Wake Up! Stop Trying to Catch the Falling Knife: The Harsh Truth Behind the $26 Billion Crypto Liquidation
- Core Thesis: This article argues that the core reason for the sharp decline in global financial markets (including cryptocurrencies) is that the massive AI capital expenditure cycle is transitioning from "injecting liquidity" to "draining liquidity." This has caused a substantial shortage of global financial capital, triggering a "knockout tournament" among assets.
- Key Elements:
- In its initial phase, AI capital expenditure acts like fiscal stimulus, potentially boosting asset prices through a multiplier effect, but this is contingent on consuming the "dry powder" (idle capital) in the economy.
- Once idle capital is exhausted, every dollar invested in AI must be withdrawn from other sectors, leading to capital scarcity, rising costs, and triggering a "convex scramble" for capital.
- During capital shortages, markets reassess the efficient use of capital. Speculative assets with long durations and reliance on distant future cash flows (like cryptocurrencies) suffer disproportionately.
- The current issue is attributed to excessively high monetary demand (for productive investments like AI) outstripping supply, creating a crowding-out effect, rather than being a simple problem of monetary supply.
- Rising capital costs benefit assets with near-term cash flows (e.g., memory chip companies) relatively, while punishing assets dependent on long-term expectations.
- Cryptocurrencies, acting as the most liquidity-sensitive "frontier probe," bear the brunt of this environment, experiencing severe declines with little effective market resistance.
Author | @plur_daddy
Compiled by | Odaily (@OdailyChina)
Translator | DingDang (@XiaMiPP)
Editor's Note: Gold and silver both plummeted, US stocks fell across the board, and the cryptocurrency market was even more brutal, with over $2.6 billion in liquidations within 24 hours. Bitcoin briefly crashed to the $60,000 mark, plunging nearly 20% in a single day; from its high of $126,000 in October last year, the price of BTC has been halved. Even more frightening is that the market has shown almost no meaningful resistance.
Everyone is frantically searching for reasons: US tech stocks dragged down crypto; Trump's nomination of Warsh sparked hawkish expectations; the dollar is too strong, employment data is poor... These explanations all sound plausible. But in the author's view, they are more like symptoms than the core of the problem. The real underlying reason is: There is simply not enough money in the world. The massive AI capital expenditure cycle itself is shifting from "injecting liquidity" to "draining liquidity," leading to a substantial shortage of global financial capital. The following is the author's original text, which will deconstruct step by step how this mechanism operates.
We are experiencing a paradigm shift in the markets due to a shortage of financial capital caused by the AI capital expenditure cycle. This has profound implications for asset prices, as capital has been excessively abundant for a very long time. The Web 2.0 and SaaS paradigms that fueled the market boom of the 2010s were, by nature, extremely capital-light business models, which allowed a massive surplus of capital to flow into various speculative assets.
While discussing the market landscape yesterday, I had a sudden "aha moment." I believe this is the most differentiated piece I've written in a long time. Below, I will deconstruct, layer by layer, how all of this actually works.
There is actually a highly similar mechanism between AI capital expenditure and government fiscal stimulus, which helps us understand the underlying logic.
In fiscal stimulus, the government issues bonds, and the private sector absorbs the duration risk; the government then takes the cash and spends it. This cash circulates in the real economy and creates a multiplier effect. The net impact on financial asset prices is positive, precisely because of this multiplier effect.
In AI capital expenditure, mega-cap tech companies either issue bonds or sell Treasury bonds (or other assets), again with the private sector absorbing the duration risk; these companies then take the cash and deploy it. This cash also circulates in the real economy and creates a multiplier effect. Ultimately, the net impact on financial asset prices remains positive.
As long as this money comes from "dry powder" (idle, uncommitted capital) within the economic system, this process runs smoothly. It works wonderfully, almost "lifting all boats." For the past few years, this has been the dominant paradigm—AI capex acted like incremental stimulus, injecting adrenaline into the economy and markets.
The problem is: Once the dry powder is exhausted, every dollar flowing into AI capex must be pulled from somewhere else. This triggers a convex battle for capital. When capital becomes scarce, the market is forced to reassess: where is capital "most usefully" deployed? Simultaneously, the cost of capital (i.e., the market-determined interest rate) rises.
Let me reiterate: When money becomes scarce, a "knockout tournament" occurs among assets. The most speculative assets suffer disproportionately—just as they benefited disproportionately when capital was extremely abundant but lacked productive uses. In this sense, AI capex actually plays a role akin to "reverse QE," creating a negative portfolio rebalancing effect.
Fiscal stimulus typically doesn't face this issue because the Fed often ends up being the ultimate absorber of duration risk, thus avoiding "crowding out" other uses of capital.
The "money" referred to here can be used interchangeably with "liquidity." But the term "liquidity" can be confusing as it has different meanings in different contexts.
Let me use an analogy: Money or liquidity is like water. You need the water level in the bathtub to be high enough for financial assets (those floating rubber ducks) to all rise together. There are a few ways to achieve this:
- You can increase the total amount of water (rate cuts / QE)
- You can unclog the inflow pipes (plumbing operations like the current RRP (Reverse Repo) / RMP (Reserve Management Purchases))
- Or you can reduce the speed at which water drains from the bathtub.
Discussions about liquidity in the economy almost always focus on the money supply. But in fact, the demand for money is equally important. And the problem we face now is: Demand is too high, leading to significant crowding out.
Media reports suggest that the world's deepest pockets—Saudi Arabia and SoftBank—are essentially tapped out. The world has been gorging on assets for the past decade and is now "stuffed." Let's look at what this means concretely.
Suppose Sam Altman (OpenAI founder) reaches out to them, asking them to fulfill previous commitments. Unlike in past periods when they still held dry powder, now they must first sell something to free up cash for him. Hypothetically, what would they sell?
They would look at their portfolios and pick the assets they have the least confidence in: sell some underperforming Bitcoin; sell some SaaS software assets facing disruption risk; redeem funds from long-term underperforming hedge funds. And these hedge funds, to meet redemptions, must sell assets. Asset prices fall, confidence weakens, margin availability tightens, triggering more forced selling elsewhere. These effects cascade and amplify through the financial system.
Worse, Trump chose Warsh. This is particularly problematic because he believes the current problem is too much money, when in fact, we face the opposite problem. This is why the pace of these market changes has noticeably accelerated since he was selected.
I've been trying to understand: Why are memory chip makers like DRAM / HBM / NAND (e.g., SNDK, MU) performing so much better than other stocks. Sure, underlying product prices are skyrocketing. But more importantly, these companies are now and will be in the near future in a state of supernormal profitability—even though it's clear their earnings are cyclical and will eventually revert. When the cost of capital rises, so does the discount rate. The result is: Speculative assets with long duration and reliance on distant future expectations get hit, while assets with near-term cash flows benefit relatively.
In such an environment, crypto assets naturally get "hammered," as they are the front-line probes for changes in liquidity conditions. This is also why the market feels like it's "falling endlessly."
Highly speculative retail momentum stocks can barely hold any gains, and even sectors with improving fundamentals are struggling.
As demand for money exceeds supply, both sovereign bond and credit spreads are rising.
This is not a time to be complacent and extremely long. This is a time for defense, extreme selectivity in holdings, and serious risk management. I'm not telling you to sell everything; this article is not a trading directive. You should treat it as a contextual framework to help you understand what's happening.
I personally sold gold and silver near the highs, and my portfolio is mostly cash now. I'm in no rush to buy anything. I believe that if you are patient enough, there will be exceptionally rare opportunities this year.
Finally, thanks to the brilliant friends in the group chat who helped me think through these issues thoroughly, including @AlexCorrino, @chumbawamba22, @Wild_Randomness.
