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Bubbles rise before they pop – a strong and familiar metaphor in financial markets.
A financial bubble refers to the rapid price increase of an asset, usually based on speculation rather than fundamentals, followed by a sharp decline.
After a bubble pops, many assets, projects and companies crumble, never to recover.
Every financial market is driven by speculation, but when speculation runs wild, that's when bubbles start to form.
So you might be asking yourself: is Bitcoin a bubble?
Let's find out.
What creates a bubble in traditional finance?
Speculation and greed are the primary driving forces in creating a bubble.
As share prices climb, hysteria mounts. Investors who were once eagerly waiting on the sidelines can no longer sit and stare. FOMO kicks in. New investors throw theirs hat into the ring.
New companies and projects are launched en masse. It starts to feel like a wondrous moment.
Investors become enthralled with the thrill of the climb…
Until the bubble pops.
That's when share prices come crashing down and many investors get caught out and lose a significant amount of money.
Bubbles of the past
Tulip Mania was the first recorded financial bubble.
It sounds crazy, but as the story goes, tulips were introduced to the Dutch in the late-1500s, soon becoming a highly sought-after commodity. The price of tulip bulbs shot up. Price speculation was driven by massive demand, low supply and greed.
Then tulips started getting a disease that made them look like flames and they became even more valuable. People were buying tulip bulbs in a frenzy.
But at some point people started buying tulips for the purpose of selling for profit, which ultimately led to more selling and buying, and, alas, the price crashed, bursting the bubble that was Tulip Mania.
No flowers this time, but you've probably heard of the Dot-Com bubble. In the late-1990s with the introduction of the Internet, new companies were popping up left and right, trying to get in on this new tech.
The Internet was the next big thing and everyone wanted a piece of it. This led to huge speculation by Internet startups. Companies could form, join the dot com revolution and achieve ludicrous valuations seemingly overnight.
Share prices skyrocketed, but it couldn't last and eventually the bubble burst. Few companies survived. But it paved the way for a more sensible Internet landscape.
Is Bitcoin a bubble?
On the other hand, crypto enthusiasts are certain that this asset class has a fruitful future ahead.
But equivalencies can indeed be drawn between the Dot-Com Bubble and the rise of cryptocurrency. Price movement driven by speculation based on new technology is apparent in both cases.
During the Dot-Com Bubble, sketchy companies built on dubious concepts could IPO for millions of dollars. Speculation over-saturated the market.
Cryptocurrency followed a strikingly similar trajectory in 2017, when ICOs were everywhere, raising millions of dollars, with plenty of investors lining up to fund projects that were often little more than a whitepaper.
Here are a couple of things to think about though:
- Those companies that emerged from the rubble of the Dot-Com pop did so with enormous force, so if crypto is a bubble and it pops, would Bitcoin be one of the survivors?
- Past Bitcoin market cycles can tell us a great deal.
As you can see, the end of 2017 was not the first time that the price of Bitcoin has shot out of nowhere and broken incredible new highs before a heavy correction.
These past market cycles can perhaps help us answer the question ‘is Bitcoin a bubble?’. We've seen this all before. Each correction could technically be classified as a bubble pop, sure, but it doesn’t mean it’s the end of Bitcoin.
For those who call Bitcoin a bubble like Tulips, South Sea Co or Beanie babies, take a look at this chart.— James Todaro (@JamesTodaroMD) April 5, 2019
Bitcoin isn't dead. Bitcoin isn't a bubble that's popped for good. This run-up to $5,000 is bringing eyes back to the space. We are just getting started. pic.twitter.com/JTSj5TXGIG
Bitcoin is a relatively new asset. It’s not a new company, it’s not a flower – it’s a challenge to the status quo. Bitcoin has the potential to change payments as we know it.
The price movement of Bitcoin is driven by supply and demand, based on speculation of Bitcoin’s future.
No-one knows how Bitcoin will evolve and what role it will play in 10 years time.
But what we do know is that Bitcoin is a nascent technology and that future application is not really quantifiable, so over speculation and bubbles are to be expected along the way.
So, is Bitcoin a bubble?
At this time, Bitcoin is not a bubble, but that does not rule out another "pop" in the future. For now, what we've seen are healthy and standard market corrections.
This content is not financial advice and should not form the basis of any financial investment decisions nor be seen as a recommendation to buy or sell any good or product. Trading cryptocurrency is complex and comes with a high risk of losing money, particularly if you trade on leverage. You should carefully consider whether trading cryptocurrencies is right for you and take the time to learn how trading works and decide how much money you are prepared to lose.
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