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Why Bitcoin’s Bubble Matters

Ask most people about the bitcoin bubble, and they’ll probably have the same reaction: It’s interesting, but it won’t affect me. After all, they’ll figure, they aren’t investing in bitcoin, so if there is a bubble, and it does burst, they’ll be just fine.

Well, maybe they should start worrying.

The market for cryptocurrencies—digital tokens used to transfer money between individuals’ computers with minimal fees—has grown in stature in recent years and is increasingly entwined with broader financial markets as well, a trend that is likely to continue. Bitcoin is now traded by some of the institutional investors around which bond and stock markets revolve. The Wall Street Journal has reported that Goldman Sachs Group Inc. GS -0.02% is considering opening bitcoin-trading operations. Cryptocurrencies also are being used to raise capital by more companies. Reported on WSJ.

As the bubble grows, analysts say, a crash has a greater chance of affecting investor sentiment about stocks, especially in the technology and financial sectors.

“Any product that blows up, there’s always collateral damage,” says Joe Kinahan, chief market strategist at brokerage TD Ameritrade. Tech and financial “companies who are relying on it for business, and those who have put a significant investment into the [blockchain] infrastructure would be the first” to suffer collateral damage, Mr. Kinahan says.

What has some market observers concerned is that in less than six months, bitcoin went from around $1,000 a token to $5,000. It is back now to $4,400. But in early 2016, bitcoin was trading at less than $400, bringing its 18-month gain to 1,000%. Consider that the math-based currency has yet to find a widespread use outside of speculation, and warnings of an implosion from J.P. Morgan Chase Chief Executive James Dimon and others in the financial establishment sound like more than curmudgeonry.

At around $150 billion, the market capitalization of bitcoin and other cryptocurrencies is up by a factor of roughly eight this year, according to the Cointelegraph website. If this growth rate continues, what’s now a relatively small part of global investible assets could become a significant one, says Lorenzo Di Mattia, manager of hedge fund Sibilla Global Fund and a student of the history of speculation. By next year, Mr. Di Mattia expects the bubble to have inflated to the point where a pop could send a shock wave through the stock market.

Another analyst says bitcoin is at a similar stage in its development as the internet was in 1994, early in the speculative bubble. “What we’re looking at is a new technology that people are still trying to understand,” says Matthew Gertler, senior analyst and counsel at Digital Asset Research, which provides research to institutional investors on cryptocurrency issues.

Give bitcoin its due: Most people in finance agree that bitcoin and the blockchain, the open-access ledger that underpins the currency, were great inventions; even as J.P. Morgan’s Mr. Dimon derides bitcoin as a “fraud,” his bank is working on its own blockchain technology.

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