Crypto Bubbles Explained: How to Stay Safe as a Crypto Investor?

In 17th-century Holland, the price of tulips exploded. A frenzy enveloped the Dutch consumer market, and the price of these everyday flowers appeared to be caught up in a permanently bullish cycle.

Households bet everything they had on tulips, and at the peak of tulip mania, just one of the flowers was worth more than the average highly skilled artisan's yearly salary. Did people stop buying? No, they carried on for the best part of three years.

Unfortunately for a large part of the 17th-century Dutch population, the music did eventually stop. Approximately three years after the speculative frenzy began, the price of tulips crashed in early 1637. Within just a few days, tulips were once again more or less worthless, and investors were left holding bunches of quickly decaying flowers with empty bank accounts.

The tulip mania story has become common knowledge among investors. These days, whenever an asset appears to be forming what is commonly referred to as a bubble, analysts will warn investors with the tulip analogy. And while speculation on tulips is no longer a threat, financial bubbles remain at the forefront of all investors' minds.

The crypto market is no stranger to bubbles. In fact, many bearish traders have been quick to claim that Bitcoin itself is a crypto bubble; however, they have been constantly disproved as Satoshi's coin has amassed a market capitalization in excess of $1.5 trillion.

For those traders who spend their time scouring the crypto market for the next best crypto for long term investment, being able to identify bubbles is critical. This guide will provide a detailed analysis of what a crypto bubble is by looking at the history of financial bubbles and then provide some tips on how to avoid ending up like the people of 17th-century Holland.

The Free Dictionary defines a financial bubble as "a market phenomenon characterized by surges in asset prices to levels significantly above the fundamental value of that asset. Bubbles are often hard to detect in real-time because there is disagreement over the fundamental value of the asset.

The history of financial bubbles stretches back hundreds of years. It appears that if there is an opportunity for speculation, human psychology will often lead to price distortions, resulting in overly inflated asset prices.

The major issue with financial bubbles is that they are very hard to detect, and arguably, due to the euphoria that they generate, no one actually wants to detect them.

For example, prior to the 2008 subprime mortgage crisis, leading economists and central bankers declared that the US property market was stable and in no way overheated. In hindsight, anyone can see just how wrong they were.

The 2008 housing crisis is a classic example of a modern-day financial bubble. The crisis was fueled by the rapid expansion of subprime mortgages, which were loans given to borrowers with poor credit histories. This led to a dramatic increase in housing prices, as demand outstripped supply. 

The Japanese stock market bubble burst in the early 1990s. Source: Google

When the housing bubble burst, many homeowners found themselves owing more on their mortgages than their homes were worth, leading to widespread foreclosures and a global financial crisis.

2008 is far from an isolated event, even if it has become one of the most cited. The Japanese stock market bubble began in the late 1980s and eventually popped in 1991. It wasn't until the past year, 2024, that Japanese asset prices recovered to their all-time highs.

These historical examples should teach every investor to be cautious, avoid FOMO, and always ask critical questions before risking capital. Investors should focus on the underlying value of assets, understand market cycles, and diversify their portfolios to mitigate risk. These lessons apply just as much to crypto bubbles as they do to the price of tulips in 17th-century Holland and the valuation of tech stocks in 1980s Japan. 

When talking about crypto bubbles, the best example to cite is arguably the 2021 bull run. Although the leading cryptocurrencies like Bitcoin and Ethereum survived the bubble, and in the case of Bitcoin, new all-time highs were seen just a couple of years later, there's no doubt that a bubble-like environment developed in 2021.

Following the pandemic-induced lockdowns around the world in 2020, the stock market and crypto market tumbled. However, the tides quickly changed as liquidity flooded the market from central banks around the world that embarked on massive quantitative easing (QE) programs.

A huge amount of this QE money was distributed to individuals and institutions. Large amounts of capital flooded the crypto market as interest rates reached zero, forcing investors to hunt for yield outside of treasury bills and savings accounts.

Arguably, Bitcoin got caught up in the crypto bubble of 2021.

Bitcoin price and other assets exploded within just a few months. For context, Bitcoin's market capitalization in early 2020 was around $100 billion; by the end of the year, it was above $300 billion.

The gains had only just begun to accumulate as 2021 kicked off. In March, the market cap hit $1 trillion, and its price was over $60,000. At this point, everyone in the market was talking about $100,000 next; it was euphoric: it was a classic crypto bubble.

Shortly after hitting $69,000, the price of Bitcoin began to tumble along with the broader market. A series of events, including China banning crypto, popped the bubble. The crash was brutal, leaving Bitcoin trading at just $16,000 by December 2022.

While Bitcoin has recovered from much of the crash, the altcoin market never did. Thousands of alts went to zero, and investors lost everything.

The 2021 crypto bubble should serve as a pertinent reminder for traders and investors about the threat that bubbles present.

There's no way to completely avoid bubbles. These phenomena are notoriously hard to identify and catch traders off guard due to the almost deafening hype that accompanies them. Fortunately, there are some steps that investors can take to avoid getting caught up in crypto bubbles:

• Thorough Research: It is essential to conduct in-depth research before investing. Do not rely solely on the opinions of others, especially when dealing with altcoins. Utilize multiple sources, including official documents, and verifying the team's credentials, to form your own decisions.
• Focus on Utility: Prioritize projects that have long-term plans and real-world utility. Utility-focused projects, like BlockDAG, are designed to offer tangible solutions that will remain valuable even after a boom-bust cycle. This is arguably why Bitcoin has survived so many market crashes.
• Understand Market Cycles: Recognize that market cycles are a natural part of investing. Avoid letting short-term volatility influence your long-term investment decisions. Consider learning about Warren Buffett's investment philosophy, which emphasizes a long-term, value-driven approach.
• Develop a Plan: Create a clear investment plan with defined goals and risk parameters. Take profits when you reach your target, and avoid overexposure to any single asset. Always consider your individual risk appetite and invest accordingly.

Crypto bubbles are always in the back of a savvy investor's mind. History has shown that the market is constantly distorted with speculative frenzies that force the price of assets to dizzying heights before letting them crash back down to earth. The best way to manage the threat of crypto bubbles is to focus on carrying out proper research, avoiding hype, and finding crypto projects that offer long-term utility. 

Arguably, BlockDAG is a typical example of a project that is built to outlast crypto bubbles by providing the industry with much-needed utility in the form of a lightning-fast Layer-1 blockchain, an extensive crypto mining ecosystem, and a community of experienced developers.