Bitcoin, Markets, and the Yen Carry Trade
After a choppy July in early August, Bitcoin experienced a significant drop in price from ~63,000 down all the way to ~$49,700. The entire cryptocurrency market faced substantial selling pressure, influenced by a ~10% drop in Japan’s Nikkei index on August 2 and compounded by a disappointing U.S. jobs report for July. The following illustrates how bad this "bull market" year of 2024 has been for some specific tokens.
YTD returns for different crypto tokens in different sectors. Source
Despite this downturn, Bitcoin continues to trade within a broad range, making future price
movements challenging to predict. Notably, Bitcoin "whales," or holders of large quantities
of Bitcoin, remain optimistic. In July alone, addresses with over 1,000 Bitcoin accumulated
an additional 84,000 Bitcoin. Simultaneously, exchanges witnessed a significant
withdrawal of 64,000 Bitcoin, the largest since 2015, according to Glassnode.
Since July 30, Bitcoin's price has fallen by 21%, mirroring downturns in the U.S. stock
market, which has been affected by rising unemployment claims, a decline in
manufacturing, issues with the Japanese economy, and stress on a very popular FX trade
called the Yen Carry Trade.
Mechanics of the Yen Carry Trade
The yen carry trade, a well-known financial strategy, has recently garnered significant
attention due to its influence on market volatility. This approach, which involves borrowing
in a low-yielding currency like the Japanese yen to invest in higher-yielding assets, hasbeen a staple in traditional finance for years. However, its popularity has surged over the
past two years, impacting various markets, including U.S. equities.
At its core, the yen carry trade exploits the interest rate differentials between countries.
Investors borrow yen at low interest rates and convert it into higher-yielding currencies or
assets, such as U.S. Treasuries or equities. This strategy not only benefits from the
interest rate spread but also from potential gains in the invested assets. Over the past two
years, a significant portion of the borrowed yen has flowed into U.S. equities, contributing
to market rallies, particularly in big-cap tech stocks.
Recent Developments and Market Impact
The carry trade's impact on markets became evident with the recent volatility in the yen
and its subsequent effects on global markets. A series of events, including a surprise rate
increase by the Bank of Japan, heightened expectations of U.S. Federal Reserve rate
cuts, and growing recession fears in the U.S., catalyzed a reversal in the yen's value. This
reversal prompted interventions by Japan's Ministry of Finance to stabilize the yen, further
exacerbating market turbulence.
The unwinding of the yen carry trade has led to significant asset sales as investors repay
their yen-denominated loans or top up their margins due to rising margin calls. This
process has created substantial volatility, particularly in Japanese equities, which
experienced a 12% drop in a single day—a stark contrast to the more gradual movements
typically observed in traditional markets.
Broader Implications
The relationship between speculative futures positioning in the yen and U.S. equities,
particularly the NASDAQ 100, reveals a tight correlation. Continued unwinding of the yen
carry trade could trigger further selling in U.S. equities and other foreign assets,
compounding market volatility. This concern underscores the uncertainty facing investors,
as it's challenging to predict the full extent and duration of this unwinding process.
Tether Keeps Setting Revenue Records
Tether, the preeminent stablecoin in the crypto space, has released its financial results for
Q2, revealing an all-time high in US Treasury holdings. The quarterly attestation by auditor
BDO disclosed that Tether’s US Treasury holdings, encompassing both direct and indirect
exposure, surged to $97.5 billion. This milestone positions Tether as the 18th largest
owner of US debt globally, surpassing countries like Germany, the UAE, and Australia.
According to Tether's press release, the firm ranked third in purchases of 3-month US
Treasuries during the first half of 2024, trailing only the UK and the Cayman Islands. The
company anticipates potentially leading this category by next year, driven by the continued
adoption of its USDT stablecoin.
Key Highlights from Q2
Net Operating Profit: Tether reported a net operating profit of $1.3 billion in Q2, a
decline from the previous quarter’s $4.5 billion, which was bolstered by substantial mark-to-market gains on Bitcoin positions. This quarter saw a $653 million loss.
US Treasury Holdings: Now constituting 68.3% of Tether's reserves, US Treasury
holdings reached another record high.
USDT Issuance: Over $8.3 billion in USDT was issued in Q2, raising the total
circulating supply to $112.7 billion.
Excess Reserves and Equity: Tether's excess reserves, which exceed its liabilities,
stood at $5.3 billion, while the Tether Group's equity, including investments not part
of reserves, reached $11.9 billion.
Bitcoin Holdings: Tether’s Bitcoin reserves were valued at $4.7 billion, a 12%
quarter-over-quarter decline due to the falling Bitcoin price. The firm maintained its
Bitcoin holdings at 75.3k BTC. CEO Paolo Ardoino asserted that the company
continued its quarterly Bitcoin acquisitions via Tether’s investment arm.
Stablecoin capital inflow is a crucial barometer for the broader cryptocurrency market,
reflecting investor confidence and technology adoption. Tether's addition of $8 billion in
USDT during Q2 reinforces its market leadership in inflows and sustains its dominance at
70% of the global stablecoin market throughout 2024. However, Tether’s global
dominance faces potential challenges with the implementation of the Markets in Crypto-
Assets (MiCA) regulation in the EU. Unlike its competitor Circle, Tether has not secured a
license from the European Banking Authority to operate in the region.
Supporting this outlook is the behavior of Bitcoin ETFs, which have continued to increase
their holdings, albeit at a much smaller clip than ~two months ago. This institutional accumulation underscores a sustained investor interest in Bitcoin, reinforcing a long-term
bullish perspective despite short-term supply shocks.
Looking forward, stakeholders are keenly awaiting further transparency from CEO Paolo
Ardoino regarding Tether’s reserve composition, particularly the specifics of the alleged
Bitcoin purchases. Since Tether committed to allocating up to 15% of its net operating
profit to Bitcoin acquisitions starting Q3 2022, clarity on these transactions remains vital.
Currently, Tether’s identified Bitcoin address ranks as the 8th largest holder, with a
balance of 75.3k BTC, valued at nearly $5 billion.
Jump Exiting?
In the midst of ongoing market turbulence, Jump Crypto, the cryptocurrency arm of Jump
Trading, is actively selling its assets. Blockchain data reveals significant movements of
cryptocurrency, including ~$300 million of staked ETH, indicating a strategic reshuffle of
their holdings, possibly in response to volatile market conditions and recent regulatory
developments.
The timing of these asset movements coincides with the recent departure of Jump
Crypto’s President, Kanav Kariya. This adds another layer of intrigue, suggesting potential
internal changes or strategic shifts within the firm. Moreover, the increased regulatory
scrutiny by the U.S. Commodity Futures Trading Commission (CFTC) could also be
influencing these decisions, as companies frequently adjust their strategies in response to
regulatory pressures.
The broader context of these strategic movements by Jump Crypto highlights the
complexities and uncertainties in the current cryptocurrency market. As regulatory scrutiny
intensifies and market conditions remain volatile, firms like Jump Crypto must navigate a
challenging environment, making strategic decisions to safeguard their positions and
adapt to evolving circumstances.
DeFi, DAOs, and Compound
Compound aims to provide a trustless money market for the cryptocurrency ecosystem,
eliminating central points of failure and the reliance on centralized entities typical in
traditional finance. Initially launched as a tokenless protocol in 2018, Compound was
governed unilaterally by its founding team. This central control was deemed necessary for
security and development during its early stages. However, in June 2020, Compound
introduced its governance token, COMP, marking a pivotal shift towards decentralization.
Transition to Decentralized Governance
The launch of the COMP token empowered the Compound community to govern the
protocol. COMP holders can propose and vote on protocol changes, fostering a
decentralized decision-making process. For instance, in May 2021, COMP holders
approved the addition of TUSD and LINK as supported markets, which have since grown
to $100 million and approximately $160 million, respectively.The initial centralization of Compound’s governance was an intentional but temporary
measure. Robert Leshner, Compound's co-founder, emphasized that the initial unilateral
control was meant to ensure security but would eventually be transferred to the user
community. The Compound Whitepaper outlines specific powers transferred to COMP
holders, including listing new cToken markets, updating interest rate models, and choosing
new administrators through decentralized autonomous organizations (DAOs).
COMP Token and Governance Mechanism
The COMP token enables holders to propose and vote on protocol changes. Any user with
1% of COMP tokens delegated to their address can initiate a governance proposal. Voting
on proposals lasts three days, and a consensus requires a minimum of 400,000 votes.
This mechanism ensures that protocol changes reflect the community's consensus, akin to
a corporate board's decisions.
The decentralized governance model aims to address the shortcomings of centralized
exchanges like Bitfinex and Poloniex. Centralized exchanges require users to trust the
exchange's integrity, limit participation to specific customer groups, and restrict the use of
assets within the exchange's ecosystem. In contrast, Compound’s decentralized model
allows for on-chain asset utilization, enhancing accessibility and transparency.
Governance Challenges and Strategic Exploitation
Despite its decentralized governance, Compound faces challenges typical in DeFi. A
prominent example is the "governance attack" by a whale known as Humpy, who
leveraged their holdings to influence protocol decisions. Humpy's strategy involved
acquiring significant governance tokens to control reward distributions, first seen with
Balancer during the DeFi Summer of 2022. Humpy's tactics highlighted vulnerabilities in
governance models that allow strategic exploitation by large token holders.
Humpy’s actions underscore the need for DeFi protocols to reassess their governance
structures to mitigate risks posed by influential market players. This includes implementing
safeguards to prevent governance manipulation and ensuring that community interests
are protected.
DAOs, as governance entities within DeFi, blend smart contracts with central
intermediaries to manage risk. While this central governance model allows for expert
oversight and responsive adjustments to market conditions, it also introduces operational,
cyber, and political risks. DAOs must navigate these challenges to balance efficient
management with the decentralized ethos of DeFi.
Our Take
At Event Horizon Capital (EHC), we believe select cryptoassets will outperform all other
asset classes over the next five, ten, and possibly even twenty years due to their superior
qualities as new money/assets for the internet age. Because of this, we seek the best risk-
adjusted exposure to protocols that personify the blockchain benefits outlined above. With
crypto markets being one of the world’s most dynamic markets, our agile and active management provides the flexibility required for swift, decisive action while also never
compromising on security.
EHC’s multi-strategy approach is built upon:
Qualitative fundamental research,
Quantitative tools and valuation metrics
Narrative and sentiment-driven market swings
INSIGHTS is brought to you through a collaboration between Event Horizon Capital and
CryptoEQ. Together, we strive to deliver timely and in-depth market analysis to empower
your investment decisions. For more information, visit our partners and explore their
unique offerings.
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