Professional Documents
Culture Documents
Assignment 2
JANUARY, 2023
TABLE OF CONTENTS
1.0 Introduction
2.0 Identifying a speculative bubble in the Cryptocurrency market
2.1 Speculative bubble defined.
2.2 How to identify a speculative bubble using the cryptocurrency market.
2.3 Speculative bubbles in the cryptocurrency market
3.0 The formation of a speculative bubble in the cryptocurrency market
4.0 How speculative bubble in cryptocurrency market can move from mania phase to blow
off phase
5.0 Conclusion
1.0 INTRODUCTION
In this section, the study defines a speculative bubble and describes how it can be
identified in a cruptocurrency market. It further identifies the current stage that speculative
bubble is in the cryptocurrency market.
The term “speculative bubble” is a popular concept in the global financial market. There
are many controversies among scholars about what actually constitutes a speculative bubble.
This has made the understanding of speculative bubble more elusive and contrasting. The fact
that the debate about speculative bubble cut across geographical boundaries, races, nations,
people and culture makes it difficult to define.
The cryptocurrency market is a modern market where digital means of exchange exists
(Hardle et al., 2019). There are a vast range of cryptocurrencies which include Bitcoin (BTC),
Litecoin (LTC), Bitcoin cash (BCH), EOS, Ripple (XRP), Ethereum (ETH) and many more. In
the recent years, there was evidence of existence of speculative bubbles in the cryptocurency
market as we have seen a powerful price rally followed by crashing market prices (Demmler and
Fernández Domínguez, 2022). The speculative bubbles in the cryptocurrency are being identified
through the following indications.
i. Excessive Enthusiasm
ii. Speculations
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20
15
Column1
10
0
2013 2014 2015 2016 2017 2018 2019
Source: CoinDesk
The figure 1 shows that in 2013, the BTCs valued $124, $200 in 2014, $380 in 2015,
$900 in 2016, $19,167 in 2017, $3,195 in 2018 and $12,576 in 2019. This implies that there was
a bubble in 2017 when the value went higher beyond the fundamental value and crashed again in
2018. Since 2018, there has been increase in the price of BTCs as it currently stands at $60,000
in December 2022.
Speculative bubbles can also be identified when there are low interest rates that are
helping in fueling more speculations. As long as the interest rates, the speculative bubbles
become flourish (Jegadeesh and Titman, 2001).
A review of literature indicates that there are four stages of speculative bubbles as shown
below in figure 2.
Be that as it may, it can be said that the speculative bubble is currently in the Mania stage
in the cryptocurrency market. This is because the speculative bubble has gone beyond the first
stage in the cryptocurrency market. We have seen investors investing based on unproven
speculations. It was reported by Dominique, Tobin and Andreas (2019) that most of those who
invested in cryptocurrency between 2013 and 2018 did so based on speculations. This has made
the speculative bubble to move beyond the second stage as we now have many investors such as
Amazon, Elon Musk, Google, Tesla, financial institutions etc who are aware of the booming
cryptocurrency market through positive media reportage.
It can be justified that the speculative bubble is currently in the Mania phase as there is
growth in the number of investors as well as the price of cryptocurrency. Today, there are more
than 15 million investors involved in cryptocurrency worldwide (Makarov and Schoar, 2020).
Also, there is evidence that the price of cryptocurrency is currently going up. Unless in 2018,
when the value of BTCs crashed from $19,167 to $3,195, the value has been relatively and
steadily going higher. At the moment, the price of BTCs as it currently stands at $60,000 in
December 2022 (CoinDesk, 2022). Therefore, it can be concluded that the speculative bubble is
at the Mania stage in the cryptocurreency market.
In the cryptocurrency market, there are three major participants (which include the
miners, exchanges and traders) who contribute significantly to the formation of a speculative
bubble. Other institutions that play crucial roles in the formation of a speculative bubble in the
cryptocurrency market include the media, the financial institutions and policy makers. The
Minsky’s (1986) bubble formation model is adopted in this study. The model is a systemic model
with five consecutive phases as shown in figure 3. The analysis is presented in line with these
phases.
i. Displacement
This is the first stage of bubble formation. In this phase, investors get enamored by a new
paradigm known as innovation. This displacement can be formed by the miners (who are the
companies or individuals who engage in the production of new cryptocurrency products).
Displacements are formed in the circulation of new cryptocurrency products into the market. For
example, a displacement occurred in the cryptocurrency market when Cayman Islands Company
built the EOS.io software in 2012. Following this, Vitalik Buterin also caused another
displacement in 2013 with the introduction and circulation of Ethereum. The reason for the
emergence of many miners is not far-fetched. As put by Garrick and Michel (2013) “the
development of a considerable number of digital currencies and the associated blockchain
technologies was motivated with the aim of exploiting the potential embodied in this unexplored
industry, by providing services designed to facilitate the use of cryptocurrencies, especially for
beginners.” This does not negate the fact that most the miners seek competitive advantage
(Lannini, 2018). Today, there are now more than 1,586 different cruptocurrencies products
available (Lannini, 2018).
ii. Boom
After when a displacement has taken place, the price of an asset is presumed to raise
slowly as more participants and buyers enter the market. Boom can be formed by exchanges
sectors, media and financial institutions that create a market space for cryptocurrency buyers and
sellers. In this phase, exchanges sectors, media and policy makers spur more speculation and
drawing an increasing number of traders into the fold. For example, in 2017, the authorities of
New York and Luxembourg recommended that digital coin-related activities must be granted
after when some pre-determined conditions are met (Lansky, 2018). Also, in 2018, the North
American Securities Administrators Association (NASAA) affirmed that cryptocurrencies are
investments rather than means of payment. These disclosures spurred many traders into the
cryptocurrency market.
iii. Euphora
In this phase, asset prices rise beyond fundamental values. During this phase, all cautions
will be thrown to the wind as more investors are willing to pay more. For example, despite the
introduction of several exchange control methods by the Chinese government in 2016, there was
still rapid rise of the bitcoin price in the country (Charles, 2016). Globally, in 2017, the price of a
bitcoin was higher and exceeded $19,300, which was not in accordance with its fundamental
value. Euphora is formed primarily by traders of cryptocurrency products. The more these
traders invest without second thought, the more a speculative bubble is created. The entry of the
likes of MicroStrategy, MassMutual, Jack Dorsey’s Square into the cryptocurrency market in
2020 created more euphoria. It is evident that large companies have decided to invest in crypto
like never before.
After when euphoria has been formed, profit taking comes next. This is the penultimate
stage to where the bubble gets burst. During this stage, traders sell assets and positions and take
profits. Major contributors to profit taking include the exchanges sectors, traders, financial
institutions and policy makers. Here, , “institutional investors and financial professional detect
the sign of an imminent crash and thus sell the asset for profits before the bubble burst, whose
timing is quite difficult to estimate” (Minsky, 1986; Lannini, 2018).
v. Panic
This is the last stage where “the price of asset is understood to start falling more and
more rapidly” (Minsky, 1986). In this stage, there is a growing panic among traders and other
investors and the need for investors to liquidate their assets becomes essential. Such panic was
experienced in the cryptocurrency market in 2017 when the price of bitcoin crashed drastically
from $19,167 to $3,195.
There must be some pre-determined conditions that will contribute to the movement of
the speculative bubble from mania phase to blow off phase in the cryptocurrency market.
Investors must be irrational (Mcqueen and Thorley, 1994) in order to move the speculative
bubble from mania stage to blow off stage. Here, delusion, greed and unnecessary enthusiasm
must be formed among investors. As argued by Minsky (1986) a panic must be created before a
blow off takes place. In such case, there must be more increase in the crypto prices and increase
in the number of investors. This increment will eventually lead to the arrival of a “moment of
epiphany”, which is needed for the speculative bubble to move from the mania phase to the blow
off phase. After when a “moment of epiphany” (otherwise known as a trigger), then every
investor realizes that the situation has changed and there is a blow off.
As Osagie (2021) puts it, “economic bubbles regularly happen when an excessive
amount of cash is chasing excessively a couple of assets, causing great and terrible assets to
excessively appreciate beyond their fundamentals to an unsustainable point”. In this case,
Osagie (2021) argued that for a blow off phase to exist, market correction needs to occur. Once
price of cryptocurrency products are corrected, the bubble bursts and the speculative bubble
move to blow off phase. For example, the South Sea Company speculative bubble move from
mania phase to blow off phase when there rumours about their operations and profits were
extremely spread which made investors to become greedier (Garbar, 1990). Suddenly, the stock
price of the South Sea Company fell abruptly from £1000 in August 1720 and went back to less
than £200 at the end of the year.
5.0 CONCLUSION
The study sought to discuss the current stage of speculative bubble in the cryptocurrency
market using historical prices of bitcion over the period 2013 to 2019. The study identified that
the speculative bubble is currently at the mania phase where there are more investors coming
into the market and a growing price in crypto products. The study used the Minsky’s model to
explain the formation of speculative bubble in the cryptocurrency market. It is evident that there
are tendencies for the speculative bubble to move from the mania phase to the blow off phase.
The existence of delusion, greed and unnecessary enthusiasm among investors can help to get the
bubble to blow off stage.
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