Cryptocurrency Bubbles: Causes and How to Identify Them

1. What is a Cryptocurrency Bubble?

A cryptocurrency bubble is when the value of cryptocurrency assets is inflated beyond their actual worth, similar to other economic bubbles such as the dotcom bubble, real estate bubble, or Tulip mania. The primary causes of this over-inflation can come from economic, psychological, and social factors, sometimes even due to unforeseen events (black swan events). Cryptocurrency bubbles are often referred to as "Bitcoin bubbles" or "cryptocurrency bubbles."

What’s important to note in the cryptocurrency market is its high volatility. Not every price drop is a sign of a bubble bursting—often, it’s simply a necessary market correction that helps the market recover.

2. Notable Cryptocurrency Bubble "Explosions"

The 2017 Surge and the 2018 Winter

At the beginning of 2017, the market capitalization of cryptocurrencies was only around $18 billion. However, just one year later, this number surged to over $800 billion. But just months later, the market lost 80% of its value, surpassing even the collapse of the dotcom bubble.

The strong growth in 2017 was driven by multiple factors, such as loose monetary policies, instability in traditional markets, and the popularity of ICOs. These factors led to increased investment in cryptocurrencies, resulting in FOMO (Fear of Missing Out), which drove asset prices to unsustainable levels.

The Bubble Burst

After peaking, the market began to drop significantly in 2018, with Bitcoin falling from $19,000 to about $6,000, and by December 2018, Bitcoin's value had dropped to $3,000. Scandals like the BitConnect exchange fraud and other negative events heightened anxiety and panic among investors, causing many to lose all their investments.

3. Cryptocurrency Bubble Phase: 2020 - 2022

After the crypto winter of 2018, the market began to recover in 2020 thanks to the explosion of DeFi and positive events like Coinbase's listing on NASDAQ and Elon Musk publicly supporting cryptocurrencies. Bitcoin’s price surged dramatically, from $5,000 to over $39,000 in 2021, before reaching a peak of $69,000 in November 2021.

However, after Bitcoin reached its peak, the market experienced a significant downturn, accompanied by the collapse of major exchanges and other negative events such as the FTX bankruptcy and the Terra-Luna crash. These events resulted in substantial losses for investors.

4. The Four Phases of a Cryptocurrency Bubble

"Emerging Bubble" Phase

This phase is characterized by the shift of investment capital from traditional channels into cryptocurrencies. While prices gradually increase, the influx of capital into the market is not yet large enough to establish a clear trend.

"We Are All Warren Buffett?"

In this phase, positive news explodes, and many new investors start joining the market. They begin buying assets without paying attention to fundamental analysis, leading to asset prices being inflated beyond their real value.

Crisis Strikes

When the bubble becomes too large, it only takes one triggering factor to make it burst. At this point, investors start selling off their assets to protect their holdings, which leads to a sharp price drop.

Back to Reality

After the bubble bursts, the market typically stabilizes at a low price, creating a bottom. This is a difficult period, but it also presents an opportunity for long-term investors to enter the market when things start to stabilize.

5. The Impact of Cryptocurrency Bubbles

Although cryptocurrency bubbles can cause severe damage, they also help the market mature and become more sustainable. After each bubble bursts, weaker projects are eliminated, making way for stronger and more promising ones, helping the market develop in a more stable and robust manner.