Depending on whom you ask, blockchain technology is either a revolutionary and disruptive development or a meaningless marketing term representing an overhyped concept. Whatever you think of the underlying technology, you can’t deny that blockchain-based assets like cryptocurrencies—and more recently, non-fungible tokens (NFTs)—have exploded. At one point, a single Bitcoin was worth more than $68,000, and NFTs have sold for millions of dollars.
But crypto prices are the very definition of volatile; Bitcoin’s value cratered to under $35,000 in early 2022, and that was not the first time there’s been a crash like that in the crypto market. That volatility has inspired a healthy dose of skepticism because it makes it impossible to regard Bitcoin and other cryptocurrencies as useful for anything other than speculation. Part of Bitcoin’s appeal was the idea that it was hard-limited, unlike fiat money—there would only be so many Bitcoins in the world. But crypto coins can be forked into new versions, and it’s incredibly easy to simply invent a new crypto coin out of thin air. There are currently more than 10,000 cryptocurrencies in existence.
All of this has many worried that crypto is in a classic bubble. Past bubbles—the housing bubble, the dot-com bubble—have shown us that the only sure thing about a bubble is that it will burst. But economic bubbles follow some pretty clear stages if you know where to look, which means we can at least make a fairly educated guess as to where we are with crypto—and where we’re going.
What’s a bubble?
An economic bubble is a simple concept: It happens when the price for something stops relating to its actual value. Back in the 1600s, the market for tulip bulbs in the Dutch Republic went bonkers, with single tulip bulbs selling for many times the average person’s annual income. The prices rose and rose, people desperately bought their way in so as not to miss out—and then the bubble burst, prices collapsed, and a lot of folks were financially ruined.
There are different sorts of bubbles for different things, like stocks or houses. A crypto bubble would be a form of asset market bubble. But regardless of what the bubble is centered on, an economic bubble goes through about five stages:
- Displacement. This could also be thought of as “disruption.” This is when a new concept or product gets the attention of investors. The blockchain and cryptocurrencies are exciting new developments, and when Bitcoin was first dropped in 2009 it was a truly innovative concept that grabbed focus.
- Boom. After a period of slow growth, the price starts to ramp up rapidly as awareness spreads. Instead of a small number of savvy investors, the product hits the mainstream and gets a lot of media hype. People rush to get in on this hot new investment, which drives the prices even higher.
- Euphoria. Prices reach ludicrously high levels but no one seems to care, because there appears to be an infinite supply of “greater fools” willing to shell out to buy-in.
- Profit-taking. A portion of investors get squirrely about the valuation and start nervously eying the exits. Once they start to sell or reduce their positions to offset risk, others follow suit.
- Panic. Everyone notices the whales cashing out, and a race to the bottom begins. Prices crate, and as they fall people become more and more desperate to cash out before they lose everything.
Crypto Bubble or shakeout?
The description of a financial bubble probably looks familiar to anyone paying attention to crypto. Defenders argue that cryptocurrencies go through frequent shakeouts that reduce value and then regain value—often exceeding previous valuations. Economist Tyler Cowen argues that the market is saturated with crypto assets, most of which will disappear once the hype dies down, but that core assets like Bitcoin aren’t going anywhere. History bears this out: The dot-com bubble didn’t destroy technology companies or the Internet, and the fact that a large number of social media platforms failed doesn’t mean social media is no longer a thing.
But just because crypto and blockchain-based assets are here to stay doesn’t mean they’re not in a bubble right now. It’s pretty clear that the value of many cryptocurrencies has been wild—wildly—overblown considering how relatively useless they are as currencies or stores of value (heck, the Shiba Inu crypto coin—which was started as a joke—was valued at $30 billion late last year). Plus, the NFT market is being propped up by “wash” trades where folks are purchasing their own NFTs to create the illusion of value.
The recent crash of crypto values—and lack of a speedy recovery—indicates we’re in the fourth stage, and the profit-taking has begun. But there’s one reason to think that the crypto bubble isn’t going to descend into full-scale panic: The cult-like atmosphere surrounding Bitcoin and other cryptocurrencies might save it. The hold-on-for-dear-life (HODL) and buy-the-dip crowd believe that these boom and bust cycles are natural and nothing to fear—and their insistence on hanging on and rallying behind crypto may avoid a full-on panic.
No one can say with certainty that the crypto bubble is about to burst. Whether you have the stomach to find out depends entirely on your level of risk tolerance and ability to deal with the toll crypto can take on your mental and emotional health.
Originally published on www.lifehacker.com