Four signs that a crypto bubble is forming
Introduction
Cryptocurrencies are off to a great start this year: Bitcoin is up 40%, according to the American weekly magazine Barron’s.
But there are already signs of another bubble. Here are four warning signs.
Specifications look wobbly
Bitcoin’s January rally was one of the longest cryptocurrency winning streaks in the past six years, and it pushed prices up across the digital asset space. But that came amid low liquidity, or insufficient trading volume, and the same short-squeeze momentum that propelled GameStop and other “meme” stocks into 2021.
Liquidity in the cryptocurrency markets has been historically low since FTX’s bankruptcy in November. Low liquidity essentially means that there are fewer buyers and sellers in the market. When prices jump, fewer sellers meet the demand for the asset, putting upward pressure on prices. The same thing can happen in the opposite direction, causing prices to plummet.
A sign of a healthier underlying demand for cryptocurrencies and a stronger market overall is greater market depth for bitcoin and other tokens. This, in turn, will reduce volatility.
Another unstable element can be a short compression. In crypto, this happens when traders making “short” bets against Bitcoin prices are forced to close their positions when the market fluctuates against them. This so-called liquidation triggers automatic buy orders, which in turn increase upward pressure on prices.
This seems to be exactly what happened when bitcoin rose from a two-year low last month.
However, the short squeeze eventually dries out. Bitcoin needs organic demand to keep prices going up — a fundamental shift, for example, as more major asset managers move into crypto, or the return of retail investors who drove the 2020 bull market and pretty much went uphill.
Altcoin fever
More signs of effervescence are showing up in smaller tokens known as “altcoins” or “memcoins” – the latter being everything from Dogecoin to Shiba Inu, coins that lack genuine use.
The FTT token, issued by FTX and used as the currency on its exchange, is up 125% since the start of the year, jumping from 84 cents to almost $2. But FTT is no longer useful: FTX has gone bankrupt, so the rally seems to be just the result of optimism that a restructured and restarted FTX could breathe life into the ghost token.
Solana, which was wiped out due to its association with FTX, including trading firm Alameda Research, is up almost 150% this year. The same picture is with Dogecoin and Shiba Inu, which have outperformed the rest of the crypto market at times.
Exotic Deals
One of the biggest crypto deals this year involved what is known as staking Ethereum, a traded derivative of Ethereum, the native token of the Ethereum network. Ethereum holders can lock or stake their tokens while earning income and protecting the blockchain.
Staked Ether, or StETH, is a product issued by platforms that stake coins themselves, including Coinbase Global.
It opens up an income pool for those who don’t want to lock up tokens or don’t have enough to stake with Ethereum itself. One stETH trades at roughly 1 Ether, while the Ethereum network requires 32 Ether, or about $50,000 to stake.
The problem is that this synthetic version of ether is not real. According to Clara Medali, head of research at Kaiko. “stETH… played a huge role in the collapse of Celsius and the wider crypto lending crisis.”
Basically, there is nothing wrong with investors buying staked ether, but the gap between its price and the price of ether can create problems, especially when stETH is used by market participants as if it were real.
StETH shows no signs of danger, but its current popularity is reminiscent of the frenzy that preceded some of the most violent events in bitcoin history.
Macroscene
Aside from technical factors, another major force behind bitcoin’s rise this year has been a more supportive economic environment, or at least the perception that it has improved. Investors are betting that declining inflation will allow central banks to cut interest rates this year, paving the way for financial conditions to once again be favorable to riskier assets, from equities to cryptocurrencies.
But there is no guarantee that the economy will grow. And the high correlation between digital assets and stocks, which improved towards the end of 2022, means bitcoin is vulnerable to fluctuations. Falling stocks associated with a change in views on the economy or monetary policy can become a threat to coin prices.
Analyst warnings have been piling up this week as the Dow Jones Industrial Average and the S&P 500 rose ahead of the Fed’s decision and the US jobs report on Friday. There is growing concern in the markets that investors are trying to “fight the Fed” by raising prices, despite the likelihood that the central bank will pursue a tight monetary policy.