Arthur Hayes's blog post: If Bitcoin ETFs are too successful, they will destroy Bitcoin!

Author | Arthur Hayes

Compiled | GaryMa Wu Says Blockchain

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Every investment theme has an optimal expression (the way it is presented or expressed). When we think about the ongoing devaluation of fiat currency, what is the best way to profit from the collapse of the dirty fiat financial system? What is the best expression of this trade?

This is one of my favorite charts, clearly showing that Bitcoin, or broadly speaking, cryptocurrencies, are the best expression of fiat currency devaluation trades. I adjusted the values of Bitcoin (white), gold (yellow), the S&P 500 index (green), and the Nasdaq 100 index (red) for inflation, using the Federal Reserve's balance sheet as a benchmark, and indexed their performance from January 1, 2020 (starting point of 100). Bitcoin has risen by 228%, far exceeding all other high-risk assets.

If you set the index starting point for these assets in 2010, when Bitcoin began trading on exchanges, the results are even more favorable for Bitcoin.

Fundamentally, why is this the case? Cryptocurrencies represent a movement to separate money and finance from the state. By using computers, the internet, and most importantly, cryptographic proof, we the people have created the most robust currency in history—Bitcoin; we have established a completely new decentralized financial system (DeFi) supported by public blockchain networks like Ethereum. This new crypto financial system relies on mathematics and the foundational support from dissatisfied humans, rather than the coercive violence of states and their banks. As capital seeking a safe haven from devaluation flows into the crypto space, it is still minuscule compared to the total value of all fiat financial assets. This is why a small portion of capital fleeing the collapse of the fiat financial system can generate such enormous returns in such a short time.

Not all cryptocurrencies, tokens, and investment themes are equal in the crypto space. At the end of the year, I want to discuss some crypto traps being peddled by enthusiasts and fools. As always, my goal is to present a different perspective for you as a reader to contemplate. By answering these questions, you can hope to make more informed investment decisions.

Federal Reserve Shift

2-Year U.S. Treasury Yield

The first and largest shift that occurred in the first quarter of 2023 was the Federal Reserve and the Treasury Department quickly pushing through a $4 trillion relief plan for the U.S. banking system and the Treasury market using the Bank Term Funding Program (BTFP). Powell's recent comments are merely a confirmation of the loose U.S. monetary policy.

What changed in two weeks? …… Politics.

What is the worst thing for politicians? Not being re-elected.

For a politician who is a member of the Democratic Party, what is the second worst thing? Trump being re-elected, along with a wave of Republican Congress members and Senators.

Using these two guiding principles, the political motivations behind the Fed's actions from 2021 to now become very clear.

As post-pandemic inflation surged, Biden had Powell sit down and instructed him to control inflation. As you can see from the chart above, by March 2023, the 2-year U.S. Treasury yield skyrocketed from essentially 0% to 5%. This was driven by the fastest rate hikes by the Fed since Paul Volcker's tenure in the 1980s.

The massive money printing to appease the public led to the highest inflation in over 40 years, and months of Fed tightening were insufficient to strangle this monster before the critical November 2022 midterm elections in the U.S. Subsequently, the Biden administration decided to drain the U.S. Strategic Petroleum Reserve to flood the oil market, thereby lowering gasoline prices on election day. This was a very "strategic" use of a scarce resource… to allow party members to be re-elected, and it worked.

No matter which clown is in charge of America, the reasons for the empire's decline have been set in stone by policies established decades ago. In 2023, the Biden administration, in collaboration with Yellen, worked to significantly increase fiscal spending and shift borrowing to the short end of the U.S. Treasury yield curve. The result is a booming U.S. economy, with a real GDP growth rate of 5.2% in the third quarter of 2023, and a projected real GDP growth rate of 2.6% in the fourth quarter, which is very impressive for the world's largest economy. But even this cannot quell voter dissatisfaction with Biden and his merry band of Democratic bureaucrats for their mistakes. Due to Biden's poor performance, the most feared person in America, former President Trump, would defeat Biden if an election were held today.

Trump must be stopped, and Biden knows how to get it done.

To further stimulate the economy and satisfy all financial asset holders, even if it may lead to more inflation in the future, Powell had to cooperate by loosening financial conditions. The hope is that the aforementioned inflation will arrive after the November 2024 elections. This is why Powell has been vague about the Fed's desire to maintain this "tight" fiscal situation. No worries, according to various recognized economic theories such as the Taylor Rule, flexible average inflation targeting, and core CPI exceeding the Fed's 2% target, the current fiscal situation is not tight enough. As the Wall Street Journal pointed out, less than two weeks ago, Powell's view on the possibility of rate cuts was completely different.

This is probably how it happened:

Yellen called Powell to her office and told him what was going on. Powell acted on the instructions… conveying the possibility of rate cuts. Now financial assets will rise until the U.S. falls into recession or inflation returns significantly. Given the federal government's determination to spend as much money as possible to maintain GDP growth, I do not foresee a recession in the election year of 2024. It remains unclear whether inflation in food and fuel prices will manifest in a meaningful way before November 2024, triggering protests and instability. But let’s not worry too much about the future. Right now, the Fed, the U.S. Treasury, and the leaders of America are all shouting at you to buy, buy, buy. Don’t be foolish; be prepared to participate in the best expression of this trade, which is cryptocurrency.

Any other major country or economic bloc, like Japan and the EU, will cooperate, allowing the dollar to depreciate against the yen and the euro. As the dollar depreciates, everyone benefits, except those who do not have enough financial assets to offset the effects of inflation.

Having grasped the macro reasons for being bullish on cryptocurrencies, let me help you avoid some potential value traps.

Permissioned DeFi

This is currently one of the most meaningless cryptocurrency themes. If we simply consider the meanings of these words, anyone who thinks should realize that these projects are doomed to fail.

These projects are designed for institutional investors, who have various regulations that often prohibit them from trading on real DeFi projects. This is bad because there is a lot of retail trading in the real DeFi free market, and institutional investors cannot participate. A market filled with retail trading is the best market because it provides opportunities for "smart" institutional capital to profit from "dumb" retail investors, as they have faster computers to execute trades without human emotions. At least this is how it operates in traditional financial markets, where exchanges have special order types and latency rules that give large high-frequency trading firms a substantial advantage. Michael Lewis has an excellent book on this topic called "Flash Boys."

The fact is, there will not be enough retail traders using these permissioned DeFi platforms because they do not need to trade with institutional investors. It is institutional traders who need to trade with retail. The entire reason DeFi is attractive to global retail cryptocurrency traders is that it has a market structure different from traditional financial stock and derivatives markets. When the hype fades, these permissioned DeFi markets will only become circles where high-frequency traders wait for each other to cross the spread and be affected. When enough directional retail fails to show up to justify deploying capital on these protocols, institutional investors will pack up and leave. The result will be a ghost town with no activity or interest, with neither retail traders nor institutional traders.

Venture capital firms, essentially high-paid puppets, are jumping on this theme's bandwagon. Thus, they will continue to burn capital just like they did when investing in "blockchain, not Bitcoin" from 2014 to 2017. Most of them missed or passed on investing in Uniswap, dYdX, Compound, Aave, etc. Rather than analyzing what caused them to miss these groundbreaking primitives, they decided to dive into something that superficially looks similar and sounds very sexy. As an investor, who wouldn’t want a trading platform that brings institutional investors together with their massive capital base and DeFi, which is seen as a completely new way to organize financial markets?

As usual, there will be those who quickly take action, peddling snake oil to desperate venture capital firms eager to invest in cryptocurrencies but unwilling to engage with the current cryptocurrency ecosystem. I bear no ill will towards the founders pushing this nonsense; I appreciate their ability to secure funding from qualified investors whose IQs are yet to be challenged. But for you, dear reader, please do not become the exit liquidity for these garbage projects when they launch governance tokens. If you choose to use the project, do so, but engage in some critical thinking to avoid becoming a victim of the periodic cash grabs that governance tokens will turn into over time.

RWA

RWA (Real World Assets) is the evolution of the security token theme that emerged in the last bull market cycle. In short, the goal of RWA projects is to incorporate assets like real estate, tradable debt securities, stocks, etc., into special purpose vehicles (SPVs), and then tokenize them to provide fractional ownership to ordinary people who cannot afford to buy an entire house or enter specific asset markets.

I firmly believe that any cryptocurrency token that relies on the existence of state law will not achieve success at scale. Decentralized public blockchains are expensive because they do not require the existence of the state. Why pay a premium for decentralization when it already exists and is very cheap and liquid? The most direct example is the fragmentation of real estate.

The current problem is that due to asset inflation—which is a direct result and goal of central bank policy—many millennials and Zoomers cannot afford to buy their own homes. If they could own a part of a one-bedroom apartment and step into the real estate market, that would be a noble goal, but there are some issues.

First, young people trying to leave their families or start their own families do not want a share of a house or apartment located in the void. They want a real building with four walls and a roof that they can actually live in. Buying a token that represents a non-assignable financial performance of real estate does nothing to solve this problem.

Second, every piece of real estate is unique. This lack of standardization stifles the development of a truly liquid market. For example, when you purchase a token representing 1/10 of a house, how do you find someone willing to buy it at a reasonable price when you want to sell? The buyer needs to understand the location, local real estate regulations, taxes, and ultimately must genuinely want that specific piece of real estate. This can never come close to the liquidity of owning a standardized share of stock or bond. With this type of investment, it’s easy to get in, but hard to get out… if you can get out at all.

Finally, and most importantly, you can already own fractional shares of real estate by purchasing very large and liquid Real Estate Investment Trusts (REITs). Many traditional financial stock markets around the world offer such securities. They are managed by large and reputable companies that have been in the business for a long time, with experience that surpasses that of most target market participants. I see no reason why you need to go through all this blockchain trickery and issue tokens.

Decide for yourself whether to buy these low-liquidity RWA tokens. But worse yet, investing in the governance tokens of RWA issuance platforms themselves.

Debt Ownership Tokens

Another very popular expression of RWA is the creation of tokens representing the ownership of debt yields. The most popular projects offer their token holders the yields of U.S. Treasury bills (T-bills). The idea is that Tether is great because it allows those who may not have access to affordable dollar banking channels to send tokens pegged to the dollar 24/7 via public blockchains like Ethereum and Tron. However, Tether does not pay yields; Tether's owners are able to capture all the yields from their dollar investments held in reserves in T-bills. What if there was a dollar stablecoin that also provided these T-bill yields?

This is a great development, and I fully support the competition to allocate more of the net interest margin (NIM) of these dollar-pegged stablecoins to holders. Using and holding these tokens is not a bad thing in itself, but investing in the governance tokens of the projects is foolish. Because it is merely a bet on the path of U.S. interest rates.

If U.S. interest rates remain significantly above zero, then the project should be profitable and pass those profits on to governance token holders. If U.S. interest rates fall back close to zero again, then the project will incur losses because it must pay developers, legal, and compliance fees, but does not have enough interest income to share. So, as an investor, why would you pay multiples of the project’s net interest margin to hold governance tokens?

Instead, you should short hold a liquid trading fund (ETF) that holds T-bills. You can express the same bet on interest rates, profiting when rates rise, without paying extra multiples to a bunch of crypto people. If you want real high-leverage trading, then apply high leverage.

In short, leave the "real" world governed by state law to traditional financial intermediaries. They can provide a more consistent and cheaper investment product to express the same theme. Real DeFi projects should rely solely on well-written code, not on laws that must be adjudicated and interpreted by potentially fallible humans.

Bitcoin ETF

Fundamentally, if ETFs managed by traditional financial institutions are too successful, they will completely destroy Bitcoin.

Any other currency asset used in human civilization has existed due to natural laws. Gold is gold not because we say it is, but because of the arrangement of atoms. The interactions between these atoms are governed by universal laws. Fiat currency is a nonsensical statement printed on a piece of paper, but it is still a substance. A piece of paper is still paper, regardless of whether you believe it has monetary value. If you dig a hole, put in gold and a pile of paper, and come back in 100 years, the gold and the paper will still exist. Bitcoin is entirely different.

Bitcoin is the first currency asset in human history that only exists as long as it maintains dynamics. After the Bitcoin block reward halves around 2140, miners will only be rewarded for verifying transactions through transaction fees. This means that miners will only earn Bitcoin income when the network is used. Essentially, if Bitcoin is not flowing, it has no value. However, if there are no more transactions between two entities involving Bitcoin, miners will not be able to pay for the energy required to secure the network. Therefore, they will shut down their machines. Without miners, the network dies, and Bitcoin disappears.

Blackrock, the world's largest traditional financial asset management company, is involved in the asset accumulation game. They absorb assets, store them in metaphorical vaults, issue tradable securities, and charge management fees for their "hard work." They do not use what they hold on behalf of clients, which poses a problem for Bitcoin if we hold extreme views about the possible future.

Imagine a future where the largest Western and Chinese asset management companies hold all the Bitcoin. This happens organically because people confuse financial assets with value storage. Due to people's confusion and laziness, they buy Bitcoin ETF derivatives instead of purchasing and HODLing Bitcoin in self-custodied wallets. Now, only a few companies hold all the Bitcoin, and with no actual use for the Bitcoin blockchain, these tokens will no longer move. The end result is that miners shut down their machines because they cannot pay for the energy to run them. Goodbye, Bitcoin!

When you consider the ongoing devaluation of fiat currency, you must choose a side. Either you trade financial assets to earn more fiat currency, or you try to preserve value in terms of energy while using a financial system beyond state control. In the former case, trade ETFs to your heart's content. That’s why they exist. In the latter case, you must buy Bitcoin and withdraw it from centralized exchanges to your own self-custodied wallet.

U.S. Election Year

Since the viral idea of "nation-states" infected our collective consciousness hundreds of years ago, 2024 will see the most national elections. Any politician seeking re-election needs to provide benefits to the people. For wealthy asset holders, this means encouraging the central bank to print money and provide loose financial conditions. For the poor, it means giving them subsidies to pay for rising food and energy costs, a direct result of policies that support asset wealth. For the middle class, it means giving them "democracy," telling them to pay taxes, bend over, and vote happily. Given this, it makes no sense for a politician seeking re-election to stop the fiat currency devaluation party. The votes of constituents benefiting from fiat currency devaluation and inflation allowances will outweigh those of suffering constituents. Therefore, in 2024, every "democratic country" in the world will ramp up money printing.

If you think today’s historical moment is special, look at the chart above, which shows the value of various global reserve fiat currencies over time in terms of gold. Fiat currencies always tend toward zero. No political system can resist the temptation of money printing.

The best time to buy Bitcoin and start your crypto journey was yesterday; the next best time is now.