Although Bitcoin may rise in the long term, it does not mean that its price will not experience violent fluctuations, nor does it mean that all altcoins will benefit equally. The key is to reasonably control the scale of investment.
By Arthur Hayes
Compiled by: Deep Wave TechFlow
(The opinions expressed in this article are only the personal opinions of the author and should not be used as a basis for investment decisions, nor should they be regarded as investment advice.)
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I spent the first two weeks of October skiing in the South Island of New Zealand. My guide, who spent the last ski season with me in Hokkaido, assured me that New Zealand is one of the best places in the world for backcountry skiing. I believed him, so I set off with him in Wanaka and spent two weeks chasing powder and spectacular lines. The weather cooperated perfectly and I skied down several stunning peaks and traversed huge glaciers. Additionally, I improved my alpine climbing knowledge.
Storms in the South Island are extremely ferocious. Once the weather is bad, you can only stay at home or in a mountain hut. To kill time, one day my guide gave an avalanche science course. I have trained in avalanches many times since my first backcountry adventure in British Columbia as a teenager, but had never taken a formal certification course.
This knowledge is both fascinating and alarming, because the more you learn, the more you realize there are always risks when skiing avalanche terrain. Therefore, our goal is to control risks within acceptable limits.
The course covers different types of snow and how they cause avalanches. One of the scariest of these is a persistent weak layer (PWL), which can trigger persistent plate avalanches when stressed.
In avalanche science, a persistent weak layer (PWL) refers to a specific layer in the snow layer that remains structurally vulnerable for an extended period of time, thereby significantly increasing the risk of avalanches. These layers are particularly dangerous because they can be buried deep in the snow and remain unstable for long periods of time until triggered by additional pressure, such as passing skiers or new snowfall. Understanding the presence of PWLs is critical to predicting avalanches because they are often the cause of large, deep, and deadly avalanches.
The post-World War II geopolitical situation in the Middle East is like a layer of PWL under the modern global order, with the trigger often associated with Israel. From a financial markets perspective, the "avalanche" we are concerned about includes volatility in energy prices, the impact on global supply chains, and whether hostilities between Israel and other Middle Eastern countries, particularly Iran or its proxies, escalate. could lead to the use of nuclear weapons.
As investors and traders, we are in a dangerous yet exciting situation. On the one hand, as China has begun large-scale money printing and reflation activities, major economies are lowering currency prices and increasing money supply. This is the time to take the most long-term risk, and obviously, I'm talking about cryptocurrencies. However, if tensions between Israel and Iran continue to escalate, leading to the destruction of Persian Gulf oil fields, the closure of the Strait of Hormuz, or the detonation of nuclear weapons, crypto markets could take a hit. As is often said, war cannot be invested.
I am faced with a choice: should I continue selling fiat and buy crypto, or should I reduce my crypto holdings and instead hold cash or U.S. Treasuries? If this is indeed the start of a new crypto bull run, I don’t want to miss the opportunity. But I also don’t want to lose a lot of money when Bitcoin plunges 50% in one day due to the avalanche of financial markets caused by Israel and Iran. Bitcoin will always bounce back, but I'm more worried about having some worthless stuff in my portfolio...like meme coins.
I want to walk readers through a simple scenario analysis as I think about how to position Maelstrom's portfolio.
Scenario Analysis
Scenario 1: The conflict between Israel and Iran gradually evolves into a small-scale military confrontation. Israel continues its assassination campaign, and Iran responds with some predictable, non-threatening missile strikes. No critical infrastructure was destroyed and no nuclear strike occurred.
Scenario 2: The conflict between Israel and Iran escalates, eventually leading to the destruction of some or all of the Middle East oil infrastructure, the closure of the Strait of Hormuz, or even a nuclear attack.
In scenario one, the persistent weak layer remains stable, but in scenario two it fails, causing financial markets to collapse. We focus on the second scenario because it poses a threat to my portfolio.
I will evaluate the impact of the second scenario on the crypto market, specifically Bitcoin. Bitcoin is the reserve asset among cryptocurrencies, and the entire crypto market will fluctuate accordingly.
I am more concerned that Israel may step up its offensive now that the United States has committed to deploying the THAAD missile defense system in Israel. Israel may be planning a large-scale strike and anticipates a strong response from Iran. Therefore, they asked US President Joe Biden to send reinforcements. Furthermore, the more publicly Israel states that it will not attack Iran's oil or nuclear facilities, the more doubtful I become that this is their true intention.
According to Reuters, the United States announced on Sunday that it would send US troops and advanced anti-missile systems to Israel, a very rare deployment aimed at strengthening Israel's air defense capabilities after being attacked by Iranian missiles.
Risk 1: Physical damage to Bitcoin mining machines
War is extremely destructive. Bitcoin miners are the most valuable and important physical asset of the cryptocurrency. What kind of damage would they suffer if war breaks out?
In this analysis, the main hypothesis is the region to which the conflict will spread. Even though the war between Israel and Iran is just a proxy war between the US/EU and China/Russia, I assume that neither side is willing to go to war directly. Confining the conflict to these countries in the Middle East is a more preferable option. Moreover, the final belligerents are all nuclear powers. The United States, the most aggressive global military force, has never directly attacked another nuclear power. This is saying something, since the United States is the only country to have ever used nuclear weapons (when they forced Japan to surrender through nuclear explosions to end World War II). Therefore, it is reasonable to assume that actual military conflict will be limited to the Middle East.
The next question is, are there any countries in the Middle East that do a lot of Bitcoin mining? According to some media reports, Iran is the only country where Bitcoin mining is booming. According to different sources, Iranian Bitcoin miners account for 7% of the global hashrate. What would be the impact if Iran’s hashrate dropped to 0% due to internal energy shortages or a missile attack on its facilities? Basically not.
This is a graph of Bitcoin network hashrate from January 2021 to March 2022.
Remember when China banned Bitcoin mining in mid-2021 and saw a rapid 63% drop in hash rate? Hashrate has returned to its May 2021 highs in just eight months. Miners have either moved out of China, or players from other countries have increased their computing power due to more favorable economic conditions. On top of that, Bitcoin hit an all-time high in November 2021. The severe drop in network computing power has no significant impact on prices. Therefore, even if Iran were completely destroyed by Israel or the United States, resulting in a reduction of up to 7% of global computing power, it would have no impact on Bitcoin.
Risk 2: Sharp rise in energy prices
The next thing to consider is what would happen if Iran destroyed major oil and gas fields in retaliation. The Achilles heel of the Western financial system is a shortage of cheap hydrocarbons. Even if Iran could destroy Israel, it would not be able to prevent war. Israel is merely a useful and expendable appendage of the American hegemonic system. If Iran wants to strike a blow against the West, it must destroy hydrocarbon production and prevent oil tankers from passing through the Strait of Hormuz.
Oil prices will soar, driving up all other energy prices, as oil-starved countries will use other energy alternatives to sustain their economies. So, what will happen to Bitcoin’s fiat price? It will rise accordingly.
Bitcoin can be thought of as energy stored in digital form. Therefore, when energy prices rise, Bitcoin’s fiat currency value also rises. The profitability of Bitcoin mining will not change as all miners face a simultaneous increase in energy prices. For some large industrial miners, access to energy may be difficult as governments require utilities to invoke force majeure clauses and cancel contracts. But if computing power drops, mining difficulty will also drop, making it possible for new entrants to still be profitable despite higher energy prices. The elegance of this mechanism designed by Satoshi Nakamoto will be fully realized.
If you want a historical example of the resilience of hard currencies during energy shocks, look at how gold traded from 1973 to 1982. In October 1973, Arab states imposed an oil embargo on the United States in retaliation for U.S. support for Israel in the Yom Kippur War. In 1979, Iran's oil supplies were withdrawn from global markets as a result of the revolution that overthrew the Western-backed shah and installed the current theocratic regime.
Spot oil prices (white) and gold prices (yellow) have a benchmark index of 100 relative to the U.S. dollar. Oil prices rose 412%, while gold nearly matched its gains, reaching 380%.
Here's the price of gold (gold) versus the S&P 500 (red) divided by the price of oil, with a base of 100. The purchasing power of gold fell by just 7%, while the purchasing power of stocks fell by 80%.
Assuming either party removes Middle Eastern hydrocarbons from the market, the Bitcoin blockchain will still continue to operate and its price will at least maintain its value relative to energy and will certainly rise in terms of fiat currencies.
I've discussed physical and energy risks, now let's explore the final currency risk.
Risk Three: Currency
The key question is how the United States responds to conflict. Both Democrats and Republicans firmly support Israel. Even as innocent civilians suffer losses as Israeli forces try to destroy Iran and its proxies, America’s political elite continues to support Israel. The United States supports Israel by providing weapons. Since Israel cannot pay for the weapons it needs to fight Iran and its proxies, the U.S. government has borrowed money to pay U.S. arms dealers such as Lockheed Martin to provide ammunition to Israel. Since October 7, 2023, Israel has received $17.9 billion in military aid.
The U.S. government makes purchases by borrowing, not saving. That’s what the picture above conveys. To provide free weapons to Israel, the heavily indebted US government would need to borrow further. The question is, who will buy the debt when national savings are negative? The green arrows in the graph mark periods when the U.S. national net saving was negative. Luke Gromen points out that these arrows correspond to a sharp expansion of the Fed's balance sheet.
The United States plays a warlord role in supporting Israel's military operations and therefore needs to borrow more. As in the aftermath of the 2008 global financial crisis and COVID-19 lockdowns, the balance sheet of the Federal Reserve or the commercial banking system will grow dramatically to absorb the new debt issuance.
How will Bitcoin respond to another major expansion of the Federal Reserve’s balance sheet?
This is the price of Bitcoin divided by the Fed’s balance sheet, with 100 as the base. Bitcoin has outperformed the growth of the Federal Reserve’s balance sheet by 25,000% since its inception.
We know that war causes inflation. We understand that the U.S. government needs to borrow money to sell arms to Israel. We also know that the Federal Reserve and the U.S. commercial banking system will purchase this debt by printing money and expanding their balance sheets. Therefore, it is foreseeable that as the war intensifies, the fiat currency price of Bitcoin will rise significantly.
Regarding Iran's military spending, will China and Russia support Iran's war effort in some way? China is willing to buy Iranian hydrocarbons, while China and Russia also sell goods to Iran, but none of these transactions are on credit. From a more realistic perspective, I think China and Russia may play a role in the aftermath. They will publicly condemn the war but will actually take no effective steps to prevent Iran's destruction.
Israel is not keen on nation-building. Instead, they may hope to use their attacks to trigger the collapse of the Iranian regime due to popular unrest. This would allow China, in particular, to use its usual diplomatic tactic of providing loans to the weak new Iranian government to use Chinese state-owned enterprises to help rebuild the country. This is actually the Belt and Road Initiative promoted by Chinese President Xi Jinping during his term. In this way, Iran, which has rich mineral and hydrocarbon resources, will be fully integrated into China's economic circle. China could find a new market in the Global South to dump its overproduction of high-quality, low-price manufactured goods. In exchange, Iran will provide China with cheap energy and industrial raw materials.
If you look at it this way, support from China and Russia will not increase the global supply of fiat currencies. Therefore, this will not have a noticeable impact on Bitcoin’s fiat price.
The intensification of conflict in the Middle East will not destroy any of the critical physical infrastructure that supports cryptocurrencies. As energy prices soar, the value of Bitcoin and cryptocurrencies will rise. Hundreds of billions or even trillions of newly printed dollars will once again fuel a bull run in the Bitcoin market.
Trade with caution
While Bitcoin is likely to rise in the long term, that doesn’t mean its price won’t experience wild swings, nor does it mean that all altcoins will benefit equally. The key is to reasonably control the scale of investment.
I prepare myself for wild market value swings in every investment I hold. As some readers know, I've invested a few meme coins in the past. When Iran fired missiles at Israel, I decisively cut these investments because in the short term, cryptoassets’ response to an intensification of the conflict is difficult to predict. I realized I was overinvesting because I would be very upset if I lost all my money on some joke cryptocurrency. Currently, the only memecoin I hold is Church of Smoking Chicken Fish (ticker: SCF). R’amen.
I have not asked Akshat, Maelstrom’s head of investments, to slow down or stop the pace of our investments in pre-sale tokens. For the idle funds held by Maelstrom, I plan to stake on Ethena in order to earn a decent yield while I wait for the right time to get into various liquid altcoins.
The worst thing you can do as a trader is to trade based on who you think is on the "right" side of the war. This approach leads to failure, as both sides in the war face financial repression, asset confiscation, and destruction. The smartest thing to do is to keep yourself and your family safe first, and then put your capital into investment vehicles that can withstand the devaluation of fiat currencies and maintain their energy purchasing power.
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This article is reprinted from Shenzhen Chao TechFlow with permission
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