Core Question
What are market (either crypto, stock, or real estate) bubbles? What are the implications if everything crashes?
What are market bubbles
Market prices are based on the last completed transaction. Say the last bitcoin transaction was $60,000. Suddenly, someone decides to buy at $60,010. That is now the new market price. Some bad actors also do this with new cryptos in order to inflate the marketcap and draw investors in.
But anyways, with how market price works, which is just what people are transacting the thing for, people could fall into a spiral of price increases. Essentially, the price starts to pick up very rapidly. More and more people start to buy, driving the price even further, which in turn induces more people to buy, with the cycle repeating.
Minsky's 5 stages
That is the definition of a bubble. The current price of something is far off from its true value. It is characterized by Minsky's 5 stages.
Displacement. This is when something new or news breaking comes to light. That could be a new product, realization, upgrade, or future prices.
Boom. Prices slowly start to rise, but that rapidly changes. The asset starts to get more and more attention in social media and news channels. People are driven by FOMO (Fear Of Missing Out), buying because they feel like they will miss out on the price increases. This further increases the price.
Euphoria. Prices start to reach extreme levels that people start to get cautious. Stats are released and people start to talk about how it is overvalued, yet, people still buy it to a degree. This is where we get into another core market aspect, the Greater Fool Theory, which just says that people buy an asset because they believe there will be a greater fool willing to buy at a higher price, because someone will buy at a higher price, so on and so forth.
Profit-Taking. Due to all of the talk around how the asset is overvalued and acknowledging the bubble, smart investors sell off their positions to take profits. This is the start of the price crash. The bubble has started to burst.
Panic. As the price starts to crash, people start to sell off, even if at a loss, because no one is buying and they believe that it will keep on crashing down. Funnily enough, you may want to sell, but sometimes, a special phenomenon (which is called many names, but I call it a liquidity freeze) can happen where no one buys. This in turn further crashes the price further down as people undercut each other in hopes to attract people in buying.
What happens after?
Usually, the price after the bubble is lower than where it started. It can take a long time to recover, if ever. This results in massive financial losses and digital money (money that lives only as a number on a screen) being completely wiped away from the market.
Real World Examples
There are multiple examples. Two of the most prominent are the 2008 financial crisis, with step 5 happening after investment banks like Lehman Brothers declared bankruptcy and AIG (an insurance firm) also almost went bankrupt. The U.S. government bailed out AIG to prevent a worse chain reaction, otherwise AIG would've shut down.
The second is the Great Depression lasting from 1929-1939, with step 5 happening in October of 1929.
We are currently in a AI bubble. As for which step we are on, that is pretty debated. Some economists say that only specific AI companies are part of the bubble, while some say that we are on Stage 4. However, the majority agree we are in late Stage 2/Stage 3. And, due to all of the recent Nvidia news, Stage 4 may come sooner than we think, as a bubble is pretty easy to burst, as it is all speculation and feeling.
Usually, bubbles last for about 3-5 years (Steps 2 and 3). The AI bubble is about 1-2 years old. But we'll see what happens.
Also, whether crypto is in a bubble is also a question that is somewhat debated. Some analysts say that crypto is inherently a big bubble of speculation, prone, and by design, supposed to experience large moves unless you have a stablecoin, though they can depeg.
DISCLAIMER
I am not a financial advisor. All assets carry an inherent risk. Always do your own research before investing in an asset. I am not liable nor responsible for any of your results. No asset is truly safe.
