Crypto bubbles transpire when there is a surge in demand for a specific cryptocurrency, especially meme tokens, that triggers a widespread buying frenzy. This is based on the collective belief that the particular asset’s price will ascend as investors seek to capitalize on expected gains.
However, the seemingly unstoppable upward trajectory may oftentimes prove to be unsustainable, triggering a price reversal that will set in motion a domino effect. As the overinflated prices start to decline, investors are put in panic mode, which sets fire to a mass sell-off event.
This panic-driven selling drives the token’s price to decline even further, forming a self-reinforcing cycle, where the more the asset’s price drops, the more people will sell off their holdings. This perpetuates a downward spiral until the once-popular token sees its value plummet to insignificance.
The bubble burst as a consequence of unsustainable demand. Once the market realizes that the asset’s inflated prices are unjustified, a correction occurs. This manifests a sharp and often drastic decrease in price, where the token may even plummet to levels lower than the pre-bubble period.
Unfortunate investors who joined the market during the buying frenzy would then find themselves grappling with substantial financial losses.
How To Identify Crypto Bubbles?
Spotting a crypto bubble is not a straightforward process, and it can be hard to come by for even the seasoned traders among us. Nonetheless, certain indicators can help you identify whether a given cryptocurrency is a prudent investment or merely a bubble that is waiting to burst.
Below we have listed some ways in which you can assess whether a crypto token is in the presence or forming a bubble.
Sudden Price Increase
Whenever a cryptocurrency experiences a rapid or substantial surge in price within a brief period, it may be indicative of an unstable and unsustainable demand. This is also a signal of the token being overvalued by the market.
In such a scenario, it is advised to observe the coin price trend over some time. If the price escalation lacks a corresponding event of huge significance like a piece of related news or technological advancements, then it could be a potential crypto bubble in the making.
Hype and Speculation
Social media is said to be the biggest hype machine to ever exist in human history. All it takes for a cryptocurrency to be hailed as the “next Bitcoin” is just a few shares, likes, and retweets. Whenever there is excessive hype surrounding a specific token, chances are that people are buying into speculation without properly assessing its intrinsic value.
These are scenarios that will fuel the fervent buying that contributes to the rapid formation and subsequent bursting of the crypto bubble.
Market capitalization represents the total value of all the tokens that are in circulation. Whenever the market cap of a cryptocurrency experiences a rapid ascend to a record-high level, then chances are that it may be overvalued.
If a token witnesses a swift increase in market capitalization without a corresponding growth in practical utility or an influx of users, it could be the onset or occurrence of a potential crypto bubble.
Many crypto projects promote themselves as ambitious using fancy white papers that outline their goals and objectives. If at all you come across a crypto project that seems to be overly optimistic or lacking concrete plans, then be vigilant. Such claims can contribute to the formation of a crypto bubble as the project’s creators may attempt to hype the token up to create a buying frenzy.
Uninformed investors may buy into the promise without a second thought. So stay informed.
In a certain scenario, you may see a token surging in value just because a group of individuals start to actively trade it. During these times, it is crucial to take a step back and assess the profile of those participating in these trading sessions.
If a majority of the token’s investors appear to lack substantial knowledge about the asset or the overall market, then it could be indicative of a crypto bubble. Never trust a trending token if the majority of its investors or traders lack experience in the crypto market.
Lack of Community Engagement and On-Chain Development
A healthy and promising cryptocurrency project is a combination of a thriving and engaged community and active developmental efforts. Conversely, if a token project lacks engagement from its supposed community on social media or development repositories, then that might suggest a lack of interest or confidence in the project.
This diminished interest can be a warning sign of a potential market bubble where speculative trading outweighs genuine enthusiasm for the project.
No Real World Use Case
It is estimated that there are over 8,000 different cryptocurrencies currently active in the market. However, out of these, only a fraction of them have any genuine use case or potential in the real world.
If a particular cryptocurrency is characterized more by hype than utility and there is a notable influx of investors, then chances are that it may be a potential crypto bubble waiting to burst.