Have you ever wondered that when the Bank of Japan takes action, the crypto world trembles? This is actually due to the breakdown of the arbitrage chain.

In simple terms, over the past twenty years, the Federal Reserve and the European Central Bank have periodically raised and lowered interest rates, but what about Japan—maintaining near-zero interest rates or even negative interest rate policies for a long time. This has turned Japan into a liquidity reservoir for the global financial system. What does the crypto market rely on to survive? It depends on this overflow of cheap liquidity. Only when traditional markets (US stocks, bond markets) are flooded with funds do the excess money flow into the riskiest areas, including the crypto space.

Imagine this scenario: the Bank of Japan offers you yen loans with near-zero interest, and you use this almost interest-free money to arbitrage. For example, buying US bonds, trading US stocks, or entering the crypto market. The price difference is your profit—this is riskless arbitrage, essentially swapping zero-interest bonds for high-yield assets.

But this strategy has two prerequisites: the yen interest rate must stay low, and the yen exchange rate cannot fluctuate too wildly. Once the Bank of Japan announces a rate hike, these two conditions are broken. The cost of borrowing instantly rises, and the yen exchange rate will also strengthen (a basic economic law). At that point, you need to repay the loan, and the exchange rate difference alone becomes a significant expense, plus interest costs, causing the arbitrage space to evaporate completely, even turning into losses.

What will institutions and hedge funds do when they realize profits are disappearing? They can only close their positions. Large amounts of Bitcoin and other cryptocurrencies are sold off for USD, then converted back to yen, leading to a large-scale outflow of funds from the crypto space. To put it plainly—creditors are demanding repayment, and everyone is rushing to sell coins to pay back loans. This is why a small yen rate hike cycle can trigger a chain reaction in the crypto world.

Under rate hike expectations, market risk appetite also declines, with high-volatility assets being hit first. This logical chain is very clear: central bank policy → arbitrage costs → capital flow → price volatility.