Financial bubbles: key traits and how they work
A financial bubble, also called a market or economic bubble, occurs when asset prices shoot up quickly, only to crash just as fast afterwards. Experts and even the public know a lot about bubbles, but they’re often only identified after they’ve already burst.
Key traits:
● Lack of fundamentals
● Instability
● Excessive risk-taking
● Media hype
● Crash
The idea is simple: buyers push prices above what assets are really worth. But as bubbles form, they become quite intricate and difficult to unravel. The progression of a bubble follows five stages:
1. Displacement. This stage begins with a major shift, like a new technology or record-low interest rates. For example, the decline in federal funds rates from 6.5% to 1% (May 2000 – June 2003) paved the way for the housing bubble.
2. Boom. Prices start to rise, drawing more participants into the market and gaining widespread media attention.
3. Euphoria. During this phase, people get overly excited, and asset prices shoot up. For instance, during the Japanese real estate bubble, land in Tokyo sold for as much as $139,000 per square foot (for comparison, now it’s about $25,000).
4. Profit taking. Smart investors recognise the signs of an impending bubble burst and begin to sell their positions.
5. Panic. When the bubble bursts, prices crash as everyone rushes to sell. This happened in October 2008 when big financial institutions collapsed and sparked a global market crash.
Does this apply to Bitcoin? Well, let’s start by examining Bitcoin’s journey so far.
Bitcoin’s complex journey
Bitcoin’s journey has been quite intricate. It began over 15 years ago with a mysterious creator named Satoshi Nakamoto, who introduced the concept in a nine-page white paper back in October 2008. Since then, the cryptocurrency has seen its share of ups and downs. Bitcoin has gained recognition for its potential as an investment, a hedge against inflation, and a store of value. However, it has also faced criticism for its use in illicit activities on the dark web.
Navigating regulations has been a major hurdle for Bitcoin. Policymakers seek to prevent fraud and money laundering while supporting the growth of the industry, so they work to strike a balance between encouraging innovation and protecting consumers. And the regulations are getting clearer every year.
Bitcoin is a mix of opposites: still niche but rather popular, polarising but captivating. And it continues to evolve daily as more people, businesses, and governments use it.
The one area that’s been bustling is Bitcoin trading. If you’re ready, Octa, a globally recognised broker, offers accessible trading tools and instruments to participate in this evolving movement. With us, you can trade on weekends—and be flexible with your schedule. Also, you can place your trades from anywhere globally, in the spirit of the borderless nature of cryptocurrency.
Bitcoin and bubble characteristics
Yes, there are some similarities. Bitcoin has experienced rapid, massive price increases over short periods. The cryptocurrency market, including BTC, is known for its high volatility, so it attracts speculative traders seeking short-term gains. Also, Bitcoin gains media attention during periods of price surges, and there is some herd behaviour where people buy into it primarily because others are doing so.
There’s no denying that these traits can cause concerns and anxiety among investors and market participants. Still, Bitcoin exhibits unique traits that distinguish it from typical bubbles.
● The asset has been increasingly adopted by institutions, its utility has grown as a financial asset, and it is globally recognised as a digital store of value.
● Bitcoin doesn’t fit traditional valuation methods because it doesn’t generate revenue like companies and commodities do. It’s in a category of its own.
So, it doesn’t quite meet all the criteria of a bubble.
Bitcoin’s role in the financial revolution
Bitcoin introduced a grand idea that hadn’t been thoroughly explored before. Yet, there are still doubts about whether the creator’s envisioned total change in financial structures will happen.
Bitcoin was always meant to provide an alternative to existing systems without replacing them entirely. Many projects show potential for independent monetary policies, but appropriate regulatory frameworks are still to support adoption. By 2024, many of such measures are in place or are about to be.
The recent embrace of Bitcoin by mainstream institutions signals a notable shift in public acceptance. Morgan Stanley and JPMorgan launched Bitcoin funds, with Goldman Sachs set to do the same globally, while Citi Private Bank is considering its options for client inquiries about cryptocurrencies. Even Japan’s Government Pension Investment Fund is considering adding assets like Bitcoin to pension fund portfolios.
Bitcoin has become a major player in the financial world and maintains its prominence.
Spotting and avoiding bubbles
You can never be entirely certain that something is legitimate. Let’s explore the tools available to verify whether something is a bubble or not.
What can help you avoid getting caught in a crash is staying informed. For example, pay attention to practical use cases driving genuine demand for Bitcoin, like increased adoption for online payments or as a store of value.
Next, practise good risk management: diversification, using stop-loss and take-profit orders, and maintaining a balanced portfolio. Avoid overleveraging and only invest funds that you can afford to risk comfortably. Thorough analysis is another key aspect. If you’re considering Bitcoin as an investment vehicle, look into underlying technology and evaluate market sentiment.
Finally, keep an eye on regulations as they indicate an asset’s legitimacy. In the U.S., the SEC ensures investor protection in the crypto sector. In the U.K., crypto assets are regulated under the Financial Services and Markets Act 2000 by the FCA. India’s Finance Bill of 2022 defines virtual assets as property and outlines tax requirements for income from them.
These strategies should keep you well-informed and ready for changes in the crypto world.
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About Octa
Octa is an international broker that has been providing online trading services worldwide since 2011. It offers commission-free access to financial markets and various services already utilised by clients from 180 countries with more than 42 million trading accounts. Free educational webinars, articles, and analytical tools they provide help clients reach their investment goals.
The company is involved in a comprehensive network of charitable and humanitarian initiatives, including the improvement of educational infrastructure and short-notice relief projects supporting local communities.
Octa has also won over 70 awards since its foundation, including the ‘Best Educational Broker 2023’ award from Global Forex Awards and the ‘Best Global Broker Asia 2022’ award from International Business Magazine.
