Author: Arthur Hayes, Medium; Translated by: Song Xue, Golden Finance
From a healthcare perspective, the last moments of life are the most expensive. We are willing to spend unlimited amounts of money on any advertised cure to prevent the inevitable. Likewise, the elites in charge of Pax Americana and their minions are willing to preserve the current world order at all costs because they benefit most from its existence. But Pax Americana has been dying ever since 2008, when shady mortgages issued to bankrupt Americans triggered a severe global economic crisis. What is the medicine prescribed by the medieval neo-Keynesian barbers, led blindly by Ben Bernanke? The same basic cure that always is for dying empires…money printing presses go.
The Empire and its European, Chinese and Japanese vassals, strategic rivals and allies print money to solve different symptoms of the same problem. The problem is a deeply unbalanced global economic and political architecture. The United States, led by the Federal Reserve (Fed), prints money and buys U.S. government bonds and mortgages. Europe, led by the European Central Bank (ECB), prints money and buys euro member government bonds to maintain a flawed monetary union (not a fiscal union). China, led by the People's Bank of China, requires the banking system to lend to industrial companies that overbuild apartments, steel mills and other large infrastructure projects. China has built so much useless capacity that it has launched the Belt and Road Initiative to export these products to developing countries that are desperate for capital investment. Japan, led by the Bank of Japan (BOJ), continues to print money in an attempt to create the phantom inflation that disappeared after the 1989 real estate crash.
The result of this reckless money printing is an accelerating rise in the ratio of global debt to GDP. Global interest rates have fallen to their lowest level in 5,000 years. Nearly $20 trillion in corporate and government bonds have negative yields at their peak. Since interest is compensation for the time value of money, if interest is negative, does that mean time is no longer valuable?
Thanks to Danielle DiMartino Booth of Quill Intelligence for this chart. As you can see, in response to the 2008 Global Financial Crisis (GFC), interest rates were pushed to 5,000-year lows.
This is a Bloomberg index of the total amount of negative yielding debt in the world. It went from nothing before the 2008 global financial crisis to a high of $17.76 trillion in 2020. This is the result of central banks around the world cutting interest rates to 0% and below.
Most of the world’s population does not have enough financial assets to benefit from the global debasement of fiat currencies. There is inflation on all kinds of commodities around the world. Remember the Arab Spring in 2011? Remember when a piece of avocado toast cost less than $20 in major financial centers around the world? Remember when a middle-income family could afford a moderately priced home without turning to the bank of mom and dad for handouts?
The only way out is to own a little gold. But actually owning gold is impractical. It is heavy and difficult to hide from greedy governments in large quantities. As a result, people just eat their humble pie so that the elites can continue to party in Davos like it’s 2007.
But like a lotus flower blooming in the mud, Satoshi Nakamoto indulged a morally, politically, and economically bankrupt empire while publishing the Bitcoin white paper. The white paper proposed a system by which people could use networked machines and cryptographic proofs to separate money from the state in a way that scaled globally for the first time in human history. I say “globally scalable” because Bitcoin is not measured by weight. Whether you hold 1 satoshi or 1 million Bitcoins, the weight is the same. In addition, you can protect your Bitcoins by remembering the mnemonic phrase that unlocks your Bitcoin wallet. Bitcoin provides a complete financial system for everyone.
People have finally found a way to escape the global fiat currency debasement binge. However, Bitcoin is too immature to provide a reliable escape valve for loyal users after the 2008 financial crisis. Bitcoin, and the entire cryptocurrency market, must increase the number of users and prove that they can withstand severe crises.
We the faithful were severely tested in 2022. The Fed and most of the world’s central banks followed suit and began a journey to tighten financial conditions at the fastest pace since the 1980s. The Pax Americana banking system and debt markets could not withstand the Fed’s attack. In March 2023, three US banks (Silvergate, Silicon Valley Bank, and Signature Bank) failed within two weeks of each other. If US Treasury and mortgage-backed securities holdings were marked to market, the US banking system was and remains insolvent. As a result, US Treasury Secretary Bad Gurl Yellen created the Bank Term Funding Program (BTFP) as a secret way to bail out the entire US banking system.
Cryptocurrency was not immune to the disruption caused by high and rising interest rates. Centralized lenders like BlockFi, Celsius, and Genesis all went bankrupt as loans to over-leveraged trading firms like Three Arrows Capital went bye-bye. Terra Luna, a stablecoin pegged to the US dollar, also went bankrupt due to a drop in the price of Luna, the governance token that backed the issued UST stablecoin. This event wiped out over $40 billion in value from fugazi in two days. Then centralized exchanges began to fail, with FTX being the largest. FTX, run by “correct” American-style peaceful white guy Sam Bankman-Fried, stole over $10 billion worth of customer funds and his scam was revealed as crypto asset prices plummeted.
What happened to Bitcoin, Ethereum, and DeFi projects like Uniswap, Compound, Aave, GMX, dYdX, etc.? Did they falter? Did they call home and get bailed out by crypto central banks? Absolutely not. Overleveraged positions were liquidated. Prices dropped. People lost a lot of money. Centralized companies ceased to exist. But Bitcoin blocks are still being mined every 10 minutes on average. DeFi platforms themselves did not go bankrupt. In short, there was no bailout because crypto cannot be bailed out. We took the hit and kept on going.
In the afterglow of 2023, it became clear that Pax Americana and its vassals could not continue to tighten monetary policy. Doing so would bankrupt the entire system because the leverage and debt burdens were too high. As long-term U.S. Treasury yields began to staircase higher, a strange thing happened. Bitcoin and cryptocurrencies rose while bond prices fell.
Bitcoin (white) and the U.S. 10-year Treasury yield (yellow)
As you can see in the chart above, when interest rates rise, Bitcoin behaves like every other long-term asset…it falls.
After BTFP, the relationship shifted. Bitcoin rose with yields. Rising yields, especially in a bear market steep way, show that investors don't trust "the system". In response, they are selling the empire's safest government bonds - US Treasuries. These funds have mainly flowed into the seven major AI tech stocks (Apple, Alphabet, Microsoft, Amazon, Meta, Tesla, Nvidia), and a small part has flowed into cryptocurrencies. Nearly 15 years later, Bitcoin has finally shown its true face as "the people's currency" and not just another risky asset derivative of the empire. This poses a very difficult problem for TradFi.
Capital must stay within the system to eliminate the massive amount of unproductive debt through inflation. Bitcoin is outside the system and now exhibits zero to slightly negative correlation with bonds (remember, when yields rise, bond prices fall). If bond vigilantes express their displeasure with government bonds by selling them and buying Bitcoin and other cryptocurrencies, the global financial system will collapse. It collapses because the inherent losses incurred within the system are finally realized, and large financial companies and governments will have to shrink dramatically.
To avoid this liquidation, the elites must financialize Bitcoin by creating highly liquid exchange-traded funds (ETFs). This is the same trick they played on the gold market when the SEC approved ETFs such as SPDR GLD in 2004 that allegedly held gold bars in vaults around the world. If all the capital looking to escape the collapse of the global government bond market buys a Bitcoin ETF managed by a large TradFi company such as Blackrock, then that capital remains safely within the system.
As it became apparent that the Fed and all other major central banks would have to turn to money printing again in order to protect global bond markets, BlackRock formally applied for a Bitcoin ETF in June 2023. Spot Bitcoin ETFs are approved in the United States. However, in 2023, the US SEC appears to have finally accepted such an application. I present the following to highlight the oddity of current events surrounding the ETF approval process. The Winklevoss’ applied for a spot Bitcoin ETF in 2013, but the SEC rejected their application for more than a decade. BlackRock applied and was approved within six months. Something that makes you go “hmm.”
The Spot Bitcoin ETF is a traded product. You buy it with fiat to earn more fiat. It is not Bitcoin. It is not a path to financial freedom. It is not outside the TradFi system. If you want to escape, you have to buy Bitcoin, withdraw it from an exchange, and self-custody it.
I wrote this lengthy preface to explain “Why now?” Why is a spot Bitcoin ETF finally being approved at this critical time for the Empire and its financial system? I hope you can appreciate the significance of this development. The global bond market is estimated at $133 trillion; imagine the inflows into Bitcoin ETFs if bond prices continue to fall, even as the Fed may begin cutting rates in March. If inflation bottoms out and resumes moving higher, bond prices may continue to fall. Remember, wars cause inflation, and there are certainly wars going on in the periphery of the Empire.
Also, don’t forget that China will launch exact copies of US-listed ETFs in Hong Kong financial markets to capture Chinese and Asia-Pacific flows. Pax Americana leads, her friends and foes will follow.
The rest of this article will discuss the market impact of a spot Bitcoin ETF. I will only focus on the BlackRock ETF because BlackRock is the largest asset manager in the world. They have the best ETF distribution platform in the world. They can sell to family offices, retail financial advisory firms, retirement and pension plans, sovereign wealth funds and even central banks. All other companies will try their best, but the BlackRock ETF will be the undisputed winner in terms of assets under management (AUM). Whether this prediction is correct or not, the following strategy will work if any issuer's ETF has significant trading volume.
This article will discuss the following and how the inner workings of ETFs can create amazing trading opportunities for those who can trade in TradFi and the cryptocurrency markets:
- Creation and redemption process;
- Spot exchange arbitrage and transaction time series analysis;
- ETF derivatives, such as listed options;
- Impact of ETF financing transactions
With all that out of the way, let’s make some money!
Cash rules everything around me
Already resolved. Inflows (creations) and outflows (redemptions) can only be made using cash. The most concerning aspect of this ETF is that it allows people to purchase the ETF with fiat currency and choose to redeem the ETF in physical form in exchange for Bitcoin. The purpose of this product is to store fiat currency, not to provide an easy way to buy physical Bitcoin with a retirement account.
create
To create ETF shares, an Authorized Participant (AP) must send the dollar value of the creation basket (i.e., a certain number of ETF shares) to the fund by a certain time each day.
AP is a large TradFi trading firm. A who’s who of TradFi vampire cephalopods have signed on to be APs for various ETF issues. Companies like Jamie Dimon, the CEO of JPMorgan Chase, who has called on governments to ban cryptocurrencies, will be involved. Surprised me ;).
example:
Each share of the ETF is worth 0.001 BTC. The creation basket is 10,000 shares; as of 4pm ET, those bitcoins are worth $1,000,000. AP must wire the money to the fund. The fund will then instruct its counterparty to buy 10 bitcoins. Once the bitcoins are purchased, the fund credits the ETF shares to AP.
1 basket = 0.001 BTC * 10,000 shares = 10 BTC
10 Bitcoin * $100,000 BTC/USD = $1,000,000
redemption
To redeem ETF units, AP must send the ETF shares to the fund by 4pm ET. The fund will then instruct its counterparty to sell 10 bitcoins. Once the bitcoins are sold, the fund will deposit $1,000,000 with AP.
1 basket = 0.001 BTC * 10,000 shares = 10 BTC
10 Bitcoin * $100,000 BTC/USD = $1,000,000
For us traders, what we want to know is where Bitcoin must be traded. Of course, the counterparties that help the fund buy and sell Bitcoin can trade in any venue they like, but in order to reduce slippage, they must match the fund's net asset value (NAV).
The fund's NAV is based on the BTC/USD price at 4pm EST on CF Benchmark. CF Benchmark receives prices from Bitstamp, Coinbase, itBit, Kraken, Gemini, and LMAX between 3pm and 4pm EST. Any trader who wishes to perfectly match the NAV by taking minimal execution risk will trade directly on all of these exchanges.
Bitcoin is a global market and price discovery is dominated by Binance (I guess headquartered in Abu Dhabi). Another large Asian exchange excluded from the CF benchmark is OKX. For the first time in a long time, the Bitcoin market will have predictable and persistent arbitrage opportunities. Hopefully, billions of dollars in flows will be concentrated within an hour on exchanges with lower liquidity and prices following their larger Eastern competitors. I expect there will be plenty of spot arbitrage opportunities.
Obviously, if ETFs are wildly successful, price discovery could shift from East to West. But don’t forget Hong Kong and its copycat ETF products. Hong Kong will only allow its listed ETFs to trade on Hong Kong-regulated exchanges. Binance and OKX may serve this market. But new exchanges will be established to serve China southbound flows.
No matter what happens in New York and Hong Kong, neither city will allow fund managers to trade Bitcoin at the best price, but they may only be able to trade it on "selected" exchanges. This unnatural state of competition will only create more market inefficiencies that we as arbitrageurs can profit from.
Here is a simple arbitrage example:
Average Daily Volume (ADV) = (Exchange CF Benchmark Weight * Daily Market Close (MOC) USD Notional) / CF Benchmark Exchange USD ADV
Choose the least liquid exchange in CF Benchmark, i.e. the exchange with the highest ADV days. If the pressure is on the buy side, the Bitcoin price on CF Benchmark exchange will be higher than Binance. If the pressure is on the sell side, the Bitcoin price on CF Benchmark exchange will be lower than Binance. Then you sell Bitcoin on the expensive exchange and buy it on the cheaper exchange. You can estimate the direction of the creation/redemption flow by the premium or discount at which the ETF trades relative to its intraday net asset value (INAV). If the ETF is at a premium, there is creation flow. AP sells short the ETF at a high price and creates the ETF at a cheaper NAV. If the ETF is at a discount, there is redemption flow. AP buys the ETF at a low price in the secondary market and redeems it at a higher NAV.
To trade this in a price neutral manner, you need to have both USD and BTC on both the CF Benchmark exchange and Binance. However, as a risk neutral arbitrage trader, your Bitcoin needs to be hedged. To do this, buy Bitcoin with USD and short the BitMEX Bitcoin/USD Bitcoin Margin Inverse Perpetual Swap contract. Place some Bitcoin margin on BitMEX and the remaining Bitcoin can be held in a distributed manner on the relevant exchanges.
ETF Options
To really make the ETF casino work, we need leveraged derivatives. The zero-day option (0DTE) market in the US has exploded. Options that expire in one day are akin to a lottery ticket, especially when you buy them out-of-the-money (OTM). 0DTE options are currently the most traded options instrument in the US.
After the ETF has been listed for a while, listed options will start to appear on U.S. exchanges. Now the real fun begins.
It's hard to get 100x leverage in TradFi. They don't have a place like BitMEX that can solve the problem. But OTM options with short expiration dates have very low premiums, which creates high leverage or leverage ratios. To understand why, brush up on your theoretical options pricing knowledge by studying the Black-Scholes theory.
Degen traders with brokerage accounts that can trade on U.S. options exchanges will now have a liquid way to make highly leveraged bets on the price of Bitcoin. The underlying of these options will be ETFs.
Here is a simple example.
ETF = 0.001 BTC per share
BTC/USD = $100,000
ETF share price = $100
You think the price of Bitcoin will increase by 25% by the end of the week, so you buy a $125 strike call option. The option is out-of-the-money because the current ETF price is 25% below the current strike price. Volatility is high, but not extremely high, so the premium is relatively low at $1. The most you can lose is $1, and if the option goes in-the-money soon (over $125), you can make more profit through the change in the option premium, while if you had just bought the option, you could have made a 25% profit. This is a very crude way to explain gearing.
With these new highly leveraged ETF options products, the US market degenerates are going to screw something up in terms of Bitcoin’s implied volatility and forward structure.
Forward Arbitrage
Call — Put = Long Forward
As lottery buyers cause ETF options prices to rise, the price of at-the-money (ATM) forward contracts will also rise. This provides an opportunity to arbitrage between Bitcoin/USD perpetual contracts on exchanges such as BitMEX and ATM forward contracts derived from ETF options prices.
Futures basis = futures price - spot price
I expect the ETF ATM forward basis to trade at a premium to the BitMEX futures basis. Here’s how you can trade it.
Go short on the ETF ATM forward by selling the ATM call and buying the ATM put.
Go long a BitMEX Bitcoin/USD fixed expiry futures contract with a similar expiry date.
Wait for prices to converge closer to expiration. This will not be a perfect arbitrage because BitMEX and the ETF use different exchange prices to construct the spot index price of Bitcoin.
Volatility (Vol) Arbitrage
To a large extent, when you trade options, you trade volume. The types of ETF options traders and their preferences for expiration dates and strike prices are different from the traders currently trading Bitcoin options on non-US cryptocurrency exchanges. I predict that ETF options volume will dominate global Bitcoin options flows. Since the two groups of traders, US and non-US, cannot interact on the same exchanges, arbitrage opportunities will emerge.
A direct arbitrage opportunity exists when options with the same maturity and strike price trade at different prices. There will also be more general volatility arbitrage opportunities, where the volatility surface of some ETF options differs significantly from the Bitcoin volatility surface outside the United States.
MOC Process
The 4pm print of the CF Benchmark will be important as the ETF will cause a surge in trading volume in US listed ETF derivatives. Derivatives derive their value from the underlying asset. Billions of notional options and futures will expire every day compared to the closing trading price of the ETF, so matching the net asset value is critical.
This will produce statistically significant trading behavior at and around 4pm ET compared to the rest of the trading day. Those who are good with the dataset and have a good trading bot will make a lot of money by arbitrage these inefficiencies.
ETF Financing (Creating Loans)
Centralized lending platforms like Blockfi, Celsius, and Genesis are extremely popular with Bitcoin holders who want to borrow fiat against Bitcoin. Sadly, the dream of an end-to-end Bitcoin economy has yet to be realized. Believers still need fiat to pay for necessities using their dirty fiat.
All of the centralized lenders I just mentioned are bankrupt, along with many others. It is more difficult and expensive to borrow fiat using Bitcoin as collateral. TradFi is very used to lending against liquid ETFs. Now you can get a competitively priced, large fiat loan as long as you stake your Bitcoin ETF shares. For those who believe in financial freedom, the problem is maintaining control of Bitcoin and taking advantage of this cheaper capital.
The solution to this problem is to trade Bitcoin for ETFs. Here’s how it works.
APs that can borrow in the interbank market will create ETF shares and hedge the Bitcoin/USD price risk. This is what creates the lending business. In Delta-One's words, it is the buyback value of the ETF shares.
Here is the flow:
1. Borrow USD in the interbank market and create ETF shares in cash.
2. Sell the ETF’s ATM call option and buy the ETF’s ATM put option to create a short synthetic forward.
3. The act of creating ETF units creates a positive carry, i.e. forward basis > interbank USD rate.
4. Lend ETF shares in exchange for Bitcoin collateral.
Let's ask Chad to talk about what he needs to do with his Bitcoin.
Chad is a holder with 10 BTC who needs to pay his AMEX bill in USD. The price of those bottles of bubbly in the club is too expensive. Chad hooks up with his son Jerome, a dodgy French guy at SocGen who used to be a major financial middle office puppet who worked in active futures trading for a while but got back to work (you can’t fire anyone in France) and now runs the crypto trading desk. Chad asks Jerome for a 30-day BTC to ETF swap. Jerome quotes him -0.1%. This means Chad will exchange 10 BTC for 10,000 shares of the ETF, assuming each share is worth 0.001 BTC, and after 30 days Chad will get back 9.99 BTC.
During the 30 days that Chad owns 10,000 shares of the ETF instead of 10 BTC, he pledges his ETF shares to borrow USD from TradFi stockbroker at a very cheap rate.
Everybody is happy. Chad can continue to be a player at the club without having to sell his Bitcoin. Jerome takes a financing spread.
ETF financing business will become extremely important and impact Bitcoin rates. As this market develops, I will focus on attractive ETF, physical Bitcoin and Bitcoin derivative financing transactions.
Summarize
In order for these trading opportunities to persist for long enough and allow arbitrageurs to execute them at sufficient scale, the Bitcoin spot ETF complex must trade billions of dollars worth of shares every day. On Friday, January 12, total daily volume reached $3.1 billion. This is very encouraging, and as fund managers begin to activate their vast global distribution networks, trading volumes will only increase. By trading the financial version of Bitcoin through a liquid method within the TradFi system, money managers will be able to escape the terrible returns that bonds bring in the current global inflationary environment.
We are in the early stages of a transition from a period of persistent global inflation. While there's a lot of noise, over time it becomes clear to managers managing stock-bond correlations that things have changed. With interest rates at zero, bonds no longer play a role in investment portfolios, and even more so with ongoing inflation. The markets will slowly wake up to this and a hasty exit from the $100 trillion+ bond market will destroy the country. These managers must then find another asset class that does not have a significant correlation with stocks or any of the TradFi asset classes. Bitcoin achieves this.
