How do you identify a crypto bubble?

A bubble is a round body of air, gas or liquid, like a soap bubble or bubbles inside boiling water or a glass of coke.

In economic or financial terms, a bubble can describe a situation where something becomes popular, and people invest a lot of money in it, whether it makes sense or not.

This huge and widespread investment can make the value of that thing increase fast, but it eventually crashes (or pops like a soap bubble), leaving people with less money than they put in.

In this article, we explain what a crypto bubble is, how to identify one and how to manage it as a trader.

What is a Cryptocurrency Bubble?

A cryptocurrency bubble happens when many people start buying a particular cryptocurrency because they think the price will keep increasing and they can make lots of money from it.

But, as often happens, the price gets too high and starts falling. Everyone panics and starts selling off that crypto, causing the price to fall even lower.

The lower it drops, the more people sell off, creating a cycle where the price continues falling, and people keep selling until the value of the coin or token crashes to nearly zero.

Bubbles burst because demand for an asset is not sustainable, and the market realises the price was inflated and starts to correct.

What follows after is a sharp drop in price, sometimes even lower than before the bubble began. People who invested in the asset when the price was inflated end up losing a lot of money.

How To Know When A Crypto Bubble Is Happening Or Forming

Identifying a crypto bubble can be difficult, and even the most experienced traders can be caught unawares. However, there are some things you can look out for to determine if a cryptocurrency is worth buying or if it's a bubble waiting to burst.

Here are some signs that a crypto bubble may be forming or is present:

1. Fast Increase In Price

When the price of a coin or token quickly increases over a short time, it could be a sign that the demand for it is unreliable and unsustainable. It also means the crypto may be overvalued.

An advisable thing to do in this situation is to watch the price of the coin or token for a while. If it significantly increases and there hasn't been any big news or technological development to back up the price increase, a bubble may be forming.

2. Social Media Hype and Online Speculation

Social media is one of the biggest hype machines. All it takes is a couple of shares, likes or retweets, and a coin is being called "the next big thing to make you rich".

When there is a lot of hype around a particular cryptocurrency, it can be a sign that people are buying it without fully considering if it has real value. This kind of buying often leads to a bubble that bursts as fast as it forms.

3. Inflated Valuation

When the market capitalisation, or the total value of all the coins in circulation of a cryptocurrency, rises very quickly to a high level, it can be a sign that the asset is becoming overvalued.

The market capitalisation of a cryptocurrency is the total value of all the coins in circulation. It is calculated by multiplying the current price of the coin or token by the total number of coins in circulation.

For instance, if a cryptocurrency has 2000 coins in circulation and a current price of $5 per coin, its market capitalisation would be $10,000. Currently, Bitcoin has a market cap of $568.676 billion, Ethereum has $237.209 billion, and USDT has $ 81.103 billion.

If the market capitalisation of a particular coin or token is increasing fast without an increase in practical use or real everyday users, a bubble may be forming or is already happening.

4. Market Saturation

This one may be tricky because it's not always a bad sign when many people are interested in something.

However, when many people start trading a particular cryptocurrency, it's advisable to take a step back and observe who's involved in the trading. If it seems like many people investing in that coin or token have little knowledge about it or the market in general, a bubble may be forming.

If most investors or traders of that coin have shown no previous interest in crypto or are simply inexperienced, be extremely cautious about buying it.

5. Lack of Real-World Use

There are over 5000 cryptocurrencies in the market, but only a small number have actual practical uses or potential. If a cryptocurrency has more hype attached to it than real everyday use, and many people seem to be investing in it, it could be a sign of a bubble.

Examples of Crypto Bubbles That Have Happened In The Past

Here are three examples of notable crypto bubbles that have happened in the past:

The ICO (Initial Coin Offering) Bubble of 2017:

A crypto ICO (Initial Coin Offering) is a way crypto startups, creators or project owners raise money by selling their newly launched tokens or coins to investors, who in turn give them Bitcoin or US dollars to run their business.

Here's how an ICO offering typically works:

A company wants to raise money to create a new platform that helps users access all their crypto and NFTs in one wallet.

The company would create a token and announce that it is open for investors to buy at a certain price. This token would have a limited amount available and would usually be offered at a low price to encourage investors. They can also be traded on cryptocurrency exchanges like any other cryptocurrency.

Interested investors would buy these tokens with Dollars, BTC or ETH, or any other accepted currency by the company.

Investors buy these tokens because they hope their value will increase if the company succeeds in becoming profitable. It's similar to buying shares in an upcoming company in the hope that the shares will increase in value as the company grows.

In 2017, many new cryptocurrencies were introduced through ICOs, and their prices went up very fast, often without actual products or services backing them up.

Many of these ICO projects turned out to be scams, and many investors lost their money.

The Altcoin Bubble of Early 2018

An altcoin is any cryptocurrency that is not Bitcoin. Examples of altcoins include Ethereum (ETH), Litecoin (LTC), Ripple (XRP) and Cardano (ADA).

In early 2018, the prices of many altcoins reached all-time highs. This price increase was driven mainly by hype rather than logic or practical use cases for the crypto tokens.

By July 2018, the prices started falling significantly, and by December, the altcoins had lost nearly all their market value.

For more context, Ethereum (ETH) hit $1k in January, and by December, it was trading at less than $150. Litecoin (LTC) hit nearly $300 in January and, by December, was trading at $30/

Like the crypto ICO of 2017, many investors suffered significant losses when the altcoins crashed.

The NFT (Non-Fungible Token) bubble of 2021

Non-Fungible Tokens, or NFTs, a unique type of digital asset, gathered a lot of attention worldwide in 2021, with some NFTs selling for millions of dollars.

Here's a short explanation of what NFTs are:

NFTs stand for "non-fungible tokens." They are like a one-of-a-kind digital item that no one else has. These digital items can be things like artwork, videos, or even music. They're stored on a special computer system called a blockchain, which helps ensure they're actually one-of-a-kind and can't be copied.

Most people buy NFTs hoping they will increase in value like rare artwork (for example - The Mona Lisa painting) does. Other people buy them because they love collecting art or owning rare items.

The NFT bubble was short-lived, and by 2022, it burst. From January 2022 to September 2022, NFT trading volume fell by 9%, from $17 billion in value to $466 million.

An example of how the NFT crashed is the case of Sina Estavi, a famous crypto entrepreneur. He bought an NFT of former Twitter CEO Jack Dorsey's first tweet for $2.9m in March 2021. In April 2022, Estavi put up the NFT for resale on the NFT marketplace OpenSea, for $48m. The highest bid he received for the sale was about $6,800.

It is important to mention that although NFT prices have fallen considerably, the NFT market generated $24.7 billion in trading volume in 2022, a minor change from $25.1 billion in 2021.

How To Manage a Crypto Bubble As a Trader

Crypto bubbles come and go, so knowing how to manage the market and your trades is necessary when it happens.

Here are four tips you can use:

1. Reduce loss or exposure by selling some of your crypto

You can reduce some loss by selling off some of the crypto you have in your wallet, especially if that coin or token suddenly becomes very popular quickly and increases in price. Selling some of it would help lower your general potential for loss and possibly make you some money.

On the other hand, if the bubble has already burst and the coin or token is quickly losing value, you have two choices:

Hold the coin: If you believe the coin still has long-term potential and will eventually increase in price again, you could hold onto it and wait.

Sell the coin: If you don't believe it will regain its high price or don't want to risk losing any more money, you could sell the coin and make the best of the situation.

2. Monitor the market

Stay updated with crypto news and stay informed about price trends, market developments, and regulatory changes that could affect the market.

Knowing the latest news can help you plan how to get out of the bubble with as minimal loss as possible.

3. Talk to a financial expert

You can talk to experienced traders, financial advisors, or other experts to get insights and advice on navigating the crypto market and the bubble that is forming or already present. They understand the market cycles and can guide you through them.

4. Think Long-Term

Crypto bubbles can be challenging or tricky to manage, but a long-term approach to cryptocurrency can help keep you balanced through these market changes.

It is advisable to understand the basics of the crypto market, trading, coins and tokens. Once you know what you're dealing with, you can make more informed trading decisions.

Overall, the key to dealing with a crypto bubble is to stay calm and informed and avoid making hasty decisions based on emotion or market hype.

Final Word

It's important to know that not all significant price increases are bubbles and that cryptocurrencies, like any other financial asset, can be measured based on factors such as technological development and market demand.

Sometimes prices can increase for valid reasons, such as increased demand or improved technology.

Disclaimer: This article was written to provide guidance and understanding. It is not an exhaustive article and should not be taken as financial advice. Obiex will not be held liable for your investment decisions.