Crypto Traders Need to Pay Attention to Chinese Yuan

China's yuan (CNY), one of the five currencies in the International Monetary Fund's special drawing rights basket, has depreciated by 2.7% against the U.S. dollar (USD) this month, its worst performance since September.

Going back to February, the decline goes to 5% versus the greenback, and investment banking giant Goldman Sachs suggests it could drop further.

Historically, yuan devaluation has been considered bullish for fiat currency alternative assets like bitcoin and gold, but the other side of that coin is a strong dollar. The U.S. unit is already on a rising trend and further strength might lead to continued monetary tightening worldwide and a headwind for risk assets, cryptocurrencies among them, say some observers.

The People's Bank of China (PBOC), the country's central bank, loosely pegs CNY's value to a basket of 24 currencies through a managed-float system. The daily fix or midpoint is set every trading day to provide direction to the market. The currency basket reflects China's trading partners, and with the U.S. being the largest, the dollar has the highest weighting at 19.83%. The euro, Japanese yen, British pound, Australian dollar, Mexican Peso are some of the basket's other currencies.

The PBOC's managed float allows the yuan to fluctuate 2% on either side of daily fix, and the bank manages that band via active buying and selling of yuan. If USD/CNY threatens to rally beyond the 2% limit, for instance, the PBOC sells the dollar and buys yuan to shore up the latter's value. At the same time, the bank buys the dollar against other currencies to keep the proportion of the greenback in reserves stable, ensuring the intervention gets recycled back into other foreign units.

This process inadvertently puts upward pressure on the dollar index, mainly comprised of the euro and the Japanese yen, causing financial tightening worldwide and leading to risk aversion.

"USD/CNY rally means PBOC will sell the pair to maintain the 2% band and has to buy the dollar against other currencies to maintain a stable proportion of USD in reserves. That pushes up the dollar index, leading to financial tightening and risk aversion," David Brickell, director of institutional sales at crypto liquidity network Paradigm, told CoinDesk.

Those with borrowings in the U.S. dollar and receipts in other currencies struggle to service their debt when the dollar surges. Per Brickell, more than $17 trillion of USD debt has been issued outside of the U.S. Thus, dollar strength tends to create risk aversion worldwide.

The dollar index has rallied 2.7% this month. Bitcoin, meanwhile, has declined by 7.3%, its most significant monthly loss since December.

Noelle Acheson, former head of research at CoinDesk and Genesis Trading, said that the PBOC's interventions may be dollar bullish but stressed that such actions are not assured.

"The PBOC has been hinting at more flexibility on the CNY target band than in the past - so it's not a given that it will intervene, especially if a weaker yuan helps exports (which are suffering)," she wrote in her latest newsletter. "Now China's priorities are different - also, PBOC has been diversifying reserves and could buy gold instead of more USD."

Last month, PBOC Governor Yi Gang said that the central bank can wind down regular interventions, providing market forces more leeway in determining the yuan's exchange rate. Yi, however, stressed that the bank retains the right to intervene in times of market turbulence.