How Bitcoin keeps Central Banks in check

Bitcoin booked its 4th consecutive weekly gain last week, rising by 4.54%. It has now rallied by almost 40% since the start of the year. It has been consolidating around the $23,000 price level for a few days now, which has allowed the relative strength index to come down from “overbought” conditions. This creates a healthier setup for the potential next leg up.

In terms of key support and resistance levels, bitcoin continues to trade above its 200-day moving average, which is currently sitting at $19,700 and should act as support to the downside in the next leg down. In terms of resistance, the next key level for Bitcoin to break will be its 200-week moving average, which is currently at $24,480.

One more thing to note is that in light of the recent rally, we have not seen a new build-up of short positions around bitcoin. As a reference, short interest in bitcoin on the BitFinex exchange remains near its historic lows. The fact that investors are not piling on into their short positions at these levels could be a signal that they see limited downside left. 

As a further reference, here at Ledn we typically see a higher number of bitcoin-backed loans relative to B2X loans during down or sideways markets, and a higher number of B2Xs relative to bitcoin-backed loans in rising markets. Currently, we are seeing about an equal percentage of bitcoin-backed loans and B2Xs, which suggests a potential change of tides around consumer sentiment. 

Digital Asset Markets:

Yes, you read that right. Yesterday the Central Bank of Lebanon determined that they would be changing their “official exchange rate” to the U.S. dollar from 1,507 pounds to 15,000 pounds.

In other words, a Lebanese person with 300,000 pounds in savings went from having $199 worth of savings to $20. That’s a 90% reduction in the value of their savings.  

Many of us that live or grew up in emerging economies have seen this happen before. Venezuela did it many times while I was there, and our friends from Argentina will remember the “corralito” back in 2001 very well.

These types of drastic and massive changes to the local exchange rate are typical in countries that have lost control over their monetary policy. 

As an example, even the new rate of 15,000 pounds per dollar is only accessible to select few Lebanese citizens, likely those who are friends with or close to the government. The open market exchange rate between Lebanese pounds and U.S. dollars is reportedly 57,000 pounds per dollar. Almost 4X higher than the new “official” exchange rate. 

If history rhymes, it would not be surprising to see further increases to the official rate as the Central Bank is forced to drive it closer to the open market rate of 57,000. Public protests and pushback against these measures should also be expected. These economic circumstances should lead to much higher interest in stablecoins and cryptocurrency for the region as citizens look to opt out of a broken system.

2. Bitcoin is exposing currency flaws in Nigeria

As we covered last week, a new limit on cash withdrawals imposed by the Central Bank of Nigeria last week led many Nigerians to explore alternatives. This led to a record increase in the search term “buy bitcoin” for Nigeria. 

Not surprisingly, demand for bitcoin in Nigeria has soared since, and so did bitcoin’s price in the local currency (the Naira).

To the untrained eye, this may look like the price of Bitcoin in Nigeria is trading much higher, in dollar terms, relative to other parts of the world. However, to those of us that have experienced these types of woes, the picture is much clearer. 

In Naira terms, bitcoin was trading for around $17.8 Million Nairas. The Nigerian Central Bank claims that the Naira to USD exchange rate is 460. If both of these were true, then that would mean Nigerians are paying the equivalent of ~$38,600 USD per bitcoin - which is almost a 60% premium to the global price of bitcoin.

This formula has a problem though. The “price premium” is being calculated using the “official” exchange rate. This assumes Nigerians can convert Nairas to U.S. dollars freely at the N460/USD rate. This is not the case. Most Nigerians have to buy and sell dollars in the open market, and the exchange rate for Nairas to U.S. dollars in the open market is close to N750/USD. 

If we apply the N750/USD exchange rate to the same calculation, we get that Nigerians are paying roughly $23,700 per bitcoin, which is very close to the global price of Bitcoin. 

In summary - Bitcoin prices in local currency will expose all kinds of currency shenanigans and inefficiencies that governments try to hide. You can always calculate how honest a central bank is about their exchange rate by comparing the “official” exchange rate to the implied exchange rate for bitcoin. 

Macro

As we’ve covered at length in our previous dispatches, there is a close correlation between financial asset prices and the aggregate level of liquidity in the global economy. In layman terms, if Central Banks are injecting new cash into the economy and fostering economic activity by lowering interest rates, asset prices should move higher. If Central Banks are draining cash from the economy and raising interest rates to slow down economic activity, asset prices should move lower. This relationship is best illustrated by the chart below:

As you can see, liquidity has been improving since March 2020, and it led to one of the greatest asset price rallies in modern history. About a year ago today, the Federal Reserve openly stated that it would start removing liquidity from the system and tightening interest rates. Since then, we have seen markets drop as liquidity gets removed from the system. 

However, since October 2022, liquidity has stabilized and so have asset prices. This has to do with the Reverse Repo Facility and the Treasury General Account. 

For context, there are 3 big drivers of liquidity for the U.S. economy. 

1. The Federal Reserve Balance Sheet (when they buy bonds, they inject cash into the economy, when they sell bonds, they drain cash from the economy)
2. The Reverse Repo facility (you can think of the RRP as the place where people park their excess savings to earn a risk-free return. As the RRP balances grow, money gets drained from the productive economy. As the RRP balances fall, this cash is put back to work in the economy). 
3. The Treasury General Account. This is the government’s checking account. When the balances grow, it is taking cash from the economy via taxes or from the Fed via loans. As the balances drop, it means that money is being spent back into the American economy. 

Since October, the balances on the Reverse Repo facility and the Treasury General Account have been dropping - meaning liquidity is entering the system from these 2 avenues. 

These liquidity injections have neutralized the Fed’s tightening efforts and kept liquidity stable over this period.  Which has greatly helped asset prices, including bitcoin. Based on their balances, the RRP facility and the TGA could continue being sources of liquidity in the near term.

4. Could a common currency for LatAm work in practice?

In a recent Op-ED the presidents of Brazil and Argentina floated the idea of creating a common currency for the Latin American region. Among their stated goals were:

• “To boost economic cooperation within the countries”, and 
• “To reduce the dependency on the U.S. dollar”

While Brazil managed to keep its exchange rate relatively stable over the last few years, it has recently changed governments and the new administration does not have a great track record of exchange rate stability. Argentina’s local currency and exchange rate regime is a dysfunctional disaster that we’ve written about at length.

So, while the idea of more cooperation and less reliance on the U.S. dollar might seem attractive on its surface, the practical implications of this regional currency could be disastrous to its citizens. 

Among the chief concerns are:

• None of the participating central banks have a strong track record of keeping a stable currency
• More centralization around a regional currency could lead to even more corruption in the system
• There are wide economic differences between potential participating countries, making it difficult to balance roles and responsibilities
• The proposing countries are currently ruled by left-leaning governments that differ in views from the U.S. and European governments.

In short, based on what is known today, the probability of this initiative gaining traction is low.

The Week Ahead 

We have a big week coming up with 3 Central Bank interest rate decisions, U.S. corporate earnings reports, and we may also get more updates on the DCG/Genesis bankruptcy. 

On the Central Bank front, we get decisions from the Federal Reserve, the European Central Bank and the Bank of England this week. Details, estimates and possible market reactions are included in the chart below.

On the Corporate Earnings front we get reports from Meta, Alphabet, Apple, Amazon and other giants. Any commentary or mention of bitcoin could potentially move prices.

Lastly, DCG/Genesis lawyers told the bankruptcy judge last week that they were close to reaching an agreement with creditors last week. While no agreement was reached then, we may get more updates this week.

As always, here’s a summary of the events and data that could move markets in the week ahead:

Notice for Canadian Residents: As of January 4, 2023, Canadian clients will no longer be able to take out new B2X loans. As of February 1, 2023, Canadian clients will no longer be able to open a new BTC or USDC Savings Account, deposit BTC or USDC to existing Savings Accounts or earn yield on any existing BTC or USDC Savings Account balances.

Notice for U.S. Residents: Effective April 4, 2022, U.S. clients will no longer be able to earn interest on any newly deposited funds in their BTC and/or USDC Savings Accounts, where available; however, they will continue to earn interest on their pre-existing balances in their BTC and/or USDC Legacy Savings Accounts.

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