4 signs a crypto bubble is forming and how it might burst

Cryptocurrencies got off to a remarkable start this year


40% is collected. But signs of another bubble are already visible – even if the last one is barely over. Four warning signs of a market bubble and what may need to change to keep the rally going.


‘s January rally was one of the cryptocurrency’s longest winning streaks in six years and sent prices soaring across the digital asset space. But this occurred in the same short-term squeeze dynamics that fueled the low liquidity or lack of trading volume.


(ticker: GME) and other “meme” stocks in 2021.

After the bankruptcy of FTX in November, liquidity in cryptocurrency markets has been historically low.

Bitcoin’s market depth — a measure of liquidity that represents the number of bids and offers within 2% of the middle of the bid range — is down from about 14,000 bitcoins before the FTX collapse to almost 6,000 since November, according to the cryptocurrency data provider. fell. Kaiko. Although market depth recovered towards the end of 2022, it has since returned to levels seen after the FTX collapse.

Low liquidity actually means that there are fewer buyers and sellers in the market. When prices rise, there are fewer sellers to meet demand for the asset, putting upward pressure on prices. The same can happen in reverse, causing prices to fall rapidly.

A sign of healthier underlying demand for cryptocurrency and a stronger market overall would be deeper market depth for Bitcoin and other tokens. This in turn reduces volatility.

Another unstable element can be a short squeeze. In cryptocurrency, this occurs when traders who bet or “short” Bitcoin prices – often with margin money borrowed from a broker – are forced to close their positions when the market swings against them. This so-called cancellation triggers automatic buy orders, which in turn puts more upward pressure on prices.

This appears to be the case with bitcoin rallying from two-year lows over the past month.

“The entire rally is built on the backbone of sustained market shorts,” analysts at cryptocurrency exchange Bitfinex said in a January report. “The move can be interpreted organically, but it’s entirely made by limited traders.”

Although the short-term squeezes eventually disappear. Bitcoin needs organic demand to support a price rally – a fundamental shift to the cryptocurrency as more mainstream asset managers or a return of retail investors who drove the 2020 bull market and mostly headed for the hills.

However, there are some technical factors that have improved this year. Market watchers note that much of the forced selling that occurred in the weeks after FTX’s failure — as other firms collapsed, lending platforms faced massive defaults and many margin traders were liquidated — has ended. This reduces selling pressure, but alone is not a reason to raise prices.

Altcoin fever

More signs of the bubble are evident in smaller tokens known as “altcoins” or “memecoins” — the latter being everything from Dogecoin to Shiba Inu, coins with few original uses.

FTT, the token issued by FTX and used as currency on its exchange, has risen 125% since the beginning of the year, rising from 84 cents to nearly $2. But FTT is no longer of any use: FTX has gone bankrupt, so the rally seems to be only the result of optimism that a restructured and relaunched FTX can give life to the dream token.

The once high-flying coin, which has been stripped of its ties to the FTX empire, including trading firm Alameda Research, has soared almost 150% this year.

Solana’s blockchain is considered a competitor to Ethereum – a blockchain that can be used for other applications, tokens and services. The token’s gains reflect a toe-to-toe optimism, including after Ethereum co-founder Vitalik Buterin. On Twitter, he wrote positive things about Solana and said that he hoped for a bright future. This comes despite reports showing Alameda liquidators are holding hundreds of millions of dollars worth of tokens, representing huge potential selling pressure.

It’s pretty much the same picture



Shiba Inu,

outperformed the rest of the cryptocurrency market. Their prices rose on Elon Musk’s optimism about Twitter and the metaverse, respectively.

“The biggest surprise of crypto markets in 2023 has been the strength of alts,” Bernstein analysts Gautam Chhugani and Manas Agrawal wrote in a note on Monday. “Do these actions bother us? Let’s just say we’re not surprised – even in the bear markets of 2018/19, we’ve seen some sharp rallies in select alts.

Indulge in Exotic Trades

One of the biggest cryptocurrency trades this year has been in so-called staked Ether, a tradable derivative of Ether, the native token of the Ethereum network. Ether holders can lock or distribute their tokens while simultaneously earning revenue and securing the blockchain.

Staked Ether, or StETH, is a product issued by platforms that include the coins themselves.

Coinbase Global


This opens up the revenue pool to those who don’t want to lock in tokens or don’t have enough stake with Ethereum itself. A single stETH trades for about 1 Ether, while the Ethereum network requires 32 Ether or about $50,000 for staking.

The problem is that this synthetic version of Ether is not the real thing. According to Clara Medali, head of research at Kaiko. “stETH … played a major role in the collapse of Celsi and the broader crypto credit crisis,” the Medalie team said in a report on the 2022 review.

There is no problem with investors buying staked Ether, but gaps between its price and Ether can be problematic, especially when stETH is used by market participants as if it were the real thing. StETH changes hands at a price independent of Ether, even though the two assets are closely related. During periods of market turmoil – such as the meltdown of the Terra stablecoin last year – staked Ether has traded at a significant discount to Ether. This can cause problems for traders who use it as collateral for loans, for example.

StETH shows no signs of trouble, but its current popularity is reminiscent of the frenzy that preceded the most violent events in Bitcoin history. Showing how popular trading is right now, the local token used in Lido – a decentralized exchange that issues stETH – has grown by 130% this year.

Mixed Macro Scene

Aside from technical factors, another big force that has lifted Bitcoin this year has been a more favorable economic environment, or at least the perception that it is improving. Investors are betting that softening inflation will allow central banks to cut interest rates this year, making financial conditions once again favorable for riskier assets, from stocks to cryptocurrencies.

But there is no guarantee that the economy will cooperate. The high correlation between digital assets and stocks intensified as the last year drew to a close, meaning Bitcoin is vulnerable to fluctuations exogenous to the cryptocurrency. A fall in stocks associated with a change in opinion about the economy or monetary policy can be a threat to coin prices.

Analysts’ warnings are on the rise this week

Dow Jones Industrial Average


S&P 500

It rose on Friday ahead of the Federal Reserve’s latest policy decision and the US employment report. There is growing concern in markets that investors are trying to “fight the Fed,” pushing up prices despite the central bank’s likelihood of keeping monetary policy tight.

Barron’s indicated to investors that the stock’s recent rally may be worth selling. Given the impressive gains in Bitcoin in recent weeks, cryptocurrency holders may want to follow suit.

Write to Jack Denton at jack.denton@barrons.com

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