Any opinions expressed herein are Arthur Hayes’s personal opinions and should not be relied upon in making investment decisions or be considered advice to engage in investment transactions.

I spent the first two weeks of October skiing in the South Island of New Zealand. My guide (who I skied with in Hokkaido last season) assured me that New Zealand was one of the best places in the world for off-piste skiing. I took his word for it and spent two weeks with him, chasing powder and big snow lines from Wanaka. The weather was great and I was able to ski over some spectacular peaks and across huge glaciers. As an added bonus, I also improved my alpine climbing knowledge.

Storms in the South Island are ferocious. When you have bad "weather," you stay home or in a mountain cabin. To kill time, one afternoon my guide took me to an avalanche science course. I've taken several avalanche training courses since I first ventured into the British Columbia backcountry as a teenager, but I've never taken a formal certification course.

This information is both interesting and thought-provoking because the more you learn, the more you realize that there is always a risk when skiing in avalanche terrain. Therefore, the goal is to reduce the risk to an acceptable level.

The course will introduce you to different types of snowpack and how they can cause avalanches. One of the most dangerous is a persistent weak layer (PWL), which can cause a persistent slab avalanche when stressed.

In avalanche science, a PWL is a specific layer of snow in a snowpack that is structurally weak for an extended period of time, greatly increasing the risk of avalanches. These layers are particularly dangerous because they can lie deep within the snowpack, dormant and unstable for weeks or even months until they are finally triggered by additional stressors, such as skiers or more snowfall. Knowing that a PWL exists is critical to avalanche forecasting, as these layers often lead to large, deep, and deadly avalanches.

The geopolitical situation in the Middle East is fundamental to the modern global order after World War II. The trigger is usually related to Israel. From a financial market perspective, we are concerned about how energy prices will react, how global supply chains will be affected, and whether a nuclear weapons exchange will occur if hostilities escalate between Israel and another Middle Eastern country (especially Iran or its proxies).

As investors and traders, we are in a dangerous but exciting phase. On one hand, now that China has started monetary stimulus, every major country or economy is reducing prices and increasing the money supply. Now is the time to take the biggest long-term risks, and obviously, I mean cryptocurrencies. However, if the Israeli/Iranian tensions continue to escalate, resulting in the destruction of Persian Gulf oil fields, the closure of the Strait of Hormuz, or the detonation of a nuclear bomb or device, the cryptocurrency market could fall sharply. As they say, war is not investable.

I'm faced with a choice: continue selling fiat to buy crypto, or reduce my crypto exposure and hold cash or US Treasuries? If this is truly the start of the next leg up in the crypto bull market, I don't want to be under-allocated. However, I don't want to burn capital if Bitcoin drops 50% in a day because of the ongoing financial market avalanche triggered by Israel/Iran. Never mind Bitcoin, it will always rebound; I'm more worried about some outright alt… memecoins in my portfolio.

I want to walk readers through the simple scenario analysis I employ when I consider how to allocate Maelstrom's portfolio.

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Scenario 1: The conflict between Israel and Iran devolves into tit-for-tat, small-scale military operations. Israel continues to carry out assassinations of civilians and beheadings, while Iran responds with non-threatening missile attacks. No critical infrastructure is destroyed, and no nuclear strikes are carried out.

Scenario 2: The Israel/Iran conflict escalates, ultimately leading to the destruction of some or all of the Middle East oil infrastructure, a blockade of the Strait of Hormuz, or a nuclear attack.

The persistent layer of weakness is maintained in Scenario 1, but fails in Scenario 2, leading to a financial market crash. Let's focus on the second outcome, because it's the one that would endanger my portfolio.

I will evaluate the impact of the second scenario as it specifically affects the crypto market, but primarily Bitcoin. Bitcoin is the crypto reserve asset and the entire crypto capital market will follow its path.

I am more concerned that now that the US has committed to deploying the THAAD missile defense system in Israel, Israel will up the ante. Israel is definitely planning a massive strike, and they expect Iran to respond strongly. So they called President Biden, Daddy, to send in reinforcements. Also, the more Israel publicly states that it will not strike Iran's oil or nuclear facilities, the more I believe that this is exactly what they are planning to do.

The United States said on Sunday it would send U.S. troops to Israel and deploy an advanced U.S. anti-missile system, a highly unusual move aimed at bolstering Israel’s air defenses following an Iranian missile attack.

Risk 1: Physical damage to Bitcoin mining equipment

War is physically destructive. Bitcoin mining rigs are the most valuable and important physical manifestation of cryptocurrency. What will happen to them?

The main assumption of this analysis is where in the world the conflict dynamic will spread. While the Israel/Iran war is merely a proxy war between the US/EU and China/Russia, I don't think either side wants to attack the other directly. It is much better to limit the conflict dynamic to the countries in the Middle East. In addition, the final belligerents are all nuclear powers. The US is the most aggressive military power in the world and has never directly attacked another nuclear power. This is saying something, as the US is the only country to deploy nuclear weapons (they nuked two cities at the end of WWII to force Japan to surrender). Therefore, it is reasonable to assume that the physical conflict remains limited to the countries in the Middle East.

The next question is, which countries in the Middle East have a lot of Bitcoin mining activity? According to some media reports, Iran is the only country where Bitcoin mining is booming. Depending on the source, Iranian Bitcoin miners account for 7% of the global hash rate. What would happen if Iran's hash rate dropped to 0% due to internal energy shortages or missile attacks on its facilities? Nothing would happen.

This is a chart of the Bitcoin network hash rate from January 2021 to March 2022.

Remember when China banned Bitcoin mining in mid-2021 and the hash rate quickly dropped by 63%?1 The hash rate recovered to its May 2021 high in just 8 months. Miners relocated out of China or other global players were able to increase their hash rates due to more favorable economic conditions. On top of that, Bitcoin hit a new all-time high in November 2021. This massive drop in the network hash rate has no discernible effect on the price. Therefore, even if Iran were completely wiped out by Israel or the United States, which would drop the global hash rate by up to 7%, it would not have any impact on Bitcoin.

Risk 2: Sharp rise in energy prices

The next question to consider is what would happen if Iran destroyed major oil and gas fields in retaliation. The Achilles’ heel of the over-leveraged Western financial system is the lack of cheap hydrocarbons. Even if Iran could destroy Israel, it would not prevent a war. Israel is merely a useful and expendable vassal of the United States. If Iran wants to strike at the West, it must destroy hydrocarbon production and prevent oil transporters from passing through the Strait of Hormuz.

The price of oil will soar, dragging all other energy prices up with it, as oil-scarce nations turn to other energy alternatives to power their economies. What will happen to the fiat price of Bitcoin? It will go up.

Bitcoin is energy stored in digital form. Therefore, if energy prices rise, Bitcoin will be worth more in fiat currency. The profitability of Bitcoin mining will remain the same, as all miners face the problem of rising energy prices in sync. Some large industrial miners may face greater challenges in obtaining energy as governments invoke force majeure clauses and cancel contracts. But if the hash rate drops, the mining difficulty will also decrease, allowing new entrants to easily mine and profit despite rising energy prices. Satoshi Nakamoto's masterpiece will be on full display.

If you want a historical example of hard currency’s resilience to energy shocks, look at how gold traded from 1973 to 1982. In October 1973, the Arab oil embargo began in retaliation for U.S. support for Israel in the Yom Kippur War. In 1979, the Iranian Revolution overthrew the Western-backed Shah regime and established the current theocratic Ayatollah regime, resulting in Iranian oil supplies being withdrawn from global markets.

Spot oil (white) and gold (yellow) prices versus the U.S. Dollar Index (100). Oil prices have risen 412%, while gold has risen almost as much, at 380%.

Here is the price of gold (gold) compared to the S&P 500 (red), divided by the price of oil, with the index being 100. Gold is buying only 7% less oil, while oil is buying 80% less gold.

Assuming either party removed Middle Eastern hydrocarbons from the market, the Bitcoin blockchain would continue to execute and the price would at least maintain its relative value to energy and would certainly rise in fiat currency terms.

Now that I have discussed physical risk and energy risk, let’s move on to the last one, currency risk.

Risk 3: Currency

The key question is how the United States responds to the conflict. Both major political parties in the United States firmly support Israel. No matter how many innocent men, women and children the Israeli army kills in the process of destroying Iran and its proxies, the American elite political group will continue to support it. The United States supports Israel by providing weapons. Since Israel cannot afford to buy the weapons needed to wage war against Iran and its proxies, the US government lends money to American arms dealers such as Lockheed Martin to purchase ammunition for Israel. Since October 7, 2023, Israel has received $17.9 billion in military aid.

The US government buys with credit, not with savings. That is the message of the above graph. Providing free weapons to Israel requires the bankrupt US government to increase borrowing. The question is, who will buy this debt if national savings are negative? The green arrows show the situation where US net national savings are negative. Luke Gromen correctly points out that these arrows correspond to the following:

The arrows in the above chart correspond to a sharp increase in the size of the US Federal Reserve's balance sheet. As the US plays the role of the war lord supporting Israel's military operations, it must borrow more money. Just like after the 2008 Global Financial Crisis (GFC) and the COVID-19 lockdown, the US Federal Reserve's balance sheet or the balance sheet of the commercial banking system will increase infinitely to buy the increased debt issuance.
How Would Bitcoin React to Another Sharp Increase in the Fed’s Balance Sheet?

This is the price of Bitcoin divided by the Federal Reserve's balance sheet, indexed at 100. Since its inception, Bitcoin has outperformed the growth of the Federal Reserve's balance sheet by 25,000%.

We know war brings inflation. We understand that the U.S. government must lend money to Israel to buy bombs. We know that the Federal Reserve and the U.S. commercial banking system will buy up this debt by printing money and increasing their balance sheets. Therefore, we know that as the war intensifies, Bitcoin will rise sharply in terms of fiat currency.

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 these deals are on credit. From a cynical perspective, I think China and Russia will act like cleanup agents. They will publicly condemn the war, but will do nothing to prevent Iran's destruction.

Israel is not interested in nation-building. On the contrary, they would be happy if the Iranian regime collapsed due to popular unrest. China, in particular, would then be able to pursue its preferred diplomacy. Provide funds to the new weak Iranian government and use Chinese state-owned enterprises to rebuild the country. This is essentially the "One Belt, One Road" plan that Chinese leaders have been promoting throughout their time in power. Iran, with its vast mineral and hydrocarbon deposits, would then be completely under Chinese control. China would gain another captive market in the global south to dump its overproduced, high-quality, and low-priced manufactured goods. In return, Iran would sell cheap energy and industrial goods to China.

China and Russia’s support will not expand the global fiat money supply, if you will. Therefore, it will not have a noticeable impact on the fiat price of Bitcoin.

Intensified conflict in the Middle East will not destroy any of the critical infrastructure that supports cryptocurrencies. As energy prices soar, Bitcoin and cryptocurrencies will rise. Hundreds of billions or trillions of newly printed dollars will revive the Bitcoin bull market.

Trade with caution

Bitcoin will rise over time, but that doesn’t mean the price won’t fluctuate wildly, or that all altcoins will share the glory. The key to the investment game is to size your positions appropriately.

I’m prepared for a crazy market cap drawdown on any position I hold. As some readers know, I’m invested in several meme coins. When Iran launched its latest round of missile attacks on Israel, I cut those positions significantly. Given the unpredictability of how crypto assets react to increased hostilities in the short term, I’m too big. I know I’m too big because I’d be pissed if I had my money invested in a bunch of joke cryptocurrencies and lost 100%. Currently, the only meme coin I own is Church of Smoking Chicken Fish (ticker: SCF). Amen.

I have not yet instructed Akshat, Maelstrom’s head of investment, to slow down or stop putting capital into pre-sale token transactions. With the idle fiat currency held by Maelstrom, I will stake it on Ethena and earn some good returns while waiting for good entry opportunities in various liquid altcoins.

The last thing I should do as a trader is to trade based on who I think is on the "right" side of this war. This will lead to you going bankrupt as both sides of the war will experience financial repression, outright asset confiscation, and destruction. The best thing to do is to get yourself and your family out of harm's way and then put your money into an instrument that will protect against the devaluation of fiat currencies and preserve their energy purchasing power.

1– I say this because when looking at the IP addresses of miners submitting blocks, China still counts as one of the largest locations for Bitcoin mining.