From CoinShares Research Blog by Christopher Bendiksen

Part 2

I spent Part 1 of this series setting the stage for and constructing my thesis, namely that the combination of stablecoins and bitcoin are a threat to emerging market currencies. Then, at the very end, I had to confess that actually, I believe it’s not only weak emerging market currencies that are threatened, it is all mismanaged fiat currencies. In this part, I will lay out what I think the effect of this might end up looking like in practice.

Let’s briefly recap the mechanism. In short, my argument is that the availability of stablecoins on simple smartphones (or even ‘dumb’ phones) makes the enforcement of import restrictions on harder currencies into weak currency jurisdictions expensive to the point of being unworkable in practice. Nothing short of a China-style total surveillance state will do it, and I think this is just simply beyond the competence of most emerging market states, and beyond the realistic cost, (democratic and fiscal) of most ‘advanced democracies’.

As a result, the availability of US dollars will be dramatically increased across the world, leading to increased rates of de facto dollarisation (see Part 1, and its linked piece) — first in the weakest currencies, but then over time, in every currency substantially weaker than the dollar.

America Gets (Even) Fatter and Weaker from the Dollar Milkshake

Unsurprisingly, the first effect of this mechanism is the expansion of the dollar into the various global economies plagued by weak fiat currencies. As mentioned, this will tend to happen first in poorly managed emerging market countries. Over time however, even after its recent geopolitically-driven contraction (think sovereigns reducing their dollar balances due to the confiscation of Russian reserves), I believe individuals demanding stablecoins will start expanding the dollar network effect again, again increasing its attractive force in global monetary markets.

I should interject here that I don’t necessarily believe the mechanism I’m describing will have a huge impact on treasury markets as a whole given its enormous size. It will merely be an added effect to the already immensely complicated interplay of geopolitical games played around the US dollar. But I do think it will happen gradually in the short- to medium term. Given the tacit acceptance of Tether by the US government, and the straight up confession by former Speaker of the House Paul Ryan of the beneficial role stablecoins can play in assuaging current US debt problems, it’s clear that the US government is already aware of the benefits that can be had. The interesting question is really if it’s enough to ‘tip the scales’, so to speak, in the giant-sized Treasury markets.

A lot of people already know the core of this thesis as The Dollar Milkshake Theory, and I believe that its full consummation will be brought about by the unparalleled dollar access offered by stablecoins on mobile phones. New demand for cryptodollars means new demand for treasuries and herein, the US Government will find a new untapped market into which I believe it will sell as many dollars as it can. If they don’t, and demand outpaces supply, the value of the US dollar might increase to the point where it causes problems for the US export industry, and so I basically consider the government’s hands more or less tied on the matter.

The problem is that in the long run, bingeing on milkshakes makes you fat and weak, and this is exactly what I think will continue to plague the US. Instead of facing the necessary (and inevitable) reckoning, reshoring its industries and reconstituting a productive middle class, I believe the US will succumb to even more and seemingly endless deficit spending, essentially financing bread and circuses with its newfound demand for Treasuries.

Manufacturing will continue its current path of atrophy, reducing national productivity and making the US even more reliant on the financial sector for GDP growth and tax income. I believe that this trend will continue until the dollar has eaten up much of the available global monetary market, meaning, most of Africa and South America, as well as much of Asia minus China.

Falling isn’t Flying

The increased demand for US dollars driven by stablecoins will present the US with the illusion that Everything is Fine™. Faith in the US economy will appear strong, even though what’s actually happening is simply a flight from terrible fiat currencies into a less terrible one. As the US dollar continues to swallow up global M2 demand, I believe two things will happen that will be critical to my thesis:

This is where the real danger to the US dollar starts to manifest. Having already eaten up most global monetary demand, the US dollar will at this point be more or less the only fiat game in town. In my opinion, the only other realistic fiat survivors with any appreciable size will be the likes of the Yuan, Euro, Yen etc. But I believe they will all be rather small and globally insignificant compared to the dollar at this point. The market for stablecoins is already almost entirely skewed towards the dollar, and it’s hard to see any other fiat currency catching up at this point.

In other words, there won’t be much more M2 demand to eat up at that point, as the remaining fiat currencies out there will be both comparatively small, and well defended by competent states and central banks. It is hard to imagine that the US economy can grow at the same rate of the additional global demand for dollars, not even considering its current unsustainable fiscal path. The US debt to GDP will therefore only get worse, with all the fiscal pitfalls and practical central bank policy restrictions this generates.

Having probably done nothing to shore up its fiscal position, more likely the opposite, the US will at this point face the inevitable reckoning in one of two ways: default or war. There is of course also a third way, that is massively shrinking the state and/or raising taxes, but we all know this is, at least currently, completely politically infeasible.

Traditional ‘Default’ is Politically Unacceptable for the US, so Monetary Repression will Have to at Least be Attempted

I don’t want to deal with the war scenario be it either civil, regional or global, so let’s concentrate on the default scenario. I think the crowd waiting for a ‘traditional’ US default will eventually be right, but that the path that takes us there might be weird and unexpected. The optics of a ‘proper’ default are simply unacceptable, and so in order to handle their debt issues I believe the US government will attempt some good old fashioned monetary repression.

Let’s be clear what I mean with that: I mean negative real interest rates, over a long enough time that government debt levels can be materially reduced. I suspect this will be done via relatively low interest rates (so as to not immediately bankrupt the state, and without causing obvious recessions), coupled with moderate to high real price inflation. In order to make this palatable, they will keep tweaking CPI to retain and even improve its ability to gaslight the population into believing price inflation is not as bad as it actually is.

A lucky tailwind of AI-driven productivity improvements will help this strategy, enabling monetary inflation to significantly outpace price inflation. In fact, over a decade or so, this could have actually succeeded… if it weren’t for the fact that this time around, the US dollar will run into the same exact problem it was previously causing for its weaker fiat competitors — the easy availability of alternatives.

A Swiss Bank Account — with Hard Money — in Everyone’s Pocket

Barack Obama once referred to cryptographically secured systems such as Bitcoin as “a Swiss bank account in your pocket”. He obviously meant this from the problematic point of view of the state, that is, one of a fundamental inability to censor, confiscate, or even view its contents. But the description is apt, and the benefits of these technologies for regular people will be so great that they will obviously want to have it.

It will probably take years, perhaps even decades, for this thesis to play out. Most people will by then have discovered these beneficial properties of bitcoin. Having used stablecoins for years and being completely comfortable with crypto rails in general, bitcoin will not be some weird foreign concept to most stablecoin users — and remember, more than half of all people in the world are under 30, and 90% of them live in emerging markets — it will simply be another familiar asset they’ve grown up with.

The trend of holding bitcoin for savings and stablecoins for spending will probably start growing organically, already well in advance of this multi-year (or even decade) thesis playing out. Indeed our research suggests it’s already well underway. But a key effect of its idea already starting to disseminate throughout the world is that, just as we found in our investigation of competing hard monies in historical instances of fiat collapse, effective monetary repression in the age where hard monies are instantly available via smartphone — and information flows faster and more freely than ever — will simply be impossible.

To quote ECB president Christine Lagarde: “If there is an escape, that escape will be used”. I think that is exactly right. As soon as people see that, over time, even holding dollars for anything other than immediate spending is a losing proposition, the game of large debt-financed deficits is over. People will prefer saving in a harder currency, dollar velocity will start rising, and its exchange rate against the harder money (or monies, if there are others too) will fall. This is the point at which I believe bitcoin will capture the most market share in monetary markets in the shortest amount of time.

For holders of both US debt and US dollars this is of course not a great scenario. Since monetary repression won’t work, the value of the dollar and the debt denominated in it, will have to be repriced downwards until it reaches a level where the US government is solvent again. What these numbers will look like is for people smarter than me to figure out. All I know is that I’d prefer to be minimally exposed to that, and rather own scarce assets.

And Wouldn’t You Know it, It’s all Already Happening

We don’t have to look very far for examples of the thesis already playing out. Some notable countries with significant stablecoin uptake on the back of miserable local currencies are Turkey, Argentina, Venezuela and Nigeria. But to me, the biggest giveaways of the real impact offered by bitcoin and stablecoins are to be found in the government reactions to them. To illustrate this, I’ll offer two particularly interesting examples.

My first example comes from Russia, where the government is quite experienced, and dare I say

savvy, at rinsing their citizenry. Russian government antagonism towards all things crypto is not at all new but the recently announced “blanket ban on the general circulation of cryptocurrency assets” is particularly revealing in its content.

Here, the Russian government plans to ban all crypto transactions — for the citizenry, mind you, not the government. That’s right, the ban will only affect regular citizens. Any transaction involving the central bank (and interestingly, any miner) will be exempt. In other words, the Russian government is keenly aware of the dangers of letting its citizens wield the monetary powers of bitcoin, and they are also quite keenly aware that they want to retain those powers for themselves.

The second example is that of Nigeria, whose government has been on a multi-month journey to attempt ridding the country of anything that smells of monetary freedom, culminating in its recent decision to ban p2p trading. I find this recent example particularly telling because the Nigerian government has been so perfectly clear about what they believe the problem is. In this article by the Financial Times, Bayo Onanuga — a special advisor to President Bola Tinubu — is paraphrased saying “Binance was ‘blatantly’ setting the exchange rate for Nigeria and hijacking the central bank’s role as the currency rate setter”.

It doesn’t get much clearer than that: Stablecoins on crypto rails are unacceptable, even dangerous, because they create a true market price for the imploding Naira, preventing the Nigerian government from confiscating the wealth of its citizens via inflation.

The Dollar ‘Reckoning’ Could be Quite Boring in the End

Unlike a lot of other people in the Bitcoin space, I don’t necessarily think the natural outcome of the thesis is ‘hyperbitcoinisation’ or something of the sort where all fiat currencies all spectacularly collapse in the face of bitcoin. At least not for a long time.

I think it’s just as likely that it all simply means a forced return to well-managed national currencies, with some level of convertibility to bitcoin and/or gold. It will also likely mean a large reduction in the number of countries that will bother issuing a national currency at all since it in most cases will no longer come with the privilege of seigniorage, only the privilege of surveillance (at least for now).

This is also why I find it unlikely that bitcoin will ever eat up all global monetary demand. I do however believe that once this mechanism plays itself out — however long that will take, probably decades — bitcoin will end up capturing most of global monetary demand. A scenario like that is what we describe in our TAM valuation of bitcoin. It is an interesting prospect, and I think the above thesis describes a way in which bitcoin might end up eating up the lion’s share of all global monetary demand, over time.

For our investors, the most interesting and obvious outcome, of course, is a total bitcoin value capture substantially higher than current levels.