Original title: Persistent Weak Layer
Original author: Arthur Hayes
Original source: https://substack.com/
Compiled by: Mars Finance, Daisy
(Any opinions expressed in this article are the author’s personal opinions and should not be used as the basis for investment decisions, nor should they be understood as recommendations or suggestions for investment transactions.)
I spent the first two weeks of October skiing on New Zealand's South Island. My guide, who had spent the entire season with me in Hokkaido last year, assured me that New Zealand was one of the best places in the world for backcountry skiing. I took his word for it and spent two weeks with him chasing powder and steeps around Wanaka. The weather was great and I was able to ski several stunning peaks and cross vast glaciers. As a bonus, I also improved my knowledge of alpine climbing.
Storms in the South Island are extremely severe. When the weather is bad, you stay at home or in a mountain cabin. To kill time, one afternoon my guide gave an avalanche science course. I have taken many avalanche training courses since I first hit the backcountry skiing in British Columbia as a teenager, but I have never taken a formal certified course.
This information is both fascinating and sobering because the more you learn, the more you realize that you are always taking a risk when skiing in avalanche terrain. Therefore, the goal is to reduce the risk to an acceptable level.
The course teaches about different types of snow layers and how they can cause avalanches. One of the most feared is the persistent weak layer (PWL), which, when stressed, can trigger a persistent slab avalanche.
Scenario Analysis
Scenario 1: The Israel/Iran conflict cools down to small-scale military retaliation. Israel continues with assassinations and targeted strikes, while Iran responds with overt but non-threatening missile attacks. No critical infrastructure is destroyed, and no nuclear strike occurs.
Scenario 2: An escalation of the Israel/Iran conflict culminates in the destruction of some or all of the Middle East oil infrastructure, the closure of the Strait of Hormuz, or a nuclear attack.
In scenario one, the weak persistence layer remains stable, but in scenario two it fails, causing a financial market crash. We will focus on the second scenario, which would endanger my portfolio.
I will evaluate the impact of the second scenario on the crypto market, especially Bitcoin, which is the reserve asset of cryptocurrencies and the entire crypto capital market will follow its trend.
I am more concerned that now that the US has committed to deploying the THAAD missile defense system in Israel, it may mean that Israel will step up its efforts to launch a major strike, expecting a strong response from Iran. Therefore, Israel has asked US President "Slow Joe" Biden for reinforcements. And the more Israel publicly states that they will not strike Iranian oil or nuclear facilities, the more I believe that this is exactly what they are planning.
The United States said on Sunday it would send American troops and an advanced U.S. anti-missile system to Israel, a rare deployment aimed at bolstering Israel's air defenses following Iranian missile attacks.
Source: Reuters
Risk 1: Physical destruction of Bitcoin mining machines
War has devastating effects. Bitcoin mining machines are the most valuable and important physical manifestation of cryptocurrency. So, how will they be affected?
The main assumption in this analysis is what parts of the world the war would expand to. While the Israel/Iran war is really a proxy war between the US/EU and China/Russia, I am assuming that neither side wants to attack the other directly. It is much better to limit the war to these "messy" countries in the Middle East. Moreover, the main belligerents are all nuclear-armed countries. The United States is the most aggressive global military power and fortunately has not yet directly attacked another nuclear-armed country. This is important because the United States is the only country that has used nuclear weapons (at the end of World War II, the United States bombed two cities in Japan to force its surrender). Therefore, it is reasonable to assume that the physical conflict will be limited to the Middle East.
The next question is, is there a lot of Bitcoin mining activity in the Middle East? According to some media reports, Iran is the only country where Bitcoin mining is booming. According to different sources, Iranian Bitcoin miners account for about 7% of the global hashrate. What would happen if Iran's hashrate dropped to 0% due to internal energy shortages or missile attacks on its facilities? The answer is: nothing would happen.
This is a graph of the Bitcoin network hashrate from January 2021 to March 2022.
Remember when China kind of banned Bitcoin mining in mid-2021? The hashrate promptly dropped by 63%. But the hashrate recovered to its May 2021 high in just eight months. Miners migrated from China, or other global players increased their hashrate due to more favorable economic conditions. On top of that, Bitcoin hit a new all-time high in November 2021. Severe drops in the network’s hashrate have no discernible effect on the price. So even if Israel or the United States completely destroyed Iran, resulting in a 7% reduction in global hashrate, it would have no impact on Bitcoin.
Risk 2: A 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 the lack of cheap hydrocarbons. Even if Iran could destroy the Israeli state, this would not help prevent war. Israel is nothing more than a useful and expendable vassal of "Pax Americana." If Iran wants to strike at the West, it must destroy hydrocarbon production and prevent ships loaded with oil from passing through the Strait of Hormuz.
Oil prices will soar, dragging all other energy prices up with them as oil-starved countries turn to other energy alternatives to power their economies. So what will happen to the fiat price of Bitcoin? It will soar.
Bitcoin is energy stored in digital form. Therefore, if energy prices rise, the value of Bitcoin relative to fiat currencies will also rise. The profitability of Bitcoin mining will not change, because all miners face a parallel increase in energy prices. Some large industrial miners may have a harder time obtaining energy, because governments may invoke force majeure clauses and require utility companies to cancel contracts. However, if the hash rate drops, the mining difficulty will also drop, which will make it easier for new entrants to mine Bitcoin profitably at higher energy prices. The beauty of Satoshi's creation will be revealed.
If you want a historical example of hard currency resilience to energy shocks, look to gold trading between 1973 and 1982. In October 1973, Arab states initiated an oil embargo in retaliation for U.S. support for Israel in the Yom Kippur War. In 1979, as the Iranian Revolution toppled the Western-backed Shah and established the current theocracy of the Ayatollahs, Iranian oil supplies were withdrawn from the global market.
Spot oil (white) and gold (yellow) prices against the US dollar index of 100. Oil is up 412% and gold is up almost 380%.
This is the price of gold (gold) and the S&P 500 (red) divided by the price of oil, with the index being 100. Gold bought only 7% less oil, while the S&P 500 lost 80%.
Assuming either party removed Middle Eastern hydrocarbons from the market, the Bitcoin blockchain would still continue to operate and its price would at least maintain its value relative to energy and would certainly rise in fiat terms.
Now that I have discussed physical and energy risks, let’s turn to the last one, currency risk.
Risk 3: Currency
The key question is how the United States will respond to this conflict. There is a strong bipartisan support for Israel. No matter how many innocent men, women, and children the Israeli military kills in its quest to destroy Iran and its proxies, the American elite political class will continue to support Israel. The United States supports Israel by providing weapons. Since Israel cannot afford the weapons it needs to fight Iran and its proxies, the U.S. government borrows money to pay American arms dealers such as Lockheed Martin to provide the ammunition to Israel. Since October 7, 2023, Israel has received $17.9 billion in military aid.
The US government buys goods by borrowing, not saving. That’s what the graph above tells us. In order to provide Israel with weapons for free, the heavily indebted US government needs to borrow more. The question is, who will buy this debt if national savings are negative? The green arrows show a situation where the US has negative net national savings. Luke Gromen correctly points out that these arrows correspond to the following situations:
The arrows in the above chart correspond to a sharp increase in the size of the Fed's balance sheet. As the United States plays the role of "lord of war" by supporting Israel's military actions, it must borrow more money. Just as after the 2008 Global Financial Crisis (GFC) and the COVID-19 lockdown, the balance sheet of the Federal Reserve or the commercial banking system will rise sharply to purchase these additional debt issuances.
So, how would Bitcoin respond to yet another sharp increase in the Fed’s balance sheet?
This is the ratio of Bitcoin price to the Federal Reserve's balance sheet, with a base of 100. Since its inception, Bitcoin has outperformed the growth of the Federal Reserve's balance sheet by 25,000%.
We know that war is a catalyst for inflation. We understand that the U.S. government must borrow money to sell bombs to Israel. We know that the Federal Reserve and the U.S. commercial banking system will buy up this debt by printing money and expanding their balance sheets. Therefore, we know that as the war intensifies, the value of Bitcoin in fiat currency will rise dramatically.
So what about Iran's military spending? Will China/Russia help Iran's war effort in some way? China is very willing to buy Iran's hydrocarbons, and China and Russia also sell goods to Iran; however, none of this trade is done on credit. From a cynical perspective, I think China and Russia will act as the "cleanup team." They will publicly condemn the war, but will not make any significant efforts to prevent Iran's destruction.
Israel is not concerned with nation-building. Instead, they would be happy to see the Iranian regime collapse due to popular unrest as a result of their attack. China, in particular, could then launch their preferred diplomatic tool. Provide the newly-formed weak Iranian government with funds to rebuild its country, using Chinese state-owned enterprises. This is essentially the Belt and Road Initiative that Chinese President Xi Jinping has been promoting throughout his tenure. Iran, with its vast mineral and hydrocarbon resources, would then be completely under Chinese influence. China gains a new captive market to dump its excess, high-quality, and low-priced manufactured goods into the Global South. In exchange, Iran sells cheap energy and industrial goods to China.
China and Russia’s support does not expand the global fiat money supply, if you want to call it that. Therefore, it has no discernible impact on the fiat price of Bitcoin.
Intensifying conflict in the Middle East will not destroy any of the critical physical infrastructure that supports cryptocurrencies. As energy prices soar, Bitcoin and cryptocurrencies will rise. Tens or trillions of newly printed dollars will reactivate the Bitcoin bull market.
Trade with caution
Just because Bitcoin will rise over time doesn’t mean there won’t be wild price swings, or that every “altcoin” will share in the glory. The key to the game is in properly sizing your holdings.
I was prepared for a wild market cap drawdown in any position I held. As some readers know, I was invested in several meme coins. I significantly reduced my position when Iran launched its latest round of missile attacks on Israel. I was overly overweight given the unpredictable reaction of crypto assets to increased hostilities in the short term. I realized I was overweight because I would be very annoyed if I lost 100% of my investment in a bunch of joke cryptocurrencies. Currently, the only meme coin I hold is Smoking Chicken Fish Church (ticker: SCF). May the ramen bless you.
I have not yet instructed our head of investment, Akshat, to slow down or stop our capital deployment in the pre-sale token sale. With Maelstrom's idle fiat, I will stake it on Ethena and earn a good yield while waiting for a good time to enter various liquid "altcoins".
The worst thing to do as a trader is to trade based on who I think is on the "right" side of this war. This will lead to your destruction as both sides of the war will experience financial repression, outright asset confiscation, and destruction. The best thing to do is to ensure you and your family are safe from harm and then direct your capital into an instrument that will outperform the depreciation of fiat currency and preserve its purchasing power.
