All that glitters: A theory of multiple bubbles with implications for cryptocurrencies

We analyze a model of heterogeneous rational bubbles that compete and complement each other. When some bubbles burst, surviving ones gain value, offsetting losses from collapsed bubbles. This “compensation effect,” combined with diversification, enhances welfare. A portfolio of fragile bubbles may rival a single, stable bubble. The stationary equilibrium imposes a tight upper bound on bubble size, considering covariance structures, price fluctuations, and the emergence of new bubbles. These results have important policy implications, particularly for managing crypto ETFs and issuing CBDCs, highlighting the potential benefits of a diversified approach to fragile financial systems. • We study a model of heterogeneous rational bubbles that compete and complement each other. • A bubble’s market size is driven by agents’ confidence, with greater confidence leading to larger bubbles. • When some bubbles burst, survivors appreciate in value, offsetting losses and mitigating welfare impacts. • A diversified portfolio of fragile bubbles such as a crypto ETF may rival a single, stable bubble thanks to this “compensation effect”.