Crypto Has All The Hallmarks of a Massive Bubble

But, it will have zero impact on how I invest

Photo by Christopher Burns on Unsplash

I’ll be honest: I have never been a fan of crypto.

Mostly for the simple reason that I have never been given a real answer to this question:

“Beyond increasing in price, what is the most influential impact that Bitcoin or crypto has had on the real economy.” We’re going on 16 years of Bitcoin existence, and it still plays a near-meaningless role in the day-to-day economic lives of most people.

That being said, I could be wrong, and the crypto enthusiasts could be right about its future importance. I don’t much care what you invest in, I see my job in this newsletter as helping to spotlight research and evidence to help you learn more about money and make informed decisions.

With that in mind, I can’t help but notice that since the election of Donald Trump, the crypto market has exhibited all the signs of an ‘attention-driven asset bubble.’

A new theory on how to spot an asset bubble before it pops

In a previous post, I reviewed a 2021 research paper that put forward an interesting theory on how to spot an investment bubble as it forms—something that should be impossible in a perfectly efficient market.

Here’s what I wrote previously, which sums up the research:

bubbles should be more likely in assets where increases in past returns make excited speculators relatively more persuasive to their peers.

People who buy speculative assets usually don’t sit quietly waiting for the money to start rolling in. They try and recruit others to also buy the speculative asset—because the only way speculators make money is if they can find someone else willing to pay more than they did.

The above theory would suggest a big increase in the price of a speculative asset makes it easier to recruit new ̶m̶a̶r̶k̶s̶ investors to buy the asset, too. They tap into people’s FOMO.

“This thing is going to the moon! Better jump on while you can!”

And people indeed do jump on.

This further pumps up the price, which gives the speculators more “credibility” to recruit even more people to invest.

This is how bubbles are formed.

The researchers provide empirical evidence to back up this intuitive explanation of bubbles.

They do this by examining the relationship between media coverage and daily returns of a particular industry—in this case, tech companies in the late 90s:

• The more a speculative asset increases in price, the more often it is written about in financial publications like The Wall Street Journal.

• It also leads to a greater proportion of “positive coverage” of the asset— coverage that makes the speculative asset sound like a great opportunity.

• So-called “pre-bubble” assets saw positive media coverage after positive returns 9.2% of the time compared to 2.8% for the control group.

Here’s the important point:

A disproportionately large amount of positive media coverage for a speculative asset following increases in price turned out to be an excellent predictor of future bubbles.

This brings us to the frenzy of headlines hyping up Bitcoin—and really all crypto—since Trump won the election on Nov 5th.

Here’s where the price of Bitcoin has done in the past month—tell me if you can spot Nov 5th on this chart:

And as Bitcoin prices go up and we see more headlines about the prices going up, people get interested:

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The same story plays out with Dogecoin, which is a much more obvious bubble than Bitcoin because even many of the people who own Dogecoin acknowledge it has no economic value other than “funny” and “price goes up.”

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So, is crypto a massive bubble ready to pop?

I don’t know.

While financial markets (especially crypto) are not perfectly efficient, I’ve seen enough data about what happens to investors who try to time the market, so I just act as if markets are perfectly efficient. And, if markets are perfectly efficient, the rational choice is to diversify and keep buying and holding for as long as possible.

But, if we are looking at this from an academic perspective, crypto markets seem to be perfectly fitting the definition of an attention-driven bubble:

• Prices go up

• Media covers prices going up

• People jump on the bandwagon.

If it is a bubble, it will pop eventually.

But that brings me to my last point on why I just push forward as a boring, buy-and-hold investor:

Even if I assume crypto is a massive bubble that will definitely pop, there’s no way of knowing how long the mania will continue. With Trump and Musk in charge of the U.S. government, you can expect the hype to continue into the foreseeable future.

With that in mind, I’ll leave you with a parting thought from John Maynard Keynes' which explains why I never try to time financial markets:

"Markets can remain irrational longer than you can remain solvent.”

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This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any significant financial decisions.