What Is a Bubble? Bitcoin and Cryptocurrencies Price Plunge Prompts Investor Alarm

An Israeli consultant trades the cryptocurrency bitcoin online in the Israeli city of Tel Aviv on January 17. JACK GUEZ/AFP/Getty Images

Since hitting a December high price of $20,000, bitcoin has fallen nearly 50 percent, to a price of $11,490 on Tuesday, according to the CoinDesk price index. The recent plummet has led to alarm among investors that bitcoin mania is the next big bubble.

Financial bubbles like the 1990s internet bubble, the 2008 U.S. housing bubble and the 1683 Dutch tulip mania are characterized by a surge in the price of an asset to a level much higher than its fundamental value. Bubbles often pop, followed by an economic crash.

In the case of bitcoin, the price of the currency has inflated 60-fold in just three years. In November and December of 2017, bitcoin mania drew both professional and amateur investors. Speculation swirled that the bitcoin bubble could pop following the Tuesday fall in prices among major cryptocurrencies including bitcoin, ethereum, ripple, and litecoin.

American economist Paul Krugman tweeted about the cryptocurrency Wednesday, writing "more than ever, this looks like a pure bubble."

North American Securities Administrators Association regulator Joseph Borg told CNBC in December that some people seeking to invest in bitcoin were taking out mortgages on their homes. "This is not something a guy who's making $100,000 a year, who's got a mortgage and two kids in college ought to be invested in," Borg said.

"In terms of cryptocurrencies, generally, I can say with almost certainty that they will come to a bad ending," Berkshire Hathaway Chairman and CEO Warren Buffett said on CNBC last week.

Many significant bubbles, including the American housing bubble, the stock market and the tulip craze in Holland in the 1600s involved commodities— physical goods or representative shares that could be used for transaction. Unlike these bubbles, an investment in bitcoin is an investment in a currency, wrote Bronwyn Howell, an adjunct scholar at American Enterprise Institute, in a recent article.

A non-virtual currency, like the United States dollar, does not experience the same volatility.

So Bitcoin just lost half its value. Where does it now stand relative to fundamentals? Hard to say, because there aren't any fundamentals. More than ever, this looks like a pure bubble https://t.co/L9LbDyuZKD

— Paul Krugman (@paulkrugman) January 17, 2018

The blockchain currency's Tuesday plunge was not the first time the bitcoin bubble popped. In April 2013, the price of bitcoin dropped 70 percent in two days, falling from $266 to about $77. After the cryptocurrency slide this month, governments including Germany and Russia have called for regulations of virtual currencies.

Some experts say that bitcoin is not a bubble. "We've seen price falls like this before, and when you look back on them now, you'll see they weren't part of a bubble, just a blip," Michael Jackson, a bitcoin expert and the former COO of Skype, told Newsweek last month.