Why is Crypto Crashing? Here is the Explainer

Why is crypto crashing? The market is experiencing a significant that started on August 5, 2024.

The crypto media have been referring to the price falls as a .

While there is no standard definition for such a term, a bloodbath in this context is akin to a major volatile event coinciding with complex economic and political events. So is it a “bloodbath”?

Not yet, so everyone calm the farm. There is a decline in price, however.

Several interconnected factors appear to be driving this decline. While market volatility is not unusual, especially in crypto, this particular crash coincides with a complex economic and political landscape. So let’s break it down and try to work out what is driving the fall.

Election year cycles and market uncertainty

Historically, often bring about a degree of market correction during this period.

This phenomenon is attributed to uncertainty surrounding potential policy changes and their impact on various sectors.

As we approach the upcoming US election, investors may act with caution, leading to a temporary dip in prices.

Historically, election years have been associated with market volatility. It’s going to be a choppy ride, at least until whoever is elected settles into the job.

Japan's shifting financial landscape

Japan's economic decisions are also playing a role in the current crypto crash. Japanese investors have historically been big players in the US stock market. They would borrow money to invest, taking advantage of very low interest rates. But! The Bank of Japan has recently started raising interest rates after a long period of keeping them very low. This move is aimed at combating inflation and stabilising the economy. However, higher interest rates mean it costs more to borrow money. This is making borrowing more expensive. Japanese investors are facing higher costs for the money they borrowed.

Selloff

To deal with these increased costs, Japanese investors are selling some of their investments, including US stocks. They need the cash to cover their debt obligations back in Japan.

While the Bank of Japan's interest rate increase was modest (0.25%), it's not really the primary concern. Market anticipation of potential US interest rate cuts is weakening the US dollar.

Additionally, Japanese investors are selling US stocks and converting the proceeds into Japanese Yen to repay their loans. This increased demand for Yen is further strengthening it against the US dollar, explaining the 10% appreciation in the past 30 days.

Essentially, Japanese investors are selling their US assets and converting them to Yen to mitigate potential further losses due to currency fluctuations.

Domino effect

This massive sell-off doesn't just affect the US stock market. The money they get from selling is flowing back into Japan, and this sudden shift in money movement is causing ripples across other financial markets. Cryptocurrencies are part of these global markets and are feeling the effects of this change.

It has a domino effect. Cryptocurrencies are caught in the crossfire and are experiencing a downturn.

The leverage trap: A house of cards

Leverage is a common practice. Leverage involves borrowing funds to increase the potential return on an investment.

It is like using a credit card to amplify potential gains.

Leveraging also amplifies potential losses, making it a high-risk strategy. Even small changes in the value of an investment can have significant impacts on leveraged positions.

Here's where it gets dangerous:

Small changes, big impact

Even a tiny shift in the value of the Japanese yen against the US dollar (JPY/USD) can trigger a chain reaction. Since many crypto trades are paired with these currencies, a 10% swing in their exchange rate can mean disaster for traders who borrowed heavily.

Forced selling

When losses start piling up, these leveraged traders often get a "margin call" from their lender – basically a demand to pay back the borrowed money immediately. To do this, they're forced to sell their crypto holdings, even if it's at a huge loss.

This wave of forced selling pushes the price of the crypto down even further, triggering more margin calls for other leveraged traders.

Why this matters for the crash

On August 5th, we likely saw this leverage trap in action. A relatively small change in the JPY/USD exchange rate might have been the initial spark, setting off a cascade of forced selling that contributed to the broader crypto crash.

Crypto-specific factors: liquidations and institutional activity

Within the crypto market itself, institutional entities like have been selling off huge swathes of crypto.

These events can trigger a cascade of sell-offs as other investors react to market movements, amplifying the overall impact.

It hasn’t helped that the has been selling some of its Bitcoin holdings, which it acquired through various law enforcement seizures. This move adds to the overall selling pressure in the market.

Similarly, the has been liquidating some of its Bitcoin reserves, contributing to the downward trend.

Other investors, seeing the large-scale selling and falling prices, panic and start selling their own holdings. This creates a snowball effect, with more and more selling pushing prices down even further.

And yet… during the recent market downturn, there has been noticeable trading activity on CoinJar, with some customers instead increasing their cryptocurrency holdings.

Yield curve inversion and recessionary concerns

The interest rates on two types of US government bonds (2-year and 10-year) briefly flipped, with the shorter-term bond paying out more. However it needs to stay uninverted for a few days at least to be considered an accurate signal. If the flip stays around, then larger players might adjust their holdings based on market indicators.

The 2-year and 10-year treasury bonds are commonly used as benchmarks for interest rates and economic forecasting.

This has , and often a recession follows within the next year or two.

It's not a guaranteed sign, but it has made some people worried. This worry can lead to increased interest in traditionally safer investment options, which may affect the interest in crypto.

Anticipated interest rate cut

The expected interest rate cut by the U.S. Federal Reserve in September 2024 introduces another layer of complexity. , initial rate cuts have been associated with market corrections, typically lasting 3 to 12 months. However, if the underlying economic conditions deteriorate further, a more prolonged downturn could ensue.

Why is the crypto market crashing?

The cryptocurrency market crash of August 5, 2024, is the result of a number of factors.

Election year uncertainties, shifts in Japan's financial strategies, crypto-specific events, yield curve inversions, and impending interest rate adjustments are all contributing to the current volatility.

For those observing the market, downturns are times when asset prices are lower, but individual strategies and risk tolerances vary.

The extent and duration of this downturn will depend on how various factors interact in the coming weeks and months.

Asher Tan, the CEO of CoinJar, observes that market fluctuations are common in the crypto landscape. “Currently, we're seeing a combination of factors contributing to market uncertainty, including macroeconomic conditions and shifts in investor sentiment. These factors have impacted crypto prices in the short term. Historically, the crypto market has experienced significant volatility and has shown resilience over time.”