Japanese Yen "Carry Trade" Blamed For Crypto Crash But What Is It?

As analysts and industry experts clammer in the dark to find a reason behind the abrupt and abnormal market crash, fingers are now being pointed at the Japanese.

In the past 24 hours, the crypto market saw more than $1 billion in liquidations, with $800 million in longs liquidated as Bitcoin (BTC) dropped below $50,000 briefly. 

Bitcoin also saw a surge in Bitcoin ETF trading with volume reaching $5 billion in daily trading volume, the highest level since April. Eric Balchunas, senior ETF analyst at Bloomberg, explained that high trading volume in a market downturn is a "pretty reliable measure of fear."

"If you bitcoin bull you actually DONT want to see crazy volume today as ETF volume on bad days is a pretty reliable measure of fear [sic]," he said.

"Deep liquidity on bad days is part of what traders and institutions love about ETFs, so you also want to see volume too, good for the long term."

Initially, Jump Crypto took the brunt of the blame for unstaking more than $300 million but as market participants began realizing that the crypto powerhouse actually began its sell-off earlier in the week, traders looked elsewhere to pin the blame for Monday's crash. Genesis and Mt. Gox repayments also added to the selling pressure.

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Macroeconomic data also took its fair share of the blame too, with US rising unemployment levels and weak manufacturing index figures suggesting a recession is inbound.

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To make matters worse, the narrowing Japanese "Yen Carry Trade" supposedly sent the market into freefall. But what is this exotic-sounding phenomenon?

Yen-ter the Dragon

A yen carry trade is a financial strategy that involves investors borrowing Japanese yen at low interest rates and then converting the converted yen into other currencies to invest in assets with higher returns.

Investors essentially profit from the difference between low borrowing costs in Japan and higher returns in other countries. "The wide spread between rapidly rising rates in the US and other countries and negative rates in Japan made it possible," explained The Kobeissi Letter.

However, this strategy only works if the Yen's value falls or remains low and interest rates remain enticing. Last week, the Bank of Japan (BOJ) raised interest rates for the first time in seventeen years, thereby increasing borrowing costs.

"As the Yen strengthens, many of these Yen carry trades are being "margin called." Suddenly, the era of "free" Yen loans is coming to an end. As these margin loans are called, the underlying assets are being sold and crashing equity markets. The carry trade is unwinding," The Kobeissi Letter added.

With more rate hikes in the pipeline, the BOJ's moves have made the Yen carry trade less profitable. Additionally, the Yen has strengthened as investors turned to the currency to deploy their strategies.

Jake Ostrovskis, an OTC Trader at the market maker Wintermute told Decrypt, “As they sell risk assets and convert back to yen, the yen has strengthened. Risk assets like equities and cryptocurrencies have experienced increased volatility and downward pressure as a result of those positions being closed."

Traders who buy yen to close their positions can inflict more pain on Yen borrowers, which could cause an increase in liquidations.

“Everyone was leaning the same way,” Amberdata Director of Derivatives Greg Magadini said, adding that the Yen carry trade is “a crowded [one] because it's such an obvious trade.”

Yen-durance

As carry trade strategies fell flat, Japan's Nikkei then stock market experienced its steepest drop since the 1987 Black Monday crash, which caused ripples across all markets including crypto.

However, Japanese stocks rebounded sharply on Tuesday, with the Nikkei seeing its best day since October 2008, rising 10.23%. Bitcoin also showed some hope of revival and is currently trading around the $50K mark.

BRN analyst, Valentin Fournier, believes that while short-term volatility might distress the market, investors should consider these price drops as buying opportunities.

"We believe that Bitcoin will keep pushing higher until the end of the year with an acceleration in October, but August and September could be volatile," he explained.

"This major dip remains an interesting buying opportunity, so we recommend progressively increasing positions and staying updated through our content on BRN."

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