Monday crash - what happened?
Matt Curda
I help Angel Investors & HNWIs understand blockchain and unlock its investment potential | Forbes Web3 | Weekly Market Updates
Dear Investors,
This week was crazy on many fronts.
Let’s explore together what happened and what I take out of that.
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Monday crash - what happened?
First of all, tech companies reported mediocre earnings, which was the first “hit” to the markets —> The magnificent seven (the seven biggest tech companies) represent 30.31% of the S&P index, I mentioned three weeks ago that it is a potential trigger.
Then, Israel reported the assassination of Hamas’ political leader Ismail Haniyeh. As a response, Iran vowed revenge on Israel, which drives fear among the markets of further war escalations — the US expects an attack in the coming days and is preparing to support Israel while trying to de-escalate the conflict*.
Then, the US labor market on Friday indicated a serious slowdown in the US economy.
But Monday's biggest driver was something very different: a move called a?carry trade?that many investors have?made in recent years.
What is a carry trade
A carry trade is an investment strategy that involves borrowing the currency of a territory where interest rates are low and investing it in a place where interest rates are high.
For years, investors borrowed “cheap” money in Japan, where interest rates were steadily near or at zero, and invested it in stocks, bonds, or other currencies.
Warren Buffet and Charlie Munger leveraged this in 2023 to make 37 - 62% on each stock they picked.
Easy money turned sideways
However, last week, the Bank of Japan raised interest rates for the second time since March, pushing the already rising yen even higher.
Combined with the weakening US dollar (reaction to labor data, recession, and war) and the declining stock market, investors were scared that they could not repay their debt and started selling their positions to close this carry trade.
The result?
Japan's stock market crashed by more than 12%, the biggest one-day drop since 1987*.
US bonds up and stocks down —?The S&P 500 opened at -3.64%, and the Nasdaq at?-6.34%.
Does this mean we should panic? Probably not.
Unwinding the carry trade will take longer, but the Bank of Japan is already signaling that it will not continue rate hikes until the economy stabilizes.
Numbers came in bleak, but the FED was trying hard to control the overheated economy and inflation. Now they have succeeded, and higher unemployment means they can cut rates.
It feels like we went from:
“The economy is too strong, any good data scares investors because FED might increase rates”
To a 180-degree switch:
“we have bad data, the economy is in recession.”
We still have major positive factors happening closer to the end of 2024, like highly likely rate cuts in September and a possible election rally.
How has it affected crypto?
Crypto is a risky asset class, and when markets are down, crypto usually leads the way.
This time, additional forces pushed it even further - so much so that ETH dropped by 25% and BTC by 18% in a few hours.
Three additional factors were playing a role in crypto:
ETH ETF Outflows
Similarly as with the approval of BTC ETFs, there have been significant outflows of the former Grayscale trust, which has now been converted into a regular spot product.
ETH outflows are faster because there was no discount compared to BTC (we discussed the details here).
This resulted in a net outflow (selling) of $364m.
Jump Trading and other market makers selling over $290m in ETH
Jump Trading has sold over 83,000 wstETH between July 24 and Aug. 5, contributing to the market crash that began on July 24 — the first drop from $3,464.
On Wednesday, Jump Trading sold another 11,501 ETH worth over $29m and redeemed $48m worth of ETH, with $63m in Wrapped Lido Staked ETH (wstETH) left to sell.
The aggressive selling by Jump Trading and other market makers like Paradigm VC and Wintermute has been linked to Ether's price drop below $2,200.
We don’t know for sure the reasons behind this selloff.
Liquidations
Crypto is known for leveraged trading.
A big part of the DeFi is based on some form of leverage.
That means that if the market drops, many leveraged positions might be liquidated (sold off by the protocol to cover the losses).
On Monday, $801m in liquidations occurred, creating significant pressure on the price and accelerating the drop and further liquidation.
My Thoughts
I was surprised and scared on Monday. Even for crypto, this was a lot of movement and volatility.
I didn’t panic, and I hope no reader of this newsletter started panic selling or was struggling with liquidations, but I was glued to my screen the whole morning.
Seeing how the US market reacted after the opening was crucial — ETFs have the power to accelerate the price, but on both sides.
I expected a further decrease as investors would exit ETFs, but the opposite happened, and as soon as the US market opened, ETH started recovering the losses.
I was prepared for both scenarios, and in the morning I deployed most of my cash, both in stocks and crypto.
Once the US opened and I saw the price going up, I increased my leverage.
I closed part of it the same day for a quick +40% return, keeping the rest for a long period with a possible increase if we see a similar movement.
I invest long-term and, in general, welcome any market corrections as a chance to increase my positions. I believe the macro cycle will turn in our favor later this year and will help fuel the next bull market, which can make another 2x-4x on the crypto market by the end of 2025.
From someone much smarter than I am, Raoul Pal, this is similar to 2016 when Japan made a similar move to help reduce the strength of the US dollar, helping pour in liquidity and start the bull run that went through 2018.
The risk I see is the ETH sell-off from market makers. That might be driven by something I don’t know, which could significantly affect the ETH ecosystem.
My strategy remains the same: long crypto, farm ETH airdrops and yield, and be extra careful with leverage. Even ETH can still drop 20+% in a single day.
Regards,
Matt Curda