Europe can’t eat, can’t heat and ETH merge is upon us
“There will come a time when you believe everything is finished. That will be the beginning” — Louis L’Amour
Overall markets continue to be driven by global macro, which in turn is being driven by multiple concerns across the globe from wars to food to civil unrest in Europe. More specifically, markets are primarily watching how the FED will react given that CPI is still sticky in spite of energy prices coming off by approximately 10% AND the looming European energy crisis. A lot of that negativity seems not only to be priced in, but also things could turn around very quickly to the upside if cooler heads prevail. What does that mean for crypto? How does one position oneself in the medium to longer term? And then there is the once in a life crypto event — ETH merge. Exploring these in this month’s newsletter, and more. Let’s start with macro first.
MACRO — EU Energy crisis is real
Most Europeans live day to day, salary to salary. They are looking forward to their Christmas bonuses, which might not be very forthcoming this season. My European friends tell me that summer was already really f*****g bad. I was there for a few weeks and I can testify that things were pretty expensive amidst an already crumbling infrastructure. Everyone is generally scared of the upcoming winter.
1. The Energy Crisis is Real
Almost 40% of Europe’s energy comes from Russian natural gas. That’s huge. Russia has stopped the Nordstrom 1 gas pipeline impacting retail spending (demand destruction) as well as industrial production, some of whom are on the verge of collapse due to margin calls and creditors payments. This is causing panic across the market especially as winter is approaching. Most Europeans are already rationing and cutting back on unnecessary purchases. Others are out protesting on streets in several countries demanding subsidies, and an end to rising food and energy prices. And if this winter gets bad, the crisis will deepen further. How does this play out in all probability? What options does the EU have? Or more specifically, do the politicians listen to their populace who are on verge of civil riots and give into Russia by coming to the table? Or does it get worse from here impacting millions leading to EU economic collapse?
2. Current EU Gas Situation
By some arguments, there is not enough European gas storage to last this winter. Power prices were already 3–4X before Nordstrom was shut down. Russia is selling directly in Rubles and China is buying. Then China is selling to the EU at a higher price so that sanctions are bypassed. There is some incremental supply coming from efficiencies across coal to gas, nuclear power supply, US LNG exports to Europe, and some storage facilities in parts of Europe, but that is just that — incremental.
3. Is that the worst that could happen?
No. It could get worse. Russians have much more in their arsenal including shutting more pipelines, accelerating attacks in Ukraine and price controls across other commodities. All that could make things worse. To add to that woe, other commodity exporting nations have also started rationing — wheat in India, coffee in Brazil, chicken in Malaysia (yes that’s true) and the list goes on. If prices of staple bread go up steadily, we might have civil unrest in several EU nations. Government mistrust is already sky high everywhere. All it needs is a simple spark to light this EU economic collapse rocket.
4. Base Case Scenario
If cooler heads prevail — EU & NATO might not have any other option but to come back to the table with Russia. It is anyone’s guess how hot those heads would be and how much either side is willing to give up. But in my base case scenario, cooler heads will prevail. Or be forced to prevail by their populace. Parts of Ukraine will go to Russia, gas supplies will be back and some sanctions will be reversed to keep Russia happy. Everyone wins — at least on the face, while terrible for Ukrainians who are living through this horror for months now. Chances of a systematic collapse are mild. The world cannot afford that. Financial markets will cheer back again, inflation comes back in control in following months, but it won’t be without drama. So get your popcorn out.
5. Worst Case Scenario
There are multiple agendas across the EU. Everyone is working in their own self interest first. A single politician has the ability to derail any discussions among parties, leading to a nasty end to this winter. Inflation could turn to hyperinflation which could lead to bankruptcies everywhere. Higher prices mean tightening of purses and that is real demand destruction. This will have global consequences. EU sovereign debt yields will rocket and Europe will have no other choice but to print more and put in yield controls so that the bond market doesn’t collapse. EU yield controls will lead DXY to spike with Euro potentially dropping 25%-50% from here.
6. What about the rest of the world
Exponentially rising DXY will crash emerging markets and their bond markets. Emerging nations will have no choice but to sell whatever USD bonds they are holding to buy dollars to feed their trading economies. With such huge demand for dollars, the US will have to open their swap facilities back with some nations to meet the USD demand. For some indebted emerging markets, it might be too late already. The US markets will not be spared as forward looking P/E models are all based on US treasuries (bonds). That is when the FED starts to print again to provide dollars to a collapsing world. DXY takes reprieve and with US printing once again, that is when you back your truck and go all in. But timing that would be almost impossible as there are several other factors that could play their ace card and might just take precedence over everything. A list of some of those macro events that we are observing carefully:
i) CPI stayed sticky at 8.3% YoY, 0.1% MoM. Forecast was for 8.1% YoY, -0.1% MoM. CPI Core was no better at 6.3% YoY, 0.6% MoM vs an expectation of 6.1% YoY, -0.1%. The probability that the Fed will raise interest rates by 100bps has reached 16%, and the probability of 75bps is 84%. There could still be a relief rally going into Q4 as most of this is priced in and institutions are already starting to accumulate. Also hoping for our EU base case scenario to play out at the same time.
ii) Rising DXY is a major issue for emerging markets while Yuan and Yen are easing considerably. A major crisis could be looming if other nations like Sri Banks start to collapse and a worse case scenario plays out in the EU. Raoul Pal is already comparing these currency dislocations to Asian 1997–98 financial crisis. With rising DXY, the exchange rate plunges, and starts a vicious rumor of foreign debt default that feeds itself. This leads to further inflation as prices of imports go up and further dampen the spirit and currency plunges further. We hope we do not get there but early signs in Sri Lanka and Lebanon seem like a precursor to a 1998-style mayhem.
iii) Russia ups their ante against Ukraine in response to the EU / US playing dirty (which they cannot afrd to, but who knows). That could escalate very quickly into something global and something ugly.
iv) China, the silent spectator so far and reeling under its own COVID policies, is definitely planning something against Taiwan. I do not know when and how as I am not a war expert but that is one blackish swanish event that keeps me on my toes. Pelosi and the US are just making things worse. They know that the world is dependent on dollars. For now. But that could all change very quickly and that period of transition to a non US dollar denominated world is going to be very painful. Always has been for the last 500 years.
v) Food inflation is real. As supplies become tighter led by rationing or climate, more and more exporting nations will start hoarding. That starts to create a vicious circle of hyperinflation and demand destruction. You can wear two sweaters and manage winter but you cannot let your child go hungry. That is a recipe for revolutions.
CRYPTO NARRATIVES — All eyes on ETH Merge
Heading into August, ETH’s upcoming merge was overshadowed by sanctions against Tornado Cash and various ETH addresses. However we seem to have lost all interest in Tornado cash as we draw closer to merge around 15th September. BTC & ETH would stay correlated to macro with main events to watch out for September being CPI numbers that came in today and the next FOMC meeting (Sept. 20th).
August saw a nice price reversal across the board inspired by macro uncertainty in the background led by ATOM and the entire Cosmos ecosystem, which are catching some early narrative fire.
New L1s like Aptos and Sui are also the talk of the town but no token yet. Private sales at obnoxious valuations only please.
GMX and MAGIC are leading the new real yield narrative.
However, all eyes on ETH merge which is slated to be the biggest event in crypto’s history. Some background and some thoughts for the ones sleeping under a rock for last 2 months.
What is merge: To ensure the Proof of Stake chain would operate smoothly before launching it to the public, ETH foudnation launched it as a separate Beacon chain. “The Merge” is when the Beacon chain merges with the current Proof of Work chain, completing the shift to Proof of Stake. The plan is to do this instantaneously with no network downtime, which has already been done successfully on all of the Ethereum testnets. You can read in much more detail here by Arthur Hayes
Why switch to PoS:
- Less energy usage
- Easier validator requirements, more network security
- 90% reduction in ETH supply
Concerns:
- More centralised, 51% power attacks possible
- Less censorship resistance
- Staking chain reliability — PoS has never operated at such. scale
- Rich gets richer — by staking more ETH
What’s the fuss about ETH merge: The fuss is that merge will happen successfully without any downtime or not. People are betting on either side. No one knows how this will all pan out.
The Merge Happens: If the merge is successful, there is a positive reflexive relationship between the price and the amount of currency deflation. Therefore, traders will buy ETH today, knowing that the higher the price goes, the more the network will be used and the more deflationary it will become, driving the price higher, causing the network to be used more, and so on and so forth. This is a virtuous circle for bulls. The ceiling is when all of humanity has an Ethereum wallet address.
The Merge Does Not Happen: If the merge is not successful, there will be a negatively reflexive relationship between the price and the amount of currency deflation. Or, to put it another way, there will be a positively reflexive relationship between the price and the amount of currency inflation. Therefore, in this scenario, I believe traders will either go short or choose not to own ETH.
There is a floor to this relationship in that the network is the longest operating decentralised network. ETH hit a very large marketcap without a merge narrative. The most popular dApps are built using Ethereum, and Ethereum also possesses the largest number of developers of any layer-1 chain. In light of that, and as I mentioned in my previous essay “Max Bidding”, I believe that ETH won’t go lower than the $800 to $1,000 prices it experienced during the TerraUSD / Three Arrows crypto credit meltdown.
-Arthur Hayes
Bottomline: A quick look into August and what has prevailed in September so far, one can clearly see stress everywhere — financial stress, war stress, geopolitical stress, civil unrest stress. The macro scenario is ugly to say the least. In the short term, the are a lot of moving parts. There is hardly anything to be bullish about:
- FED seems to be on track to tighten more, especially with this sticky CPI numbers today, perhaps 100 bps
- Global recession is looming everywhere — from EU to US to emerging markets, China etc
- Bankrupt nations on the verge of collapse or civil unrest escalating everywhere
- Wars — Russia / Ukraine could turn ugly or who knows what China has in store for Taiwan or when something escalate in M.East
But like Baron Rothschild, said “the time to buy is when there’s blood in the streets.” And that is what smart money and deep pockets are doing right now it seems. Plenty of opportunities to start dipping in. Several funds are raising new money almost daily to capture these rock bottom prices. Valuations on private deals have come off considerably as well. Retail is still cautious but institutions are starting to accumulate leading to a floor on current prices.
If we look longer term, we are back in a build phase just like in 2018/19. The FED printer was in full swing while this rally lasted. We’ve go to wait again to that day when FED is back behind this monetary wheel. Meanwhile, you focus on building and reap rewards in next rally.
Many traders are betting that ETH merge will decouple from BTC and might even rally crazy. Don’t get too excited. Macro continues to narrate how BTC and ETH behave. Shorter to medium term we are bullish on ETH vs BTC but it would be naive to expect BTC or ETH to decouple from broader macro markets and catch a rally of its own. Not just yet. Plus keep in mind that there is hardly any spare retail or institutional money after the last few months of mayhem to push prices to extremes. There is hardly any leverage. Everyone is trading day to day now and all that combined should keep a lid on ETH or BTC prices for now.
Bottomline — Smart money is accumulating and providing a floor for now. Any macro improvements could lead to a relief rally into October / November but capped by global uncertainties. Unless global macro improves or something breaks AND FED is back to printing, these rallies have limited steam.
RISING CAP THESIS — Keeping it simple
We are macro investors driven by narratives that shape the world, and in turn what shapes crypto. Right now we are very focused on infrastructure as we are back in the build phase. If you are a brilliant founder with an awesome project idea, do reach out to us either to the funds or the venture builder at hello@risingcap.co
RISKS: The current biggest risks in our opinion are as follows:
- Regulatory Risk — Every country piling up more regulations on crypto in general (high probability)
- FED Risk Would FED unwind more aggressively as CPI stays sticky (medium probability)
- European energy crisis and collapse (medium probability)
That is why we stay diversified and ask ourselves everyday, and you must too.
- What is the market cap that the entire industry can collectively achieve from here? 10X to $10-$20 trillion?
- Where are the medium & long term opportunities?
- What are the risks? How do we protect against those? Basically how do we keep our investors money safe?
- How do we build Rising into one of the marquee digital asset firms?
The following make Rising a very compelling proposition vs a long only passive Bitcoin position:
- Highly experienced team in crypto with one of the largest networks for deal allocations
- Resourcefulness for founders, not just passive investors