This article is also available in Spanish.
Arthur Hayes, co-founder and former CEO of BitMEX, published a report article Titled “The Persistent Vulnerability” on October 16, it examines the potential impact of rising tensions between Israel and Iran on cryptocurrency markets. Through the analogy of avalanche science, Hayes explores how the geopolitical situation in the Middle East can act as a “persistent weak layer” (PWL) that may lead to significant financial market disruptions, impacting Bitcoin and cryptocurrency prices.
How will the cryptocurrency market react?
Hayes begins the article by recounting a recent ski trip he took, saying, “One of the scariest conditions is the persistent weak layer (PWL), which can lead to a continuous avalanche when stressed.” He parallels this with the geopolitical situation in the Middle East after World War Second, suggesting that it serves as the PWL above which the modern world order lies.
“The trigger usually has something to do with Israel,” Hayes notes. He stresses that the main concern for financial markets is how energy prices will respond, their impact on global supply chains, and the possibility of a nuclear exchange if hostilities escalate between Israel and another country in the Middle East, especially Iran or its proxies.
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Hayes identifies two scenarios. In the first case, the Israeli-Iranian conflict turns into small, mutual military actions. He frankly describes: “Israel continues to assassinate people and behead stupid people, and the Iranian response has been non-threatening missile strikes.” No critical infrastructure was destroyed, and there were no nuclear strikes; Hence, PWL holds. 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 JCPOA and causing a “financial market avalanche.”
Expressing his concerns, Hayes says: “War is uninvestable, as they say.” He faces a strategic choice regarding his investment portfolio: whether to continue converting fiat currencies into cryptocurrencies or reduce his exposure to cryptocurrencies in favor of cash or US Treasuries. “I don’t want to be underallocated if this is truly the start of the next leg higher in the crypto bull market,” he explains. “However, I also don’t want to burn capital if Bitcoin drops 50% in one day because Israel/Iran causes a sustained collapse in the financial markets. Forget about Bitcoin; it always bounces; I’m more concerned about some absolute bullshit out there. My wallet…funny coins.
Buy or sell now?
To overcome this dilemma, Hayes conducts a scenario analysis focusing on how the second, riskier scenario would impact cryptocurrency markets, especially Bitcoin, which he refers to as “cryptocurrency reserve assets.” It addresses three main risks: physical destruction of Bitcoin mining rigs, spikes in energy prices, and monetary impacts from conflict.
In terms of physical destruction of mining infrastructure, Hayes identifies Iran as the only country in the Middle East with significant Bitcoin mining operations, accounting for up to 7% of the global hashrate. Reflecting on the 2021 scenario when China banned Bitcoin mining, he concluded that even the complete removal of Iranian mining capacity would have little impact on the Bitcoin network and its price.
Addressing the risks of a spike in energy prices, Hayes examines the potential consequences if Iran responds by destroying key oil and natural gas fields or closing the Strait of Hormuz. Such actions would lead to higher oil prices, leading to higher 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 in terms of fiat currency.
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He draws historical parallels with the oil shocks of the 1970s. During the Arab oil embargo of 1973 and the Iranian Revolution of 1979, oil prices rose significantly. “Oil rose 412%, and gold almost matched its 380% rise,” Hayes notes. He explains that while gold has maintained its purchasing power compared to oil, stocks have lost significant value when measured against energy prices. Hayes points out that Bitcoin, as a form of “hard money,” will similarly maintain or even appreciate in value relative to rising energy costs.
Finally, Hayes examines monetary implications, especially how the United States might respond to the conflict financially. He asserts that American support for Israel includes the provision of weapons, which are financed through increased government borrowing rather than savings. He highlights that “the United States government buys goods on credit rather than from savings,” referring to data showing that US net national savings are negative. He wonders who will buy this debt and notes that the Federal Reserve and the US commercial banking system are likely to intervene, effectively expanding their balance sheets and printing more money.
Hayes points to historical cases in which negative national savings corresponded with sharp increases in the Federal Reserve’s balance sheet, as happened after the 2008 global financial crisis and during the COVID-19 pandemic. “The Federal Reserve and the US commercial banking system will buy this debt by printing money and growing their balance sheets,” he asserts. He points out that this monetary inflation would significantly boost the price of Bitcoin. “Bitcoin outperformed the rise in the Fed’s balance sheet by 25,000%,” Hayes asserts, indicating Bitcoin’s strong performance relative to the expansion of the monetary base.
However, he warns investors of the potential for extreme price volatility and uneven performance across different crypto assets. “Just because Bitcoin will rise over time doesn’t mean there won’t be extreme price fluctuations, nor does it mean every bitcoin will share in the glory,” he warns.
Hayes reveals that he invested in several meme currencies but reduced those positions significantly after Iran launched missile attacks. “When Iran fired its final barrage of missiles at Israel, I cut those positions dramatically. “My volume was very high, given the unpredictability of how crypto assets would react to increased hostilities in the short term,” he admits. Currently, he only holds one meme coin, noting that “the only meme coin I have is the Smoked Chicken Fish Church.” (Symbol: SCF Ramen).
At press time, Bitcoin was trading at $66,907.
Featured image created with DALL.E, a chart from TradingView.com