What crypto bubble?

In my entire 67 years on this planet, I’ve never seen a less bubble like asset than bitcoin. I’ve watched its price rise from less than a $1 to more than $16,000. That’s pretty impressive! Thus in January 2023, I would not expect gloating from people that “always knew” crypto was a bubble.

Over at the Financial Times, Martin Sandbu has this to say:

My colleague Jemima Kelly, who always saw the crypto bubble for what it was, writes on what the year in crypto taught us.

I’m certainly no fan of crypto. I’ve never invested in any cryptocurrency. I do not have any sort of expectations for the future path of crypto. But I am interested in bubbles, and the amazing tendency of people to see bubbles where they clearly do not exist.

Just for the fun of it, I googled Jemina Kelly and crypto bubbles, and came up with a Reuters article that she wrote in August 2017:

The price of a single bitcoin hit an all-time high of above $3,500 this week, dragging up the value of hundreds of newer, smaller digital rivals in its wake. Now some investors fear a giant crypto-bubble may be about to burst.

[To be clear, that’s the view of “some investors”, not necessarily Kelly.]

But what exactly does Martin Sandbu mean when he suggests that Kelly “always saw” that crypto was a bubble? Does he mean that she saw that bitcoin was a bubble way back in 2017, when the price was $3500? As of today, it’s $16,815.

Again, I could care less what anyone thinks of any particular investment. We all have opinions. I’m certainly no expert on forecasting asset prices. What interests me is the persistent attraction that people have to the idea of bubbles. An attraction so powerful that an example where bubble warnings were made at $3500 and the price later rose to $16,815 is seemingly viewed as confirming the earlier bubble warning.




22 Responses to “What crypto bubble?”

  1. Gravatar of Philo Philo
    6. January 2023 at 10:21

    The ability to predict big price declines–most of which can be cast as “bubbles”–would be wonderful to have. Nobody really has it, but you can almost feel like you have some of it–and you can get other people to regard you that way–if you make a lot of passing remarks about coming price declines, and then say “I told you so!” when some (but only *some*) of them come to pass. “At least *that* time, I foresaw the future!”–it’s a nice feeling.

  2. Gravatar of foosion foosion
    6. January 2023 at 11:27

    What makes me think that crypto is a bubble is that it’s an asset seemingly without intrinsic value that has experienced a massive price rise (to about $65,000). This was following by a large price decrease (losing about 75%), although not back to its initial level. https://www.statista.com/statistics/326707/bitcoin-price-index/

  3. Gravatar of ssumner ssumner
    6. January 2023 at 11:50

    foosion, It’s lack of intrinsic value doesn’t really bear on the question of whether it’s a bubble. In any case, those who view it as a bubble have lost a LOT of money. No one should be gloating about bubble predictions for crypto, unless something happens to justify that claim.

  4. Gravatar of Carl Carl
    6. January 2023 at 12:35

    Good point that I’m not hearing many other places. I think the important point is not whether it is a bubble, it is whether anyone should treat it as a currency.

  5. Gravatar of John Hall John Hall
    6. January 2023 at 14:09

    Debating about whether something is a bubble ultimately comes down to what your definition of bubble is.

  6. Gravatar of ssumner ssumner
    6. January 2023 at 22:24

    John, I can’t imagine any definition where going from $3500 to $16000 proves that something was a bubble. But I always figured that people prefer profits to losses.

  7. Gravatar of Kenneth Duda Kenneth Duda
    7. January 2023 at 06:45

    Scott, I think this is simple. When a pundit is storytelling around why an asset’s market price is higher than the casual observer would expect, the author can call the asset a “bubble” to indicate:

    1. Dear reader, you are right, the market price is much higher than it “should” be. So you can feel good about yourself for recognizing that, and stop feeling bad for not understanding why the market price seems so high. Even better, you can feel some good righteous indignation about the whole situation, particularly if the asset is “housing”.

    2. People who trade this asset are bad people, either greedy idiots buying out of stupidity, or greedy jerks trying to rip off the idiots. So you can feel good about yourself that you’re not involved, and stop feeling bad for having missed an opportunity to buy earlier.

    3. The price will soon come crashing down, so you can look forward to feeling even better when all these bad people lose a lot of money.

    “bubble” a lazy way to give the reader permission to feel smart and good about themselves. Whenever someone calls something a “bubble”, I always ask, “so you’ve mortgaged your house to take a large short position, right, so you can profit from being so much more insightful than other market participants?” Funny thing is, I never receive any response.

    I think part of what’s going on here is that it’s hard for non-finance-people to grasp the concept of present value of future returns, because there are so many unobservable variables in there. How many times have you heard about market “corrections” that were really just increases in the discount rate? Nothing was “wrong” that is being “corrected”. Instead, something changed that makes future earnings less valuable today. I put the term “correction” in the same category as “bubble” — a word used by people explaining markets without having the slightest understanding of finance.

    I’ve found this lack of understanding to be particularly acute in housing, where many people haven’t thought through how/why you’d regard a home as a financial asset, what “owner-occupied imputed rent” is, etc. More people need to read Kevin Erdmann.

    It’s not like it’s hard to understand why bitcoin is valuable. If you wanted to move $10M from Russia to the US without attracting unwanted attention, how would you do it? I haven’t been able to figure out any other application, but clearly, this one is a biggie. I have no way to estimate the future value of bitcoin, and so I don’t trade it either. I have no idea whether the right price is $1000, $16000, $32000, or $0 because it will soon become illegal. I’m kind of amazed that governments have tolerated bitcoin as long as they have.


  8. Gravatar of ssumner ssumner
    7. January 2023 at 08:46

    Kenneth, Very well said. In a book of cognitive illusions in economics, bubbles would form an entire chapter.

  9. Gravatar of foosion foosion
    7. January 2023 at 15:20

    Scott, based on common usage, as evidenced by internet searches, lack of intrinsic value and rapid run-up and decline are what people mean by bubbles in this context.

    Wikipedia says: “An economic bubble (also called a speculative bubble or a financial bubble) is a period when current asset prices greatly exceed their intrinsic valuation, being the valuation that the underlying long-term fundamentals justify.” Obviously no intrinsic value means prices greatly exceed their intrinsic value.

    Another top search result: “A bubble is an economic cycle that is characterized by the rapid escalation of market value, particularly in the price of assets. This fast inflation is followed by a quick decrease in value, or a contraction, that is sometimes referred to as a “crash” or a “bubble burst.”

    There are many examples consistent with these.

    I’m not suggesting these are generally sources of truth, but they are reflections of what words mean.

  10. Gravatar of ssumner ssumner
    7. January 2023 at 18:12

    foosion, A $100 bill has no intrinsic value, but most people don’t call $100 bills “bubbles”.

    As for “fundamental value” that’s begging the question.

    If you are right, then the term “bubble would lack any plausible utility. It would be meaningless, like calling something a “$#&@*$%”. Why would we care if something were a bubble?

  11. Gravatar of Jeff Jeff
    8. January 2023 at 06:00

    It seems you are basically just expressing astonishment that effect named in the title of your blog actually exists. I don’t think the average person is as dumb about pricing future cash flows as Ken seems to think, rather, they tend to view money as an emergent entity that is not accompanied by inflation in any necessary sense, and misjudge the extent to which modern state finance is committed to and reliant upon perpetual inflation. In other words, they suffer from “money illusion”.

    If a central bank announced a politically credible commitment to zero inflation in perpetuity, then wouldn’t most of these “bubble” pronouncements become correct?

  12. Gravatar of Kenneth Duda Kenneth Duda
    8. January 2023 at 08:24

    > If a central bank announced a politically credible
    > commitment to zero inflation in perpetuity, then
    > wouldn’t most of these “bubble” pronouncements
    > become correct?

    I don’t think so, Jeff. I think a credible zero inflation commitment would lower the nominal discount rate by about 2%, which would increase the present value of future cash flows (i.e., asset prices) significantly. If the discount rate is currently around 4%(?), and it suddenly went down to 2%, asset prices would double, assuming no change to expected future cash flows. Nominal expected future cash flows might be a little lower (because no inflation) but surely not by enough to cut asset values in half? Why do you think lower inflation would reduce asset prices? (I assume that’s what you mean by “bubble pronouncements becoming correct”).

    I’m also puzzled by your comment “modern state finance is committed to and reliant upon perpetual inflation.” The “committed to” part I agree with — 2% has been the Fed’s inflation target for a long time. It’s the “reliant upon” I am wondering about. Yes, inflation eats away the real value of government debt, but in a lower inflation environment, nominal interest rates would be lower (assuming the real natural rate is constant), so it looks like a wash to me. (*Unexpected* inflation reduces the value of the stock of government debt, but there’s no unexpected inflation in a successful 2%-perpetual-inflation regime.) Yes, the government profits from seigniorage as it expands the money supply, but surely this is a small fraction of total tax revenue. (Figure 1 of https://files.stlouisfed.org/files/htdocs/publications/review/92/03/Seigniorage_Mar_Apr1992.pdf estimates seigniorage at about $15B per year compared to $3.3T of tax revenue).

    In my view, one benefit of stable 2% inflation is that it helps overcome nominal rigidity, improving downward real price flexibility, particularly of labor (because it’s much easier to withhold a raise than it is to reduce someone’s nominal salary).

    Regarding “I don’t think the average person is as dumb about pricing future cash flows as Ken seems to think”: I have had many discussions with friends about house prices (a constant topic in Silicon Valley). Believe me, most people, including very smart software engineers, have given exactly zero thought to how to value a house in terms of present value of risk-adjusted future tax-free owner-imputed rents. These people are not dumb in the slightest! Asset valuation is neither intuitive nor easy.


  13. Gravatar of ssumner ssumner
    8. January 2023 at 08:50

    Ken, You said:

    “Nominal expected future cash flows might be a little lower (because no inflation) but surely not by enough to cut asset values in half?”

    I think they would roughly offset. Whether you discount nominal flows by nominal interest rates, or real cash flows by real interest rates, you should get the same answer. I do think that lower inflation tends to raise asset prices, as you suggest, but mostly because lower inflation reduces the real tax rate on capital income.

  14. Gravatar of Jeff Jeff
    8. January 2023 at 12:32


    >there’s no unexpected inflation in a successful 2%-perpetual-inflation regime.
    The existence of money illusion implies that there are economic actors for whom inflation is unexpected, or at least not well accounted for. How useful would inflation be as a policy tool in a world with no money illusion and perfect inflation expectations?

    The value of an asset that generates real cash flows should be determined by the real interest rate, not the nominal interest rate. I think a zero inflation commitment would lower asset prices because the monetary authority would have essentially no ability to push real interest rates into negative territory and only minimal ability to expand monetary aggregates.

    That’s the steady-state analysis. I think it goes without saying that the -transition- to a zero inflation commitment would lower many asset prices, right? How wlse to interpret asset price behavior during the dips on this chart? https://fred.stlouisfed.org/series/T5YIFR

  15. Gravatar of Kenneth Duda Kenneth Duda
    9. January 2023 at 04:24

    Thanks, Scott. That’s interesting. I had noticed that real (and nominal!) taxes on capital gains are lower when inflation is lower, but had not thought of how that fact impacts asset prices.

    Jeff, you wrote “How useful would inflation be as a policy tool in a world with no money illusion and perfect inflation expectations?” My answer is: useful, not really as a policy tool (since there’s no discretion anywhere here), but in helping prices adjust by partly overcoming the “sticky prices” problem (downward nominal price rigidity).

    For example, it’s hard for employers to give employees a 2% nominal pay cut. Reducing someone’s salary upsets them greatly and may even be considered constructive termination leading to wrongful termination lawsuits. Withholding raises is much easier and does not create that sort of emotional pain or legal liability even if everyone knows inflation is running at 2%. (In fact, most economically illiterate people, meaning most of the public, tend to assume that “inflation” means “prices rising faster than wages”, so employees tend to forgive employers for real wage decreases in a time where there is general inflation, as long as nominal wages are held constant.)

    When the natural wage (the real wage that leads to full employment) falls below current real wages, say because of a negative supply shock, a real pay cut is inevitable in the aggregate, and one of three things has to happen:

    1. people have to accept a nominal pay cut (implying a real pay cut)

    2. employers have to lay people off (reducing total real wages, but hurting a lot of people and reducing total production in the process)

    3. inflation has to create a real pay cut (without any nominal wage change at all)

    #1 is so difficult to implement in practice that employers pick #2 instead. Inflation is really useful in creating option #3, which gives the economy the adjustment it needs without painful layoffs or lawsuits.

    That’s why it’s so important to tolerate a small amount of inflation.

    Inflation is not theft. No one is entitled to a government-provided zero-cost instrument that holds value perfectly over indefinite time periods. I’m always amused by “conservatives” who demand government action to guarantee that the dollar in their pocket can buy the same amount this year, next year, or any year thereafter — as though they are entitled to a massive government hand-out! Economic illiteracy easily crosses party lines.


  16. Gravatar of Michael Rulle Michael Rulle
    9. January 2023 at 04:28

    What is a bubble? It is impossible to define—-because they only become bubbles after the fact. There is a big difference between believing the value of something is extraordinarily overvalued and knowing it is a bubble as the price rises.

    I wonder what the return is of having bought 100 crypto currencies when issued and cap weighting them annually like the S&P—-thus changing the mix annually. That would be called the “crypto 100”.

    I have never seen that done—-and I am not going to do it. But I definitely have no intuition as to whether that is a positive return strategy. It might be.

  17. Gravatar of Michael Rulle Michael Rulle
    9. January 2023 at 04:34


    For example—-starting in X year (say 2016) create a cap weighted Crypto 100 portfolio—-and rebalance it like the S&P——annually (or quarterly—whatever)

  18. Gravatar of steve steve
    9. January 2023 at 15:13

    “John, I can’t imagine any definition where going from $3500 to $16000 proves that something was a bubble.”

    What should we call it when it goes up to $16,000 then back down to (almost) $3500 again with nothing happening in between to make it more or less valuable?


  19. Gravatar of ssumner ssumner
    9. January 2023 at 15:20

    Steve, I’d call it a bubble, but I’ve never seen a shred of evidence that anything like that has ever happened.

    Again, ask yourself what would make bubble theories USEFUL.

  20. Gravatar of Jeff Jeff
    11. January 2023 at 07:23

    >Reducing someone’s salary upsets them greatly and may even be considered constructive termination

    This seems like it is entirely because of money illusion. Is an economist who well understands inflation less upset about getting a 5% real wage cut just because it was a nominal raise?

    The constructive termination angle is interesting, and suggests the role of a central bank is in part to nullify other laws that create economic “problems” (one might also lump in minimum wage laws)

    I’m definitely not arguing inflation is theft, just a perpetual arbitrage opportunity in favor of those who study this artificial quirk of the system against those who don’t. Considered in totality the arguments in favor of deliberately engineering something like that seem weak.

  21. Gravatar of steve steve
    11. January 2023 at 12:28

    What would you count as evidence? It looks to me like that is what happened with Bitcoin. Nothing intrinsic to Bitcoin changed. It didnt become harder to mine or suddenly get a lot easier to use, you just had a lot of publicity about the supposed benefits of crypto, including inflation protection, that were both wrong and AFAICT largely the result of the crypto owning class trying to drive up the price.


  22. Gravatar of ssumner ssumner
    12. January 2023 at 10:30

    Steve, You asked:

    “What would you count as evidence?”

    Evidence that bubble theories are useful. Useful to ordinary investors, policymakers, or academics. I see no such evidence.

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