Are We In A Crypto Bubble? 3 Ways To Identify One And How To Stay Protected

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Cryptocurrency prices have been volatile since bursting onto the scene over the past decade, but they got a major boost following the reelection of President Donald Trump after he promised to adopt crypto-friendly regulations. The price of Bitcoin surged past $100,000, and Trump and First Lady Melania Trump launched memecoins around the time of the inauguration. 

The level of excitement around crypto has caused some investors to question whether there is a bubble for cryptocurrencies. Here are three ways to identify a potential bubble and how to protect your portfolio from potential losses.

Investors issue warnings of a crypto bubble

Just days before Trump took office for his second term, he announced on X (formerly Twitter) that he’d launched a cryptocurrency called $TRUMP. The memecoin quickly surged to a market cap of more than $9 billion as speculators gobbled up the digital coin. The $MELANIA memecoin launched on Jan. 19, and it reached a peak of more than $1 billion in market value. Both coins have since dropped by more than 75 percent from their highs.

The rise of these memecoins and others like them, such as Fartcoin, has some investors concerned that there are signs of a crypto bubble.

Hedge fund Elliott Management warned of a speculative frenzy in crypto markets in a recent investor letter, according to a report in the Financial Times. The letter said that the “inevitable collapse” of the crypto bubble “could wreak havoc in ways we cannot yet anticipate,” according to the report.

Investor and hedge fund manager David Einhorn also recently highlighted memecoins in a quarterly investor letter.

“We have reached the ‘Fartcoin’ stage of the market cycle,” Einhorn said. “Other than trading and speculation, it serves no other obvious purpose and fulfills no need that is not served elsewhere.”

“It’s anyone’s guess as to what will happen next, but it feels like it’s going to be wild,” Einhorn said.

If you own cryptocurrencies and are concerned about the potential of a bubble, you may want to speak with a financial advisor, who can help you develop a strategy based on your individual needs, risk tolerance and time horizon.

3 ways to identify a crypto bubble

Identifying a crypto bubble is easier said than done. Part of the challenge is that crypto has had bubble-like characteristics since its beginnings, such as having very few uses and lacking underlying cash flow that would support intrinsic value. But there’s no denying that prices have risen significantly.

Here are three ways to spot a potential crypto bubble.

1. Rapid surge in price: A sudden surge in the price of a cryptocurrency over a few hours, days or weeks, could indicate that a particular coin or cryptocurrencies in general are in a bubble.
2. Memecoins: Memecoins are particularly susceptible to bubbles because of the ability to burst onto the scene quickly and attract an enormous amount of attention and demand. If you’re buying something that was started as a joke, be aware that you’re taking an enormous risk.
3. Social media hype: Cryptocurrencies that attract a lot of attention on social media may also turn into bubbles because of the attention they receive. Social media has the potential to pour gasoline on a fire of demand for a particular asset, so pay attention if a coin is trending on various social platforms.

How to protect yourself from a crypto bubble

If you’re concerned about a potential crypto bubble, there are a few things you can do to protect your portfolio. 

• Don’t own any crypto at all: Probably the simplest approach to protecting yourself from a potential bubble is to avoid that area of the market entirely. Many investors have warned about the dangers of crypto investing, and there are plenty of other asset classes with a long track record of rewarding investors over time, such as stocks and bonds.
• Avoid the most speculative coins: If you do own crypto, it probably makes sense to avoid the most speculative coins. These would include memecoins and all but the most popular cryptocurrencies. To be sure, there’s no guarantee that this approach will help you avoid any pain in the event of a crypto downturn, but it may keep you from getting completely wiped out.
• Limit your crypto exposure: Due to crypto’s extreme volatility and concerns about a potential bubble, it’s probably best to limit your overall crypto exposure to just a few percent of your overall portfolio. If your exposure is greater than 5 percent, consider selling some crypto to protect yourself from potential losses. 

If you aren’t sure about the best way to protect yourself from a possible crypto bubble, consider meeting with a financial advisor to discuss your situation. Bankrate’s financial advisor matching tool can help you find an advisor in your area. 

Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.