#57 - August 2022: Monthly Update on Bitcoin & Macro
#57 - August 2022: Monthly Update on Bitcoin & Macro
My honest thoughts on the state of the market
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Hi all,
The cryptocurrency markets continued their sideways trend over the last month. All else equal, the current price action and market sentiment is exactly what we saw during the several months that marked the bottom in prior four-year cycles. Performance for the month:
Bitcoin: -14%
Overall, the story remains more or less the same as the last few months: markets have had a relief rally during the summer, but are now where they were at the start of the summer. All eyes continue to be on the Fed and their current posturing to keep deflating markets through raising interest rates.
The Fed has chosen pain
I mentioned last month that the stock market's upbeat interpretation of Powell's July comments caused a dilemma for the Fed. The Fed, seeking to pivot only after deflating some of the wealth effect from elevated equities and real estate valuations, now had less reason to pivot. To add to this, the most recent inflation data showed 8.3% YoY inflation, which was higher than the 8.1% expected. As a result, the Fed is obliged to keep following its chosen path: hike rates until inflation meaningfully ebbs (by killing demand through wealth destruction) OR something big breaks.
Interestingly, inflation is coming down in categories that are more sensitive to short-term changes in demand (energy), but going up in the the category furthest downstream from the immediate impact of money printing (services). In my October 2021 update, I focused on a deep dive on how money printing drives inflation over time, noting "Inflation is slow to materialize because it is the rate at which the entire economy processes the changed conditions [of how much currency is now in circulation] and organically moves towards equilibrium... the cost of living for working people starts to rise only when businesses begin to change their prices in reaction to the rising costs of inputs." The next step in that sequence would have been to note that service businesses eventually also have to raise their prices in order to pass on the higher cost of living they are now dealing with. In that way, inflation shows up more slowly in the costs of services than in the costs of goods. Lo and behold, that's the surprise in the latest inflation data: energy prices may already be retreating in response to the Fed's demand destruction efforts, but inflation from 2020-21 money printing is still slowly showing up in the price of services.
At any rate, this unexpectedly persistent inflation data makes the Fed's near term path a little more clear: they will keep hiking rates. They have chosen this path that is not tenable on a medium-to-long timeline (because of the math of interest expense on $30T of national debt), but for now they are committed to staying the course until the data allows them to claim victory over inflation, or the credit market seizes up. The higher they hike, the more certain it becomes that the latter will happen. Like so many of the recent narratives from the Fed that aged poorly ("stimulus won't cause inflation", "inflation is transitory"), the most recent assurance that the Fed will engineer a "soft landing" is looking increasingly implausible.
In the last few months I have cautioned that continued rate hikes risk catapulting us into a depression. Unfortunately, tomorrow's likely 0.75% interest rate hike (and any subsequent rate hikes in Q4) are milestones on a path that leads in that direction. The bad news is that the Fed seems determined to knock down equities and real estate valuations (both have remained resilient to the Fed's wealth destruction campaign relative to the bond market) and it could get ugly. The good news is that when it does, 15 years of QE means that Congress and the Fed are well versed in doing what they will have to do: print in order to stimulate our way out of the hole we just dug. This is in contrast to 2008, when there was no history of major stimulus and it took a high degree of crisis to overcome the resistance to printing the first $1T.
So, at this point, it looks like the Fed is going to pretend to be Volcker until something breaks in the credit markets and liquidity seizes up, at which point they will have no choice but to launch the latest round of printing on a bigger scale than ever before - my guess is sometime in 1H 2023. This all ties back to Bitcoin because in an environment with large scale money printing (and erosion of the integrity of the dollar & long-term standing of US Treasuries as the world's preferred reserve asset), Bitcoin outperforms everything else. It's just a matter of waiting for the inevitable Fed pivot.
Ethereum switches to proof-of-stake
You may have heard about Ethereum's recent switch from proof-of-work mining to a proof-of-stake consensus model. This is something of a non-event, but has received a great deal of positive press so it's worth addressing. The proof-of-work consensus model is the primary breakthrough of Bitcoin - it means that decentralized truth is created through the requirement that participants contribute real-world resources, and therefore real-world costs. Those costs are ongoing and create a massive disincentive for bad actors to participate (since they will have to expend cost in order to have a chance to write a fraudulent block, only to have it promptly ignored by the rest of the network) - perhaps best summarized in this 2 minute clip from 2015.
Ethereum, the leading smart contracts platform, has already been fairly centralized. (Over its 8-year existence, the central group that controls Ethereum's direction has implemented over a dozen hardforks to the project, meaning backwards incompatible changes that require everyone running Ethereum to switch to the new software version.) The fundamental truth of Ethereum is that it is ultimately controlled by a small group of people who have proven a ready willingness to change the project's parameters, most importantly its monetary policy. Here's Fidelity's take on the matter, in a January 2022 report they titled "Bitcoin First: Why investors need to consider Bitcoin separately from other digital assets".
Ultimately, Ethereum's switch to proof-of-stake is great marketing. They get to claim that they have eliminated "wasteful" energy consumption, but in reality they have simply removed the last semblance of true decentralization from the project's governance.
In the telling words of Ethereum's leader, proof-of-work means being governed by the laws of physics; proof-of-stake allows the group that controls the Ethereum project to create their own universe with their own laws of physics and change them as needed.
The switch to proof-of-stake has also created fresh interest in the question of whether Ethereum is an unregistered security. Here's SEC Chairman Gary Gensler on why Ethereum fails the Howey Test. (If you're curious to take a deeper dive into the centralized history of Ethereum, this in-depth post is scathing.)
Ultimately, the Ethereum switch to proof-of-stake is a splashy marketing move, and will strengthen the surface-level narrative that Ethereum's insiders have been pushing that Bitcoin is wasteful while Ethereum is ESG friendly. But under the surface, it's Bitcoin that is actually a positive force for ESG goals, and Ethereum only increased its centralization.
Thanks,
Jesse
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