Behind Bitcoin's Surge: Inflation Resurfaces

Author: Anthony Pompliano

Compiled by: Qin Jin, Carbon Chain Value

This is a letter written by well-known investor Anthony Pompliano to investors on February 27.

Pompliano attributes the surge in Bitcoin to the "resurgence of inflation." He states that savvy investors see inflation approaching and begin to buy Bitcoin in large quantities. They hope to protect themselves before inflation arrives.

He also presents his thoughts on the "reflexivity" behind the Bitcoin surge. The market begins to chase assets that are fleeing from them. Smart investors initiated this trend, but followers pushed everything further and faster than previously imagined. Meanwhile, short sellers continue to bet on the current upward trend and end up getting liquidated. At the peak of a true bull market, leveraged longs are wiped out. Now, it is the leveraged shorts that are being eliminated.

The "reflexivity" investment theory was developed by Soros. Simply put, it means that participants' perceptions and the objects of those perceptions influence each other; fundamentals affect views, and views in turn affect fundamentals, creating a never-ending cycle of interaction and change.

American scholar John Train has interpreted this in "The Investment Habits of Highly Successful Investors," stating that the essence of the reflexivity principle is that perceptions can change events, and events can in turn change perceptions. This effect is often referred to as feedback. It's like if you tie up a good-natured dog and kick it, calling it a bad dog, the dog will actually become aggressive and come to bite you, which will lead to more kicking and more biting.

Pompliano's perspective is quite sharp. Readers can try to digest it slowly. He previously pointed out that the current consensus on Wall Street is that inflation has decreased and the Federal Reserve is preparing to cut interest rates. Investors are ready to benefit from rising asset prices. Central banks are preparing to wave the victory flag. The media continues to report on the elusive "soft landing." So, what happens if the consensus about the U.S. economy achieving a "soft landing" is broken? The answer is that interest rate cuts become unlikely.

Below is the full text of the letter for readers to ponder.

Yesterday, Bitcoin surged sharply. In the past 24 hours, it rose by more than 11.5%. Such performance is rare in financial markets, especially without obvious catalysts like earnings announcements or mergers and acquisitions.

Why has Bitcoin appreciated rapidly in the past few weeks?

The common answer is that the Bitcoin spot ETF has triggered massive demand for the asset. This answer is not wrong. Yesterday, the ETF saw a net inflow of $520 million.

As BitMEX Research pointed out, when pricing the capital flow in Bitcoin, the net inflow of Bitcoin is 9,510. From this perspective, the Bitcoin network generates a net of 900 new Bitcoins daily. Therefore, the demand for Bitcoin is more than 10 times the daily production of the Bitcoin network.

If we assess this in the days following the ETF launch, this supply-demand imbalance is not surprising. But now, 45 days have passed since the ETF launch, making a 10-fold supply-demand imbalance hard to believe.

The cumulative net inflow since the ETF was launched has officially exceeded $6 billion. BlackRock leads with $7.2 billion in assets, and five other ETFs have asset management sizes of at least $1 billion. By almost all metrics, the launch of the Bitcoin spot ETF is the greatest issuance in ETF history.

This raises the most important question: why are so many people buying Bitcoin right now?

The simple answer is: institutions want to make money, and now they can buy the best-performing asset of the past 15 years, so they will buy as much as they can. This statement has some merit, but I believe it is not the whole story.

In fact, most people overlook a hidden detail that might scare you.

What if people are buying Bitcoin because we are going to see inflation return, and investors are preparing for the impact of inflation on their portfolios?

Let me explain.

First, let's go back to 2020. The pandemic choked the economy. Government officials and central bank presidents took unprecedented monetary and fiscal stimulus measures. Trillions of dollars flowed through the economy.

The national slogan was not to worry about inflation, later saying "inflation is temporary." But savvy investors were not fooled. Paul Tudor Jones and Stanley Druckenmiller said on CNBC, "Inflation is coming!" They stated that they bought Bitcoin because they believed it would be the fastest horse in the inflation hedge category.

This was a correct prediction.

In the summer of 2020, Bitcoin was priced around $8,000, with an inflation rate below 2%. By March 2021, less than a year later, Bitcoin's price was $64,000. There are many reasons for the 8-fold price increase, but the main reason is that the market is forward-looking.

Investors saw inflation approaching and began to buy Bitcoin in large quantities. They hoped to protect themselves before inflation arrived. Remember, investors do not wait until inflation arrives to buy inflation-hedging assets. They buy in anticipation.

There is ample reason to believe that current investors are doing the same thing.

The Federal Reserve has been tirelessly working to reduce inflation. The media celebrates the significant year-on-year decline in CPI. But this is not a true assessment of the situation.

According to WinfieldSmart, "The resurgence of inflation is the real risk at present. ISM service prices have been a leading accurate indicator of inflation, and it has just risen sharply."

Most importantly, donnelly_brent points out that businesses are still seeking to raise prices. This is the ultimate measure of future inflation—if businesses continue to raise prices, then it doesn't matter what the Federal Reserve does.

Therefore, the risk of inflation returning is increasing day by day. Some investors are buying Bitcoin in anticipation of this scenario. With the new investment tool of the ETF, there is more capital available to utilize this asset than ever before in history.

As these funds flood in, many investors who were short on Bitcoin are getting liquidated. Bitcoin analyst Checkmate explains that do you know what the difference is between this rebound and the last time Bitcoin hit $57,000 in 2021? This time, short sellers continued to bet on the current upward trend and ended up getting liquidated. At the peak of a true bull market, leveraged longs are wiped out. Now, it is the leveraged shorts that are being eliminated.

This is the best reflexivity. The market begins to chase assets that are fleeing from them. Smart investors initiated this trend, but followers pushed everything further and faster than previously imagined.

As WClementeIII wrote yesterday, anyone who buys the Bitcoin ETF is now up at least 15% because its trading is only 25% away from price discovery. Anyone waiting to see if the ETF will have an impact will soon become momentum buyers. Then, buyers breaking through historical highs will follow. Reflexivity.

I completely agree.

The Bitcoin ETF has garnered the attention of most people because capital inflows are quantifiable. They exceed everyone's expectations. It is fascinating to watch Wall Street push up Bitcoin prices to get Bitcoin holders to sell.

However, do not believe the narrative that this surge is merely related to some speculative interest from large capital allocators. There lurks a huge inflation risk in the dark corners of the economy. Many investors have seen this story before, and they will not be fooled a second time.

Inflation. ETF. Media attention. Liquidation of shorts. Reflexivity.

Satoshi couldn't have said it better.