Global financial markets were shaken over the last few days as a confluence of factors injected a level of fear into investors not seen since the COVID outbreak in 2020.
So what exactly happened?
The market crash over the weekend was initially sparked by weak economic data from the US— including a much lower jobs number than anticipated—as well as fears over increasing geopolitical tensions in the Middle East. The weak data has led many analysts to question if the Fed is behind the curve in cutting rates, and the expectation for a 25 bps rate cut in the US is now at 100%, with 70% of the market thinking the Fed will cut its target rate by 50 bps at the September FOMC meeting.
Arguably, the most notable event was the Bank of Japan’s hike to a target rate of 25 bps, after more than a decade of ultra-low policy following the Great Financial Crisis. This came as markets were expecting only a 10 bps increase, with the yen subsequently shooting up 10% against the dollar.
The Japan event was particularly impactful because of the popular yen “carry trade.” This strategy, where investors have borrowed yen at near-zero interest rates to invest in higher-yielding assets, has been a critical source of liquidity for global markets, including US treasuries, equities and crypto assets. The yen's abrupt strengthening compelled many traders to unwind these positions, resulting in a chain reaction across various asset classes. Japan's Nikkei 225 Index plummeted 12.4% on August 5, its worst day since 1987. This instability in one of the world's largest economies has greatly contributed to global market uncertainty, further intensifying the sell-off in crypto assets.
In addition to these major macro factors, crypto was also impacted by some industry-specific developments, including rumors that a very large market maker was impacted by the unwind of the yen carry trade and had to aggressively sell its positions in ether (ETH) and other crypto assets.
Early Monday, bitcoin (BTC) traded below $50,000 briefly but found some strong support later in the day, trading over $56,000 at several points. Notably, ETH ETFs experienced net inflows, suggesting that investors saw an opportunity to “buy the dip” in the wake of the widespread market selloff.
Why were crypto assets more negatively impacted than other risk assets?
There are a few key considerations to keep in mind regarding short-term price action of BTC and other crypto assets. Because BTC trades 24/7, when big events like this occur and investors need liquidity, oftentimes BTC is the only major risk asset available to unload. So, BTC can often take much of the initial pain of these selloffs, before recovering once markets open and investors have other avenues to access liquidity.
Also, unlike the stock markets, there are no circuit breaker features with BTC that can stop trading. As a result, BTC prices are not artificially propped up during these periods of stress. These idiosyncratic factors, along with the fact that this event happened over a low liquidity summer weekend, help explain the stronger initial crypto asset selloff.
Every major market crash is a stress test for the system, and crypto has been here before. The March 2020 COVID crisis was a far more significant initial crash and BTC only took around 45 days to recover. It is, of course, impossible to predict the future, but as we have seen in its 15-year history, crypto cycles tend to rhyme.
Does the current environment negatively impact crypto’s investment case?
What’s more important than short-term price developments is that the events of last week have no impact on the strength of crypto’s long-term investment case. Bitcoin remains up around 40% off its 2024 low in January and has returned over 100% in the last twelve months. We do not believe this recent price drop weakens the mid-to-long-term investment case for BTC or other crypto assets.
In the short-term, there will continue to be uncertainty and price volatility. This is nothing new to crypto, especially during periods of more pronounced fear in global financial markets. Regardless of the tremendous strides made in terms of institutional acceptance this year, crypto is still a nascent, relatively smaller market with lots of speculative activity. So these types of market movements, as painful as they can be, are not entirely unexpected events.
It’s also very clear that BTC continues to strengthen in the wake of these events, maybe not surprising for an asset born out of the Great Financial Crisis. With each of these tests, more investors are made aware of the characteristics that make BTC and this asset class so appealing over the long term. This is why we believe that these periods, when fear and uncertainty are driving narratives, are excellent times for investors to consider a long-term investment in this asset class.
[1] Bitcoin was trading above $56,000 as of 12:00PM EST on Tuesday, August 6, 2024
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