The main culprit for the cryptocurrency market’s plunge last weekend was Japan’s yen interest rate hike

The cryptocurrency market experienced one of its worst days in years on August 5, 2024, as leveraged trading and a sudden uptrend in the Japanese yen led to a dramatic sell-off. The downturn saw Bitcoin and Ethereum prices drop by approximately 18% and 26%, respectively, while even traditional markets, like the S&P 500, suffered significant losses.

Key Factors Leading to the Crash

1. Leveraged Trading: Crypto prices, often driven by short-term institutional traders, are highly susceptible to leverage. Traders have been using borrowed funds to amplify their positions, with open interest reaching nearly $40 billion before the crash. These positions were often financed with yen-denominated loans, taking advantage of Japan's historically low interest rates.
2. Yen Carry Trade: The practice of borrowing yen at low interest rates to invest in higher-yielding assets elsewhere, known as the yen carry trade, had been widely adopted. By 2024, yen-denominated loans to foreign borrowers reached about $2 trillion, reflecting a 50% increase over two years.
3. Bank of Japan Rate Hike: On July 31, the Bank of Japan raised interest rates on short-term government bonds from 0% to 0.25%, following an earlier hike in March. This increase led to a surge in the yen's value, making yen-denominated loans more expensive and prompting traders to unwind their positions.

The Immediate Impact

The rise in the yen's value triggered margin calls and caution among traders, leading to a mass liquidation of leveraged positions. Over $1 billion in leveraged positions were liquidated between August 4-5, including significant sales like Jump Trading's $370 million in ETH. The market downturn was further amplified by the broader sell-off in global markets, including a 12% drop in Japan's stock market.

Potential Recovery and Future Outlook

Despite the severe market correction, there are signs that the crypto market may rebound. The unwinding of leveraged positions has reduced open interest to $27 billion, down by nearly $13 billion from pre-crash levels. Additionally, the potential for central bank intervention in Japan, given the impact on its stock market, may stabilize the yen and reduce pressure on borrowers.

Moreover, recent data from the U.S. suggests a possibility of aggressive rate cuts by the Federal Reserve, which could provide further relief to markets. If these conditions align, the crypto market might see a late-summer recovery. However, the unpredictability of the market serves as a reminder of the risks associated with leveraged trading.

In summary, the events of August 5, 2024, underscore the volatility and risks inherent in the cryptocurrency market, particularly when amplified by leveraged trading and macroeconomic factors. While a recovery is possible, the market's future remains uncertain, highlighting the need for caution among traders and investors.