The End of Fiat
May 2023: How is the fiat crisis driving crypto adoption?
We won’t be burning a million dollars to tell you that there’s a fiat crisis (à la @balajis).
Here’s our two cents instead: regulators like to say that the banking crisis is over, but it’s more like they’re taking a break from sweeping things under the rug for a little while longer. Fiat money works only until it ceases to work. In a fiat world, the banking crisis that is creating ripple effects globally will never be truly over. Financial troubles simply worsen over time - and at the cost of primarily small startups, firms, consumers, and retail investors.
This year’s banking crisis is now becoming more severe than 2008, but this is just the beginning. What’s different from the previous event is that we now have crypto as an alternative. Bitcoin has been outperforming other asset classes while fiat currencies continue to devalue and the banking crisis lingers. Bitcoin’s dominance breakout rate affirms that fiat is in trouble, with major crypto alternatives like ETH getting a similar welcome.
Lots of blockchain developments and upgrades are propping up the industry as well. Bitcoin adoption combined with L2 scaling, on the backdrop of the fiat crisis, is the perfect setup for the Web3 ecosystem growth. But we’ll save these insights for another day.
The TL;DR is that the fiat and banking crises are helping to drive the adoption of digital assets.
The struggle of fiat is all in the charts
So far, cryptocurrencies have shown the highest beta compared to the balance sheets of central banks. There is a notable relationship between digital currencies and the US dollar. Take a look at the following charts comparing the US Dollar Index (Figure 1) and Bitcoin (Figure 2).
The trends show that Bitcoin’s major breakouts tend to occur roughly within the period that the US dollar faces a significant crash. This holds true the other way around as well. The pattern is particularly obvious at the outset of Bitcoin’s rally in 2013, and of late. The US Dollar Index’s major breakdown in 2013, as well as the current prolonged slump, also corresponds with the fractals numbered on the Bitcoin chart. This serves as a good condition for a huge crypto rally.
What this means for the overall adoption of digital assets? Bitcoin is now providing a value in times of crisis by becoming a justifiable alternative to fiat. The hard evidence that cryptocurrencies are stepping out of the shadows is an indication of a new era. Think how local currencies emerged during the Great Depression in the early 1930’s.
The fiat monetary system is now crumbling due to the massive debt load. The debt that governments need to take, in order to carry on with business as usual, is the very thing that is wrecking the system. It is a self-perpetuating downward spiral, but where’s the bottom?
A market crash could come first
The US Federal Reserve can essentially decide the global monetary policy, given its unrivalled influence over the risk-free rate of the world’s reserve currency. In times of inflation, regulators tend to increase rates and pursue quantitative tightening as means to weaken the job market and quell demand. Other central banks are forced to follow suit, or risk adding pressure on the foreign exchange rates of their national currency.
The tightening has paused for a while, but it's only really over until the Fed says so. If the market rebounds slightly, financial conditions ease, giving opportunities for regulators to tighten even more. We likely need to see a severe collapse in the US markets in some way, whether that be in the housing market, labour market, or treasury. By then, it will be as clear as day - all the panic, bankruptcies, liquidations, and the Fed pivot.
A breakdown of a fiat crisis in the making
Assume the market crashes in one way or another. The likely sequence of events:
Asset prices plunge
The US dollar devalues
Yields plummet
The Fed pivots to fix the chaos
The dollar’s burden on foreign currencies lifts
The aftermath:
Asset prices would steady
Financial conditions would loosen
Credit would expand
Global economy would recover
Feels like a déjà vu? It’s the pattern of every major financial crisis since the 1980’s.
But now, a Fed pivot has an additional impact: consumer price inflation. CPI could likely rebound because governments were actually still spending money. On the chance that they did stop spending due to high debt servicing costs, it’s likely that fiscal deficit programmes would kick off again because economic pain lingers. Or to stimulate growth, expansive monetary and fiscal policies could be taken. Yet, amidst an energy crisis, deglobalisation, and war, this would cause another CPI surge. Fiat, including the US dollar, would devalue.
This would set off another round of…
monetary tightening → bear market → run-up in the US dollar
Simply put, it’s a vicious cycle that will continue as long as regulators can keep going at it. Real asset prices would remain largely stagnant until a huge portion of the debt is gone. Interest rates could also stay higher for an extended period. As a result, cash can no longer be a safe haven because another Fed pivot awaits, and we are on to another cycle once more.
Now in this scenario, staying in fiat doesn't seem so wise after all.
What to do?
Policymakers are now looking to raise the FDIC insurance deposit limit for businesses. The FDIC tends to reform its policies whenever it feels necessary during tough financial periods. It’s clear: with fiat, rules can be broken. With cryptocurrencies, rules are obeyed. Yet, many still view crypto as no more than just a fad - or worse, dangerous.
To prepare for a possible fiat crisis, being early definitely works wonders. Timing the market can pay off, but it will call for some expertise. The current market is not for the individual who follows the “long-only and diversify” mantra with absolutely no idea of what’s going on.
You should at least consider:
Reducing your debt
Diversifying your investments
Holding assets, such as crypto and foreign currencies, that are not controlled by the Fed
No fiat currency has ever effectively controlled inflation because regulators go back on their words by printing more money and increasing the supply during times of trouble. The impending global fiat crisis is unlike any economic mayhem that the world has ever seen before. Unless we look for viable alternatives, we are all being thrown in at the deep end.
Remember this next time you hear another speech by Jerome Powell or Janet Yellen.