These days it seems any market that goes up for two sessions in a row is a bubble. This is of course nonsense. While the chaotic nature of bubbles makes definition difficult, there are characteristics of bubbles on which many traders agree.

Those new to cryptocurrencies may know there are other examples besides Bitcoin. They may have heard of Ripple, Etherium and Bitcoin Cash. In fact in June this year the number of cryptocurrencies exceeded 900, and it now stands at more than 1,300. The universe of digital money is exploding as well as the prices.

What makes traders think Bitcoin is in a bubble right now? There are three requirements to tick off. The first is that the gains in the market are increasingly higher and faster. The price action becomes exponential. This is the first marker of a bubble, and is already occurring in Bitcoin.

The second characteristic of a bubble is a version of the argument “it’s different this time”. This saying alone is enough to make experienced traders groan. However by their nature cryptocurrencies ARE different. They are created (mined) digitally. You’ll never hold a Bitcoin in your hand. They are unregulated. Governments and central banks have no say in the supply, the relevant interest rates, the exchange and the records of transactions. 

The “it’s different” argument is important because it permissions market behaviour that is unusual. Despite eye-watering gains and dramatic volatility, new and potential participants are not deterred. Extravagant and enthusiastic optimism rules.

The third characteristic of a bubble is the giveaway that the end is coming. A term commonly used is a “blow-off top”. This price action can vary enormously, and there are many chart based patterns that fit the description. Most of them involve an even larger gain than previous moves quickly followed by a sharp reversal that takes the price below its starting point. Examples include “island reversals”, “evening stars” and “a hanging man”.

The Bitcoin market is yet to make a blow off top.

The newer aspects of digital currencies do not exempt them from their organic nature. Market prices are an organic function of human behaviour, not a product of a mathematical process. Bitcoin prices are subject to the same conditions and drivers as any other market, although many will dispute this during the “it’s different” phase.

The anonymous and unregulated use of cryptocurrencies was the initial driver of their success. They are used to circumvent government currency controls and make illicit purchases. There is a contradiction in them becoming mainstream financial instruments, potentially alienating the original users. Here may lie the seeds of crypto destruction.

Now that Bitcoin is moving into the mainstream with the listing of futures contracts, family, friends and clients ask; “Is it too late? Should I buy Bitcoin?” The problem is that despite what we know, no one can say with certainty when or at what price a bubble will burst. Bitcoin may collapse tonight, or it may reach $100,000 US dollars first.

Perhaps the answer lies with one of the best salesman I’ve ever come across. He was a ruthless blackheart who could seduce minds with his soft patter – so his motives may not have been pure. It was 2000, about a year before the tech bubble burst. He overheard a group of traders ridiculing the height and valuation metrics of the Nasdaq index (it gained a further 65% before imploding). He interjected:

“Sure, the fools are dancing. But the even bigger fools are sitting on the sidelines.”