Arthur Hayes: Bitcoin could be heading below $30,000 on capitulation
A summary and analysis of last night's bearish warning.
Billionaire co-founder of cryptocurrency exchange BitMEX Arthur Hayes dropped a bearish warning last night that I wanted to highlight. His post covered many of the core themes we’ve obsessed over in The Bitcoin Layer over the past few months, including inflation, Fed tightening, and bitcoin’s correlation with stocks. Instead of sifting through Hayes’ splashy language and entertaining loose tone in his full post “Maelstrom,” here is instead a summary and my analysis.
Maelstrom, the article’s title, means a powerful often violent whirlpool sucking in objects within a given radius.
On March 16, 2020, bitcoin’s price reached $4,000 in a massive capitulation and “correlation 1 moment” in which all global risk assets collapsed in unison as the reality of a global pandemic took hold.
Hayes believes that we are heading into “a string of trading days as disastrous as 16 March 2020” as a result of “the Fed reducing the growth of their balance sheet to 0%, and subsequently raising rates one to three times in 2022.”
Inflation is becoming a political problem, and the Fed is cornered into tightening monetary policy, or what he calls engaging in the “kabuki theater” of raising interest rates. He believes this will “inflict max pain on global risk assets” but eventually results in central banks easing policy once again.
He dropped a stinger about crypto’s eternal optimists that are blind to macro forces: “my read on the sentiment of crypto investors is that they naively believe network and user growth fundamentals of the entire complex will allow crypto assets to continue their upward trajectory unabated.”
This confluence of Fed hikes and investor naivety “presents the setup for a severe washout” as the “pernicious effects of rising interest rates on future cash flows will likely prompt speculators and investors at the margin to dump or severely reduce their crypto holdings.”
Hayes identifies a lagged correlation between the money supply (M2) growth rate and bitcoin, and claims that bitcoin’s sideways price has corresponded with a stall in Fed balance sheet growth. With the Fed’s QE program coming to and end and asset portfolio maturing and possibly shrinking, bitcoin’s price should follow lower.
He would dump all shitcoins because “Bitcoin and Ether are the highest quality coins” and “shitcoins could go down 75% to 90%” due to their illiquidity.
BTC and ETH are being used as collateral to borrow dollars to finance other purchases, financial or otherwise. This could cause forced liquidations.
He believes that an opaque part of the money market will break and the Fed will restore order in quick fashion: “The government will then get back to the business of pumping financial asset prices with printed money. It’s the business model of America, and one that must be maintained due to the structure of the global economy.”
Hayes is long duration, meaning he’s betting on a fall in interest rates, and presumably long the dollar via exposure through options, representing a long volatility position to "make up for any losses on the crypto side of the book.” He admits to not having enough exposure to this position.
His portfolio after reaching these macro conclusions: “I went through my entire crypto portfolio. After a 75% drop from the current levels, any shitcoin I wouldn’t increase my position in, I dumped. That left me with Bitcoin, Ether, and a few other large positions in metaverse and algorithmic, stablecoin-related tokens.”
At below $20,000 BTC or $1,400 ETH, he worries about the long-term viability of each asset.
“I stand ready for the capitulation candle.”
It’s impossible to catch the very bottom, but once you spot the capitulation, add with confidence.
Hayes is a popular character in the bitcoin saga and a noteworthy read when he rarely puts pen to pad. I generally agreed with his premises but wanted to add some nuance to it. Hayes conveyed some of the key themes that we’ve covered in this publication over the past few months. First, the Fed is starting a tightening cycle due to rampant, and no longer “transitory” headline inflation. Whatever the cause, long-term effects of monetary stimulus, short-term effects of supply chain disruption, or both, the Fed must respond by raising rates. This will eventually break risk markets, and the Fed’s unofficial mandate, stock prices, will cause it to stop tightening and go back to its money printing ways. Bitcoin will be caught in the crossfire on the way down and back up. This is a must-read post from November in which I covered and reviewed all of these topics (including help with interest rate terminology), and concluded that bitcoin is still trades as a risk asset:
Readers would have been prepared for bitcoin’s price weakness if they had spotted the bearish divergence on bitcoin’s price chart I flagged in my year-end chart pack:
Now that you’re caught up, you can see why I wanted to flag Arthur Hayes’ latest post. He is warning against a large flush in bitcoin’s price, in correlation with other risk assets, primarily driven by Fed hikes, which are driven by inflation. The thesis is sound. The reaction function, in which the Fed eases policy because it’s the lender of only resort, a concept covered extensively in Chapter 6 of Preston Pysh’s #1 read of 2021 Layered Money, is also a concept I strongly believe in. Let’s go deeper into some of the nuance to what Hayes is saying.
There is misplaced optimism in crypto and a refusal to see that bitcoin is driven by a macro flow, not just network growth. This is one of the most important points made in Hayes’ essay. Bitcoin no longer exists in a bubble with its own fundamentals. Bitcoin evangelists have been too successful over the past several years in spreading the gospel of decentralized money, that bitcoin has become just another mainstream market. Bitcoin still has its own fundamentals and long-term value drivers, but the traditional markets have quite the grip on bitcoin’s price recently. Bitcoin, for most of the past several months, has traded off Fed news, yield-curve flattening, pandemic headlines, and much of the same news flow driving stock prices. Bitcoin is maturing.
Rising interest rates affect valuations: it’s just math. Hayes talks about the “pernicious effect” of rising rates, but the dangers are strictly arithmetical in nature. When interest rates go up, higher discount rates reduce valuations—this is finance 101. From a mathematical standpoint, future cashflows (nominator) are discounted to the present, and a higher discount rate (denominator) results in a lower present value. This simple math formula ripples throughout every asset class, bitcoin not excluded, when the Fed tightens monetary policy. Higher discount rates are a force too strong to fight, and why a Fed that wants to raise interest rates multiple times in 2022 will face a jittery stock market, as Excel spreadsheets across Wall Street recalculate equity valuations with higher discount rates as the input. The Fed, beholden to stock prices, will be tested on how far it is willing to tighten policy. The last time the Fed tried this, starting in 2015, it was able to raise interest rates over 200 basis points before breaking the risk market. I slightly disagree with Hayes here: I don’t think the Fed will be forced to reverse course in the next six months—that seems too quick. Headline inflation will be a key metric to watch, as well as the S&P 500’s performance.
If money printing is the reason investors buy bitcoin, a contracting Fed balance sheet should have the reverse effect. With Hayes pointing out the relationship between M2 growth rate and bitcoin’s price, we can see that a more disciplined Fed should drive investors away from the bitcoin thesis, as the following meme loses relevance when an end to QE and a reduction on the Fed’s asset portfolio:
He’s hedged his crypto portfolio with a long duration and long dollar trade. Hayes is exposed to a long duration, long dollar, and long volatility trade. This means he will make money when interest rates fall, the dollar increases relative to a basket of currencies, and volatility (presumably FX and equity) rises. He has this trade to hedge crypto exposure, expecting his hedge to increase in value when bitcoin prices fall. This would confirm bitcoin as a risk asset, at least in the current market regime. I found it very interesting to see him discuss the relationship between his crypto exposure and macro hedges.
The reason to be in the bitcoin trade in the first place is this whole Fed dance. The dollar is a broken system, and the Fed is forced to create trillions of dollars when anything even slightly breaks. When a lapse in this money printing occurs, as is about to happen right now, it is reasonable to expect the bitcoin market to react accordingly. This is the main point of Arthur Hayes—bitcoin will fall victim to Fed tightening, but it should resume its trend as soon as the Fed reverses course. The crises in dollar liquidity markets are frequenting our shores at an increasing rate, and the Fed’s responses are only becoming more fierce and grandiose. Those future responses still warrant the long bitcoin position.