Bitcoin juiced by Fed or PayPal?

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Macro Afternoon

Via FTAlphaville:

Bitcoin’s price has been mooning in the wake of the US election, so much so it is nearing the record highs it set back in December 2017, at pixel time trading above $18,000:

Speculation as to what is causing the run-up is rife. Some blame growing distrust in authority following the yet-to-be conceded US election. Others believe it’s the result of Covid-related stimulus gone mad. Others still see it as simple confirmation of bitcoin’s time finally having come.

But another theory fell into our inbox on Thursday, which we think possibly has legs. That is that the price increase has come as a result of a bitcoin shortage propelled by Paypal getting into the crypto space, announced on October 21.

As Erik Lowe, head of content at bitcoin fund Pantera noted to FT Alphaville by email:

PayPal’s October 21st launch announcement coincided with the service’s availability for select US accounts. It was a gradual roll out. You can see a spike in the chart the day of the announcement. Paxos Crypto Brokerage provides crypto custody and trading for PayPal. Paxos owns itBit, their exchange.

Pantera’s CEO Dan Morehead, meanwhile, had contextualised the October spike vis-a-vis the Fed’s overall balance sheet expansion in a note on Wednesday as follows:

According to Morehead, the idea PayPal may already be having an impact after launching on Oct 31 is supported by the fact that its rival Square, which began offering bitcoin access 30 months ago, is now estimated by Pantera to purchase about 40 per cent of all newly issued bitcoin.

That doesn’t leave a lot of spare supply on the table for any other payment giants to get their teeth into without moving the price significantly.

What also makes a big difference is that with the entry of PayPal comes a large pool of already-KYC’ed users, meaning the friction usually associated with getting into bitcoin (from taking selfies of yourself with your passport to extended daily limits) is eliminated.

Another indicator of the PayPal influence is the increase in itBit volume since PayPal entered in the market:

ITBit is owned by Paxos, PayPal’s broker-dealer. Morehead estimates the above volume spike indicates PayPal may already be buying more than all the supply of newly issued bitcoin that’s available (currently there are 6.25 bitcoins mined every ten minutes.)

Another thing to bear in mind is that all of this comes in the context of a wider crackdown on official bitcoin intermediation in China. Long-standing cryptocurrency-watcher David Gerard, for example, drew our attention to Chinese reports that domestic miners are finding it so difficult to convert bitcoin into yuan, they are facing a major problem paying electricity bills.

If this is true, this would definitely make it much more difficult for new bitcoin to make its way to market — at least for as long as the miners remain operational.

Echoes of dollar shortages 2008

The bigger question to consider is: should the bitcoin community really be celebrating a price rise driven by a potentially structural shortage of bitcoin?

One of the big problems in 2008 — and what eventually distressed the entire global financial system — was a shortage of dollars in the offshore market, which began to impede everyone’s capacity to keep servicing pre-existing dollar-denominated debts.

It was this dollar shortage which eventually prompted the Federal Reserve to initiate one of its boldest extraordinary interventions to date: the provision of unlimited dollar swap lines to a number of foreign central banks.

Bitcoin clearly isn’t as leveraged as the equivalent dollar fiat system was in 2008. Indeed, the rehypothecation — or relending — of bitcoin is strictly controlled in regulated markets, limiting much of this problem.

However . . . the rise of bitcoin-funded stablecoins has created a different type of vulnerability, especially among stablecoin-issuers that cannot properly back their outstanding dollar liabilities with real dollars all of the time.

To explain what we mean, think of Tether not as a stablecoin but as a sort of central bank that works hard to stabilise the price of bitcoin by flooding the market with lookalike (unfunded) dollars whenever the price of bitcoin weakens. This pre-emptive and unfunded issuance of Tether dollars (USDT) is usually justified by the notion that their unfunded nature is only temporary. If the reserve expansion is sustained, funding eventually materialises by those seeking entry into the USDT market with real dollar collateral.

The growth in Tether reserves during a bitcoin down market is thus akin to the expansion of a central bank balance sheet when it conducts quantitative easing operations.

The underlying assets this “QE” supports (US Treasuries in the conventional market and bitcoin in the Tether example) can help maintain the appearance of stability. But only for as long as an artificial shortage is not replaced by a bona fide shortage — as eventually happened with the dollar fiat market.

In such a scenario somebody eventually has to pay for the engineered stability.

In the fiat world, the scenario has translated into a stealth wealth transfer from savers to the indebted via negative interest rates.

In the bitcoin Tether scenario, the prospect of a genuine bitcoin shortage in the face of a system that has regularly run asset-liability mismatches into bitcoin weaknesses presents the realistic scenario that Tether’s dollar reserves could break a buck. That is to say, a sustained bitcoin spike could incentivise a major bitcoin cash-out spree against new USDTs that cannot be funded quickly enough to maintain Tether’s USDT/USD 1:1 peg (which, we should add, has not always been successfully maintained).

To what degree that poses a financial panic or not depends entirely on Tether’s ability to convince those cashing out to keep holding USDT instead of demanding real dollars.

PayPal’s ETF/MMF structure

One other way of thinking of it is that PayPal’s bitcoin offering represents the exact countervailing force to that of Tether in the bitcoin market.

To understand that, it’s important to recognise that PayPal is in many respects the original digital stablecoin: its structure represents a type of MMF/ETF, obliged to hold every dollar of customer funds in a specially dedicated bank account.

From the PayPal perspective, every dollar in its system converted into bitcoin will also need to be reserved in exactly the same way to avoid any price fluctuation risk (regardless of whether payments are later facilitated with those reserves).

That, to a large extent, makes PayPal a pseudo Bitcoin ETF/MMF: its bitcoin balances representing bitcoin liabilities (or bitcoin lookalikes) rather than customer-controlled bitcoins outright. (Though it’s important to note this is also the case with many bitcoin broker-dealers, including those that accept USDT.)

Once you can use PayPal to switch effortlessly from lookalike bitcoin into lookalike dollars on a whim AND be able to spend those dollars anywhere PayPal is accepted AND be confident that you can cash out against real dollars whenever you want to TO BOOT, the real question is why anyone take a chance on Tethers at all? Especially given PayPal have also committed to not charging any fees on their Bitcoin offering.

Only, presumably, if you could not meet PayPal’s KYC/AML criteria for opening an account.

If that makes you wonder how PayPal actually plan to make money from bitcoin, the answer, duh, is on the FX conversion cost, a hefty 2.3 per cent on purchases between $25-$100, staggering lower the larger the transaction gets to a minimum of 1.5 per cent. (So much for bitcoin ending extortionate third-party transaction costs, eh.)

The other puzzle is how PayPal can be sure it is backing its crypto hoards with ethically (rather than criminally) sourced bitcoin?

One instant method that comes to mind is doing a long-term discounted off-take agreement with a legitimate mining source, much the way dealers in conventional commodity markets do with commodity producers.

But that too would be a sure-fire way to immediately reduce supply-side bitcoin availability. Conclusion: price goes moon.

So, as the highly dubious store of value becomes a medium of exchange, the price of the store of value skyrockets, rendering the medium of exchange utterly useless.

BTC is one confused ponzi-scheme that will be destroyed by global regulation in due course.

Still, before that happens, the mice will play. Via Citi:

  • The whole existence of Bitcoin has been characterised by unthinkable rallies followed by painful corrections (The type of pattern that sustains a long term trend.)
  • The first major rally on this chart as Bitcoin came into the mainstream was the exponential move from 2010 into the 2011 high followed by a deep correction. This is interesting for 3 reasons
  • That surge, as it came into the mainstream, was very reminiscent of what happened with Gold as it was allowed to float in the early 1970’s after 50 years of trading in a $20-$35 range.
  • That period with regard to the Gold price was a structural change in the modern day monetary regime as it broke the orthodox relationship between FIAT currencies and Gold ushering in a World of fiscal indiscipline, deficits and inflation.
  • The Bitcoin move happened in the aftermath of the Great Financial crisis which saw a new change in the monetary regime as we went to ZERO per cent interest rates (negative in some countries) and massive QE.
  • Are we on the cusp of another such structural development? A number of things come to mind in that respect
  • With the onset of a new crisis (Covid) Fiscal Orthodoxy has gone out the window (and likely rightly so for now). The unprecedented societal crisis that we are seeing today leaves little if any room around the World for Fiscal austerity.
  • The Fed (The Central Bank of the World) has given 2 pieces of very clear guidance in recent years about how monetary policy is being reshaped, in possibly the most dramatic fashion since the floating of Gold in the 1970’s, even more so than the introduction of QE in the last cycle.
  • The first guidance was before the Pandemic hit and was an assessment of the actions taken during the Financial crisis. If I remember the phrase correctly it was something like “better a dime today than a Dollar tomorrow”. In essence the conclusion was that it was better if a crisis developed to hit it hard and early rather than piecemeal over time- the “big bazooka” effectively. True to their word that is exactly what they did as the Pandemic roiled financial markets in Feb-March this year.
  • The second and (in my view) more “monumental” guidance was the indication that as the economy/inflation and employment pick up they will not look to constrain monetary policy in the same fashion they have in the whole post Volcker era. This change in monetary policy and simultaneous opening up in fiscal policy is (despite protestations to the contrary) MMT in all but name and a clear intention of debasing FIAT currency.
  • Historically this has been good for Gold and likely will again. However, Gold has some restrictions that also need to be noted. Physical Gold needs to be stored, is not readily portable across borders, has paper equivalents on exchanges that may or may not fully reflect the actual move in Gold and could possibly be called “yesterday’s news” in terms of a financial hedge.
  • Bitcoin is the new Gold- It is an asset with limited supply. It is digital (This is the 21st century- Gold is a 20th century asset). It moves across borders easily and ownership is opaque. That last point is, I believe, very relevant. The huge Fiscal deterioration of today has a cost in the future, either directly or indirectly. Directly it is that at some point the “bills have to be paid” which means at some time in the future the money needs to be found. While Bitcoin may become subject to more regulatory constraints going forward it is a natural store of “money” to avoid this. Indirectly the argument can be the debasement of FIAT currencies by creating high nominal growth and inflation (effectively a soft default- I do not believe hard default, particularly in the World’s reserve currency is a real concern. However in lesser currencies it could well be)
  • Central Banks are increasingly discussing digitisation of currencies: This is a double edged sword. On one side it creates a much more effective mechanism for distributing stimulus (particularly fiscal) but on the other side it also makes capital confiscation easier (eg negative interest rates). Both these scenarios would look to me to be positive Bitcoin and in the 21st Century give us the digital equivalent (Bitcoin versus FIAT digital) of what we saw in the 20th century when the financial regime changed (Gold versus FIAT paper)
  • So let us go back to the chart. After the high was posted in 2011 we saw Bitcoin retrace 93% over 5 months (not for the faint hearted). That was followed by a 9 year period that has been much more symmetric as Bitcoin as an asset became more visible and increasingly more mainstream

1. It rallied for 2 years from 2011-2013 (multiplying by an incredible 555 times)
2. It fell from Dec 2013 to Jan 2015 (13 months) by 86%
3. It rallied from Jan 2015 to Dec 2017 (2 years and 11 months) multiplying by 121 times
4. It fell from December 2017 to Dec 2018 (12 months) by 84%
5. It rallied from December 2018 to? by ? %

  • If you look at the chart below and the price action to date you could argue 2 things

1. Timeframes for the rally are getting longer (10 months, 2 years, 3 years and next 4 years? So end of 2022.) Of course in doing that you likely argue even higher levels as a consequence.
2. You look at price action being much more symmetrical over the past 7 years or so (while still huge numbers) forming what looks like a very well defined channel giving us an up move of similar timeframe to the last rally. Such an argument would suggest that this move could potentially peak in December 2021, at the high of the channel, suggesting a move as high as $318k. Improbable though that seems it would only be a low to high rally of 102 times (the weakest rally so far in percentage terms) at a point where Time will tell if we end up seeing such lofty levels but the backdrop and the price action we are looking at clearly suggests the potential for a major move higher nonetheless in the next 12-24 months.

  • So just to clarify , do I think we will head to those lofty levels by the end of 2021 or even 2022? Probably not. Ever? Who Knows. Time will tell and I am certainly not a Crypto expert.However the technical setup below and the backdrop we see today combined with Financial market and Economic history does suggest that 2021 may be a pretty good year for Bitcoin bulls, even if we only see a fraction of those gains.

In short, voodoo technicals support a voodoo ponzi-scheme. You don’t get much less rational than that.

Still, reflexivity can keep it bid almost permanently, until one morning when you get up and BTC is worthless owing to government fiat.

David Llewellyn-Smith
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