Crypto Apocalypse? Why Bitcoin, Ethereum, and Crypto Collapsed

The crypto market began to melt down around 8:00 PM ET on Sunday and has yet to recover. As of 11:30 AM ET on Monday, Bitcoin (CRYPTO: BTC) was down 8.3% in the past 24 hours, Ethereum (CRYPTO: ETH) was down 14.7%, and Dogecoin (CRYPTO: DOGE) was down 9.1%. The two most popular crypto exchange-traded funds (ETFs) were also down. The iShares Bitcoin Trust was down 12.6% and the Grayscale Ethereum Trust was down 19.2%. Both were compared to Friday’s closing prices.

It was leverage that caused the sell-off. This time, it wasn’t just leverage in crypto, it was yen carry trading that moved the market.

Yen carry trade

Recently, a popular trade known as the yen carry trade has been on the decline. The trade involves borrowing yen, which had a near-zero interest rate before the 2008 financial crisis, and converting it into a currency such as the U.S. dollar to buy higher-yielding assets.

This is essentially an interest rate arbitrage and there is a good explanation here.

Where trade runs into problems is when the yield on yen debt increases or (worse still) when the value of the yen rises, making it more costly to convert money back into yen.

Both incidents occurred in the last few days after the Bank of Japan raised interest rates from the 0-0.1% range to a still modest 0.25%.

The biggest problem, as you can see below, was the increase in the yen or the decrease in the conversion rate between the US dollar and the yen. This quickly turns profits into losses.

US Dollar to Japanese Yen Exchange Rate Chart

Unwinding a trade involves selling the acquired assets and converting the funds back into yen. This can reduce the underlying asset values ​​and make the problem worse.

Leverage makes everything both faster and worse.

The leverage problem of cryptocurrencies

This hit crypto first because crypto is traded 24/7 and there is a lot of leverage. And in the last 24 hours, leverage has led to $1.22 billion in liquidations in the crypto markets. $955 million of those liquidations were long positions by traders.

Liquidations can be a self-reinforcing cycle for the market, as declines lead to more liquidations and liquidations lead to more declines.

For now, the downward spiral appears to have stopped, but if other leveraged trades come under pressure, the spiral could begin again.

Crypto is not a hedge

Cryptocurrencies were thought to be a hedge against currencies or the market, but it has repeatedly emerged that cryptocurrencies are traded in conjunction with growth stocks.

This is why crypto has fallen so much while the stock market has also fallen. This is a concern because stocks are still near all-time highs and investors are starting to worry about the economy. If the economy worsens and growth stocks fall, it could take crypto with it.

The story continues

Leverage is a danger in the market and there are few markets that use more leverage than crypto, so buyers should be careful.

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Travis Hoium has positions in Ethereum. The Motley Fool has positions in and recommends Bitcoin and Ethereum. The Motley Fool has a disclosure policy.

Crypto Apocalypse? Why Bitcoin, Ethereum, and Crypto Crashed? was originally published by The Motley Fool