Is a Bitcoin bubble forming?

Bitcoin (BitfinexUSD ) price has rallied sharply in recent weeks with the December future contract hitting a peak of $105,325 on December 5, and the June 2025 contract reaching $110,935 on the same day.

This surge in value has prompted discussions among investors and analysts about the possibility of a Bitcoin bubble. Brett Friedman, Winhall Risk Analytics/OptionMetrics contributor, examines 5 factors to consider. Is A Bitcoin Bubble Forming?

The characteristics of a financial bubble are often only clear in hindsight, but certain indicators can suggest an overheated market, Friedman suggests.

For instance, a growing spread between implied volatility and out-of-the-money to at-the-money volatility skew in options trading may signal an overbought market. While this spread in Bitcoin has been increasing, it has not reached "abnormal levels."

Futures curves can also provide insights into market dynamics. A backwardated curve, where near-term contracts are priced higher than longer-term ones, or a flattened contango curve, can indicate bubble-like behavior.

However, Bitcoin, which has been in contango since the introduction of futures in late 2017, has seen its deferred months outperforming nearby contracts recently. This trend suggests trader confidence in the sustainability of the rally well into 2025, which would not align with typical short-lived bubble patterns.

Another sign of market frothiness in the cryptocurrency market is a surge in volume and open interest, according to Friedman.

Since the election, Bitcoin futures have seen increased activity, particularly in the Micro BTC contract favored by retail investors. The Micro BTC contract's open interest has jumped by almost 2.5 times since before the election, while the full-sized contract's interest has remained stable. 

"This could indicate that traders are comfortable with the risk of the deferred contracts and believe that the current rally will be sustained and last into 2025," he said.

"This would not be the case if BTC were forming a bubble, since they are usually short-lived and confined to the front end of the curve."

Another factor that prompted Friedman to examine if Bitcoin is really in a bubble is the emergence of related financial products with high leverage and promises of rapid returns. Products like the MicroStrategy stock, leveraged Bitcoin-related ETFs, and the proliferation of crypto evangelists on social media could be indicative of speculative behavior.

So, what's his conclusion?

While there are signs of an enthusiastic market for Bitcoin futures, it is not yet clear if this constitutes a bubble. 

"There is evidence that the market may indeed be frothy, but not necessarily on the way to a full-fledged bubble yet.

"In the short run, it appears that BTC will need some new bullish fundamentals or will have to get back over $100K to reignite speculation that a bubble might be forming," he concluded.

Source: Investing.com