Japan Triggers Crypto Correction?
A guest piece by Denis Vuckovac, Founder and Managing Partner at very early Ventures
This piece is a guest piece written by Denis Vuckovac, Founder and Managing Partner at very early Ventures.
Free Markets
In the realm of Bitcoin and cryptocurrencies, many believe these digital assets to be the last bastion of true free markets. Unlike their traditional counterparts, cryptocurrencies operate 24/7, with no trading halts or circuit breakers to slow the frenetic pace when things turn a bit too volatile. They are the only global marketplace, forever open and ever unpredictable.
Because of that, cryptocurrencies can serve as early warning systems for the broader economy. Their unregulated and decentralized nature makes them sensitive indicators of shifting economic sentiments. When something feels off in the financial world, crypto markets often react before traditional markets do, providing valuable and usually stronger signals of potential instability.
A walk down memory lane
This was evident during the onset of the COVID-19 pandemic on March 12th, 2020, often referred to as "Black Thursday", when Bitcoin's price dropped by about 40% in a single day. This dramatic fall was mirrored by the S&P 500 (SPX), which fell a mere 10%, before stabilizing the following week. Bitcoin’s drop was more pronounced compared to the SPX, it bottomed out earlier and in fact it had already declined more in anticipation of Black Thursday. Despite this sharp decline, Bitcoin's quick rebound following “Black Thursday“ highlighted its resilience and unique characteristics.
August 5th 2024
August 5th, 2024, will go down in financial history as a day of upheaval, all thanks to an unexpected interest rate hike from Japan that sent shockwaves through global markets. The chaos hit Asia, Western markets, and even the wild world of cryptocurrencies, leaving a trail of losses and bewildered investors.
The drama began brewing earlier in the week. Bitcoin, the leading digital asset, had already shown signs of weakness in the week leading up to August 5th, dropping a staggering 26% over the past seven days. It was clear that Bitcoin was struggling even before the August 5th crash. Traditional markets were also showing signs of stress, as weak economic data contributed to a brewing storm.
Then came the big bang on August 5th. The Yen had surged more than 11% against the dollar, thanks to the Bank of Japan’s surprise decision to raise interest rates to 0.25% (!!!) and trim bond purchases. This unexpected move sent shockwaves through global markets, leaving investors scrambling. The Japanese Nikkei 225 crashed by an eye-popping 12.4% in one day, marking its worst single-day drop ever. This plunge made the Black Monday of 1987 look like a mere blip. Western markets didn’t escape the turmoil. In the U.S., the Dow Jones Industrial Average tumbled by 2.6%, the S&P 500 fell by 3%, and the tech-heavy Nasdaq took an even bigger hit, dropping 3.4%. Recession fears, exacerbated by a surprising rise in the U.S. unemployment rate to 4.3% and weaker-than-expected job growth, fueled the sell-off. It was a perfect storm of bad news that set the stage for the market’s dramatic downturn.
The root cause
The root cause of the frenzy was the unwinding of the Yen Carry trade. This strategy, where investors borrow Yen at low rates to invest in higher-yielding assets, backfired spectacularly when the Yen spiked (by, recall, the aforementioned 0.25% interest rate hike) and the liabilities of these investors suddenly became bigger. As the Yen appreciated, investors were forced to liquidate assets, triggering a vicious cycle of falling prices and rising Yen. This sell-off hit a variety of markets, from U.S. tech stocks to cryptocurrencies.
The scale of the market’s upheaval has been compared to the 2008 financial crisis. While today’s central bank interventions might (hopefully?) cushion some of the impact, the events of August 5th serve as a stark reminder of how interconnected global financial (and even exotic cryptocurrency) markets are. A single move by the Bank of Japan sent ripples across the world, shaking up everything from traditional equities to digital currencies.
A real-time gauge into market sentiment
Once again, Bitcoin has demonstrated its tendency to react to economic conditions even when traditional markets are closed. Over the previous weekend, Bitcoin’s value fell from $61,000 to $50,000, an 18% drop. When trading started in U.S. markets on Monday, they opened significantly down, but Bitcoin’s price in fact recovered in that very moment from $50,000 to about $54,000, suggesting that market participants were reassured by the less severe-than-expected declines in traditional markets, showcasing Bitcoin's role as a real-time gauge of market sentiment.
In recent weeks and months, the cryptocurrency and Bitcoin markets have experienced significant fluctuations, with sentiments shifting rapidly between bullish and bearish outlooks. This volatility has been driven by a variety of factors, including developments in ETFs, governmental actions, influential figures' stances on crypto, and macroeconomic changes. Most recently, the fear of an impending recession and the Japanese central bank's decision to raise interest rates have exerted additional downward pressure on cryptocurrency prices. These macroeconomic factors have added to the uncertainty, causing further fluctuations in market sentiment and contributing to the ongoing volatility in the crypto and Bitcoin markets.
Current Drivers of Cryptocurrency Markets
Today, Bitcoin and Ether price are mostly driven by
1. ETF Flows:
The impact of ETF flows is significant, with Grayscale's selling activities being a notable negative factor (an old and expensive product that traded at a discount and that now can be redeemed for the actual underlying). Conversely, new demand for ETFs drives prices upward, creating a push-pull dynamic in the market.
While not strictly ETF flows, other fundamental factors in the form of previously locked supply have had a substantial impact too: governments selling confiscated coins were driving markets in June and July and the distributions of MtGox coins that have been anticipated for years had caused fears of a supply glut as well. Usually however, anticipation of such events and attempted front-running have a bigger impact than the events itself, therefore often causing a reversal when that supply hits the market.
2. Political Uncertainty:
The upcoming U.S. election has added another layer of uncertainty. The Republican administration has been viewed as more favorable to cryptocurrencies, while the Democratic perspectives on crypto varied. Presidential candidate Trump has come out as a fierce defender of “the rights to hold crypto” and his expected win caused a steep increase in prices initially. The candidacy of Kamala Harris has heightened concerns within the crypto community about regulatory headwinds as her candidacy increased chances of a Democrat president compared to if Biden were to still run.
3. Macroeconomic Conditions:
Broader macroeconomic trends, such as interest rate decisions and recession fears, play (as discussed) a critical role. These factors influence investor sentiment and, consequently, the prices of Bitcoin and Ethereum. Bitcoin especially remains an asset hard to assess: is it a macroeconomic hedge like gold or is it a risk-on asset with a higher Beta than the “Magnificent 7”?
Other cryptocurrencies are heavily influenced by the movements of Bitcoin and Ethereum. They also face their own unique challenges, such as concerns about high FDV (fully diluted valuations) and low float (essentially translating into high inflation numbers), which have led to downward price pressure. The general cyclical nature of the market also means that assets that have seen substantial gains often face substantial corrections when momentum is lost. As of now, prices are back to levels last seen in February, yet causing increased investor anxiety.
Closing words
In essence, the cryptocurrency market is a dynamic and often turbulent space, driven by a mix of internal peculiarities and external factors that all markets are subject to. Bitcoin and Ethereum lead the charge, but their movements ripple through the entire crypto ecosystem, impacting other digital assets and highlighting the ever-present volatility of this exciting financial frontier, meanwhile showing cracks in the overall financial system.
As such, August 5th, 2024, was a vivid demonstration of how quickly things can go sideways in the financial world. It’s a day that will be remembered for its dramatic shifts and the harsh reminder of the global market’s delicate balance.
