speculative attack, season 2

the case for the greatest pair trade in history

pierre rochard
& allen farrington

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introduction

Ten years ago today, present coauthor Pierre Rochard published Speculative Attack, on the Nakamoto Institute website. Speculative Attack lays out the case that the economic rationale to borrow fiat in order to buy Bitcoin is so overwhelmingly favorable that it is inevitable that this will drive up the price over the long term. The rise could arguably only ever be limited by the spread of information about what Bitcoin even is, and why it has properties inviting such a speculative attack in the first place. The price drives news and news drives the price.

Bitcoin was priced at roughly $630 on the day of publication, suggesting a not-too-shabby return of over 100x in dollar terms, or around 158% annualized. Indeed, Bitcoin has been the best performing asset in the world for most of the single intervening years. While these numbers are unlevered, the original argument was that everybody is also levered to some or other degree, when moving beyond financial portfolios and generalizing to include the reality of personal finances: mortgages, student and auto loans, credit card debt, and so on. Any liability a Bitcoiner chooses not to pay down and to buy Bitcoin instead makes this Bitcoiner leveraged. Bitcoiners are speculative attackers.

This calculation becomes increasingly extreme the weaker the local currency. Speculative attacks are compelling enough if using US Dollars as the strong currency, with liabilities denominated in (even more) rapidly devaluing currencies, but the presence of an asset as hard as Bitcoin to pair with such a debt changes the game. The returns figures cited just above are magnified even further if one takes as one’s starting point the Turkish Lira or the Argentinian Peso. In some fiat currencies the return cannot even be meaningfully quoted.

The difference between the Lira and the Dollar is one of degree, not of kind. There is no cap to the number of dollars that will ever exist, and no floor to the pressure to continue creating them to satisfy the credit-fueled financial system their presence necessitates. The degree of difference is solely to be found in how urgently insolvent their respective monetary systems are at a given moment in time, and hence how fast a given fiat is printed to both solve the problem now and cause it in the future. This is the essence of the speculative attack. As Bitcoin strengthens, the demand for fiat credit goes up, more is printed, and the problem Bitcoin solves gets even worse.

season 2

And so, ten years on, it would appear as if the thesis of Speculative Attack was absolutely right – the article may well have suggested, for free, on the Internet, the single greatest pair trade in the history of financial markets. And yet we find ourselves surveying the terrain today, finding a speculative attack to be an even more fundamentally sound trade than it was ten years ago. Sound for the individual considering such exposure, and sound as a prediction of the aggregate of market activity.

There are two clear reasons to believe this. First, fiat is in far worse shape today than it was ten years ago. Debt/GDP ratios globally have marched upwards. Deficits have spiraled. Banks have failed, as have entire financial markets, on occasion. A yet-more-deranged-still version of Chartalism has emerged in academia to explain why all of this is actually a good thing. Roughly one third of all dollars in existence have been printed in the past four years, never mind ten. As usual, the dollar’s reserve currency status means its inflation can largely be exported, and hence weaker currencies are almost all in even worse shape. The list goes on. It becomes clearer and clearer every passing day that none of this can ever be fixed. The necessary political will simply does not exist, and it is unlikely it ever could.

The second reason is perhaps more intriguing: the avenues for attack have widened. Speculative Attack originally focused on the relatively simple “trade” of borrowing in an inflating currency to invest in a harder one. Over the past ten years it has become clear that fiat is utterly out of control in leaking de facto monetary premia into practically every asset class in existence. In other words, there are short dollar positions everywhere, almost all of which are involuntary. More suggestively, there are orders of magnitude more dollar shorts looking for a long than there is Bitcoin looking for a hodler.

El Salvador famously made Bitcoin legal tender in 2021, a moment that will surely be looked back on as pivotal in world history. An apparently less newsworthy component of President Bukele’s strategy has been to accumulate Bitcoin on the country’s balance sheet. As with unpaid mortgages and car loans of individuals, El Salvador has dollar-denominated sovereign bonds. It is borrowing in dollars to buy Bitcoin. El Salvador is a speculative attacker.

Unsurprisingly, these bonds have done extraordinarily well – within the realm of financial performance to be expected from such a supposedly “stable” asset – meaning its credit rating has improved, its interest rate has fallen, and it can borrow even more cheaply, diverting fewer cash flows to covering its cost of capital and more to accumulating Bitcoin.

Or consider MicroStrategy, which has famously pioneered a strategy not only of accumulating a Bitcoin treasury, but of tapping credit and equity markets to accelerate its accumulation. As the price of Bitcoin in dollar terms inevitably rises, MicroStrategy’s leverage and interest coverage becomes healthier, its interest goes down, and it can afford to both buy more Bitcoin and issue more debt. As its stock price rises (equally unsurprising given it is levered to Bitcoin) it can issue more stock and buy more Bitcoin. Its stock has no cap, and neither do the dollars being used to buy it; it is sucking up freshly minted dollars with nowhere better to go and using them to buy Bitcoin. MicroStrategy is a speculative attacker.

Imitators are not far behind, with Semler Scientific and MetaPlanet Inc having copied this playbook to a tee much more recently and seen literally immediate appreciation in capital markets. On a long enough time horizon, we expect the share of equity market participants adopting a similar strategy to trend to 100%. Public Bitcoin mining companies are arguably even more potent and concentrated versions of the same phenomenon. The financial profile of a public miner is effectively to go short equity markets and long local hash rate, the latter of which it is naturally assumed will translate into a long Bitcoin position. Miners are speculative attackers.

Little-known hedge fund Kerrisdale Capital recently got in on this act, angering many Bitcoiners with its supposedly anti-mining commentary, but burying the lede of its “short miners, long bitcoin” pair trade. One can (humorously, but still accurately) recognize the commutative algebra of lining up these pair trades such that Kerrisdale is effectively contributing the final piece to a “short equity markets, long Bitcoin” trade. Hedge funds are speculative attackers.

One might wonder where these dollars come from and why they are looking for assets in the first place? Well, to once again refer to our first point of just how far fiat has deteriorated in the past ten years, perhaps the most startling development is the volume of direct intervention in capital markets and stockpiling of listed securities on the balance sheets of central banks worldwide. This has simply become necessary recently to prevent – or at least forestall – the collapse of the fiat ponzi, such is the leverage forced into every monetizable nook and cranny. 

It is worth reminding oneself that not only have equity, credit, and real estate markets, and beyond, become de facto monetized, but that their monetary premia are dependent on their holders being leveraged. In some sense they are defined this way: the ever-spiraling collapse of fiat has the same dynamics whether Bitcoin is present or not. Securities have monetized in the first place due to asset allocators going long real assets and short the dollar in order to protect themselves from the dollar’s slow-motion collapse.

The conundrum these allocators now face is that Bitcoin is significantly harder than equity, credit or even real estate. “Shorting equity markets” is really betting on the transfer of the monetary premium of equities to something else. And given the leverage supporting the existence of the premium in equities in the first place, this trend cannot fail to be largely self-fulfilling once it gains sufficient momentum. The more central bankers inflate bubbles in each and every asset class under the sun, the more will top-heavily topple into the well of Bitcoin, the only truly scarce asset and the only real money around. Central bankers are speculative attackers.

And while one may be tempted to think of Bitcoin itself as in some sense above all these dirty fiat games, Zen-like in its calm acceptance of eventual yet inevitable acquisition of all monetary premia worldwide, even this is not quite true. Bitcoin is such a pristine asset that its growing value makes it increasingly attractive as collateral against which ever-depreciating fiat can be borrowed. 

Unchained is well-known for popularizing the “bitcoin-backed loan” – an overcollateralized fiat loan, paying healthy interest to the lender, and suffering zero loan losses to date. This has so far been aimed mostly at Bitcoiners looking to realize some of their newfound wealth without having to sell. However, we strongly predict this model will morph into a tool of corporate finance and demonetization arbitrage. Bitcoin holders still (typically) have fiat bills to pay. Capital markets participants engaging in however roundabout of a speculative attack will have a fiat cost of capital to cover. Selling Bitcoin to cover these costs would require forfeiting the expected long term gains, and in the short term would put downwards pressure on the price and be contrary to the overall strategy, however marginally. Whereas the flood of dollars looking for assets is so torrential it will happily find a trade in the mere potential of acquiring Bitcoin in the case of default, all the while having the principal value protected (in dollar terms, at least) by the inevitability of Bitcoin’s monetization.

The only limiting factor on these modalities of speculative attack will be Bitcoin’s (fiat-denominated) price volatility. Those who are too aggressive and reckless in their leverage risk liquidation in the inevitable short-term drawdowns of this rapid monetization. As herd mentality contributes to adoption progressing in waves rather than monotonically, risk management will be key to sustain the attacks.

conclusion

The more mainstream Bitcoin becomes, the more compelling the speculative attack will be. Eventually it will become necessary, and not long after that it will simply cease to be possible, as nobody will trade Bitcoin for any amount of fiat, or even risk its loss in financial calculation. While we are clearly incredibly far along from 2014, we are nowhere near this final state. The slow-motion collapse of fiat continues, and the avenues for directing fiat shorts to Bitcoin longs widen. The speculative attack lives on. Season Two begins.