Face your fears, we are all about beating inflation

Original title: Fear Is The Mind-Killer

Original author: Arthur Hayes

Original translation: 0x55, 0x71 rhythm BlockBeats

As the time point of the Ethereum London hard fork approaches, this fork will implement the EIP1559 plan, which will introduce an ETH deflation mechanism into Ethereum by modifying the gas fee structure, which will undoubtedly have a huge impact on the price of ETH. Arthur Hayes, former CEO of the well-known cryptocurrency trading platform BitMEX, conducted a detailed analysis of this change in "Fear Is The Mind Killer", explaining why he believes that there is a 30% probability that the market value of Ethereum will exceed Bitcoin in the future.

 

At the same time, he also shared his views on currency, Bitcoin and Dogecoin. He said: "Face your fears, we are all trying to beat inflation."

 Arthur Hayes, former CEO of BitMEX, a well-known cryptocurrency trading platform

(Any of the following views are the author's personal views and should not be used as an investment basis, nor should they be regarded as advice for engaging in investment transactions.)

 

Rhythm BlockBeats translated the full text as follows:

"I must not be afraid. Fear is a mind killer. Fear is a little reaper that brings utter destruction. I will look fear in the face and let it pass through me. When fear is gone, I will open my eyes and see its path. Wherever fear passes, nothing is left but me." - Science fiction novel "Dune" I love science fiction. I read at least one at any time. Frank Herbert's Dune is the best single science fiction novel so far. The whole series of six books is good, but the quality drops after the first one. The best series of science fiction is Liu Cixin's Three-Body trilogy, which is very well written. I hope my Chinese can be better so that I can read the original Chinese version instead of the English translation. I am also very excited about the upcoming science fiction TV series Foundation, in which Asimov (the author of the novel of the same name) is a gangster boss.

 

American traders and investors are simple creatures driven by fear and greed. While greed drives people to do many incredible things, the fear of losing overrides everything. According to Daniel Kahneman's extensive research, humans are not as rational in making decisions as classical economists believe. It is worth mentioning that losing money hurts our hearts more than gaining money. As we delve deeper into this epic crypto bull run, it is critical to evaluate what we fear because this type of thinking may kill the speculators’ desire to BTFD (Buy the Fxxking Dip).

 

Big Reversal

 

A few weeks ago, Su Zhu of Three Arrows Capital asked me out of the blue what was the probability that ETH (Ethereum) would surpass Bitcoin in market value in this bull run? My answer was 0%. He countered with 50%. Shortly after this conversation, Raoul Pal published the May 2021 edition of Global Macro Investor, which included a section of a long report written by Nikhil Shamapant on why ETH could reach $150,000 in January 2023. After reading the report, I sent Su another message to change my answer to 30%.

 

In the Bitcoin community, there is a small group of people who worry day and night that ETH will eventually surpass their beloved Bitcoin. Just look at the fierce war of words on Twitter about Bitcoin and ETH. The “Bitcoin Maximalists” believe that Bitcoin is the only true currency god in the crypto world. All other cryptocurrencies are either auxiliary gods or Satan.

 

On the other side, there are the Ethereum fans. They believe that ETH is both the most “hard” cryptocurrency and the best decentralized computer in the world. To them, after the launch of ETH 2.0, Ethereum completes the transition from proof-of-work to proof-of-stake consensus algorithms (currently scheduled for later this year), ETH’s market cap will soon surpass Bitcoin’s.

 

In my thinking, I try to avoid being dogmatic, so as not to get stuck in an outdated mindset over time. I, like everyone, will fail in this endeavor. But I hope to reduce future losses by reminding myself to only predict possible outcomes and act accordingly. The arbitrary claims surrounding Bitcoin and Ethereum must be brought back to the actual fundamental vision of these two cryptocurrencies. We can then reconstruct the state of events and assess whether these claims make sense at all.

 

What is Bitcoin/Ethereum?

 

The best currencies have no industrial use. Fiat currencies are very useful in commerce because they are inherently worthless. The demand for use of a particular fiat currency is entirely related to the effectiveness of its network. By network, I mean the number of domestic and foreign parties that will exchange goods or labor for a particular fiat currency.

 

The reason that currencies with commodity characteristics are not suitable for everyday use is that their value is tied to a real-world use case. For example, a barrel of oil is a very poor form of money. Relative to labor and commodities, oil has two demands that affect its price. The first is the demand function for energy consumers. The second is the demand function as a medium of exchange. How do I price labor with a barrel of oil? I have to price oil based on its usefulness for my daily energy needs, and what I think other people think it is worth, relative to the good or service I am trading. Pricing gets quite complex as the number of economic participants increases, and the supply of oil and velocity of money contain interdependent vectors.

 

ETH's primary mission is to power the world's largest decentralized computer. ETH has value because the Ethereum network is the most used smart contract protocol, has the most developers, the most Dapps, and the largest total value locked (TVL). ETH is the commodity used to pay gas fees so that you can use Ethereum.

 

ETH's use cases are not purely monetary. The best example of this is The DAO hack. For those readers who are not familiar with the crypto world in 2016, the following is a very brief introduction to the events. At that time, in order to save investors in the DAO, the following events led to the hard fork of the Ethereum network.

 

1. A project called The DAO aims to become the first truly decentralized autonomous organization and operate an Ethereum venture capital fund.

2. Users staked ETH to the DAO, and in return they could vote on how to invest the pooled funds into promising projects.

3. At the time, the DAO attracted about $150 million worth of ETH, making it one of the largest crowdfunding campaigns in human history.

4. However, a bug in the DAO smart contract allowed individuals to siphon funds from it. Personally, I object to calling this a hack, the contract was just being performed as written. The fundamental problem with the incident is that the creators of the DAO did not fully understand how their smart contract would perform in reality. 5. The Ethereum community, led by Vitalik (founder of Ethereum), faces a very stark choice: a) Allow the DAO’s funds to be drained and maintain the immutability of the Ethereum blockchain. This will make ETH more like a hard currency tool, but considering that 2016 was still the early days of the Dapp ecosystem, this will weaken investors’ enthusiasm for participating in future DeFi projects as they suffer losses. b) Push miners to accept a hard fork, which will revert Ethereum to before the DAO hack and allow investors to recover their ETH. This makes ETH a less than ideal monetary tool, since history can be rewritten under duress, but it will give investors the confidence to continue experimenting with DeFi.

6. Faced with the choice, the Ethereum community stayed true to its mission and chose to consolidate Ethereum as a decentralized computer rather than a true monetary tool.

7. This decision frustrated many community members who valued immutability, so after the hard fork, they continued to mine the original chain, but changed the name to Ethereum Classic (ETC). It has the same community commitment to hard currency as Bitcoin, and the same smart contract logic as Ethereum.

 

I believe in market choice. In the next 5 years, the market believes that ETH should be worth 30 times that of ETC. The market recognizes that Ethereum is focused on being the best smart contract protocol, not also being a good collateral for a hard currency. It is impossible to serve two masters at the same time.

 

When in doubt, the Ethereum community has always prioritized the need for a decentralized computer over the need to be a true hard money tool. As we look to the future of ETH 2.0, a narrative is emerging that ETH may be both the "hardest" cryptocurrency and the best decentralized computer.

 

ETH inflation mechanism

 

EIP-1559, if approved, will greatly change ETH's inflation mechanism.

 

Fundamentally, ETH will no longer be transferred from users to miners in the form of gas fees, but will destroy a base fee and provide tips to miners. It is estimated that up to 70% of the gas fees in a transaction may be destroyed at that time. In a previous article I wrote called "Yes... I Read the Whitepaper", I talked about the huge growth in ETH gas fees if DeFi can replace even a small portion of CeFi.

 

If Ethereum gas fees grow exponentially with usage and then those fees are burned, then soon ETH inflation will turn into deflation. As the Ethereum platform becomes more useful, the supply of ETH will decrease. If DeFi has a much greater impact on human economic activity in the future than it does now, there may not be enough ETH supply in the future for the Ethereum system to operate.

The counterargument to this argument is that the extremely high price of ETH solves the supply problem. But this is not the case. If marginal mining profits expand enough, there will be no ETH on the ground to be mined at will. The Ethereum network will not generate enough ETH through block rewards to meet the usage needs of Ethereum tasks. At this point, the Ethereum economy has failed. Although the price of ETH was high at that time, it was a carnival for the hoarders. But if the fuel required for DeFi transactions cannot be obtained at any price, then the Great Depression will come. Considering how the Ethereum community has responded to threats in the past to complete its mission (see: DAO hack), do you think they will sit back and watch Ethereum self-destruct due to a flawed inflation mechanism? If you have hard forked once, you can hard fork again. Deflationary issuance and gas fee consumption schedules will be sacrificed so that Dapps can power decentralized computers.

 

Thus, those who believe that the current EIP-1559 inflation mechanism will never change need to review Ethereum's history. A major driver of the bull market has been the exponential growth of DeFi on-chain transactions, which will lead to more gas fees being destroyed, reducing ETH supply and driving up prices.

 

If the price of ETH really reaches $150,000 and the Ethereum network is completely isolated from the CeFi mechanism, the mere suggestion of changing the block reward mechanism to completely crush CeFi will send the price of ETH to the depths of the Mariana Trench. Remember, currency is the source of power that supports the price foundation. Failure to understand the impact of deflationary mechanisms on currencies can be fatal. ETH can never become the most "hard" cryptocurrency because it has to fulfill its true mission of powering the world's decentralized computer.

 

However, this does not mean that ETH's market cap cannot exceed Bitcoin, it just means that it will be difficult to achieve because ETH cannot have its cake and eat it too.

 

Technology is more important than money

 

The world's reserve currencies are so important because there are countless people or organizations that accept them in exchange for goods and services. Currently, that currency is the US dollar. A close estimate of the value of this currency is M0, the amount of base money in circulation. The current total M0 of the US dollar is $5.8 trillion.

 

The FAANGs (Facebook, Apple, Amazon, Netflix, and Google) are worth $6.36 trillion combined. The US dollar is just a currency that relies on the US financial system to issue it, and its value is not even as much as the products and services produced by the companies that use it for settlement.

 

Dollar holders will not cry and shout on various social media that the dollar has risen or fallen, because the products produced by companies that mainly settle in dollars are worth much more than the dollar itself. So why are Bitcoin holders so worried that other cryptocurrencies will exceed it in actual use? I think it is inevitable that the actual value of Bitcoin will be surpassed. Conversely, other cryptocurrencies will not worry about Bitcoin being too valuable because they used Bitcoin when they initially raised funds.

 

So, in fact, as the most "hard" cryptocurrency asset, Bitcoin still has intrinsic value even if its market value share has fallen a lot compared to the current situation. Bitcoin holders must firmly believe that the foundation of the entire cryptocurrency economic system is Bitcoin assets. Their persistence in this belief will help Bitcoin further consolidate its fundamental position in the entire cryptocurrency pyramid.

 

The ubiquitous "bad money drives out good money"

 

Both legal tender and gold require real people to exchange them for other forms of money, goods, or services. This traditional form of money relies on interpersonal networks. As long as there are people, the system can work.

 

But the most complex money in history, Bitcoin, is not like this. It not only requires human participation, but also requires a lot of profit-seeking miners to consume real-world energy to maintain the operation of the system. The only reward miners can get is Bitcoin. No matter what the reason, as long as the cost of energy consumption exceeds the income from Bitcoin rewards, miners will be "absent from work", and the entire Bitcoin system will be gone - just "whoosh", Bitcoin will be gone.

 

The more transactions using Bitcoin, the more fees are generated on the chain. These fees and mining rewards allow miners to buy energy to keep the system running. Everyone knows that the reward for block minting will decrease approximately every 4 years until it drops to zero in 2140, but fortunately, transactions on the chain are still growing rapidly. However, with the rise of the "unhealthy trend" of purchasing paper Bitcoin derivatives, and the long-term holding of Bitcoin by the big guys in the currency circle, the disaster predicted by Gresham's theorem may not be far away from us.

 

Bad money is spent, such as the US dollar and other fiat currencies; good money is hoarded, such as Bitcoin. This is Gresham's "bad money drives out good money" theorem. However, hoarding gold will not affect the value of gold, but hoarding Bitcoin is different. If Bitcoin is not circulated in the market, it will lose its value, because after the block reward is zero, the only source of income for miners is transaction fees. If there are no transactions, there will naturally be no fees, and miners will have no motivation to continue to maintain the system.

 

If it's not your key, it's not your money

 

Many newbies in the circle hope to find a quick way to compare the risks of Bitcoin and legal currency. They believe that Bitcoin will rise, but they don't want to learn relevant financial knowledge. What they hope is that if they forget their passwords, they can have a caring customer service like a grandmother to help them find it back, and if they lose money, they can have a trash can to listen to them. Those service providers are happy to sell them packaged Bitcoin financial derivatives, but they always charge some fees for helping them deal with various blockchain issues.

 

Judging from the success of asset-packed derivatives projects such as Grayscale's GBTC and Coinshare's XBT, the only risk that ordinary investors can bear is price risk. A good friend of mine who trades frequently uses these products because they are simple and convenient. These people are actually fully aware that if they don't invest some money, the investment opportunity of the revolutionary Bitcoin blockchain will be lost. But in fact, this is useless because they are only looking forward to price inflation, not a completely new financial system.

 

A large number of Bitcoins in escrow accounts are not used for transactions or used as collateral in the digital financial economy, which may become a hidden danger to miners' profits in the long run. Another hidden danger is that some people who hold the belief of "I am the bank" would rather use fiat currency to buy necessities and save all the previous Bitcoins. If these two problems become chronic, the growth of on-chain transactions will slow down and/or decline completely.

 

Chips Are Short

 

The strong Bitcoin price and negligible energy costs keep mining farms profitable, as the semiconductor chips needed to build new mining machines continue to be in short supply. Even if you have money, you can't buy mining machines, which makes it impossible for the computing power of the entire network to increase rapidly.

 

It is necessary to remind you that what really matters is the price ratio between Bitcoin and energy. The discussion of fiat currency will always pass, but miners must use Bitcoin income to pay for electricity costs to maintain operations anyway. The remaining Bitcoin after purchasing electricity is the real profit. 1 US dollar may buy 1 kilowatt or 1,000 kilowatts of electricity, but 1 kilowatt is 1 kilowatt.

 

Currently, large mining farms do not need a significant increase in transaction volume to cover their ongoing operating costs. Even mining farms that only use second-generation mining machines have made a lot of money, so it is not important for them whether Bitcoin is used for actual transactions.

 

From Farm to Table

 

When primary products, intermediate products, and final products are all priced in Bitcoin, Bitcoin's credit consensus is extended to the entire value chain. A true Bitcoin economic system should be a Bitcoin-based system that does not require collateral. When/if that day comes, on-chain transactions will soar into the sky.

 

Bitcoin "from farm to table" is a good way to crack the Gresham phenomenon. We have time to correct those rational but unhealthy market behaviors, stop them from buying paper bitcoin derivatives and hoarding physical currency.

 

Dogecoin

 

The most powerful force in the world is the power of collective imagination of human beings. Any non-natural object we have ever come into contact with was originally created from the imagination of individual human beings. Everything originates from imagination and then transitions to reality.

 

The value system that supports our collective illusion is closely protected. You only need to think about the millions of people who have died in the past few thousand years of human civilization because of different views on systems and beliefs. As for the value beliefs of the monetary system, everyone will be very serious, which is normal, because your monetary belief system may cause some people to become rich overnight while others will live a mediocre life.

 

Humans know that money is pure fiction at its core. So when you challenge their beliefs with an alternative monetary system, they may object strongly. The best way to respond is with humor.

 

The most talented comedians take our most cherished beliefs and use them to reflect the logical fallacies of society. If you feel offended, you should probably reflect on why you are so insecure about your beliefs. Maybe deep down you know it's wrong.

 

Dogecoin has angered the old bureaucrats of traditional finance and the old leeks in the currency circle. It is a magical Internet currency that does not package itself or pretend to have any technological innovation. All you can see on the computer screen is a cute dog. Many people know that Jackson Palmer, the founder of Dogecoin, withdrew from the operation of Dogecoin in a rage a few years ago because he thought that Dogecoin was obviously just a joke and that it was a fantasy that cryptocurrencies had value.

 

One of the best salesmen in human history, Mr. Elon Musk, used the example of Dogecoin to show us how ridiculous today's monetary system is. Musk's company Tesla has a market value that exceeds the total market value of most other car companies, while Tesla produces only 1/60 of the number of cars produced by all other companies. This is undoubtedly the result of hype. Musk has created more shareholder value than providing safe, fast, and environmentally friendly electric vehicles with just Twitter.

 

Praise him or step on him, Musk is simply the golden finger for the rise in cryptocurrency prices. A joke about Dogecoin has created countless invisible rich people, which is a great humiliation for those traditional financial conservatives who talk about value investing on TV! After the 2008 financial crisis, when central banks around the world were generally expanding their balance sheets at a compound annual growth rate of 15%, these people's returns could not even reach 10%. It can be said that "I am the clown." For those crypto believers who promote decentralized technology, they also feel like clowns because their creed is also broken by Dogecoin. How could such a technically flawed protocol enter the top ten cryptocurrencies? Isn't this a slap in the face of other cryptocurrencies? These people lamented that "Dogecoin makes us look like dogs" and "makes cryptocurrency unprofessional at all." If your "professional" means wearing a suit and tie or a black pencil skirt, and then getting a decent salary that you don't deserve, then let me bear the "pain" of Dogecoin's rise. You yourself are trading Internet coins in this bizarre Internet world, letting worthless electrons shuttle back and forth in front of the screen, and now you are pretending to be a believer in value? You probably just hope that the next time Musk touts a token on Saturday Night Live, it’s one you own.

 

The cryptocurrency community does not need to be afraid of Dogecoin. Instead, it should be used to prove that the current monetary system is nothing more than the emperor's new clothes. Money is just a spiritual symbol. The sooner ordinary people realize that everything is fictional, the more they can break away from the physical banknotes issued by the government and embrace pure decentralized digital currencies. They are actually fictional. In the face of rising energy, food, and housing costs, which currency can maintain your purchasing power? Which belief system is not exclusive? Which belief system will you participate in building?

 

Dogecoin is a blessing from heaven, long live the lovely Dogecoin!

Face your fears

 

My concern is simple, that is, I am worried that the global central bank will slow down its balance sheet expansion. Without this condition, the basis for the continuous doubling of cryptocurrency prices will be gone. When prices are no longer distorted, traditional financial analysis such as cash flow statements will take over.

 

None of the fears I mentioned in this article are specific to a particular cryptocurrency. I classify them as the same asset class, just like stocks, real estate, and commodities, which will rise as the amount of money printed increases. Face your fears and then find a suitable target to invest in to outperform inflation. As Chuck Prince, former president of Citigroup, said, "When the music stops, the liquidity problem will become very complicated," but he further said, "But as long as the music doesn't stop, you have to keep dancing."

 

Don't be afraid to be the last person to dance, everyone can take advantage of the wealth of cryptocurrency.

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