Expression. (Any views expressed in the below are… | by Arthur Hayes | Dec, 2023
(Any views expressed in the below are the personal views of the author and should not form the basis for making investment decisions, nor be construed as a recommendation or advice to engage in investment transactions.)
It’s that time of year again where I decamp from the mountainous semi-tropics to the snow-covered peaks of northern Japan. Apart from the world-class pow-pow, the other delightful aspect about skiing in Hokkaido is the amazing seafood. One of my favourite crustaceans is the Hokkaido king crab. Of course, you can purchase flash frozen crabs anywhere in the world for quite a few sats, but the taste expression of the crab in the hands of master chefs here makes for a delectable meal.
In the main town where I ski, there exists a crotchety Aussie who has been churning out the most delicious chilled crab legs for many decades. He and I got off to a rocky start the first time my friends and I attempted to dine at his restaurant. A bunch of overly aggressive Hong Kong finance bros didn’t sit well with this master chef. Over the years, the relationship has improved to the point where pre-COVID, I could walk in almost any night and get a seat to munch down some crab legs without a reservation. His boiled and then-chilled crab legs are the best expression of this animal. Unfortunately, post-COVID, he only does takeout. But I can assure you, even if you are eating them at your chalet, the taste is still sublime.
What do king crab legs and financial markets have in common? Every ingredient or investment theme has an expression that beats all others. As we ponder the ongoing fiat debasement, what is the best way to profit off of the demise of the filthy fiat financial system? What is the best expression of this trade?
This is one of my favourite charts, which clearly shows that Bitcoin, and in a broader sense crypto, is the best expression of the fiat debasement trade. I deflated Bitcoin (white), gold (yellow), the S&P 500 (green), and the Nasdaq 100 (red) by the US Federal Reserve’s (Fed) balance sheet and indexed each to 100 starting 1 January 2020. Bitcoin is up 228% and leaves all other risky assets in the dust.
The result is even more in favour of Bitcoin if you index the assets starting in 2010 when Bitcoin began trading on exchanges.
Fundamentally, why is this the case? Crypto represents a movement to separate money and finance from the state. Using computers, the internet, and most importantly, cryptographic proofs, we the people have created the hardest money ever known, Bitcoin; and we created an entirely new decentralised financial system (DeFi) that is powered by public blockchain networks such as Ethereum … there are others, but they are all dogshit so I won’t mention them ;). This new crypto financial system depends on maths and grassroots support from unsatisfied humans and not the violent coercion of the state and its banking minions. As capital, which is simply energy transformed, is looking for a safe home free from debasement, it is trickling into the crypto space. But crypto’s market cap in fiat terms is minuscule compared with the total value of all fiat financial assets. That is why a modest amount of capital fleeing the collapse of the fiat financial system can create such outsized gains in such a short time frame.
All coins, tokens, and investment themes within crypto are not made equal. As we close out the year, I want to cover some crypto value traps that are being peddled by well-meaning people and plain old fools. My goal, as always, is to present a different viewpoint and leave you, the reader, with questions. By answering these questions, you can hopefully make better investment decisions.
In my essay, “Bad Gurl,” I opined that Fed chairperson Jay Powell was US Treasury Secretary Bad Gurl Yellen’s, at best, towel boy. His subservience to the broader goals of Yellen and the big boss, US President Slow Joe, was on full display at the December FOMC press conference. I suspect prior to his speech, Jay’s knee pads got worn out in the green room backstage.
The financial establishment’s mouthpiece, the Wall Street Journal, clearly spelled out the momentous Powell Pivot:
Officially, the Fed’s policy statement indicated policymakers left the door open to raising rates again. “It is far too early to declare victory, and there are certainly risks,” Powell said.
But Powell’s comments made the carefully crafted policy communiqué feel stale less than an hour after it was released by suggesting officials had turned their attention to rate cuts. “There’s a general expectation that this will be a topic for us, looking ahead. That’s really what happened in today’s meeting,” he said.
Powell’s remarks, along with new projections showing Fed officials anticipated three rate cuts next year, marked a notable U-turn. For more than a year, he had warned that they would raise rates as much as needed to lower inflation even if that triggered a recession.
The comment about rate cuts was surprising because just two weeks ago, during an appearance at Spelman College in Atlanta, Powell said it was too soon to speculate about when lower rates might be appropriate.
US Treasury 2-Year Yield
The first and biggest pivot occurred in Q1 2023 when the Fed and Treasury joined forces to ram through a roughly $4 trillion bailout of the US banking system and Treasury market by using the Bank Term Funding Program. Powell’s recent comments are just a confirmation of a loose US monetary policy.
What changed in the span of two weeks? … politics.
What’s the worst thing that can happen to a politician? Not being re-elected.
What’s the second worst thing that can happen, as it pertains to a US politician who is a member of the democratic party? Trump is re-elected alongside a wave of Republican congresspeople and senators.
Using these two guiding principles, the politics behind the Fed’s actions from 2021 until the present moment become quite clear.
As inflation was raging post-COVID, Slow Joe sat Powell down and instructed him to get inflation under control. As you can see from the above chart, the US Treasury 2-year rate ramped from basically 0% to 5% by March of 2023. This was driven by the fastest Fed rate hiking campaign since Volker’s tenure in the 1980’s.
Unfortunately, due to the gargantuan amount of money printed to placate the plebes after locking them in their homes and forcibly enrolling them as guinea pigs for mRNA vaccines due to the flu … oh sorry, I mean COVID-19; an equally gargantuan amount of inflation, the largest in over 40 years, was unleashed. A few months of Fed tightening were not enough to slay the beast by the all-important November 2022 US midterm elections. The Democrats were forecasted to get beaten harder than Sam Bankman-Fried’s member whilst he gazes longingly at photos of Caroline Ellison. The Biden administration then decided to drain America’s Strategic Petroleum Reserve in order to flood the market with oil so gasoline prices declined by election day. It was a very “strategic” deployment of a scarce resource … getting party members re-elected. It worked; the red wave was blunted, and the show went on.
It doesn’t really matter which clown is in charge of Pax Americana; the reasons for the waning of the empire were written in stone due to policies enacted decades ago. Attempting to put lipstick on a pig, in 2023, the Biden administration, in conjunction with Bad Gurl Yellen, endeavoured to dramatically increase fiscal spending and shift borrowing to the short-end of the US Treasury yield curve. I spoke about this at length in my essay “Bad Gurl.” The result is a booming US economy, 2023 Q3 real GDP growth was 5.2%, and Q4 real GDP growth is forecasted to be 2.6%, these are seriously impressive numbers for the world’s largest economy. But even this isn’t enough to soothe voters for the myriad of mistakes attributed to Slow Joe and his merry band of Democratic apparatchiks. Due to Biden’s dismal performance, the most feared man in America, former US President Donald Trump, aka The Orange Man, would beat Biden if the election were held today. Oh, the horror, democracy is about to die because a majority of voters might decide to elect someone the establishment loathes. Ironic, isn’t it ;).
The Orange Man must be stopped, and Slow Joe knows just how to get the job done.
In order to further goose the economy and make all financial asset holders happy, Powell has to play ball by loosening financial conditions even if it may lead to more inflation down the road. Hopefully, the aforementioned inflation will arrive after the November 2024 election. This is why Powell equivocates on the Fed’s desire to keep financial conditions this “tight.” Never mind that according to a variety of well-regarded economic theories like The Taylor Rule, Flexible Average Inflation Targeting, and core CPI being above the Fed’s 2% target, the current financial conditions are not tight enough. Powell stood up on the podium and clearly communicated that rate cuts in 2024 are being actively discussed. As the WSJ spelled out, not even two weeks ago, Powell sang a completely different tune about the likelihood of rate cuts.
Here is how I imagine this occurred.
Bad Gurl Yellen called her duck into her office and told him what’s what. Powell did as he was told … communicate rate cuts are on the table. Now financial assets will rise until either the US goes into a recession or inflation comes back in a big way. Given that the federal government is determined to spend as much as is needed to keep GDP growth high, I do not foresee a recession in the 2024 election year. It remains to be seen if food and fuel inflation, the kind that causes protests and instability, will arrive in a meaningful way pre-November 2024. But let’s not get too hung up on the future. At the moment the Fed, the US Treasury, and the Leader of Pax Americana are screaming at you to buy, buy, buy. Don’t be a fool; back up the truck and get involved in the best expression of this trade, which is crypto.
Every other major country or economic bloc, like China, Japan, and the EU, will play along and allow the dollar to weaken against the yuan, yen, and euro. Everyone wins as the dollar weakens, except those who don’t own enough financial assets to blunt the effects of the inflation said currency weakening will create.
With a firm grasp of the macro reasons for bullishness on crypto, let me help you avoid some potential value traps.
This is one of the most nonsensical crypto themes right now. If we just think about the meaning of the words, it should be clear to any thinking person these projects are destined to fail.
Permissioned — the implication here is that some centralised entity will decide who can and cannot transact.
Decentralised — the implication here is that there is a network of actors who collaborate in a trustless fashion to operate a financial network. This is permissionless activity that is not directed by a centralised entity.
Given the meaning of these words, how the fuck does one create a centralised decentralised financial network? Or a permissioned permissionless financial network? It makes no sense at all … unless you are a TradFi shark who wants to find another way to screw retail investors.
These projects are built to be used by institutional investors who have a variety of rules that, in many cases, prohibit them from trading on true DeFi projects. That is bad because there is a large set of retail trading going on in the true free market of DeFi, and institutional investors cannot participate. Markets filled with retail are the best types of markets because they offer the opportunity for the “smart” institutional money to skim profits off of “dumb” retail investors because they have faster computers that execute trades without human emotion. At least that’s how it operates in the TradFi markets because the exchanges create special order types and latency rules that confer material advantages to large high-frequency trading firms. Michael Lewis has an excellent book on the subject called “Flash Boys.”
The fact is there will not be a sufficient number of retail traders who use these permissioned DeFi primitives because they don’t need to trade against institutional investors. It is the institutional traders who need to trade against retail. The whole reason DeFi is attractive to global retail crypto traders is because it has a different market structure than TradFi stock and derivatives markets. After the hype fades, these permissioned DeFi markets will just be a circle jerk of high-frequency trading shops sitting on the bid and ask waiting for the other to cross the spread and get fucked. When directional retail fails to materialise in large enough quantities to justify the capital deployed on these protocols, the institutional investors will pack up and leave. The result will be a ghost town with zero activity or interest from both retail and institutional traders.
The VC firms, who are essentially highly paid muppets, are jumping onto this theme. As a result they will continue to incinerate capital just as they did back in 2014–2017 when they invested in the theme “blockchain, not Bitcoin”. Most of them passed or missed investing in Uniswap, dYdX, Compound, Aave, etc. Instead of analysing what in their framework caused them to miss out on these groundbreaking primitives, they have decided to leap at something that, on the surface, looks similar and sounds super-duper sexy. What investor wouldn’t want to own a piece of a trading platform that brought together institutional investors with their large capital base and DeFi, which is supposed to herald a completely new way of organising financial markets?
As always, there will be those who will spring into action and sell snake oil to these desperate VC’s who want to invest in crypto, but not the current crypto ecosystem, due to all those weird and undesirable folks who inhabit our wonderful industry. I have no hate for the founders peddling this nonsense; good on them for taking money from intellectually-challenged accredited investors. But for you, dear reader, don’t be the exit liquidity for these dog shit projects when they launch their governance tokens. Use the project if you wish, but please do some critical thinking and save yourself from the sure bagel the token will become over time.
RWA is the evolution of the same security tokens theme that emerged in the last bull cycle. Simply put, RWA projects aim to take things like property, marketable debt securities, stocks, etc., create a special purpose vehicle (SPV), and then offer fractionalised ownership via tokenisation to the world of plebes who lack the means to buy a full house or access to particular asset markets.
I fully believe that any crypto token that relies upon the laws of the state for its existence will never succeed at scale. Decentralised public blockchains are expensive because they do not require the state to exist. Why pay the premium for decentralisation when a centralised option exists and is already extremely cheap and liquid? The most straightforward example is that of fractionalized real estate.
The problem currently 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 dwelling. What if they could own a fraction of a house or apartment and get onto the property ladder? That is a noble goal, but there are a few problems.
Firstly, young people trying to leave the nest or start their own family don’t want a piece of house or apartment located in the ether. They want a fucking structure with four walls and a roof in which they can actually live. Buying a token that confers the financial performance of an unattributable piece of property does nothing to solve this problem.
Secondly, each piece of property is unique. This lack of standardisation inhibits a truly liquid market. After you purchase your token that represents 1/10th of a house, for example, how do you find someone to buy it from you at a reasonable price when you wish to sell? The buyer needs to understand the location, the local property regulations, taxes, and finally, actually want that specific piece of real estate. This will never approach the liquidity of owning a fraction of a standardised stock or bond. As always, with these types of investments, it’s a big door in and a small door out … if you can exit at all.
Finally, and most importantly, you can already own fractional property shares by purchasing very large and liquid Real Estate Investment Trusts (REIT). Many TradFi stock markets around the world offer these types of securities. They are managed by large and reputable firms who have been doing this longer than most of the target market has been alive. I see no reason why you need to conduct all this blockchain hocus pocus and launch a token.
Purchase these low-liquidity RWA tokens at your own peril. But an even worse use of capital is to invest in the governance token of the RWA issuing platform itself.
The other very popular RWA expression is creating a token that represents ownership of yield-bearing debt. The most popular projects offer holders of their token the yield on US Treasury bills (T-bills). The thinking goes that Tether is great in that it allows folks who might not have access to affordable USD banking rails the ability to send USD-pegged tokens 24/7 using public blockchains such as Ethereum and Tron. But Tether pays no yield; the owners of Tether are able to capture 100% of the yield on the T-bills in which they invest the dollars they hold in reserve. What if there was a USD stablecoin that also offered this T-bill yield?
This is a great development, and I fully support competition that gives more of the net interest margin (NIM) to the holders of these USD-pegged stablecoins. Using and holding these isn’t bad per se, but investing in the project’s governance token is silly. That is because this is just a bet on the path of USD interest rates.
If USD interest rates stay markedly above zero, then the project should accrue profit and pass that along to the governance token holders. If USD interest rates decline to close to zero again, then the project will lose money because it must pay for developers, legal, and compliance but does not have enough interest income from which to take a slice. Therefore why, as an investor, would you pay a multiple on a project’s NIM to own the governance token?
Instead, you should just short a liquid Exchange Traded Fund (ETF) that holds T-bills. You can express the same bet on interest rates, that is, profiting as interest rates rise, without paying a multiple to a bunch of crypto dudes and dudettes. And if you want to truly degen, apply a high amount of leverage.
In short, leave the “real” world that is governed by the laws of the state to TradFi intermediaries. They are able to offer a more coherent and cheaper investment product to express the same theme. A true DeFi project should depend only on well-written code, not laws that must be adjudicated and interpreted by fallible humans.
As soon as the TradFi East Coast US baldies got their applications in, the Bitcoin ETF looked a lot more palatable to the US political establishment. Never fade the right kind of white boys in Pax Americana. I guess the Winklevoss twins should have shaved their heads and joined the New York Racquet Club.
Fundamentally, if ETFs managed by TradFi asset managers are too successful, they will completely destroy Bitcoin. This prediction is based on an important subtle yet profound difference between Bitcoin and every other monetary instrument humanity has ever used.
Every other monetary asset human civilisation has ever used exists physically due to natural laws. Gold as a substance is Gold not because we say it is, but rather because of an arrangement of atoms. The interactions between these atoms are governed by universal laws. Fiat, which is some mumbo jumbo printed on a piece of paper, is still a physical sheet of matter. A piece of paper is still paper regardless of whether you believe it has monetary value. If you dug a hole and deposited gold and reams of paper and came back in 100 years, the gold and paper would still exist. Bitcoin is completely different.
Bitcoin is the first monetary asset in human history that exists only if it moves. After Bitcoin block rewards hit zero around 2140, miners will only be rewarded for validating transactions via transaction fees. That means miners will only receive Bitcoin income if the network is used. In essence, if Bitcoin moves, it has value. But if there was never another Bitcoin transaction between two entities, miners would be unable to afford the energy it costs to secure the network. As a result, they would shut off their machines. Without the miners, the network dies, and Bitcoin vanishes.
Blackrock, the world’s largest TradFi asset manager, is in the asset accumulation game. They vacuum up assets, store them in a metaphorical vault, issue a tradable security, and charge a management fee for their “hard” work. They don’t use the things they hold on behalf of their clients, which presents a problem for Bitcoin if we take an extreme view of a possible future.
Imagine a future where the largest Western and Chinese asset managers hold all the Bitcoin in circulation. This happens organically as people confuse a financial asset with a store of value. Because of their confusion and laziness, people purchase Bitcoin ETF derivatives rather than buying and hodling Bitcoin in self-custodied wallets. Now that a handful of firms hold all the Bitcoin, and have no actual use for the Bitcoin blockchain, the coins never move again. The end result is miners turn off their machines as they can no longer pay for the energy required to run them. Bye-bye, Bitcoin!
It is beautiful when you think about it. If Bitcoin becomes just another state-controlled financial asset, it dies because it isn’t used. The death of Bitcoin then creates space for another crypto monetary network to grow in its place. This network could just be a reboot of Bitcoin or something different that is an improved adaptation of the original Bitcoin. Either way, the people will once again have a non-state-controlled monetary asset and financial system. Hopefully, the second time around, we will learn not to hand our private keys to the baldies.
To that end, when thinking about surviving the ongoing fiat debasement, you must choose a side. Either you are trading a financial asset to earn more fiat, or you are trying to preserve wealth in energy terms alongside using a financial system outside of the state’s control. In the former case, trade ETFs to your heart’s content. That is why they exist. In the latter case, you must buy Bitcoin and withdraw it from the centralised exchange to your own self-custodial wallet.
2024 will have the highest number of national elections since the mind virus of the “nation-state” infected our collective consciousness a few hundred years ago. Any politician who wants to get re-elected needs to give goodies to the people. For the rich asset holders, give them loose financial conditions by encouraging central banks to print money. For the poor, give them handouts to cover the rising cost of food and energy, which is a direct result of policies that favour the asset-rich. For the middle class, give them “democracy,” tell them to pay their taxes, bend over, and be glad they got a vote. With this in mind, it makes no sense for a politician seeking re-election to stop the fiat debasement party. The votes from those who benefit from fiat debasement and inflation-linked handouts will outweigh the votes from those who suffer. As a result, money printing will surge in every “democracy” globally in 2024.
If you think today’s moment in history is special, take a gander at the above chart, which shows the Gold value of various global reserve fiat currencies over time. Fiat always trends to zero. No political system is able to resist the siren song of printed money.
The best time to buy Bitcoin and start your journey into crypto was yesterday, the next best time is now. Obviously, the investing community recognises the promise of crypto to fight fiat debasement. How else would a no-talent ass clown grifter like Nouriel Roubini get an FT article written about his newest hoax called “flatcoins.” This makes your choice of the best crypto expression that much more important. The state and its cronies will present sweet delicious candy to your child brain. But do as your parents taught you, and don’t take food from strangers.