Arthur Hayes New Article: How Will Dollar Liquidity Drive the Next Bull Market in Crypto by 2025?

Original Author: Arthur Hayes, Chief Investment Officer of Maelstrom Fund, Co-Founder and former CEO of BitMEX
Original Translation: zhouzhou, BlockBeats

Editor's Note: In this article, Hayes analyzes how USD liquidity impacts the cryptocurrency market, especially Bitcoin's trend. By explaining the Federal Reserve's Reverse Repurchase Agreement (RRP) and the US Treasury General Account (TGA) fund flows, he discusses how increased USD liquidity drives the rise of the cryptocurrency and stock markets. Approximately $612 billion of USD liquidity will be injected into the market in Q1 2025, which may have a positive impact. Finally, the author mentions that the Maelstrom Fund is investing in the DeFi space and holds a bullish outlook for the future market.

The following is the original content (slightly rearranged for better readability):

The remote area ski entrance at a Hokkaido skiing resort provides excellent terrain, mostly accessible by gondola. At the beginning of each year, the most concerning question for skiing enthusiasts is whether there is enough snow cover to open these entrances. For skiers, a major challenge is "Sasa," which is the Japanese term for a type of bamboo plant.

This plant has stems as thin as reeds, but its leaves are as sharp as knives, capable of cutting the skin if not careful. Skiing on "Sasa" is very dangerous because your ski edges may slip, leading to what I call a dangerous game of "man vs. tree." Therefore, if the snow is not enough to cover the "Sasa," skiing in remote areas becomes highly risky.

This year, Hokkaido has seen record snowfall levels in nearly 70 years, with astonishingly deep powder snow. As a result, the backcountry ski entrances opened at the end of December, whereas in previous years, they typically opened in the first or second week of January.

As 2025 approaches, investors' focus has shifted from skiing to the crypto market, particularly on whether the "Trump Rally" can continue. In my latest article "Trump Truth," I suggest that the market's high expectations for Trump camp policy actions may lead to disappointment and have a negative impact on the short-term market. However, at the same time, I must also weigh the stimulating effect of USD liquidity.

Currently, Bitcoin's trend fluctuates with the pace of USD release, with the Fed and the US Treasury's financial elites holding the power to decide the amount of USD supplied to the global financial market, which is a key factor influencing the market.

Bitcoin hit bottom in the third quarter of 2022, at which time the Fed's Reverse Repurchase Agreement (RRP) reached its peak. Under the guidance of U.S. Treasury Secretary Yellen (aka "Bad Girl Yellen"), the U.S. Treasury reduced the issuance of long-term coupon bonds while increasing the issuance of short-term zero-coupon bonds, thereby draining over $2 trillion from the RRP.

This effectively injected liquidity into the global financial markets. Cryptocurrencies and the stock market, especially large-cap U.S. tech stocks, consequently surged. From the chart above, you can see the relationship between Bitcoin (left axis, yellow) and RRP (right axis, white, reversed): as RRP decreases, Bitcoin's price rises.

In the first quarter of 2025, the question I am trying to answer is whether the positive stimulus in U.S. dollar liquidity can overshadow any potential disappointment in the implementation speed and effectiveness of Trump's so-called "pro-crypto" and "pro-business" policies. If so, market risks should become relatively manageable, and the Maelstrom Fund should also increase its risk exposure.

First, I will discuss the Fed, which is a minor factor in my analysis. Subsequently, I will focus on how the U.S. Treasury is addressing the debt ceiling issue. If politicians drag their feet on raising the debt ceiling, the Treasury will tap into its General Account (TGA) funds at the Fed, injecting liquidity into the market and creating positive momentum for the crypto market.

For brevity, I will not go into detail on how RRP and TGA lending separately have negative and positive impacts on U.S. dollar liquidity. Please refer to the article "Teach Me, Daddy" to understand the specific mechanisms of these operations.

Federal Reserve

The Fed's Quantitative Tightening (QT) policy is progressing at a pace of $600 billion per month, meaning its balance sheet size is shrinking. Currently, there has been no change in the Fed's forward guidance on the speed of QT, which I will explain in the subsequent parts of the article, but my prediction is that the market will peak in mid to late March, thereby drawing out $1800 billion in liquidity.

The Reverse Repurchase Agreement (RRP) has almost dropped to zero, and in order to fully deplete the funds in this facility, the Fed has been reluctant to adjust the RRP policy rate. At the December 18, 2024 meeting, the Fed lowered the RRP rate by 0.30%, exceeding the policy rate cut by 0.05%. This move aims to link the RRP rate to the federal funds rate (FFR) floor.

If you want to understand why the Fed waited until the RRP was nearly depleted to adjust the rate to the floor of the FFR, reducing the attractiveness of depositing funds into the RRP, I suggest reading Zoltan Pozar's article "Cheating on Cinderella". The conclusion I drew from this article is that the Fed is exhausting all tools to enhance demand for U.S. Treasury issuance, seeking to avoid stopping QT, providing a supplementary leverage ratio exemption for U.S. branches of foreign banks again, or restarting quantitative easing (QE), i.e., the "money printer restart."

Currently, there are two liquidity pools that will help suppress the rise in bond yields. For the Fed, the 10-year U.S. Treasury yield must not exceed 5%, as this level would trigger a significant increase in bond market volatility (MOVE index). As long as there is liquidity in the RRP and the Treasury General Account (TGA), the Fed does not need to make significant adjustments to its monetary policy or acknowledge that a fiscal dominance situation is unfolding.

Fiscal dominance would fundamentally make Powell's position subservient to "bad girl Yellen," and after January 20, it would be subservient to Scott Bessent. As for Scott, I haven't thought of a suitable nickname for him yet. If his decisions turn me into a modern-day Scrooge McDuck due to the devaluation of the dollar against gold, I will give him a more endearing nickname.

Once the Treasury General Account (TGA) is depleted (positive for U.S. dollar liquidity) and subsequently replenished after hitting the debt ceiling (negative for U.S. dollar liquidity), the Fed will exhaust its emergency measures, unable to prevent the inevitable further rise in yields following the easing cycle that began in September last year.

This has a minimal impact on the U.S. dollar liquidity situation in the first quarter, just a contemplation of how Fed policy might evolve during the year if yields continue to rise.

The Federal Funds Rate ceiling (FFR, right axis in the chart, white, inverted) and the U.S. 10-year Treasury yield (left axis, yellow) clearly show that when the Fed faces an inflation rate above its 2% target and cuts rates, bond yields rise instead.

The real issue is the rapid decline of Reverse Repurchase Agreement (RRP) from around $237 billion to zero. I expect RRP to approach zero at some point in the first quarter, as Money Market Funds (MMFs) withdraw funds and purchase higher-yielding Treasury bills to maximize returns. It is important to note that this implies a $237 billion injection of USD liquidity in the first quarter.

Following the RRP rate change on December 18th, the yield on Treasury bills maturing within 12 months has exceeded 4.25% (white), which is the Federal Funds Rate floor.

The Federal Reserve will reduce liquidity by $180 billion through Quantitative Tightening (QT), and the adjustment of the incentive rate by the Fed leading to a decrease in RRP balances will further drive an additional $237 billion liquidity injection. This collectively means a net liquidity injection of $570 billion.

Treasury Department

'Bad Girl' Yellen has informed the market that she expects the Treasury Department to commence 'extraordinary measures' between January 14th and 23rd to fund the U.S. government. The Treasury Department has two options to pay government bills: either issue debt (negative impact on USD liquidity) or draw funds from its Treasury General Account (TGA) at the Fed (positive impact on USD liquidity).

As the total debt cannot be increased until Congress raises the debt ceiling, the Treasury Department can only draw funds from its TGA. Currently, the TGA balance stands at $722 billion. The first big question is when will lawmakers agree to raise the debt ceiling. This will be a crucial test of Trump's support within the Republican legislature. Remember his governance margin—Republicans hold a very slim majority over Democrats in both the House and the Senate.

Some Republicans like to puff their chests out and grandstand. Every time the debt ceiling issue is brought up, they claim to care about shrinking the size of the bloated government. They will delay the vote to increase the debt ceiling until they secure some hefty returns for their districts.

Trump has failed to convince them that if the debt ceiling is not raised, he will veto the spending bills at the end of 2024. Democrats, after experiencing a 'transgender bathroom'-style disaster in the last election, are unlikely to help Trump unlock government funds to achieve his policy objectives.

Harris in 2028, anyone interested? In fact, the Democratic presidential nominee will be the silver-haired man Gavin Newsom. Therefore, to advance affairs, Trump will wisely not bring up the debt ceiling issue until absolutely necessary before proposing any legislation.

When failing to raise the debt ceiling could lead to a technical default on national debt or a full government shutdown, raising the debt ceiling becomes crucial. Based on the Treasury's 2024 budget data, I estimate this situation will occur between May and June this year, at which point the TGA balance will be fully depleted.

Visualizing the speed and intensity of TGA (Treasury General Account) usage can help predict the moment of maximum impact of fund usage, as the market is forward-looking. Given these data are all public, and we know that when the Treasury cannot increase the total U.S. debt and the account is nearing depletion, the market will seek new sources for USD liquidity. At a utilization rate of 76%, March seems to be the moment when the market will ask, "What's next?"

If we add up the total USD liquidity amounts from the Fed and the Treasury to the end of the first quarter, it amounts to $612 billion.

What Will Happen Next?

Once default and shutdown loom, a last-minute agreement will be reached, and the debt ceiling will be raised. By then, the Treasury will be able to borrow again in a net borrowing manner and will have to refill the TGA. This will have a negative impact on USD liquidity.

Another important date in the second quarter is April 15, the tax deadline. As seen in the table above, government finance improves significantly in April, which is negative for USD liquidity.

If the factor affecting the TGA balance is the sole determinant of cryptocurrency prices, then I expect a local market top to occur by the end of the first quarter. In 2024, Bitcoin reached a local high of around $73,000 in mid-March, then entered a consolidation phase and began a months-long decline before April 11, just prior to the tax deadline.

Trading Strategy

The issue with this analysis is that it assumes USD liquidity is the most critical marginal driver of global legal tender liquidity. Here are some other considerations:

· Will China accelerate or decelerate the creation of Renminbi credit?

· Will the Bank of Japan start raising interest rates, causing USD-JPY to appreciate and unlocking leveraged carry trades?

· Will Trump and Bennett conduct large-scale overnight devaluation of the USD relative to gold or other major legal tender currencies?

· How efficient is the Trump team in rapidly reducing government spending and passing bills?

These key macroeconomic issues cannot be predetermined, but I am confident in the mathematical model of how RRP and TGA balances evolve over time. My confidence has been further validated, especially from September 2022 to the present market performance: as RRP balances decreased, the increase in dollar liquidity directly led to the rise of cryptocurrency and stocks, despite the Fed and other central banks hiking rates at the fastest pace since the 1980s.

FFR Ceiling (right, green) compared to Bitcoin (right, magenta) and S&P 500 Index (right, yellow) against RRP (left, white, inverted). Bitcoin and stocks bottomed in September 2022 and rebounded on the decline of RRP, injecting over $2 trillion of dollar liquidity into the global markets. This was a deliberate policy choice by the "Bad Girl" Yellen to siphon off RRP by issuing more treasuries. Powell's financial tightening actions to address inflation have completely backfired.

Despite various warnings, I believe I have answered the initial question I posed. That is, the disappointment from the failure of the Trump team to deliver on its proposed legislation supporting cryptocurrency and business can be offset by an extremely positive dollar liquidity environment, with the first-quarter dollar liquidity increase peaking at $612 billion.

As almost every year like clockwork, as planned, the end of the first quarter will be a time to sell, take a break, go to the beach, nightclubs, or ski resorts in the Southern Hemisphere, waiting for a turnaround in third-quarter dollar liquidity conditions.

As the Chief Investment Officer of Maelstrom, I will encourage risk takers in the fund to adjust their risk to "DEGEN" (extreme risk) mode. The first step towards this direction is our decision to venture into the emerging field of Decentralized Science (DeSci). We like undervalued meme coins and have bought BIO, VITA, ATH, GROW, PSY, CRYO, NEURON.

If you want to delve deeper into why Maelstrom believes the DeSci narrative may be repriced higher, please read "Degen DeSci". If things go as smoothly as I described, I will recalibrate benchmarks in March and enter the "909 Open High Hat" phase. Of course, anything can happen, but overall, I am bullish.

Perhaps Trump's market sell-off will occur between mid-December 2023 and the end of 2024, rather than mid-January 2025. Does that mean I'm sometimes a lousy prophet? Yes, but at least I can absorb new information and opinions and adjust to them before they lead to significant losses or missed opportunities.

This is why the investment game is intellectually engaging. Imagine how dull life would be if you hit a hole-in-one every time you swung, made every three-pointer in basketball, or sank every shot in pool.

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