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Liquidity in the driver’s seat
By far, one of the most important factors in any market is liquidity – which can be defined in many different ways. In this article, we cover some ways to think about global liquidity and how it affects bitcoin.
One high-level view of liquidity is that of central banks’ balance sheets. As central banks became the marginal buyer of their sovereign debt, mortgage-backed securities and other financial instruments, this provided the market with more liquidity to buy assets further on the risk curve. A seller of government bonds is a buyer of a different asset. When a system has more reserves, money, capital, etc. (no matter how one wishes to describe it), they have to go somewhere.
In many ways, this has led to one of the biggest rises in asset valuations globally over the past 12 years, coinciding with the new era of quantitative easing and debt monetization experiments. Balance sheets of central banks across the United States, China, Japan, and the European Union reached more than $31 trillion earlier this year, nearly 10 times the previous levels in 2003. This has already been a growing trend for decades, but financial And monetary for 2020 policies took balance sheets to record levels at a time of global crisis.
Since earlier this year, we have seen a peak in central bank assets and a global attempt to liquidate these balance sheets. The peak in the S&P 500 was just a couple of months before all the quantitative tightening (QT) efforts we’re watching today. Although it is not the only factor driving prices and valuations in the market, the price and cycle of Bitcoin has been affected in the same way. The peak annual rate of change in the assets of major central banks occurred just weeks before the first bitcoin was pushed to an all-time high of around $60,000, in March 2021. Whether it was the direct impact and the effect of central banks or the market perception of that impact, it was a strength A clear overall driver for all markets over the past 18 months.
With a market cap of only a fraction of the global wealth, Bitcoin faced the steamy liquidity tool that hit every other market in the world. If we use a framework that regards bitcoin as a liquidity sponge (more than other assets) — swamped with all the excess money supply and liquidity in the system in times of crisis expansion — a massive contraction in liquidity would cut the other way. Combined with Bitcoin’s 77.15% inelastic liquid supply profile with a large number of HODLers as a last resort, the negative impact on price is amplified much more than other assets.
One potential driver of market liquidity is the amount of money in the system, which is measured as global M2 in dollar terms. The M2 money supply includes cash, current deposits, savings deposits, and other liquid forms of currency. Cyclical expansions in the global M2 supply have occurred during expansions in global central bank assets and expansions in bitcoin cycles.
We view Bitcoin as a way to hedge against monetary inflation (or a liquidity hedge) rather than as a hedge against the CPI (or price) to hedge against inflation. A decrease in cash, and more units in the system over time, has resulted in many asset classes going up. However, Bitcoin is by far the best-designed asset in our view and one of the best-performing assets to counter the future trend of perpetual monetary decline, money supply expansion and central bank asset expansion.
It is unclear how long the material reduction in the Federal Reserve’s balance sheet can actually last. We only saw a roughly 2% decrease from a 8.96 trillion dollar balance sheet problem at its peak. Ultimately, we see balance sheet expansion as the only option to keep the entire monetary system afloat, but so far, the market has underestimated how far the Fed was willing to go.
The lack of viable monetary policy options and the inevitability of this permanent balance sheet expansion is one of the strongest cases of Bitcoin’s long-term success. What else can central banks and financial policymakers do in times of future recessions and crises?
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