This article is also available in Spanish.
Arthur Hayes, co-founder and former CEO of BitMEX, published an essay entitled “Persistent Weak Layer” on October 16, in which he examines the potential impact of escalating tensions between Israel and Iran on the crypto market. Using an analogy from avalanche science, Hayes explores how the geopolitical situation in the Middle East could act as a “persistent layer of weakness” (PWL) that might trigger significant financial market volatility, thereby affecting Bitcoin and crypto prices.
How Will the Crypto Market React?
Hayes begins his essay by recounting his recent ski trip, stating. “One of the most frightening conditions is the persistent weak layer (PWL), which can trigger continuous slab avalanches if stress occurs. He likened this to the geopolitical situation of the Middle East after World War II, stating that the Middle East functions as a PWL which is the basis of the modern global order.
“The trigger usually has something to do with Israel,” Hayes said. He emphasized that financial markets’ main concerns are how energy prices will respond, the impact on global supply chains, and the potential for a nuclear exchange if hostilities between Israel and other Middle Eastern countries, particularly Iran or its proxies, escalate.
Related Reading
Hayes outlined two scenarios. Firstly, the Israel-Iran conflict turned into small military actions and mutual revenge. “Israel continues to kill people and behead penises, and Iran’s response is via telegram, non-threatening missile attacks,” he explained bluntly. No critical infrastructure was destroyed, and there was no nuclear attack; thus, PWL applies. In the second scenario, the conflict escalates dramatically, culminating in the destruction of oil infrastructure in the Middle East, the closure of the Strait of Hormuz, or a nuclear attack, leading to the failure of the PWL and causing an “avalanche in financial markets.”
Expressing his concerns, Hayes stated: “War cannot be invested in, as they say.” He faces a strategic choice regarding his investment portfolio: whether to continue converting fiat currency to crypto or reduce crypto exposure in favor of cash or US Treasury bonds. “I don’t want to be under-allocated if this is truly the start of the next bull run in the crypto bull market,” he explained. “Still, I also don’t want to burn capital if Bitcoin drops 50% in a day because Israel/Iran triggers a continuous financial market avalanche. Forget about Bitcoin; it always bounces back; I’m more worried about some of the things I have in my portfolio…meme coins.”
Buy Or Sell Now?
To address this dilemma, Hayes conducted a scenario analysis that focused on how a second, more severe scenario could impact the crypto market, specifically Bitcoin, which he calls a “crypto reserve asset.” He considered three main risks: the physical destruction of Bitcoin mining facilities, a dramatic increase in energy prices, and the monetary implications of the conflict.
Regarding the physical destruction of mining infrastructure, Hayes identified Iran as the only Middle Eastern country with a prominent Bitcoin mining operation, which accounts for up to 7% of the global hash rate. Reflecting on a 2021 scenario where China bans Bitcoin mining, he concludes that the complete removal of Iran’s mining capacity will have little impact on the Bitcoin network and its price.
To address the risk of drastic energy price increases, Hayes considered the potential consequences if Iran retaliates by destroying major oil and natural gas fields or closing the Strait of Hormuz. Actions like these would cause oil prices to soar and increase energy costs globally. Hayes argues that this scenario would actually increase the value of Bitcoin in fiat terms. “Bitcoin is energy stored in digital form. “Therefore, if energy prices rise, Bitcoin will be worth more than fiat currency,” he explained.
Related Reading
He likened history to the oil shocks of the 1970s. During the Arab oil embargo of 1973 and the Iranian Revolution of 1979, oil prices rose significantly. “Oil is up 412%, and gold almost matched its gain of 380%,” Hayes pointed out. He illustrates that while gold maintains its purchasing power relative to oil, stocks lose value when measured by energy prices. Hayes argues that Bitcoin, as a form of “hard money,” will also retain its value or even appreciate compared to rising energy costs.
Finally, Hayes examines the monetary implications, specifically how the United States responded financially to the conflict. He emphasized that US support for Israel involves providing weapons, funded through increased government borrowing, not savings. “The US government buys goods on credit and not from savings,” he highlighted, referring to data showing US national net savings are negative. He questioned who would buy this debt and indicated that the Federal Reserve and the US commercial banking system would likely step in, effectively expanding their balance sheets and printing more money.
Hayes noted historical examples where negative national savings were associated with sharp increases in the Federal Reserve’s balance sheet, such as after the Global Financial Crisis of 2008 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 stressed. He argues that this monetary inflation will increase the price of Bitcoin significantly. “Bitcoin has outperformed the Fed’s balance sheet increase by 25,000%,” Hayes emphasized, pointing to Bitcoin’s strong performance relative to the expansion of the monetary base.
However, he warned investors about the potential for intense price volatility and uneven performance across crypto assets. “Just because Bitcoin will rise over time, doesn’t mean there won’t be intense price volatility, nor does it mean every shitcoin will share in its glory,” he warned.
Hayes revealed that he had invested in several meme coins but reduced his position dramatically after Iran launched a missile attack. “When Iran launched its latest missile attack on Israel, I cut those positions drastically. “My measure is too big, given the uncertainty of how crypto assets will react to increased hostility in the short term,” he admitted. Currently, he only holds one meme coin, noting, “The only meme coin I own is the Smoking Chicken Fish Church (symbol: SCF). Geez.”
At press time, BTC was trading at $66,907.
Featured image created with DALL.E, a chart from TradingView.com
