Nic Carter (00:02:45):

The same time, bitcoin is getting more institutionalized, more mashed into the world of finance and gaining more credibility by the day. It’s a literal government adoption of Bitcoin. That trend isn’t going to arrest itself anytime soon. But I think these are just the periods in time where you have to sit tight and just wait for things to happen because we’ve had like a delirious year. It’s been a crazy year and it can’t always be up only. But I think most Bitcoiners understand this is a long haul type of thing here. So patience is a virtue.

Preston Pysh (00:03:26):

And when we look at the performance over the last year, I’m doing this really quickly on a chart as I’m talking to you, it looks like we’re up, what would it be? Close to, what, 65% is what I at for 2021, which I mean, it’s not a bad year, but I think it’s not what everybody was expecting to see. I really like the comment that you just made, that the broader market, the macro backdrop is maybe what’s driving this sideways action. And I agree with you on this. When you look at the fixed income market, all the duration is selling off. Well, most of the duration is selling off, even though the federal funds rate has still stuck at zero. But when you look at the magnitude and the size of all those other durations that are selling off because of these inflation prints that we’re starting to get, that is turbulence for anything else that’s, when you’re comparing it to Fiat. So I’m assuming that’s what you’re getting at with your comment.

Nic Carter (00:04:27):

Luke Gromen says much the same thing. He thinks about stocks in a duration sense as well. If you think about your unprofitable tech stocks where you’re discounting a lot of growth and a lot of the cash flows are coming in the distant future, those have also suffered. And I think as inflation increases, it’s not just that you have to more aggressively discount those future cash flows, it’s that you just have less certainty about the future. Bitcoin for better, for worse, it’s pretty correlated with those assets. It has a very tight correlation with the flagship Ark Invest portfolio.

Nic Carter (00:05:08):

And that was something I was always a bit concerned about, was Bitcoin behaving more like a Tesla than a gold. Obviously I think it’s got, combines qualities of the two, but that’s the flip side of this becoming an institutionalized asset class, which is, it is very accountable to the macroeconomic [inaudible 00:05:26]. It’s not just an asset in its own right. And you do see the correlations. Since 2020, Bitcoin has shown positive correlation to risk assets. And for better, for worse, that’s where we stand. Meaningful amount, especially during the sell off in early 2020, but it’s remained positive since then. And I think that took a lot of people by surprise.

Preston Pysh (00:05:49):

So when we talk about the fixed income space selling off, it’s no mystery as to why, it’s because we’re actually getting inflationary prints in the basket that the governments are taking their measurement in. So first of all, talk to us about your opinions on this basket. Do you buy into the idea that the basket that they’re showing you inflation is grossly miscalculated to the benefit of the government’s so that they can keep issuing debt at very low yields. Just in general, give us a broad overview of your thoughts on inflation and particularly the inflation prints that we’ve been getting this past eight months.

Nic Carter (00:06:30):

With regards to CPI methodology, people like to make fun of shadow stats and the chapwood index and so on. Those are really common targets on [inaudible 00:06:40] for derision. I think the truth is in the middle, not to be both sides guy or anything. Does the BLS have a clear incentive and effectively a mandate to take a very minimalistic view of CPI and reinterpret the basket in a favorable way? Of course, they do. Is it as egregious as some of the worst critics make out? Probably not. But I fundamentally don’t believe in a basket of goods that can represent inflation. Inflation is a completely local phenomenon. So everybody’s composition of spending is completely unique to themselves and their household. So a lot of people are indexed. People are indexed to different things.

Nic Carter (00:07:27):

Some people, the most of their expenditures go on rent and student loans. Other people it’s healthcare, other people it’s their mortgage. It just completely depends. It depends on your real estate market, depends on where your lifestyle is. So I don’t feel that a single number can capture the turbulence of the economy in terms of the purchasing power of your dollars. So really the only honest way to interpret inflation is to construct your own index and looking at your own real estate prices and your cost of healthcare and your cost of education. It totally depends on your circumstances. I know that’s not an easy thing to do, but certainly CPI is just not representative for most people. And if you look at what has gone up enormously, it’s healthcare, it’s education, it’s rent. Those are incorporated into CPI, but probably with waitings that aren’t representative for most normal people.

Nic Carter (00:08:27):

Yeah. I think the idea that you can compress this economy wide output into a single figure is just preposterous. And you also have these games that the press will play, where one month they’ll pick core CPI, they’ll exclude food and energy for some reason, they’ll pick alternative indices. There’s like a half a dozen different inflation indices that they use. And they’ll selectively pick the one that’s increased the least in the last period. And of course, if you have a dozen or a half dozen indices, you can always pick the most favorable one.

Nic Carter (00:09:07):

But at the end of the day, we’re looking at roughly seven to 10% year over year declines in the purchasing power of the dollar. That’s where we stand. That’s enormously high. That’s the highest in effectively living memory for most people. And that’s incredibly destabilizing. That wasn’t forecasted. None of our economists anticipated that. A lot of Bitcoiners anticipated it, but your establishment economist failed to predict that. And there should be reckoning right now, but instead we’ve a number of deflections and denials and attempts to misrepresent what’s happening. And I think people are seeing through it. I think people are fed up and they’re seeing through it. But we’re seeing a number of excuses which don’t make any sense. Basically non nonsensical excuses coming from the White House, from the highest organs in our government. It’s just obscene because the relationship is pretty straightforward and they’re trying to misrepresent what’s happening here.

Preston Pysh (00:10:11):

Let me ask you this. Let’s say we could snap our finger and COVID would literally just disappear, do you think we would still have the supply chain impacts that are happening right now, even if COVID was not a thing?

Nic Carter (00:10:26):

Yeah. I think COVID was a very useful culprit or pretext, but the truth is if you look at the numbers, the supply chain is stressed because as there’s a record demand shock. The supply chains are functioning at capacity. People, they take the pictures of the ships and they say, “Oh, look, we’re bottlenecked. We have these bottlenecks. Our supply chain is not working properly.” If you look at the numbers, the ports are moving record amounts of volume in cargo. So what’s happening here is, okay. Maybe there’s some COVID related restrictions. But what’s really happening is there was an enormous demand shock based on these fiscal measures, which printed the equivalent of 25% of GDP in some quarters in 2020. I mean, you’re looking at enormous outlays. You’re looking at federal net outlays as a share of GDP surgeon at 30% for 2020, where the baseline was 20%.

Nic Carter (00:11:27):

So you’re just looking at gigantic government expenditures. The likes of which have never been seen before, only comparable to absolute total war situations where the government commandeers the economy. And of course those dollars, they’re not financed by foreign creditors, they’re financed by the federal reserve. And they make their way into the economy in a very direct way, in a direct to household way. And then those households spend that money on stuff, whether it’s electronics, or cars, or luxury goods or whatever. And then the symptom of all that is, oh, the supply chain is stress. It’s at capacity because people are moving records amount of stuff around because the US government hate us all to stay home and buy our widgets and our Knick knacks. And so of course the supply chain looks stressed because there is a huge demand shock, which originated with this monetization of the debt. And that’s clear with any data that you look at, that there was a massively out of the ordinary level of expense, which is an ongoing thing now, it appears.

Nic Carter (00:12:37):

And so of course that’s stressed everything because on the one hand, you’re printing dollars out of thin air. On the other hand, you’re trying to buy real world resources and the world can only produce so many of those resources in a given amount of time. And there’s only so many widgets and knick knacks that the world can actually produce. So all of the transport and the supply chain looks stressed as a consequence and the prices of those goods goes up because there’s more money searching for fewer goods. It’s very clear that that’s what happened.

Nic Carter (00:13:09):

And I think if you just look at your chosen variables depicting what the supply chain is doing, you’re seeing these various hubs in the supply chain. They’re not operating below capacity or below where they were in 2019. Many cases, they’re above that. They’re doing record capacity. So I think the supply chain deflection is a pretty vexatious, almost a lie. I mean, I think it’s really deceiving and it doesn’t represent reality. And I think you’re mistaking the symptom for the disease and the disease was the enormous fiscal impulse. And the symptom of that is supply chains looking stressed.

Preston Pysh (00:13:48):

So Nic, in your opinion, this isn’t transitory or is it that’s just depending on the policy response that comes next?

Nic Carter (00:13:56):

Well, I don’t know. I can’t commit to this not being transitory. I think the fact that the fed has retired that term is enough egg on their face. Obviously inflation is never transitory unless you’re on the gold standard. Inflationary events, historically will transitory in the sense that you would get deflation to counteract the inflation and the overall price level would return to its pre inflationary equilibrium. That’s what truly transitory inflation means. In our case, maybe we’re going to have a burst up to 10% that’ll settle at 5%. That’s not transitory. That purchasing power loss is permanent. You’ve permanently lost purchasing power in aggressive rate.

Nic Carter (00:14:38):

So it would’ve only been transitory if we’d experienced deflation on the other side. And that’s literally what used to happen. If you look at inflationary episodes in the pre fed US history, the US dollar started, I want to say in 1790 fast forward, 120 years from 1790 and the dollar starts and ends at the same price effectively, right? You have the same purchasing power at the start and the end of that period. From 1790 through to 1913. Of course, there were inflationary periods where loss purchasing power. And then there were offsetting deflationary periods where returned to the equilibrium, right?

Nic Carter (00:15:22):

So that’s what happens in a non central bank system. The same is true of the British pound. There is a 200 year period where the British pound started and ended the same purchasing power effectively. And so in a non centrally controlled economy, things tend to reset with benevolent deflation. Deflation that’s not actually damaging to the economy. But obviously that was never what we were going to get. We were not going to get offsetting deflation here. So the transitory thing was just like a really sketchy word play, I think because the purchasing power loss was permanent. But if I look now, it’s more of a question of looking at incentives. And I think the government’s incentive is absolutely to run inflation hot.

Nic Carter (00:16:10):

A, because we’ve normalized these fiscal expenditures and polite of handouts as a routine policy action. Like who knows what we’re going to get, build back better something else. But it seems normalized that the government’s role in the economy’s fundamentally stepped up to a level that it’s basically never been in peace time. That appears to be politically normalized, frankly, on both sides of the aisle. And to reset our enormous debt overhang, sovereign debt level, I think 127% right now to get that to a more sustainable level. It’s not sustainable right now. You have to have this period where you inflate away the debt. You have to do that soft default. The choices are soft or hard default. We’re not going to have some incredible burst of GDP growth unless we discovered nuclear fusion or something.

Nic Carter (00:17:00):

So the only way out of that is to hold interest rates slow and have an inflationary episode, but one lasting a decade or more. That’s how we got out of that pickle in the 1940s. Very significant inflation for a relatively long time. And that’s the only way out. So I don’t know exactly how that’s going to be engineered, but that appears to be the political mandate that’s unspoken, that is generally dictating policy outcomes.

Preston Pysh (00:17:32):

I guess when you look at where we’re at right now, relative to that scenario back then, it almost seems like we have compressed rates even more relative to the spending burden that we keep piling on top of it. So to come out of this in a way, like you said, at least a decade, it’d be probably more like two or three decades, how in the world could they possibly do anything like that with how quickly information flows and how readily available it is? I mean, look at us, we’re having this conversation that’s going to get blasted out to millions of people. They’re going to be armed with this idea that you have a 400 basis point spread between the inflation rate that they’re publishing, which isn’t even probably the real rate, it’s probably higher, versus the interest rates that they seem in hell bent on pushing even negative in nominal terms.

Nic Carter (00:18:28):

That’s the thing which I think isn’t price end basically. Information flows really quickly and there’s this ability to question official narratives in a really efficient way. And I think markets respond more quickly. Markets just act more quickly now. They’re trying to anticipate the future really quickly. And everyone is now aware. They have these historical case studies in mind. They probably didn’t live through the 70s, certainly not the 40s. Not a lot of people today have a good memory of what it was like in the 70s, especially not a lot of traders. But I think the realization that monetary repression is underway, that happens quickly, that happens more quickly and people are able to be more dynamic. There’s also just more liquidity in alternative instruments. There’s more ways to divest from the dollar, if that’s what you want to do.

Nic Carter (00:19:29):

That’s not just the case in the US, but that’s the case everywhere. And that’s where I think a highly liquid crypto market comes into play, which is to say, everybody can hold their wealth on their person without owning bars of gold or whatever in a really effective way. And so they can take the off-ramp from their State money system into an alternative system where they themselves are the custody. That’s never been the case before. So if you look at why Turkey has tilted hard against crypto, as they’ve been in the midst of a currency crisis with the [inaudible 00:20:05], that’s because the crypto market poses a real threat to the [inaudible 00:20:10], right? That’s not a secret. That’s clear.

Nic Carter (00:20:13):

I don’t really think the dollar is under threat necessarily, but certainly people can desert dollar denominated debt and dollar assets quite efficiently these days. And there’s this informational economy, which isn’t gate kept in any way. There’s no gate keepers behind the scenes on TV saying, Okay, well, don’t question Treasury’s official narrative. Don’t question the Fed’s narrative on this. It used to be just three channels on TV, right? And they were all institutionalized. Now we have a much more direct to consumer informational economy.

Nic Carter (00:20:51):

And I think people like Glen Alden and Luke Gromen and yourself, that is a way to get high quality analysis to regular folks in a way that’s not completely subservient to institutional narratives. But frankly the establishment doesn’t do itself any favors because they are pedaling claims that are so obviously false, like the various narratives on inflation, whether it’s supply chain, whether it’s to do with monopoly power, whether it’s to do with corporate greed. These are obviously false narratives. And it’s just a matter of pointing out why they’re false.

Preston Pysh (00:21:29):

Let’s talk a little bit about global policies and politics and other nation states, things that maybe you find interesting. There’s a lot of talk about El Salvador. Is there anything else that you see happening around the world that you think is worthy of highlighting?

Nic Carter (00:21:44):

Well, the El Salvador case, as much as Bitcoin is talk about it, gets just very limited hype for how interesting it is. So definitely want to hit on El Salvador. The other thing that I thought was really interesting, I want to say maybe last month or earlier this month was two events in Myanmar happening at the same time in the same week. So on the one hand you have the coup government, which is a Chinese backed coup, which happened earlier this year. They de-dollarized their settlement currency. They went from dollars to Chinese yuan. And so I think that’s just very indicative of the way the world is going, especially in the Chinese sphere of influence, is de-dollarization. That’s one trend to keep an eye on.

Nic Carter (00:22:33):

The other thing that happened virtually at the same exact time was the opposition government, the shadow government that was deposed in the coup adopted tether officially as their currency, right? Stablecoin. Dollar backed stablecoin. And these two things happen at the same time. So on the one hand you have official dedollarization and yuanification, and at the same time from the opposition, you have crypto dollarization happening because the opposition government wanted to raise capital from the Burmese diaspora worldwide. They needed an efficient settlement currency, but they couldn’t be encumbered by let’s say the Burmese banking system. They had to do something outside of that system. And I think this was such a telling little anecdote. It’s two visions of the future. And it’s what I would take to US policy makers that are thinking about stablecoins and think about the crypto market. They’re very scared of stablecoins, US policy makers, where they hate them. They fear them and they think stablecoins are a threat to the dollar. Some of them think that stablecoins are a form of counterfeiting, etc.

Nic Carter (00:23:44):

But just look at this little example. You have on the one hand, this secular long term threat to the dollar, which is a competing currency competing for global reserve status from a rising [inaudible 00:23:58] hedge on. And then at the same time you have the dollars reach, is actually expanding through crypto rails, through stablecoins acting as extensions of the dollar. The stablecoins are backed by dollars and then they’re issuing claims against them that circulate on blockchains. And because they are circulating on these credibly neutral infrastructures with no censorship, hopefully, depending on the blockchain, that is this frictionless way to distribute dollars to the world’s population, to places that need dollars. And they need dollars in a less encumbered way than the good old us dollar in the legacy system, which is very encumbered, very politically encumbered. And I just thought that was such a telling little story. That’s like two forks. Here’s world one and here’s world two. Which one would you rather?

Preston Pysh (00:24:53):

Well, and I think it’s also a case that you’re making maybe to US policy makers as to how important it is to not take a similar approach that China’s making with their yuan. And that a person can use the coin and not have to worry about the government necessarily seeing every single appearing into the privacy aspects of it, appearing into every single transaction. Because it appears like they don’t want to be encumbered by the fed clawing dollars back. And so they’re maybe using, you said they were using tether. So now they can get them media clearance, they can operate on those rails. They know it’s somewhat backed. I’m sure that could be a long conversation. But backed enough that they’re comfortable using it as their primary means and they don’t want to be using the Chinese yuan that they know has all these privacy concerns. So that’s crazy. I have not heard anything about this. I heard that they were using tether, but that was the extent of it. I haven’t really dug into it.

Nic Carter (00:25:51):

Yeah. They apparently ratified tether as an official currency. I mean, to the extent they have the ability to do that. Obviously they’re out of power, so they’re government and exile type thing. But I think the greatest threat to the dollar would be the federal reserve creating a CBDC product, which is highly politicized, which takes these informal political policies which are implemented through the banking system, because there are political constraints to using banks, right? Explicitly and informally. So you’ve had actual programs dedicated to politicizing the US banking system. Obviously sanctions are one, but more insidiously and locally stuff like Operation Choke Point, whereas whole industries, there were de platformed via payment processors through FDIC and DOJ requests to the banks directly. So that was a real formal program.

Nic Carter (00:26:49):

Now that’s just institutionalized and it happens informally. So banks and payment processors know to avoid certain things. That’s why the adult industry is always being unbanked because payment processors know that they’ll lose their banking relationships if they do that. And the banks know to turn the screw on the payment processors because they don’t want an FDIC or DOJ investigation. So even though it’s not actual policy, there’s a politicization. So there’s sets of things you can do with dollars and sets of things you can’t, and it’s obviously arbitrary at the discretion of the State.

Nic Carter (00:27:29):

Now if you have a CBDC and these rules get directly encoded into the physical cash that we use, that’s a really bad outcome, I think, because it’s all well and good to say, well, we’ll just censor the bad people and you’ll be fine as long as you’re not doing anything wrong. But of course you’re completely exposed to whoever happens to have power at that point in time. And so there’s a good chance that yourself end up being censored. So the best thing the US government can do with the dollar is ratify stablecoins and say, okay, we’re going to give you access to the fed window. So stablecoins themselves will be able to back their liabilities, back the stablecoins with federal reserve dollars, which they currently don’t do. They only have commercial banking relationships and they own treasuries and things like that.

Nic Carter (00:28:21):

So going that extra mile and allowing stablecoins to be on an equal footing with banks would be very powerful, but then not insisting on any political mandates for who can transact with a CBDC for instance. So I think the best model here would be a public private partnership where the stablecoins get access to federal reserve dollars directly and they act as these defacto dollar issuers. And subject to various kinds of oversight, such as many of the stablecoin issuers already are to be clear. Depending on the stablecoin, they’ll be issued on the New York trust charter, or there’s a Nevada charter or their State money transmission regime. So there’s already in terms of regulation there.

Nic Carter (00:29:08):

The worst case would be a highly politicized and highly surveilled Chinese style CBDC. And it concerns me that policy makers feel that they need to live up to the standards of the [inaudible 00:29:21] CBDC because when have we ever followed China’s lead on anything? Just because you might be technologically feasible, why would we, look at something the CCP built and say, I want that too. How does that make any sense?

Preston Pysh (00:29:34):

I think the argument, and I completely agree with everything you just said, I think the other thing that would be the pitch to policy makers is, Hey, this is all about retaining a network effect. So what’s your competitive advantage in the marketplace, global marketplace for people to want to use your currency over the alternative, which has privacy issues? Well, you got to set up the model the way that you just described where the government, private partnership that you have at the touch points is there. But beyond that, it can go in any direction, it can be used by anybody at that point. And I know that that would be maybe giving up a little bit of control that they have today.

Preston Pysh (00:30:16):

But I think the argument is, Hey, if you still want to achieve this network of effect on a global scale, that’s the one thing that you’re going to have to give up relative to the competition that’s out there with much larger privacy issues and concerns because some other country will try to step into that role of offering the type of stablecoin that you’re describing, Nic. And if it’s not the US, it’s going to be somebody else that’s going to start applying that. And I suspect that the market would prefer that token or that stablecoin.

Nic Carter (00:30:47):

And just look at the ratios. In terms of stablecoins, the dollar has more dominance than it has in foreign exchange reserves ratios, right? So in terms of international trade or an asset that’s held by central banks, the dollar is somewhere between 40% and 60%, depending on what metric you’re using. In stablecoin land, the dollar is, I want to say 95% plus of the denomination of all stablecoin. There’s some euros, there’s some yuan, there’s some rupees, but really there it a lot. It’s mostly dollars. And that’s telling. I think the pushback I often get from policy people is, “Well, we want to retain our sanctions ability. We want to retain our ability to do sanctions.”

Nic Carter (00:31:36):

And first of all, I think the effectiveness of sanctions is very questionable. You can point two examples where they failed and caused a lot of misery. Second of all, I think it’s effectively cheating by thinking that you can deal with problems purely through the financial lever, without dealing with the problem in [inaudible 00:31:56] space. And that’s, I think, why sanctions are so popular. It’s seen as really cheap hack and you can fix everything just by shutting off the banking system, instead of having to go to war with someone. But also we’ve relied on them as our primary instrument of power projection for so long now. We’ve abused our privilege as the underwriter of the global financial system that even our allies are now just affected by sanctions.

Nic Carter (00:32:25):

So our opponents and our enemies are actively building alternatives and some have already built alternatives. Our allies are trying to build alternatives. When we sanctioned Iran, our European allies built a facility to circumvent the dollar so they could do business with Iran called Instax. Now it didn’t take off, but what does it say that our close European allies were themselves trying to build tools ends around the US financial system, because the dollar at that point had become so politicized is not a good sign. So I think our sanctions ability has grown really blunt with overuse, and it’s just not necessarily going to be something we can rely on forever. I think people are going to desert the dollar faster if, as a network, it becomes a network where certain paths aren’t available. And the way to reverse that is through gratifying something like a stablecoin.

Preston Pysh (00:33:25):

God. I love some of your points there. That is stuff that we need as many people as possible to listen to. You had mentioned that you had some different comments on El Salvador and you wanted to go back there. What are some of the things that you’re seeing there that maybe some others aren’t talking about?

Nic Carter (00:33:39):

So I’d love to see more scrutiny on the Chivo system, which is the public, the official Bitcoin wallet. Now the interesting thing that’s happening there is that Salvadorian financial institutions are gradually adopting Bitcoin as a transactional tool. It’s not that all Bitcoin related commerce and all Salvador happens through the official means. So it’s interesting that Bitcoin has become normalized as a financial network in the country. And I’d expect that to continue to spread in Latin America, Central America. I think that’s a very interesting trend that hasn’t received a lot of interest so far. The thing I’m concerned about would be people that use the Chivo wallet have related to me that it’s relatively easy to get Bitcoins into the wallet, but then it’s relatively difficult to get them out.

Nic Carter (00:34:31):

And the government is custodying the Bitcoins on behalf of the users. And then they have a Bitcoin denominated claim and in theory, they can cash it out. The thing I would want to see would be first of all, proof of reserve, proving that the liabilities are equivalent to the assets. That’s a trivial thing to do. And then second of all I would be concerned that eventually the exit valve would be shut off. We’re closed. And you would no longer be able to redeem your Bitcoin claims for Bitcoins, right? And there’s no technological reason why it should be difficult to redeem your claim. Like it’s very, very trivial. That’s what every exchange does all the time they’re processing their claims.

Nic Carter (00:35:20):

And so I think the ultimate plan, and I have no direct knowledge of this, but this is what I would look out for, would be to eventually cease that convertibility and end up with the situation where the government has accumulated Bitcoins and fails to honor the obligation to redeem the claims and the wallet for Bitcoin. The structure of the system seems very favorable in terms of achieving that outcome. And obviously that wouldn’t be the first time nation, State has defaulted on its promise to redeem some asset for something else, whether it’s a currency board or peso dollar convertibility or something like that. But that’s what I would be concerned about with Chivo.

Preston Pysh (00:36:12):

How about you have some thoughts on the interbank settlement stuff that’s happening down there as well? Talk to us about some of those ideas.

Nic Carter (00:36:20):

Well, I don’t know how widespread this is, but to the extent banks are starting to use Bitcoin, certainly happening in El Salvador. I think what you might expect to see would be just direct bilateral settlements of flows using Bitcoin as that bridge currency as opposed to the dollar. And this ties into what I was saying before with the dollar being this highly politicized system with enormous gating factors built in. At a certain point, if you’re onboarded onto the Bitcoin network as a financial institution, it might be less frictional to use it as opposed to the dollar infrastructure that you’re already on. Especially if you’re holding Bitcoin balances on behalf of your users, which I think is going to continue to be the case. So at that point, you end up with a regional settlement network based on Bitcoin, as opposed to having to do your correspondent banking network, where you do your various hops back to the New York hub. And that is something that very directly challenges the dollar and is a huge [inaudible 00:37:29].

Preston Pysh (00:37:29):

This is all en lightning?

Nic Carter (00:37:31):

It could be both, I think. Honestly on chain would be probably more conducive. But if you think about the structure of lightning, it does mirror the way that financial institutions have established channels with each other. I don’t know if lightning can support significant volumes as of right now. This is what I would expect to see develop in the next couple of years, would be direct interbank settlements in Bitcoin terms, whether lightning or base layer, frankly.

Preston Pysh (00:38:02):

All right. This question, I don’t think you’re expecting. What are your thoughts on Ethereum? When we look at just from a price standpoint, and it pains me to say this, the prices outperform Bitcoin since September of 2019 to where we are right now. I have my own opinions and I’m not going to express them from a technical standpoint of why I keep talking about Bitcoin and why I think it’s a better solution. But I’m curious to hear your thoughts on Ethereum in general and why the price continues to outperform. And is this something that you think is going to continue to persist? And are there issues that you see with Ethereum in general or is there things that you see being beneficial moving forward?

Nic Carter (00:38:45):

Yeah. I think a lot of the Ethereum price action has to do with new deflationary or disinflationary mechanic that they introduced you with the EIP-1559. That is a mechanism that takes fees from usage of the blockchain and does this perpetual retirement of shares effectively of Ethereum. So it’s like a business taking its revenue and doing a stock buyback, is what I would compare it to. And obviously the Ethereum shareholders like that, and they like the commitment to a potentially deflationary monetary policy. I think Ethereum is suffering the effects of having done that because now the transactional experience on Ethereum is worse. And it’s not to say that EIP-1559 increased fees, like it may or may not have. It looks like it certainly stabilized fees at a relatively high level.

Nic Carter (00:39:41):

But the problem was that insiders massively benefited from that, right? Because if you have a group of people that primarily transacts using Ethereum, and then you have a group of people that primarily holds Ethereum tokens that are the investors, those are different groups, they’ve different interests. What that EIP did was advantage the holders of the token at the expense of the users of the system, right? And so it may not have been a deliberate mechanic to increased fees, but it certainly meant that higher fee rates significantly benefited holders and disadvantaged users, right? Because if you’re paying $200 to make a transaction, a lot of people are priced out at that point.

Nic Carter (00:40:24):

Ethereum’s always had this, I consider a problem. Some people consider an asset of this solutionism, this desire to tweak the parameters to get the perfect system and really alter key features of the system in order to compete, and show differentiation, and introduce new features and things like that, which is, some of that I think maybe is tolerable. But in the context of a monetary asset, that’s worth hundreds of billions of dollars, any each change you make, it’s going to have very consequential economic outcomes for the stakeholders in the system.

Nic Carter (00:41:04):

EIP-1559 is one of the most clear examples I’ve seen where it’s like, whatever the technical motivations may have been, there was a very clear economic motive too, which was, let’s change into this system to a fundamentally deflationary one. And we’re going to empower one group that is the key decision makers. We’re going to disempower this other group. So Ethereum has this problem now where it has an enormous optics problem because the fees are just structurally high. And it’s clear that the leadership has the power to determine effectively where the fees are. They can change the block space. They can do all kinds of stuff.

Nic Carter (00:41:42):

And then there’s other blockchains that are now competing on the basis of being more centralized and having more block space and lower fees. And they’ve actually done very well relative to Ethereum in the last year. They’re in this weird middle ground where they have this ability to intervene and change key parameters. But there’s these other even more progressive blockchains, which are more aggressive about changing certain key features and having low fees and things like that. And so Ethereum’s in this awkward middle ground where they’re somewhat committed to decentralization and monetary credibility, but not so much so that they’re able to fully compete with all this new breed of competitors.

Nic Carter (00:42:22):

As far as Bitcoin versus Ethereum is concerned, Bitcoin knows what it is. It’s very content to remain that way. And its monetary credibility is absolute. Ethereum is somewhat credible, but not fully because they change the rules all the time. It has a partial respect for property rights. The system changes a lot, so it’s has identity crises. And then it’s always trying to compete with Bitcoin, but also trying to compete with all of its other Ethereum killers. So it’s a tough place to be in. Obviously despite all that it’s done very well, but hasn’t gained the most important asset, I think, which is monetary credibility over the last year.

Preston Pysh (00:43:05):

Beyond the 59 piece that you mentioned making the monetary issuance tighter, basically quantitative tightening, they’re also locking up, the Eth one holders are locking up their coins into Eth two. And Eth two is producing more coins that aren’t coming onto the market being paid in interest to validate blocks that aren’t even really happening, like that whole Eth two isn’t even happening. For me this is a little bit of the elephant in the room, is, can they even pour Eth one into Eth two into this proof of stake system? Because it seems like every time that they’re talking about when this is going to happen, the deadline just keeps pushing further and further to the right.

Preston Pysh (00:43:51):

And it doesn’t appear that there’s an actual technical solution to something that is a massive undertaking from a technological standpoint to perform. So as we look at this and we look at some of the mechanics of what they’re doing to do this, I see it as just being concerning from a technical standpoint and maybe disingenuous as to what risk is there and when it’s actually going to happen. I’m curious to hear what your thoughts are on the migration.

Nic Carter (00:44:21):

I think there’s always an incentive to downplay the risks, especially for a significant technological shift like that. I just assume the migration will happen. It might be more belated than might have been message initially. I think it will happen. And then the question is, well, what does Ethereum look like after that? So then you have a proof of stake world. I don’t think it was strictly necessary to move to proof of stake in order to implement most of Ethereum’s agenda. It probably would’ve worked fine on proof of work, frankly. Proof of stake doesn’t give you scalability. That’s a total misconception. Proof of stake is just an alternative way to determine who is the authority to organize transactions and create blocks in the system.

Nic Carter (00:45:02):

There’s nothing about proof of work that’s inherently unscalable, nor is there anything inherent to proof of stake that makes it scalable. You’ve scalable proof of work and unscalable proof of stake. So it’s a totally different, totally orthogonal. But what I would be concerned about in a proof of stake world is what we’ve seen from a lot of proof of stake chains, which is the validation becomes pretty concentrated because owning a lot of tokens becomes tantamount to political power and discretion in the system, which is how all legacy financial consortia work, which is your influence over the system is a function of how large of a shareholder in that system you are. Whether that’s swift, whether it’s any of the financial institutions like the World Bank, or whether it’s a private company that has discretion over transaction selection like PayPal. So that’s the default model.

Nic Carter (00:45:56):

Proof of stake takes you away from the proof of work model, which is a new alternative independent model. And it takes you back to the legacy model. So it beats me as to why anyone would want to go back to the pre proof of work pre Bitcoin model, where all of a sudden, now you have all these shareholders that basically decide what’s valid, transactional validity in the system. They can decide on the inherent rules of the system. And so that’s where Ethereum’s going with this merge, which I think is unwise. Because if you look at Coinbase, they’ve a huge fraction of ether. Between Coinbase and Kraken and Binance and Huobi, between the top 10 largest exchanges, you’re going to have a huge number of tokens out there. And that’s fine in a proof of work world where owning tokens doesn’t give you political power. But in a proof of stake world, it does. And all of a sudden the exchanges and the custodians become these key entities that can actually affect policy changes, right? That’s not just me oddly speculating. This has happened in proof of stake blockchains before.

Nic Carter (00:47:03):

In EOS, infamously, there was a cauterization that occurred where the top validators were able to [inaudible 00:47:10]. In Steem, this is like an undercover example, but in Steem, Justin sun was able to actually commandeer the entire network by allying with the three largest exchanges where users held their coins. And the previous stake people always come back and say, “Well, users will be able to run a node and they’ll be able to do this. They’ll be able to participate in these pools.” Fundamentally running a proof of stake node, especially with the requirements that are being messaged to us in Ethereum, it becomes expensive. Very challenging, technically to run a node.

Nic Carter (00:47:40):

And as a regular user, you’re not going to want to incur the risk of getting slashed for instance. So you’re going to delegate your node or more realistically, you’re going to just deposit your coins to a custodial entity that will stake on your behalf. And then it becomes like a BlackRock situation or Vanguard where maybe you hold equity and Vanguard manages it for you, but they get to vote on your behalf. You don’t get to keep your vote. So it’s not a Democratic thing where the vote is carried through. Ultimately it ends up like any of these other systems where there’s a principle and an agent and the entity that is custodying your coins gets to vote on your behalf, but they don’t consult you.

Nic Carter (00:48:23):

Vanguard doesn’t ask me what my position on Exxon is when they perform an act activist campaign to alter the board composition of Exxon, right? And it’s going to be the same thing. We’ll have exchanges and custodial staking providers that will be able to effectuate policy on behalf of the individuals that have deposited their coin. So that’s the thing I’d be concerned about. I think there’s enormous economies of scale in terms of running an exchange. There will eventually be significant regulatory barriers to entry where there will be a class of exchanges that are institutionalized and highly regulated. And it’ll be very difficult to break into that. So that’s the thing I’d be worried about, is these custodial third party institutions gaining significant political power over these proof of state blockchains.

Preston Pysh (00:49:15):

What do you say to a person from that camp that would then say, Well, you’re having the same issues with proof of work, with the consolidation of hash rate by these big companies and the individual. There’s no way they’re able to compete with the large company. How do you respond back to that?

Nic Carter (00:49:34):

Yeah. My requirement isn’t that John Q. Public is on an even footing with a large institution as it pertains to validation. Because that’s never going to be the case. There’s always going to be institutionalization and industrialization of transactional processing. The question is what the competitive dynamic in the industrial validation industry? Is it very competitive or is it uncompetitive? Are there significant economies of scale or dis economies of scale? Is it a market that’s easy to break into or impossible to break into? And how fragmented is the market just empirically? Now if you look at mining, there’s constant churn in who the largest miners are. Right now the North American miners are doing well because public markets have been good to them and they’ve raised a lot of capital. And so North America will be the nexus of mining.

Nic Carter (00:50:23):

But mining is a very competitive market. All you need is energy and ASICs. And there’s tons of ASICs floating around on the secondary market. They’re very easy to acquire. What are margins like by the way, also, because that is an indication of the competitiveness of the industry. Mining margins are wide now, but at maturity they’re obviously going to be pretty narrow because anybody that believes they have an advantage can enter the mining market. Now can anybody enter being a gigantic crypto custodian market? Of course not. It’s already a very regulated industry and it’s going to become increasingly more regulated. You’re probably going to see federal regulation for exchanges. I would expect to see that in the next year. The compliance burden becomes your biggest challenge.

Nic Carter (00:51:08):

Has there been a lot of churn in the largest exchanges or have there been a few exchanges that have been the largest for a number of years? Now Coinbase has been probably the largest crypto exchange since 2012. So for about a decade now. So these things, it doesn’t appear to me that the exchange market has this dynamism. In fact, it seems very, very sticky. And so that is the thing. To me, the proof of stake validation marketplace of the industrial validators, that looks like a market with high barriers to entry with significant dynamics which keep new competitors out of the marketplace, that those barriers are only going to get greater. And it looks like a wide margin business.

Nic Carter (00:51:50):

On the other hand, proof of work industrial validation, AKA mining, that looks like a highly competitive market, one that’s laced with political risk, which throws the whole market into upheaval periodically. China, Kazakhstan, maybe certain United States. You see these periodic bands. So that throws the whole market into upheaval. And I think that looks like a thin margin business at equilibrium. So it doesn’t seem to be the case. And lastly energy is a highly fragmented thing. There’s not gigantic pools of unused energy laying around. You’d have to go after these small little pockets of energy all over the place. And so I think the dispersion of actual physical resources needed for mining is also creative to a general decentralization of mining as well. So that’s the distinction I draw there.

Preston Pysh (00:52:40):

What are your thoughts on Jack Dorsey’s Web 3.0 comments about VCs?

Nic Carter (00:52:48):

Well, I think not that he owes us anything, but I’d like to see him express his thoughts in longer form than just Twitter. Although I guess it’s ironic to ask Jack to use long form. But I think there’s something getting lost in the message there. I think maybe it’s a very lossy transmission because on the one hand I see his points, which I think the point he’s making is if Web 3 promises to disintermediate internet services and devolve power back to the hands of users instead of Silicon Valley, why is Silicon valley so aggressively investing in the ownership of Web 3? And I think that’s a very good question, is if you truly believe this is democratizing power over the internet and pushing power back to the edges of the network, rather than the internals, why are you acting as if you will be the Oligarchy of that new internet? Your actions words are contradictory, right?

Nic Carter (00:53:46):

I think that’s the point he’s making. Obviously I am a VC and we invest in what could be deemed Web 3, but that’s a contradiction I perceive, right, is if we’re claiming that users are going to be in control, why are venture funds investing in the ownership of these new protocols? So clearly it looks like the legacy model a little bit. So I think that’s the question Jack is posing, is to what extent are the narratives powering investment Web 3, like actually genuine narratives or are they contrived?

Nic Carter (00:54:16):

And then I think the Web 3 people are pushing back saying, Well, it’s a fundamentally different model and end users will end up with ownership over the platforms. And moreover just the very nature of engagement where you’re using your private keys as your identity online. That is a more democratic model. And so structurally you’re disempowering the Silicon Valley tech oligopoly. That’s also a pretty fair rejoinder, I think. Yeah. I’d love to see that debate in long form because sometimes it’s hard to tell what Jack really means there.

Preston Pysh (00:54:47):

Hey, so to wrap things up, I want to go back to where we started, which was in the fixed income space. So I’m looking for a critique or a counterpoint of how you see this. But when I think about things falling apart within the global economy, I think it’s between the dichotomy of these inflationary prints that we’re getting versus the yields that keep getting compressed lower and lower. So like right now, today, the last print that we had on the inflation was 6.8 here in the US, the 10 year treasuries at 1.4 for a massive negative spread. I suspect that if that persists call it for another year. Let’s say we’re at negative 400 basis points for another year. And the trend looks like it’s maybe starting to separate even more than what we’re seeing, where the 10 year treasury’s going lower because it’s getting manipulated down lower and you have inflation running even hotter. And that trend persists.

Preston Pysh (00:55:45):

What type of timeframe do you think that it can continue to run with such a massive negative spread before the fixed income market starts to throw a fit or starts to say, Hey, this is never coming back. In fact, I think it’s going to be even worse the following year or two years from now. Because I think that’s when you get the moment, the aha moment and everyone flips out and you start to maybe see the market throw a major tantrum that I don’t know how it would recover because the response is only going to accentuate those trends in those opposite directions that make the negative spread even worse. What are your thoughts on that idea? Do you have an opinion on what timeframe that would have to persist into the market before maybe it starts going a little haywire? What are your thoughts on it?

Nic Carter (00:56:34):

Yeah, I’ll caveat this by saying I’m not an expert or even active in the fixed income markets whatsoever. I found it very curious, frankly. The question to me is like, why are treasuries being priced as if inflation hasn’t materialized? Why is that the case? What do they know? What does the market know that I don’t know? Because it seems to be the case that anybody that’s buying treasuries right now is signing up to lose money. And I don’t know why they would do that. Yeah. As you say, if you look at the numbers, I was just running this chart recently comparing the three month T bell to CPI. And so you’re looking at a negative real rate of minus 6.8% right now. And if you look at the 70s, the worst it got during the 70s was about minus 5.7%.

Nic Carter (00:57:23):

So you’re looking at real interest rates that are as negative as they ever were in the 70s. And if you look further back into the 50s at a certain point, the 40s and 50s, when you had genuine monetary oppression, you had a negative real rate of 10%. So we’re in that territory. We’re not far from the most deepest and most aggressive monetary repression period ever witnessed in the modern era of government. And I’ve been mystified by the fact the yields of state’s so low, because you’d like to think that that’s one of the most efficient markets in the world. It’s a huge market and the traders are presumably very, very well informed. So you’d imagine it’s an informational and efficient market. So it’s a bit of a mystery.

Nic Carter (00:58:08):

And I think the only answer I can come up with is the market is buying these claims that there’s a transitory nature to the inflation, that it’s supply chain driven, that there’s other exogenous factors, which are influencing inflation. Like corporate greed is the new line that’s being pedaled. Although I don’t know how anybody could believe that, frankly. But I don’t even think Elizabeth Warren believes it or monopoly power, which is a very dubious explanation for inflation. But I guess maybe there’s a market feeling that there’s core characteristics which are highly disinflationary like demography, right? The fact that Americans are aging, technology and theory, and that the economy is going to cool off a little bit here as this fiscal burst subsides.

Nic Carter (00:58:58):

But my reaction to that would be there’s structurally inflationary factors at play here as well, which is the normalization of stimulus as apparently just like a policy on a go forward basis with or without an emergency that warrants it. And very material stimulus, significant fractions of GDP, de-globalization and the actual breakdown of trade routes and supply chains, stepped up hostility with China. Like if we do get de-globalization that is structurally inflationary, I would say. So I think there are these sort of permanent… And the other thing I would say would be looming energy crisis, right? The fact that we’ve had such prolonged period of underinvestment in actual energy infrastructure due to political mandates, political requirements that we under exploit hydrocarbon extraction, whether you think that’s for a good reason or not, the consequence of that is going to be that we are going to be able to produce less energy than we were previously able to.

Nic Carter (01:00:02):

If the green revolution does not materialize where this glorious vision of powering the earth on wind and solar, if that doesn’t materialize, then we’re going to have a structurally higher energy prices. And energy goes in everything. It’s how you make fertilizer, which is how you make food. It’s how all industrial society works. It’s like energy is the most fundamental thing. So if, as I expect, we continue to have energy crises, that’s also structurally inflationary. So I think we’re looking into inflationary next decade. And lastly, I think that’s actually politically convenient for the US, even though it’s probably costly in terms of the midterms. But it’s one of those where you just get this enormous debt overhead and you have to deal with it somehow. And monetary oppression seems to be the only way out.

Preston Pysh (01:00:50):

So Nic, you write some of the most share-worthy articles in the space, in my humble opinion. Somebody in the comments asked this question, they said, “Ask him when he is going to write an article critiquing Fiat from an ESG perspective.” I think you got a title in the making there that would be hilarious and amazing all at the same time. So I’m just going to plant that seed. I’m not going to ask you any more questions because you’ve been so kind with your time and doing this impromptu interview. I know I asked you at the last second and you said, “Yes.” I just want to personally thank you for coming on the show and just sharing your thoughts. I learned so much from you for many years at this point. So I just want to thank you personally for coming on.

Nic Carter (01:01:34):

Well, the feelings mutual Preston. It’s my pleasure and my honor to be on. So I appreciate it.

Preston Pysh (01:01:39):

Hey, you have your VC company, you got Castle Island. And people, if you want to follow Nic, we’ll have a link in the show notes to Twitter. I’m going to put a bunch of the articles that you’ve written that we were just talking about in there as well, if people want to check it out. I know your articles on Energy are just phenomenal. Is there anything else you want to highlight for people to check out?

Nic Carter (01:01:59):

Yeah. The only thing I’ll promote would be my merch. This hat is over joined to anyone that says Bitcoin is an American. I won’t name names. I know you’re out there. Look, Bitcoin is as American as apple pie. Okay. And it’s important that Congress understands this. And so anyway, you can get this onthebrink.shop. I designed it and I can sometimes be seen wearing the hat. I think if there’s one message that I like to promote is simply that America is the center of crypto innovation, Bitcoin innovation in whatever respect, however you want quantify it. America’s the nexus of this.

Nic Carter (01:02:37):

Obviously we’re looking at crossroads here in terms of, do we double down on this increasingly politicized dollar? Do we surrender control to China’s resurgent monetary dominance or do we go for a third way where maybe it’s a little bit more difficult in the short term, but we just embrace the crypto market soon in the USA? And I think that is the most prudent approach here. There’s $140 billion of stablecoins outstanding. That’s a market signal. The private sector has created this enormous settlement infrastructure for dollars with no State engagement or no State interaction whatsoever. Forget about CBDCs. Focus on what the market has produced right here in the USA and lean into that. That’s what I would tell policymakers.

Preston Pysh (01:03:27):

So you had mentioned On The Brink podcast, which I know you are on and you put out amazing content on there. We’re also going to have a link to that in the show notes so people can check that out. I’m sure there’s going to be a ton of people that want to listen to more of your conversations and that’s the spot where you can find it. So make sure you guys check out the show notes. I’m going to have a lot of links in here to just link you to all of Nic’s stuff. And Nic, thank you for coming on the show.

Nic Carter (01:03:51):

My pleasure. Thank you.

Preston Pysh (01:03:53):

If you guys enjoyed this conversation, be sure to follow the show on whatever podcast application you use. Just search for We Study Billionaires. The Bitcoin specific shows come out every Wednesday and I’d love to have you as a regular listener. If you enjoyed the show or you learned something new or you found it valuable, if you can leave a review, we would really appreciate that. It’s something that helps others find the interview in the search algorithm. So anything you can do to help out with a review, we would just grow greatly appreciate. And with that, thanks for listening. I’ll catch you again next week.

Outro (01:04:26):

Thank you for listening to TIP. To access our show notes courses or forums, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decisions, consultant a professional. This show is copyrighted by The Investor’s Podcast Network. Written permissions must be granted before syndication of rebroadcasting.