Arthur Hayes, co-founder and former CEO of BitMEX, published a rehearsal titled “Persistent Weak Layer” on October 16, where it examines the potential impact of escalating tensions between Israel and Iran on crypto markets. Drawing an analogy with avalanche science, Hayes explores how the geopolitical situation in the Middle East could act as a “persistent weak layer” (PWL) that could trigger significant financial market upheavals, affecting Bitcoin and cryptocurrency prices.
How will the crypto market react?
Hayes begins the essay by recounting his recent ski trip, stating. “One of the scariest conditions is a persistent weak layer (PWL), which can trigger a persistent slab avalanche when subjected to stress. He compares this to the geopolitical situation in the post-World War II Middle East, suggesting that it serves as a PWL upon which the modern global order rests.
“The trigger usually has something to do with Israel,” notes Hayes. He stresses that financial markets’ main concern is how energy prices will respond, the impact on global supply chains and the potential for a nuclear exchange if hostilities between Israel and another Middle Eastern nation, especially Iran or the its representatives, increase.
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Hayes describes two scenarios. In the first, the Israel-Iran conflict is reduced to minor military actions, tit for tat. “Israel continues to murder people and decapitate dicks, and the Iranian response consists of telegraphed, non-threatening missile attacks,” he describes bluntly. No critical infrastructure is destroyed and there are no nuclear attacks; therefore, the PWL is valid. In the second scenario, the conflict escalates dramatically, culminating in the destruction of the Middle East’s oil infrastructure, the closure of the Strait of Hormuz or a nuclear attack, leading to the failure of the PWL and causing an “avalanche in the financial markets”.
Expressing his concerns, Hayes states: “War cannot be invested, as they say.” He faces a strategic choice regarding his investment portfolio: continue to convert fiat currency into crypto or reduce his exposure to crypto in favor of cash or US Treasury bonds. “I don’t want to be underallocated if this is truly the start of the next leg up in the crypto bull market,” he explains. “Still, I also don’t want to incinerate capital if Bitcoin drops 50% in one day because Israel/Iran triggered a persistent avalanche in financial markets. Forget Bitcoin; always recovers; I’m more worried about some of the dog shit I have in my portfolio…meme coins.”
Buy or sell now?
To navigate this dilemma, Hayes conducts a scenario analysis focusing on how the second, more severe scenario could impact crypto markets, particularly Bitcoin, which he refers to as the “crypto reserve asset.” It considers three main risks: physical destruction of Bitcoin mining platforms, a dramatic increase in energy prices and monetary implications resulting from the conflict.
Regarding the physical destruction of mining infrastructure, Hayes identifies Iran as the only Middle Eastern country with notable Bitcoin mining operations, accounting for up to 7% of the global hash rate. Reflecting on the 2021 scenario, when China banned Bitcoin mininghe concludes that even the complete elimination of Iranian mining capacity would have a negligible impact on the Bitcoin network and its price.
Addressing the risk of a dramatic rise in energy prices, Hayes considers the potential consequences if Iran retaliated by destroying major oil and natural gas fields or closing the Strait of Hormuz. Such actions would send oil prices soaring, increasing energy costs worldwide. Hayes argues that this scenario would actually increase the value of Bitcoin in fiat terms. “Bitcoin is energy stored in digital format. Therefore, if energy prices rise, Bitcoin will be worth more in terms of fiat currency”, he explains.
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He draws historical parallels with the oil shocks of the 1970s. During the 1973 Arab oil embargo and the 1979 Iranian Revolution, oil prices rose significantly. “Oil rose 412% and gold almost matched its 380% rise,” highlights Hayes. It illustrates that although gold has maintained its purchasing power relative to oil, stocks have lost substantial value when compared to energy prices. Hayes suggests that Bitcoin, as a form of “hard money,” would similarly preserve its value or even appreciate in relation to rising energy costs.
Lastly, Hayes examines the monetary implications, particularly how the United States might respond financially to the conflict. He emphasizes that US support for Israel involves the supply of weapons, financed through increased government borrowing rather than savings. “The US government buys goods on credit and not from savings”, he highlights, referring to data that show that US national net savings are negative. He questions who will buy this debt and indicates that the Federal Reserve and the US commercial banking system would likely intervene, effectively expanding their balance sheets and printing more money.
Hayes notes historical cases in which negative national savings corresponded to sharp increases in the Federal Reserve’s balance sheet, such as after the 2008 Global Financial Crisis and during the COVID-19 pandemic. “The Fed and the US commercial banking system will buy this debt by printing money and increasing their balance sheets,” he says. He suggests that this monetary inflation would significantly increase the price of Bitcoin. “Bitcoin outperformed the Fed’s balance sheet increase by 25,000%,” emphasizes Hayes, indicating Bitcoin’s strong performance in relation to monetary base expansion.
However, it warns investors about the potential for intense price volatility and uneven performance among different crypto assets. “Just because Bitcoin will rise over time doesn’t mean there won’t be intense price volatility, nor does it mean all shitcoins will share the glory,” he warns.
Hayes reveals that he invested in several meme coins, but drastically reduced those positions after Iran launched missile attacks. “When Iran launched its latest missile barrage against Israel, I drastically reduced those positions. My size was too big, given the unpredictability of how crypto assets will react to increased hostilities in the short term,” he admits. He currently only owns one meme coin, noting: “The only meme coin I own is the Church of the Smoking Chicken Fish (symbol: SCF). R’amen.”
At press time, BTC traded at $66,907.
Featured image created with DALL.E, chart from TradingView.com