Why Bitcoin and Ethereum Crashed?

To Understand What’s Happening, You Must First Understand the U.S. Financial System. The recent crash in Bitcoin and Ethereum cannot be explained by sentiment alone. To truly understand what’s happening, you have to understand the mechanics of the U.S. financial system—especially the relationship between the Treasury market and the repo market. Modern finance revolves around U.S. Treasuries. They function as a substitute for deposits, the backbone of dollar liquidity, and the most important form of collateral within financial institutions. Yet Treasuries trade in two separate markets: the cash market and the futures market. Price discrepancies naturally arise between the two, and this small inefficiency—known as the “basis”—is what hedge funds exploit through a highly leveraged strategy called the basis trade.

The basis trade is deceptively simple. Imagine a Treasury trading at 98 in the cash market while the 3-month futures contract trades at 100. A hedge fund buys the cash bond at 98 and sells the futures at 100. When the bond converges to 100 at maturity, the fund earns a $2 gain on the cash position, while the futures settle at the contracted price with almost no P/L. The profit comes from the initial spread. But here’s the critical detail: hedge funds do not buy the cash bond with their own money. They finance it entirely through repo—overnight borrowing backed by the bond itself. That means the entire strategy is, by construction, a repo-liquidity-dependent, ultra-leveraged trade.

The repo market is where Treasuries are posted as collateral in exchange for cash. And there are only two major providers of cash in this market: banks and money market funds (MMFs). Banks hold reserves and use repos for ultra-safe short-term deployment, but regulations like SLR and LCR limit how much they can lend. MMFs, meanwhile, dominate the short-term interest rate ecosystem. They constantly shift between T-bills and repo depending on tiny yield differentials. In essence, the health of the repo market—the core funding market for leveraged Treasury strategies—depends almost entirely on these two lenders. When both banks and MMFs pull back, repo rates can spike violently.

This is why the basis trade is fundamentally a liquidity trade, not a directional trade. It doesn’t bet on interest rates going up or down; it bets on the convergence of prices over time. But maintaining the position requires rolling repo funding every single day. As long as repo rates are stable, the basis spread—minus funding cost—creates a near-risk-free return. When repo funding becomes unstable, however, everything unravels quickly. With leverage of 30–60×, even a 0.5% move in Treasury prices can trigger catastrophic losses and immediate margin calls. If funding dries up, hedge funds are forced to unwind. They sell cash Treasuries, pushing yields higher, which triggers more losses, more margin calls, and more selling. This kind of liquidation spiral is exactly what happened to the Treasury market in March 2020.

As the cash market destabilizes, the futures/cash spread widens further, causing even larger losses on basis positions. What begins as a liquidity issue cascades into systemic stress across the entire Treasury market. Treasuries are supposed to be the safest, most liquid asset in the world, but when basis trades accumulate systemically, they amplify vulnerabilities. Treasuries don’t collapse because they are risky; they collapse because they are the collateral everyone needs when liquidity vanishes.

This is the reason the Federal Reserve created the Standing Repo Facility (SRF). SRF allows banks and primary dealers to get instant cash from the Fed using Treasuries as collateral. It’s designed as a safety valve for repo market instability. But the problem is stigma: using SRF signals that an institution may be short on liquidity. On Wall Street, reputation and relationships matter. So even when funding is tight, firms avoid using SRF. As a result, SRF has remained underutilized—despite being built to prevent exactly the kind of liquidity stress we’re seeing now.

This is why the New York Fed quietly summoned primary dealers for a private meeting. The message was clear: “Use the SRF. Don’t be ashamed. Systemic stability matters more than appearances.” In other words, the Fed is trying to normalize SRF usage because it recognizes the growing liquidity risks stemming from basis trade deleveraging. SRF is no longer meant to be an emergency tool—it is being repositioned as a routine liquidity backstop.

Ultimately, the basis trade lives and dies by repo liquidity. When banks and MMFs supply cash, the trade functions smoothly. When liquidity tightens, the trade collapses, Treasuries sell off, yields spike, and systemic stress increases. A repo market spike freezes the entire short-term dollar funding system, and losses from basis trades propagate across markets. This is why the Fed is pushing SRF so aggressively. The repo–basis–liquidity–SRF linkage is now the central mechanism driving financial conditions, and a disruption in any one of these components can trigger cascading instability.

And this is precisely how the crypto market—Bitcoin and Ethereum in particular—got caught in the crossfire. The recent U.S. government shutdown drained liquidity and trapped cash in the Treasury General Account (TGA), starving markets of funding. When repo funding tightened, leveraged basis funds faced margin pressure. And when hedge funds face margin calls, they liquidate their most liquid non-core assets first: Bitcoin and Ethereum. That’s why crypto crashed almost simultaneously with signs of stress in the short-term funding market. It wasn’t sentiment. It was the liquidity trap.

So when will the market rebound? The first requirement is a recovery in the short-term funding market. The Fed’s meeting with primary dealers about SRF confirms how serious the situation is. If SRF usage increases, reserves rise, repo rates calm down, and systemic stress recedes. The end of the government shutdown also means the TGA can finally release funds back into the economy, improving liquidity. Meanwhile, two major catalysts remain on standby—the possibility of renewed Fed balance sheet expansion (QE-lite) and the Trump administration’s proposed $2,000 household rebate. Both would inject fresh liquidity into markets.

The final missing piece is NVIDIA’s earnings on the 19th. The recent liquidity stress reignited the “AI bubble” debate. When liquidity dries up, high-valuation tech names wobble first—and NVIDIA sits at the center of the global AI narrative. If NVIDIA beats expectations, investor sentiment will pivot quickly. Liquidity follows narrative, and a revived AI narrative would pull institutional capital back into tech and semiconductors. This in turn would help reverse the broader liquidity stress originating in the repo market. If AI sentiment recovers, overall risk appetite rises, and liquidity begins circulating again—including into crypto.

In short, the recent correction was not a simple price move. It was a liquidity shock, and Bitcoin and Ethereum were hit at the end of the chain reaction. But the moment liquidity returns, crypto will be among the first to rebound. Short-term funding recovery → SRF activation → TGA outflows → liquidity expansion (QE or fiscal) → NVIDIA earnings restoring the AI narrative. Once these align, liquidity will re-enter markets.

However, for Bitcoin and Ethereum to break to new all-time highs, sentiment must shift decisively. NVIDIA’s earnings this week may be the event that sets that shift in motion.