Concerns Over AI Infrastructure Profitability Cause South Korea's Market Crash

On July 28 and 29, South Korea's Kospi stock index plummeted by 16%, prompting trading halts due to a market circuit breaker. Investor fears regarding the profitability of investments in AI infrastructure, along with rising competition in memory production, were cited as the primary reasons for the sell-off, according to Al Jazeera.

Triggering Factors for the Sell-Off

Pressure on memory manufacturers began the day before the market crash. On July 27, the Chinese company CXMT debuted on the Shanghai stock exchange, with shares soaring by 466% on the first trading day, reaching a market capitalization of over $488 billion, making it the most valuable company on the Chinese market. The IPO generated $8.6 billion, setting a record for the country's semiconductor sector.

On that same day, the MSCI index for technology in the Asia-Pacific region, excluding Japan, dropped by 4.7%. This decline also affected leading companies in the industry, with shares of American memory producers Micron and SanDisk falling by 5% and 12%, respectively, in New York trading, while SK Hynix shares dropped by 8.5% in Seoul.

Source: Yahoo Finance. Source: Yahoo Finance. Source: Yahoo Finance.

The Korean market faced further setbacks following SK Hynix's report released on July 28. While the memory producer reported a record operating profit of 60.54 trillion won ($41.25 billion), a year-on-year increase of 557%, it fell short of the consensus forecast of 64 trillion won. The company also announced plans to increase capital expenditures to $31 billion, leading to a 15% drop in its stock, which continued to decline the following day.

Market Concentration and Leverage Intensify Declines

SK Hynix and Samsung Electronics together account for about half of the Kospi's market capitalization, compared to roughly a quarter at the end of the previous year. According to Reuters, on certain days this year, these two stocks represented more than 80% of the trading volume of the index. Both companies benefitted from the surge in demand for memory chips for AI data centers, with SK Hynix producing HBM chips for accelerators and Samsung remaining a major contract manufacturer.

Until late May, South Korea had no single-stock leveraged funds, with investors purchasing equivalents through foreign exchanges, primarily in Hong Kong. Regulators launched 16 domestic products on May 27 to attract these investors back to the local market. Since then, assets in leveraged funds related to Korean stocks have grown to $50 billion, according to RBC Wealth Management. Net purchases by South Korean retail investors in these new products amounted to 14 trillion won (approximately $9.4 billion), compared to about 2 trillion won by foreign investors, as reported by KB Financial Group.

Such funds buy or sell the underlying stock daily to maintain a specific ratio. When the stock price falls, they sell, adding further pressure to the price. The Kospi volatility index has remained above 80 for the past six weeks, with a historical high of 97.99 recorded on June 19. In previous decades, this index never exceeded 30. The KODEX double-leveraged fund on SK Hynix has declined by approximately 70% from its June peak, while the Hong Kong-based CSOP fund on the same stock has dropped by 83% in a month.

Insurance Costs for AI Companies' Debt Reach Record Levels

The sell-off impacted not only stocks but also the demand for memory chips driven by capital expenditures from five major American operators: Amazon, Meta, Microsoft, Google, and Oracle. The cost of insuring against their default has surged to record levels.

Five-year credit default swaps for a basket of these companies have risen from 115 to 162 basis points, according to Offside Research. These contracts allow bondholders to pay regular premiums in exchange for a payout in the event of default, so their cost reflects the perceived risk.

The widening spreads have affected companies differently. Oracle's default insurance has increased the most, up over 215 basis points from about 145 at the end of the previous year, noted Bloomberg. Barclays credit analyst Andrew Ketches described Oracle's swaps as a working indicator of concerns over AI-related debt, highlighting that while the company has a large portfolio of contracted revenue, a significant portion is tied to OpenAI, which is not currently generating cash flow and has delayed its IPO.

According to Sage Advisory, since September, the total dollar debt of this group has more than doubled, exceeding $360 billion, while free cash flow has turned negative. The combined capital expenditures of the five companies for 2026 are projected to reach $725-730 billion. Alphabet reported negative cash flow of $5.9 billion in the second quarter for the first time in its history, despite an 82% increase in its cloud division.

However, analysts from Real Investment Advice viewed the situation differently, arguing that 162 basis points for companies of such credit quality are far from levels that indicate a risk of credit events. They believe the widening spreads reflect the hyperscalers' shift to negative cash flow rather than a threat of defaults.

South Korean Authorities Tighten Regulations and Issue Apologies

On the evening of July 29, an emergency meeting in South Korea was held in the F4 format, which included the Minister of Finance, the Governor of the Bank of Korea, and the heads of two financial regulators. Following the meeting, the Ministry of Finance announced that the share of leveraged funds in a retail investor's portfolio will be capped at 20%, trading costs will increase, and requirements for investor preparedness will be implemented before access to such products. The increase in the minimum deposit from 10 million to 30 million won, decided previously on July 16, will take effect earlier on July 31.

The government is also preparing a legal framework for intervention in crisis situations, similar to the Hong Kong model, where fund managers can adjust the fund's leverage between one and two depending on market conditions.

On the same day, apologies were issued by Finance Minister Koo Yun-chul and Financial Services Commission Chairman Lee Ok-won, according to Reuters. Koo expressed regret in parliament over launching the product without adequate preparation. Lee stated in a separate meeting that the agency did not meet public expectations and is taking the spike in volatility seriously. He also mentioned that the regulator is considering limiting access to these instruments to professional investors and reducing the multiplier of the funds as part of the legislative process.

Bitcoin Remains Relatively Unaffected

The turmoil in the South Korean stock market had minimal impact on cryptocurrencies. Over the past day, Bitcoin's price fell by 0.4%, trading around $64,500 at the time of writing.

Hourly chart of BTC/USDT on Binance. Source: TradingView.

However, the sell-off did affect perpetual contracts on stocks traded on cryptocurrency exchanges. On the evening of July 27, the corresponding instrument for SK Hynix shares on the perp-DEX Hyperliquid dropped approximately 19%, leading to the forced closure of long positions worth $60 million.

This was triggered by a single executed trade on a low-liquidity Korean pre-market platform, with quotes provided by several independent data suppliers. The Trade.xyz team stated that there was no system failure and no price manipulation, promising to compensate all traders for their losses.

It is worth noting that at the beginning of July, Bitcoin and Ethereum remained stable amidst the decline in shares of AI chip manufacturers.