Here’s Everything You Need To Know About Bubble

What Is A Bubble?

A bubble is a situation in which the prices of certain assets like stocks, real estate, or commodities rise rapidly, surpassing their intrinsic or fundamental value. This price surge is often followed by a sudden and sharp decline, leading to significant financial losses for those who invested at the peak of the bubble.

Essentially, the bubble is a period of unsustainable price growth fuelled by speculation and investor psychology.

What Is A Funding Bubble In The Context Of Indian Startups?

In the context of Indian startups, a funding bubble can be created when there is a lot of excitement and interest in a particular sector or due to drastic micro and macroeconomic changes. A good example from the recent past is that of the funding boom of 2020-21.

The pandemic opened a wide door of opportunities for tech startups due to heightened online adoption, and the ecosystem saw a lot of investment pouring in. For context, Indian startups raised $73 Bn+ between 2020 and 2021, which is over 48% of the total $141 Bn+ in funding lapped up by Indian startups since 2014. 

However, when the pandemic began to wane, so did the investor excitement. Macroeconomic headwinds also impacted investor sentiments and the funding mindset quickly shifted from chasing valuations to balancing growth with profitability. 

This marked the onset of the ‘funding winter’ in 2022, as year-on-year funding levels plummeted dramatically. According to Inc42’s data, the funding raised by startups in Q3 2022 was 82% lower than the historical $17.1 Bn raised in Q3 2021. 

Why Funding Bubble Is Dangerous For Startups?

Funding bubbles can be dangerous for startups because they can lead to startups spending money on things, other than their core product such as marketing and excessive hiring.

This can make it difficult for startups to survive if the funding bubble bursts and investors become more cautious about investing in startups.

What Is An Economic Bubble?

Economic bubbles are phenomena where the prices of assets become detached from their true value, creating a situation where prices are driven by hype and speculation rather than assets’ actual worth.

These bubbles are typically followed by a sudden crash or correction, resulting in substantial financial losses for investors. The bursting of economic bubbles can also have broader economic impacts, leading to a recession or financial crisis.

What Are The Different Types Of Bubbles?

• Stock Market Bubbles: These occur when the prices of stocks rise rapidly and significantly, often driven by excessive investor optimism. When the bubble bursts, stock prices can plummet, causing financial losses.
• Real Estate Bubbles: In real estate bubbles, property prices soar to unsustainable levels due to high demand and speculation. When demand wanes or interest rates rise, the bubble bursts, leading to a sharp decline in property values.
• Commodity Bubbles: Commodity bubbles involve rapid price increases for raw materials like oil, gold, or agricultural products. Speculation and supply-demand imbalances contribute to these bubbles, followed by price crashes.
• Cryptocurrency Bubbles: Cryptocurrencies like Bitcoin have experienced volatile price surges followed by sharp declines, characteristic of speculative bubbles driven by market sentiments.

What Are The Different Stages Of A Bubble?

• Stealth Phase: This is when asset prices start to rise but only a few astute investors take notice. Prices begin to deviate from their fundamental value.
• Awareness Phase: More investors become aware of the asset’s price gains. Media coverage and excitement start to build, attracting a larger pool of investors.
• Mania Phase: In this phase, fear of missing out (FOMO) sets in, causing a rush of investors to join the market. Prices skyrocket as speculations take over, and the market becomes highly irrational.
• Blow-off Phase: Prices reach their peak, and the market experiences extreme euphoria. This is the phase of maximum speculation and risk.
• Panic Phase: Reality sets in as prices start to decline. Investors rush to sell their assets, triggering a rapid and steep drop in prices. This phase can lead to financial distress and market crashes.

What Causes Asset Bubbles?

Asset bubbles are primarily caused by a combination of psychological, economic, and market factors:

• Speculation: Investors’ belief that they can profit from future price increases of assets, leading to price surges.
• Herd Mentality: When investors follow the actions of others, driven by fear of missing out, it can amplify price movements.
• Easy Credit: Low interest rates and easy access to credit can encourage excessive borrowing and investing, inflating asset prices.
• Lack Of Regulation: Weak regulatory frameworks can allow fraudulent activities and unrealistic valuations to go unchecked, thereby creating bubbles.