Arthur Hayes Podcast Transcript: Is a Bitcoin Spot ETF Really a Good Thing?

Compiled by: Wu Says Blockchain

Debt Issues

Blockworks:

Welcome special guest Maelstrom CIO Arthur Hayes. You have been very prolific over the past few years, writing some of the most interesting pieces I think are currently out there, and you’ve offered some very clever ideas on how macro views on debt, energy, and fiscal conditions integrate into digital assets. Clearly, you got involved in this early on. So, I’d love to dive deeper into these important ideas and how they really fit into your framework. Through reading your blog posts, I found that you think a lot about debt and the fiscal conditions of various countries. How does this affect your view of the overall investment landscape?

Arthur Hayes:

I think debt is obviously the most important because it’s like time travel. We borrow money from the future to do things today, hoping that the returns from what we do today will exceed the debt we pay. This is essentially the macro framework of debt. Basically, from the end of World War II until now, this has been the Keynesian view, where we believe the economy shouldn’t have ups and downs. It should be a continuous and very low growth, no matter which country you’re in. If it deviates from that, like an economic downturn, we print money, which is borrowing from the future to ensure everyone has a job. This works for a while, but now we’ve reached a point where the population in developed markets is declining. We’ve borrowed so much money trying to eliminate the fluctuations of the economic cycle that we now face a global debt-to-GDP ratio of about 360%. This makes things harder to manage because the interest on this debt itself becomes a cost. How do I afford to pay this back? How do I afford to roll over this debt? Oh no, there’s a part of the economy that is over-leveraged.

I recognize this is a problem, and I want to do something about it. But through some practice in this field, I’ve questioned the entire strategy built around this economic cycle over the past 80 to 100 years. Now policymakers around the world face too many bad choices. There are no good choices. You could say a good choice is, well, let it all collapse and reset the entire world economy to a more sustainable state. But those in power won’t do that; it’s not in their best interest. So now we’re stuck in a dilemma, trying to pretend that what we’re doing isn’t just printing more money to buy debt, essentially to cover up past foolishness and impose this terrible situation on those who are still alive today.

Blockworks:

Yes, I completely agree with your point. I often hear the argument that household financing and government financing are not necessarily the same thing. You know, when it comes to places like the United States, there’s basically an infinite demand for our currency and debt globally, as long as we can pay the interest, as long as we can gradually print money, then it doesn’t matter. And some authoritative macroeconomic experts do hold this view. So, what would you say to proponents of this view? That is, if you are the global reserve currency and there’s a huge demand for U.S. debt, it’s a different situation?

Arthur Hayes:

Of course, there’s infinite demand at the right price. The problem is that the current price is not right. If the one-year U.S. Treasury yield is 25%, why would you choose anything other than lending money to the U.S. government? There would be no other economy. We would just borrow money. If you have excess capital, then thank your parents, inheritance, or past cleverness for accumulating some capital. If not, then you’re out of luck. You would just lend money to the U.S. government. There would be no business formation because nothing can beat Janet Yellen (the U.S. Treasury Secretary). She can borrow at any rate she wants, and you will lend her money. Is this what we want? At 25/35/45/50% interest rates, there’s infinite demand for U.S. Treasuries. But aside from Janet Yellen saying, “Hey, give me some money, and I’ll pay you back in a year, five years, ten years, thirty years with some printed dollars,” you have no other way. Is this what you want, or do you think, “Oh, I think there’s demand at zero interest rates,” which is complete nonsense.

Bear Steepener

Blockworks:

Many are pondering whether reality aligns with the clearing price, especially for long-term debt. Observing the excellent performance of U.S. 10-year, 30-year, and other long-term Treasuries. How do you currently view this situation? Is the debt market moving towards establishing a new clearing rate? If so, what are your thoughts on where it will ultimately stabilize?

Arthur Hayes:

The frightening “bear steepener.” A bear steepener refers to a situation where yields rise broadly, with long-term yields rising more than short-term yields. This is a problem because it has never happened before, as if you think about a bank only modeling trading models based on past data. If past data hasn’t shown such a situation, where central banks state they won’t continue to raise rates until inflation collapses or the economy is crushed; the bond market thinks, if you’re not going to fight inflation, why should I hold long-term bonds? Then you start thinking, Janet issued a trillion dollars last quarter. Now, in the next two quarters, it will reach one or two trillion, and all this supply will come, while the Fed isn’t fighting inflation.

The Fed hasn’t caused a recession. The real GDP for Q3 2023, although around 5%, is now all GDP is about 6.4%. The U.S. economy is just too strong. A recession isn’t coming, right? I know all these are reasons why a recession is imminent. You have to buy bonds. This is nonsense. If the U.S. government wants to maintain a federal deficit of 6% to 10%, then nominal GDP will reach 6% to 10%, and people will spend the money borrowed by the government to ensure they have a job, doing whatever they are doing. Therefore, the views on recession, like other times when the Fed raised rates, they will continue to raise rates. A recession is imminent, and the Fed’s recession will also come. The Fed will collapse. Therefore, short-term rates will fall faster than long-term rates.

The current situation is not optimistic for financial institutions. As general rates rise, especially long-term rates rapidly climb, many banks are in trouble. Especially in the U.S. and other countries, these banks are encouraged to load government debt with almost infinite leverage and hold it on their balance sheets to fund their governments. However, now in the U.S., the rapid rise in long-term rates has put banks in a bind, finding themselves severely losing money and even at risk of bankruptcy, thus unable to lend to creditworthy borrowers anymore. The government faces a choice of whether to raise rates to curb the stock market and the economy, triggering the long-anticipated recession. This leads retail depositors to turn their funds towards the more attractive Federal Reserve, which could trigger a collapse of the financial system. For banks already facing bankruptcy, the U.S. government seems to become the guarantor, essentially supporting these eight major banks, similar to the situation in Europe, China, Japan, and other developed economies. The current situation seems to create significant pressure, especially by observing the movement index (i.e., bond volatility index), which is currently at over 130 points. Some strategies suggest that if this index rises to between 140 and 150, it could signal the Fed or Treasury to intervene in the market. Therefore, we may be approaching this level. Currently, we are unclear on what the new clearing rate will be, but it’s evident that the market is quite tense, as seen from the performance of regional bank indices and the KBW bank index, both of which are performing poorly. Banks cannot profit in this environment, even if long-term rates rise, which may be because they were lured into buying a large amount of U.S. Treasuries during the period from 2020 to 2022, leading to significant losses and effectively being in a functional bankruptcy state, unable to provide loans.

Another Crisis for U.S. Banks?

Blockworks:

Yes, for those talking about bank profitability, an inverted yield curve is not good for banks because they borrow short-term and lend long-term. So, from any angle, an inverted yield curve presents a rather tough environment for banks. Do you think banks have already emerged from this predicament? Because I know another important theme in your writing is that ultimately these mild interventions will become larger and may eventually be completed by the Federal Reserve or other institutions, which will have to acquire everything. You’ve pointed out that the KBW index is approaching the levels from March, as is Silicon Valley Bank. How do you view the current state of our financial institutions? Do you think the Federal Reserve will have to intervene in the future and complete the work they started to support the entire financial system?

Arthur Hayes:

I had coffee yesterday with my favorite volatility hedge fund manager, David Dredge, and we discussed convexity strategies. He pointed out that yes, U.S. banks are showing signs of bankruptcy. I asked him what he meant. He explained that according to Q3 earnings reports, U.S. banks reported about $130 billion in unrealized maturity losses. Maturity losses refer to losses that are occurring but the government allows them not to be recognized because the banks do not intend to sell. This indicates that banks have lost $130 billion, while their Tier 1 common equity (the capital counted in Tier 1 capital adequacy ratio) is about $19 billion. This makes the bank effectively a bankrupt bank, but not one that is about to fail. For banks, this means they cannot lend to good businesses or quality borrowers and cannot engage in any economic activity. Banks ranked 9th to 3000 in the U.S. face the same problem. Whether it’s Treasuries or commercial real estate, the issues exist. The pressure on the banking system is rising. The market is telling us this. If banks had problems in March, and the current index is lower than in March, it means more banks are facing the same issues. As long as the bear steepener continues, we will see more pressure. At some point, some investors may choose a bank, and the market will gasp, look, they hold all this commercial real estate, and they face huge unrealized losses. This situation hasn’t really changed since April. At this moment, CEOs, who will pay for this company? The FDIC, how much money will you provide to help this bank that is essentially being liquidated? Then we will repeat the scenario from April, which will continue to happen, and eventually the market will question, Janet, will there be a universal guarantee for deposits? Will there be comprehensive support for everything except Treasuries? This is a significant decision she must make. We will wait and see. However, they will have to take action; otherwise, banks will continue to go bankrupt. This is what the market is telling us; someone will face bankruptcy.

Social Consequences of Excessive Debt

Blockworks: On this issue, I will take a critical stance. Because when someone says household financing is different from government financing, we can always save ourselves by printing money, I would argue against that. How do you view the social implications of doing so? Technically, that’s true, but what other effects does this have beyond the financial markets? Do you think saving and breaking the rules of capitalism will have social consequences?

Arthur Hayes:

The problem is that those who own financial assets are the top 1% of the population. They always have a certain proportion of returns, but this money comes from everyone. In terms of fiat currency, everyone is poor because fiat increases while the number of goods decreases, and the number of goods produced remains unchanged. But only a small portion of people truly benefit. This creates class divides. How this manifests varies by country, but it is inflation. Inflation is a phenomenon where we don’t know where it will happen, and you have more money chasing the same number of goods. The issue is that those who don’t hold bank stocks, tech stocks, or anything else, the average American isn’t profiting from this. How much excess capital does someone making a few million dollars a year have to invest in the financial markets? That’s the problem. Everyone pays for this, but only a few benefit.

Blockworks:

That’s the issue. In this case, what are the immediate effects, and how do you view this situation? Regarding the role of energy and oil in this entire macro process, could you elaborate on that?

Arthur Hayes:

Our modern civilization is based on hydrocarbons, and there is a close correlation between global GDP growth and oil production per barrel. Our entire existence is essentially about converting the potential energy of the Earth and the Sun into something useful for us, whether at a physiological level (like the food we eat) or at a societal level (like the modern civilization we communicate through phone and video chat). Everyone uses energy, and quality of life depends on the amount of energy available. Americans consume on average 4 to 10 times more energy than residents of the Global South, manifested in driving large pickups, owning two cars, and massive suburban expansion. We live in places with abundant energy.

So, when considering lifestyle, the key is not the monetary amount but the purchasing power in terms of energy. Thinking this way, we no longer care about the value of dollars, euros, renminbi, or bitcoin. Instead, we focus on what it can provide me in terms of energy. This way of thinking allows us to move beyond charts and focus more on how much oil a dollar can buy, how much oil U.S. Treasuries can buy. This change in relationship will be influenced by different situations, and the reason the U.S. goes to war in the Middle East boils down to the presence of oil there. The foundation of the entire U.S. existence is the demand for reasonably priced oil from the Middle East, and the U.S. military will ensure that this demand is met, even though they clearly don’t always succeed.

Blockworks:

In the context you’ve described, if we essentially have to print a lot of money to save our institutions, while energy is something that cannot be printed. When I look back at the inflation cycle we just went through, energy played a very central role in that cycle. Inflation seems to have almost started with energy and then moved into other more tricky components of CPI. So I want to ask, what is your outlook on inflation and real interest rates? Because if we can’t print energy but continue to print everything else, it seems energy prices will continue to rise and become a very tricky and persistent component of inflation. In this case, how do you view the relationship between energy and inflation?

Arthur Hayes:

First of all, I don’t trust inflation statistics; they are manipulated by every government. From a philosophical perspective, everyone’s inflation rate is different because my consumption basket is different from yours. Therefore, saying there is one inflation rate is incorrect. Each of us has our own inflation rate. If I want to determine real interest rates, I want to try something more standard.

I am a proponent of real inflation rates. Real interest rates refer to the nominal GDP growth of a specific country minus its government bond yield. Nominal GDP is just the sum of activities in the economy, i.e., what is happening in economic activity. If the government controlling a specific jurisdiction achieves 10% growth and taxes it, then a reasonable interest rate should be if the growth is 10%, then the money I lend to the government should at least yield 10% growth. As a bondholder, I would want at least that portion of the entire economic growth. Instead of looking at flawed inflation statistics, it’s better to look at nominal GDP growth and the actual economic activity.

So now the U.S. is in a very favorable position because it is achieving profitability. Its nominal GDP growth exceeds the level of its debt trading and the level at which Janet issues debt. But actually, the U.S. situation is quite bad; it’s actually somewhat deleveraging. If investors are foolish enough to think that real interest rates are positive because of some fancy charts, like the five-year breakeven rate or Treasury Inflation-Protected Securities and all these manipulated statistical indices and securities, then you should happily accept returns below nominal GDP growth. The U.S. government and Janet, they are doing their job. They have successfully deceived the public into believing they got a good deal. But if you really think about it, you should say, well, if the U.S. government achieves 6.4% nominal GDP growth, I expect my one-year bond to have a 6.4% growth. That’s a deal I’d be willing to make every day. We’ll see if that happens.

Financial Repression

Blockworks:

Yes, what you’re talking about here is essentially financial repression, which may differ from most people’s definitions of real returns. Countries have various options during the deleveraging process, one of which is nominal default on currency, especially when you owe a large amount of non-printable currency debt. Another way is to use financial repression, which means running the economy very hot, generating some inflation, and then suddenly you find that compared to stagnant debt, your GDP and income look substantial. Therefore, as a bondholder, you might just be manipulated throughout the process, and when you wake up, you find the government ultimately benefits, thanks to your loans.

Arthur Hayes:

This is not just the U.S.; every major country capable of taking this strategy is doing so. Just like the strategy the U.S. adopted after World War II, accumulating massive debt before the war. After the war, the Fed and the Treasury merged, and it wasn’t until about 1951 that the Fed gained independence and fixed the 10-year yield at 2.5%. During this period, the U.S. economy was actually the only place in the world that could still produce anything after the entire world self-destructed in war, so the economic boom was rapid. The U.S. government successfully reduced the debt-to-GDP ratio from about 140% to 30% over approximately ten years. This successful case has influenced the present to some extent, but the question is, can they continue to execute smoothly?

Blockworks:

As I think about possible scenarios, the first scenario is that the government takes actions similar to other governments globally, including the U.S., Europe, Japan, China, etc., all adopting tightening policies and experiencing a fairly severe deflation. Honestly, that seems like the least likely outcome at this point. Then there’s the second scenario you described, which is the frog in boiling water, meaning debt grows or the economy runs very hot. Mainly manifested as inflation, gradually devaluing, allowing the country to achieve a soft landing in deleveraging. There might also be a third option, which has shown some signs in recent years, where the financial system encounters certain problems or has to initiate large-scale monetary policy. Of course, it’s impossible to predict the future accurately, but as you think about these different scenarios, which one seems more likely to you?

Arthur Hayes:

The second option is clearly the way all governments hope to go. But the problem is that it’s conditional. In the 1940s and 50s, this worked for the U.S. because it was the only productive place in the world, saving the entire world by producing goods. However, in 2023, every country is producing, and every country has a demand for hiring workers. Voters choose the government or support the government because the government promises to bring back jobs. But in reality, as every country continues to produce and push products into the market without corresponding demand, we find ourselves in a dilemma—unable to employ this strategy because there is no market to sell the products. I shared a chart in an article showing this unbalanced relationship in the world, where the U.S. is a net debtor country, while net creditor countries are Germany, China, and Japan. This extreme relationship is unsustainable. Moreover, every country is taking various means to seek self-interest. For example, Biden has introduced various bills aimed at reducing dependence on other countries by printing money and encouraging domestic production. However, in this relative world, this strategy may not work because it’s no longer just one country doing this; all countries are doing it simultaneously. Therefore, we may face some kind of collapse because the market cannot bear such large-scale production without finding a way to sell.

Trade Wars as a Mirror of Currency Wars

Blockworks:

There’s a saying that trade wars are a mirror of currency wars. This logical relationship can be understood as if you devalue your currency, effectively depriving me of my wealth, then I will counter you by making trade illegal, and these frictions may ultimately lead to actual dynamic conflicts. We’ve witnessed this in the past few years. In 2016, an early trade war erupted between the U.S. and China over trade issues like steel. Now with the CHIPS Act, you’re starting to see actual conflicts spreading worldwide. Clearly, the only appropriate response is to feel sorrow because actual human lives are being lost. But this also has substantial implications for the unsustainable predicament the U.S. finds itself in, as we may now face the situation of fighting two wars simultaneously, which seems impossible.

Arthur Hayes:

This is actually a complex issue involving the large expenditures the U.S. government may incur due to wars. Janet Yellen was asked whether the U.S. government can afford to support the wars between Russia, Ukraine, Israel, and Hamas, and she responded that the U.S. can certainly bear this expenditure. The past wars in Afghanistan, Iraq, and Syria cost about $10 trillion, and the specific costs of the current wars are unclear. But it will be trillions. However, the problem is that when the government spends, it needs to raise funds by issuing debt, which also applies to the various institutions Janet Yellen mentioned. But the question is, no one issues debt in a vacuum. So who will buy these bonds?

Blockworks:

It’s probably us; the ultimate "burden bearers" might just be all of us. We are now facing a very interesting moment, as Treasury yields have been quite high, especially long-term bonds, although there has been some pullback in the past few weeks, with gold rising, bitcoin rising, and stock market trends declining. So how do you translate this geopolitical turmoil, the background of governments having to spend heavily, and this unsustainable situation into your framework for market trends over the next year or two?

Arthur Hayes:

Thus, for the first time in human history, we the people have found a way out of this situation. We have a light currency that is independent of the government. Gold has existed as a monetary tool for ten thousand years, but its problem is that it’s heavy and conspicuous. Trying to move a million dollars worth of gold will inevitably attract attention. Bitcoin is different; I can remember the private key, and no one knows how much bitcoin I have, nor can anyone prove it. Only I can sign clearly to indicate I control this address and have a certain amount of bitcoin at a specific point in time. This is a revolution because now we the people have a way to save outside the fiat currency system, and this way won’t be monitored. Thus, we can say that anyone who realizes that the EU and governments around the world are in an unsolvable predicament can choose not to participate anymore. No longer depositing funds in banks or speculating in fiat currency stock markets. I will sell fiat currency, buy solid crypto assets, and self-custody them in this crypto ecosystem. If the numerator is acquiring this massive amount of fiat currency while the denominator of bitcoin remains unchanged. Ethereum is deflationary, and there are other major tokens with fixed supplies, then their prices measured in fiat should rise. We are now in a fortunate situation because we have actually found another way out. Without this way, funds would be trapped in the banking system. We might suddenly not be able to transfer funds out of the banking system, and no matter how high the interest rates go, we can only buy government bonds. Now with cryptocurrencies, we can escape this situation.

Blockworks:

Clearly, you are a veteran in the crypto space. You’ve witnessed many different market cycles. I think we’ve been through a bear market for nearly two years, and we’re starting to see bitcoin show some life. There are some catalysts, like the collapses of FTX, Luna, etc., which were some resistances, but now it seems we might see ETFs. We are some time away from bitcoin’s halving and starting to see bitcoin’s volatility. So I think many people want to know, is this the beginning of a new bull market, and how do you view this?

Arthur Hayes:

Recently, President Biden’s speech about steadfast support for Israel and now we see a ground offensive in Gaza, with Iran and other countries making related statements, escalating tensions in the Middle East. This could trigger a global conflict. The U.S. government has stated it will support its allies. The question is, how will Iran, Russia, and China respond? This is somewhat similar to World War I, where parties had to fulfill commitments to allies, thus expanding the scope of war. Meanwhile, governments are increasing defense spending due to global conflicts. Additionally, the baby boomer generation, the wealthiest generation, is getting sick and dying. Global healthcare will cater to them, and that is something that cannot be printed. We have made a series of commitments, whether militarily or to the elderly, and these commitments now need to be fulfilled. Politicians are reluctant to admit that we made these commitments in the past, but circumstances have changed. I am a large bondholder, and I want something that can truly retain value. If this is indeed a wartime economy globally, then I want gold. Now we have this new thing called bitcoin. I shared a chart comparing the performance of long-term U.S. Treasury ETFs (TLT) and bitcoin. The starting date is February 24, 2022, when Russia invaded Ukraine. Since that day, bitcoin has risen about 50%; while from October 7 to now, bitcoin has risen about 25%. In contrast, U.S. Treasuries have fallen by 3%. The traditional approach is to invest in the U.S. because it is considered the strongest and fiscally healthiest place, but that belief is gradually collapsing. Now we have other options, like bitcoin.

Bitcoin is a global asset that anyone can participate in, and it is not tied to any specific government, intangible and unobservable. I want to protect my capital, and bitcoin has become an option. I am no longer interested in U.S. Treasuries because the U.S. government is involved in wars around the world while still needing to guarantee pensions. Bonds, once thought to reduce overall portfolio volatility, no longer serve that purpose. Thus, bitcoin’s status is gradually rising, and this is just the beginning because bitcoin is currently at $35,000, still a distance from its peak of $70,000. Gold is currently priced at $2000, and although it hasn’t broken the 2011 high, it still outperforms holding bonds. Therefore, as people gradually recognize this and accept this change, assets like bitcoin and gold will become more popular than Treasuries. The global bond market is vast, and if the times change, this will no longer be the preferred destination for my and other investors’ capital. I believe AI, tech stocks, and cryptocurrencies will become the trends of the future.

Bitcoin

Blockworks:

Bitcoin is seen as a safe haven, possessing store of value and anti-inflation characteristics. However, when observing its performance, especially from 2021 to now, we can find that its performance is very similar to tech stocks (like Tesla). You accurately pointed out during chaotic times that when the Fed starts signaling, “We’re done, we will start raising rates,” this is not favorable for crypto assets. In recent months, an interesting phenomenon is that long-term rates have risen sharply, financial conditions have tightened, while bitcoin’s performance has been very positive, with stocks moving in the opposite direction. For a long time, the trajectories of unprofitable tech stocks and bitcoin were similar, but now they are performing completely opposite. I think this might mean that bitcoin is finally starting to fulfill its role as gold rather than as a tech stock. How do you view this?

Arthur Hayes:

I think there is such a viewpoint, but the importance of bitcoin varies across different cycles. I try to elevate the discussion level; in short, the price of bitcoin is determined by fiat liquidity and technology. Currently, we are mainly focused on fiat liquidity, meaning there is a lot of fiat currency out there, so the value of bitcoin is what it is, which will fluctuate across different cycles because credit cycles, interest rate fluctuations, and liquidity expansions and contractions will all affect the price of bitcoin. But when we focus on technology, the essence of bitcoin’s technology is peer-to-peer decentralized currency. I can have a billion dollars in assets in my mind; that’s the essence of the technology. When I combine liquidity with technology, I get a double benefit. Given the vast scale of the global bond market, if investors start to question whether bonds reduce volatility in portfolios and whether the government can maintain the purchasing power of the bond market, then the prices of assets like bitcoin and tech stocks will soar. Because people will lose confidence in the bond market. If we lose confidence in the fiat currency created over the past 80 to 100 years and the global economic structure, then the amount of funds seeking alternatives will be unprecedented.

Blockworks:

So, there’s a potentially different factor. We are discussing this spot ETF. In March 2020, Paul Tudor Jones publicly stated that bitcoin is the fastest horse, which is recognition from the institutional finance world. Now we also have Larry Fink (CEO of BlackRock). The ETF from BlackRock is in a different realm; it’s a trillion-dollar asset management company. Larry Fink recently stated on CNBC that bitcoin is a hedge asset. Looking back at the last market cycle, the lows and bear markets were brutal periods, and we always hear statements like we will never experience a market cycle like the last one again, last time they injected $7 trillion. You know, we won’t have that opportunity again. But now, we’ve never really witnessed cryptocurrencies gain true institutional acceptance. Currently, we are at a moment where BlackRock might launch a spot ETF, which could just be the first among many ETFs. Do you think this could mark the beginning of true institutional adoption of bitcoin and cryptocurrencies? How do you view the impact of institutions like BlackRock getting involved?

Arthur Hayes:

The BlackRock ETF and its follow-up have both advantages and disadvantages. The beauty of bitcoin and Satoshi’s vision is that anyone can participate in this network. However, the situation that a BlackRock ETF might bring may not be ideal. Suppose people like Larry Fink enter the market and absorb a large amount of freely traded bitcoin and monitor new ETFs like mining ETFs. Currently, BlackRock controls the largest shareholder positions in some of the biggest mining companies. However, asset management companies like BlackRock are agents of the state, and they will act according to state directives. If the state needs us to stay in fiat or the fiat banking system to tax us through inflation, then allowing ETFs like BlackRock to launch seems reasonable. Your funds are stored in this tool, and in reality, you cannot use bitcoin; it’s a financial asset. If the BlackRock ETF becomes too large, it could actually pose a threat to bitcoin because that would just be a pile of illiquid bitcoin. If we need certain types of upgrades to enhance privacy and encryption to ensure bitcoin remains a robust monetary asset in the cryptographic sense, then these interests will not align with those of traditional financial institutions. Which upgrades institutions will support is an open question. When holding a currency like bitcoin, the potential damage passive investors could cause to the industry has precedent. Bitcoin is a rebellion against state currencies, established for those of us who can send funds around the world, not owned by one or a few institutions. So, I’m not saying everything will be fine, but there is indeed a risk. Yes, from the perspective of fiat price, this is good for bitcoin. But is it really good for the utility of bitcoin? Are we just getting a rush now at the expense of triggering a massive disaster in the future? I don’t know. Therefore, people need to think more long-term about this issue, not just see the price fluctuations brought by the ETF launch, but consider what the real outcome is when an institution holds all these crypto assets.

Blockworks:

Yes, the potential outcome may not be ideal. If I try to gauge the possible sentiment of this market cycle, I would guess that most people will view it in a manner similar to the previous cycle. That is, bitcoin will first rise, then gradually influence other major digital currencies, this time including Ethereum, Solana, etc. Then people will view these profits as a kind of “monetary illusion,” like chips in a casino, and then they start chasing real-risk assets, leveraging up. Do you think this development will be very similar to the last time? Are there significant changes or some factors that might lead to a different development this time? Perhaps you think bitcoin’s dominance will continue to rise and perform better across the entire market this time? Or how do you think this market cycle will ultimately develop?

Arthur Hayes:

Markets always bring forth new things. In the last market cycle, all those L1 blockchains that claimed to be faster than Ethereum and serve a specific ecosystem, like Solana, Avalanche, etc., caused a stir. However, most of these projects only had one major surge, and now people generally believe they haven’t made much progress, so it’s unlikely they will hit historical highs again. Therefore, I think the order of market development is bitcoin first, then Ethereum, and then everything else. If I had to guess what will happen at the end of this risk area’s market cycle, it must be some new factors, perhaps a new narrative. I’ve proposed the narrative of AI combined with cryptocurrency, perhaps some new type of Web 3 game, or some new way of handling social networks on the web. I wouldn’t dare to make a definitive conclusion. But we will see what people are actually focused on, and some unproven new projects will emerge at the end of the market cycle. At the tail end of market cycles, people are always enthusiastic, believing the market has created immense wealth and has a large customer base, capable of realizing various possibilities. But this optimism often shatters in the face of reality because consumer adoption is a complex and difficult process. Therefore, I believe the fundamental sequence of market development will be similar to the last cycle. The only difference may be that the types of factors we think will become the next disruptive change will change. Perhaps it won’t be projects like BlockFi, but more likely custodial services. Perhaps it won’t be individual lending like Su and Kyle, but rather things happening at the logistical level, like an employee earning $75,000 losing a billion dollars in crypto assets due to a hacker’s social engineering attack. Therefore, I think the market development sequence you proposed seems quite accurate to me.

Bitcoin Halving

Blockworks:

Do you think the four-year cycle of bitcoin will exist permanently, possibly due to the halving mechanism, or perhaps it triggers this very predictable four-year cycle on a psychological level? Although every few years there are doubts about whether the market can maintain such a pattern, it currently seems that cryptocurrencies have consistently followed a fairly consistent cycle. Do you support this view, believing it will be permanent and always present this pattern, or do you think it may change over time?

Arthur Hayes:

Overall, I believe the market will always experience cycles. As for the length of this cycle, I cannot predict. A large part of it depends on how bitcoin and cryptocurrencies respond to the development of the five major international fiat currencies. Clearly, governments usually refinance every three to five years, so a three to five-year credit cycle may form. But whether there will be some significant event that fundamentally changes our beliefs about how economics and government finance should be conducted, like the kings after World War II, is currently unclear. If a third world war occurs, will some economists tell us, “Oh no, this is how we need to reorganize the world economy,” and then the imbalances accumulated in that system will somehow lead to years of cycles? I don’t know, but there will definitely be a cycle. As for the specific length of the cycle, trying to fix it to a specific number of years may lead to disaster because the market usually does the exact opposite.

Liquidity

Blockworks:

One aspect I’d like to discuss last may be liquidity. I’ve heard you talk about credit cycles. I know you’ve previously discussed three factors to focus on in liquidity: reverse repos, the Federal Reserve’s balance sheet, and the Treasury reserve accounts. I agree with your point that cryptocurrencies often lead global liquidity cycles. What does the current liquidity situation mean to you? And how does this translate into your predictions for the next one to two years?

Arthur Hayes:

Currently, major economies like the U.S., China, and Japan are providing a lot of liquidity. The Bank of Japan is particularly leading in providing positive liquidity, implementing a negative 15 basis point deposit rate, conducting yield curve control, and purchasing various bonds. Although marginal changes in Western central bank policies may impact this, overall they are all providing ample liquidity.

China has indicated it will support the economy, which means more money printing and credit issuance to support various economic activities. The People’s Bank of China has begun to take over government debt, issuing more bonds to fund different projects. Thus, China is entering a phase of credit expansion.

Currently, there is relatively little focus on Europe, where activities seem to be relatively slow. In the U.S., although the Federal Reserve is implementing quantitative tightening and raising rates, the Treasury pays about $1 trillion in interest annually. Additionally, the Federal Reserve pays interest on excess reserves to banks and pays money market funds interest rates of 5.5% to 6%. Therefore, even while implementing quantitative tightening, the U.S. is still printing money, just in different forms. This includes interest paid to companies and high-net-worth individuals’ savings rates, which these individuals will then use to purchase goods and services.

Overall, global money printing is increasing. Although the growth rate has slowed compared to the COVID period, after experiencing a small tightening in 2022 and early 2023, we are entering a situation where three of the four major economies are providing credit to some sector of the economy in some way. This liquidity is movable, and although the government may expect it to be used for specific purposes, it may flow into different asset classes. Therefore, I believe the liquidity situation is gradually awakening, which also explains why we have seen bitcoin prices rise over 100% from the lows of FTX. Bitcoin has become a leading indicator for market trends, and tech stocks are also performing well, all of which are major beneficiaries of liquidity. When looking for investment opportunities, it will become crucial to pay attention to these trends within specific sectors. Money printing has led to bubbles in certain aspects of financial markets and bubbles in certain activities. It may just not be as obvious as last time.

Blockworks:

Okay, thank you for your time.