT technology with substantial utility.
It's crucial to recognize that both metaverses and NFTs find their foundation in blockchain technology. Blockchain's capacity to provide a distributed, decentralized digital ledger capable of securing and validating ownership across a spectrum of digital entities – from artworks to in-game assets to digital currencies – underscores the very feasibility of these advancements.
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.
