This column was co-written by Frank Chaparro, Special Projects Director at The Block, and Laura Vidiella of MNNC Group. The views expressed in this column are their own and do not necessarily reflect those of their employers.
This week has been a tumultuous one for cryptocurrencies. However, if you have been in the market for a while, you are probably familiar with these kinds of violent price drops. This is usually caused by the accumulation of leverage on offshore platforms. When leverage is accumulated, a catalyst can trigger a price drop, which can lead to a chain of liquidations that further lower the price.
Crypto wasn’t the only one suffering this week. August was a month of significant turmoil as the popular yen carry trade unraveled. For those unfamiliar, this trade involves borrowing yen at low interest rates and investing it in another currency or asset with higher yields. When the Bank of Japan raised interest rates to its highest level in 15 years, the trade collapsed, sending Bitcoin from around $68,000 to the low $50,000s. Meanwhile, the S&P 500 fell about 6% between July 31 and August 5.
Frank couldn’t help but think back to a recent drive to Washington, D.C., where he had heard his colleague George Calle give a lecture titled “The Rise of Carey: The Dangerous Consequences of Volatility Suppression and the New Financial Order of Declining Growth and Recurring Crises.”
In essence, almost every financial collapse can be traced back to the collapse of this transaction.
Kalle recently wrote a blog post exploring Carry’s role in the 2021/22 crypto crash, which he often refers to as the crypto credit crisis.
As Calle points out, several high-profile trades involving carry elements unraveled during that period.
- Terra/Luna Collapse
- GBTC Premium Flipping
- DeFi yield decline
- FTX collapse
I would argue that Calais is the furthest from Carry due to his lack of leverage against Terra.
The Terra/Luna crash is likely the most impactful event of 2022 as it triggered a credit crisis that engulfed the markets. The Anchor protocol delivered elements of the carry trade as it promised a steady 20% return on a new and risky stablecoin, but it ultimately collapsed in a very reflexive manner.
Here’s Calle’s take on GBTC:
“In contrast, GBTC trades that described themselves as “carry strategies” often involved leverage. In fact, a common theme across distressed lenders was that these trades exposed clients to losses. Due to the nature of Grayscale as a closed-end fund, GBTC trades had some mechanical differences from classic carry trades: the parties to the trade did not expect periodic payments, and so were essentially engaged in delayed arbitrage without proper risk controls.”
I highly recommend reading the entire article Blog.
Summer is a relaxed season, but the introduction of new funds tied to Ether and macroeconomic uncertainty has created this eerie volatility in crypto assets. According to CoinGecko, the total market cap of all crypto assets peaked at around $2.7 trillion in July and currently sits at around $2.2 trillion. Can developers do something about it?
As with similar declines in the Bitcoin price, institutional investors came to the rescue, with JPMorgan analysts noting that the rally was largely driven by institutional investors. As my colleague Yogita Khatri reports:
“JPMorgan’s futures position indicator, which tracks cumulative open interest for CME bitcoin futures contracts and the positive slope of the futures curve, suggests a bullish outlook among these investors, JPMorgan analysts led by Managing Director Nikolaos Panigirtzoglou wrote in a report Wednesday. They said the higher bitcoin futures price premium over spot is indicative of futures investors’ confidence.”
According to FalconX Research, selling pressure was intense but dissipated “fairly quickly.”
“Selling pressure has built up in the order book, reaching the yellow flag level of 1.25x the buy orders, but during the sell, this selling pressure has been exhausted relatively quickly, so the order book is now tilted towards buying.”
As for the future, I think the market will continue to struggle with political uncertainty. It is still unclear how supportive the Harris administration will be on crypto. Recent meetings between crypto market participants and White House advisers have done little to provide additional clarity. Here is the relevant passage from Bloomberg:
“Biden administration advisers have made no promises to cryptocurrency industry executives who raised policy concerns, according to a person who participated in Thursday’s Zoom call. White House advisers did not discuss any policy changes with the group, which included executives from Coinbase Global Inc., Kraken, and Ripple Labs.”
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