The Yen-Induced Route in the Crypto Markets Didn't Last Long

Bitcoin (BTC 5.46%) was up 7.4% as of 2:30 p.m. EDT; Ethereum (ETH 3.51%) was up 6.4%; and Dogecoin (DOGE 3.39%) rose 5.3%.

Major cryptocurrencies rose in value on Tuesday, following a sell-off in the previous session that was linked to the unwinding of the yen carry trade.

Bitcoin, the world's largest cryptocurrency, rose 7.4% over the past 24 hours to $43,880.6 by 2:30 p.m. EDT. It had fallen 6.6% on Monday.

Among other major cryptocurrencies, Ethereum rose 6.4% to $3,183.3, and Dogecoin rose 5.3% to $0.15.

The price movements mirrored an improvement in the stock market on Tuesday, continuing a correlation between the two asset classes on high-volatility days. The Dow Jones Industrial Average rose 220 points, or 0.6%, while the S&P 500 rose 0.4%, and the Nasdaq Composite dropped 0.1%.

The yen carry trade is a leveraged bet on currencies and interest rates, where traders borrow money in a low-interest-rate country like Japan and use it to buy higher-yielding assets elsewhere. But the fallout can involve other assets like cryptocurrencies as the trade unwinds.

Monday's sell-off was likely caused by a rapid sell-off in cryptocurrencies, which in turn caused losses in other assets that were bid up by the carry trade, ultimately leading to a sell-off in those assets and a return of the funds to Japan.

The move was ultimately driven by the Federal Reserve, which is expected to begin raising interest rates later this year and into next, a move that will benefit the dollar and hurt the yen carry trade.

Now, the question is whether the unwinding and deleveraging of this kind of trading is over. A few days doesn't make a trend, and there may still be volatility ahead if more leveraged trades experience rapid losses.

In other crypto news, Bloomberg reported that a total of $423 million flowed out of Bitcoin exchange-traded funds (ETFs) in the previous week.

The growth of ETFs has brought billions of dollars in new investment into the crypto industry, and that may not be sustainable if valuations drop.

For now, the ETF business is holding up, but a further decline in crypto assets could see retail investors who are buying crypto for the first time question the value of the asset.

The biggest fear is that economic weakness will be ignored in favor of crypto trades, which are driven by growth stocks and anything else that can be quickly traded.

A big reason there's been a longer decline for crypto is weakening economic news, like last week's relatively weak jobs report.

If we zoom out, Bitcoin is down 13.8% in the past week; Ethereum is down 23.9%; and Dogecoin is down 21.9% over that time because investors are selling riskier assets. Crypto falls into that camp and is dropping as a result.

Without any real fundamentals to drive the crypto market higher, it's possible a sell-off will ensue if the economy does take a turn for the worst.

The tailwinds behind crypto over the past year have been intense, including the rise of growth stocks and risk assets and the introduction of crypto ETFs to the market.

There was naturally a bounce in anticipation of some of these actions, but they're not repeatable long term.

What may be more impactful long term is a change in Washington D.C. in the regulations and legal frameworks governing crypto. But that may not be just about getting more people to buy tokens.

That will open up innovation on the blockchain, new business formations, and financial transactions, which will make crypto mainstream but may involve stablecoins and not cryptocurrencies themselves.

I think caution is in order in crypto today given the volatility and potential for a recession later this year. The crypto market's hot streak could end quickly. Ironically, it may be a slower U.S. economy that does it.